Risk Management

Topics: Insurance, Risk, Risk management Pages: 9 (1410 words) Published: April 18, 2012
Chapter 22

Risk Retention/Reduction Decisions

I.Multiple Choice

1.Which of the following is not a potential benefit to a firm from increasing retention?

a. savings on premium loadings
b. increased moral hazard
c. avoiding implicit taxes that arise from insurance price regulation d. reduced exposure to insurance market volatility

Answer: b
Type: K

2.Which one of the following firms is more likely to use retention?

a. closely held firm
b. publicly traded and widely held firm
c. a firm with a high level of financial leverage
d. a small firm

Answer: b
Type: K

3.Bilbo Industries is a technology company that prides itself on the ability to react quickly to new product developments. It maintains a significant research and development budget. Regarding risk-reducing activities, Bilbo Industries is

a. more likely to retain risks thereby retaining use of more funds b. more likely to retain risk because of their ability to react to changing developments c. less likely to retain risks to concentrate on what they do best d. less likely to retain risk to help ensure they have a steady supply of investment funds

Answer: d
Type: A

4.A disaggregated risk management approach will generally result in

a. lower transactions costs
b. higher transactions cost
c. lower expected losses
d. higher expected losses

Answer: b
Type: K

5.Which one of the following is an example of an aggregated approach to risk management?

a. hedging exchange rate risk
b. hedging interest rate risk
c. purchasing a high level of liability insurance
d. developing a (derivative) contract to stabilize fluctuations on total revenue

Answer: d
Type: A

Use these loss distributions to answer questions 6-8.

|Liability Exposures |Property Exposures | |Amount |Probability |Amount |Probability | |of Loss |of Loss |of Loss |of Loss | |$8,000,000 |.015 |$4,000,000 |.035 | |$0 |.985 |$0 |.965 |

6.If the premium loading for the liability exposure is 35% of expected losses, what is the fair insurance premium for the liability exposure? (Don’t be concerned with the time value of money.)

a. $120,000
b. $135,000
c. $147,000
d. $162,000

Answer: d
Type: A

7.If the premium loading for the property exposure is 25% of expected losses, what is the fair insurance premium for the property exposure? (Don’t be concerned with the time value of money.)

a. $140,000
b. $155,000
c. $175,000
d. $185,000

Answer: c
Type: A

8.If both the property & liability exposures are bundled together and covered under a single contract that has a premium loading equal to 28% of the bundled expected losses, how much savings in premium will be achieved? (Assume these exposures are independent and as before, don’t be concerned with the time value of money.)

a. $4,200
b. $5,350
c. $8,100
d. $11,400

Answer: a
Type: A

9.The underwriting cycle affects the retention/reduction decision because

a. the retention/reduction decision is often part of a long-term business plan b. a firm usually wants to correctly alternate between retention and reduction as the underwriting cycle dictates c. purchasing insurance in soft market will stabilize cash flows d. The underwriting cycle has little effect on the retention/reduction decision.

Answer: a
Type: A

10.Residual markets regulation can create an incentive to self-insure

a. when residual premiums are higher than those in the voluntary market b. because firms who self-insure do not participate in residual market financing c. because self-insured firms are subsidized by the residual markets d. whenever residual markets provide coverage for compulsory coverages

Answer: b
Type: K

11.A large firm with a high degree...
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