Index

Chapter 1: Risk and Its Treatment

Ques 1:
a. Explain the historical definition of risk?
b. What is a loss exposure?
c. How does objective risk differ from subjective risk?

Ques 2:
a. Define the chance of loss.
b. What is the difference between objective probability and subjective probability?

Ques 3:
a. What is the difference between peril and hazard?
b. Define each type of hazard.

Ques 4:
a. What is the difference between pure risk and speculative risk?
b. What is the difference between diversifiable risk and non-diversifiable risk?

Chapter 2: Insurance and Risk

Ques 1:
a. What is the definition of insurance?
b. From the definition, identify the four basic characteristics of insurance.

Ques 2: Explain the law of large numbers.

Ques 3: Pure risks ideally should have certain characteristics to be insurable by private insurers. List
the six characteristics of an ideally insurable risk.

Ques 8: What are the two major differences between insurance and hedging.

Ques 9: Why does non-life insurance typically use the term “property and casualty insurance” rather
than “property and liability insurance”?

Ques 10:
a. Explain how a society benefits from loss prevention.
b. What are the major government social insurance programs in your country? Consider both
obligatory and voluntary solutions as well as public and private plans.

Application 3: Numerous government insurance programs are in operation at the present time.
However, social insurance is usually treated as a part of social policy with each country having
different solutions. List the major social insurance programs in your country. Take into consideration
both obligatory and voluntary solutions as well as public and private plans.
 Chapter 5: Types of Insurers and Marketing systems

Ques 1: Describe the basic characteristics of stock insurers.

Ques 4: Explain the basic characteristics of Lloyd’s of London.

Ques 6: Why are some mutual insurers referred to as “assessment mutuals”?

Application 3: A luncheon speaker stated that “the number of life insurers has declined sharply during
the past decade because of the increase in company mergers and acquisitions, demutualization of
insurers, and formation of mutual holding companies.”

a. Why have mergers and acquisitions among insurers increased over time?

b. What is the meaning of demutualization?

c. Briefly explain the advantages of demutualization of a mutual life insurer?

d. What is a mutual holding company?

e. What are the advantages of a mutual holding company to an insurer?

Chapter 6: Insurance Company Operations

Ques 2:
a. Define the meaning of underwriting.
b. Briefly explain the basic principles of underwriting.
c. Identify the major sources of information available to underwriters.

Ques 7:
a. What is the meaning of reinsurance?
b. Briefly explain the reasons for reinsurance:

1. Increase capacity
2. Stabilize profits
3. Reduce the unearned premium reserve
4. Provide protection against a catastrophic loss
5. Other reasons for reinsurance

c. Explain the meaning of “securitization of risk.”

Application 3: Property Insurance Company is a new property insurer. The company is growing
rapidly because of a new homeowners policy that combines traditional homeowner coverages
with insurance that pays off the mortgage if the insured dies or becomes totally disabled.
Premiums written have increased substantially; new agents have been hired; and the company is
considering expanding into additional states. However, its growth has been hampered by
statutory accounting rules that require an insurer to write off immediately its first-year
acquisition expenses but do not allow full recognition of premium income until the policy period
 has expired. In this case, explain how reinsurance will enable Property Insurance to continue to
grow in an orderly fashion.

Chapter 7: Financial Operations of Insurers

Ques 1:
a. What are the three major sections of a balance sheet?
b. What is the balance sheet equation?

Ques 2:
Briefly discuss the two principal types of financial reserves needed to be maintained by property and
casualty insurers.

Ques 3:
a. What are the two major sources of revenue for a property and casualty insurance company?
b. What are the major expenses of a property and casualty insurance company?

Ques 4: Identify the various ways of measuring profit or loss for an insurance company.

Ques 5: What are technical provisions and why are they important?

Ques 6: What risks should be taken into account when calculating a life (re)insurer’s solvency capital
requirements (SCR)?

Ques 7: What are the major categories of expenses for a life insurance company?

Ques 8:
a. What are the major regulatory objectives that must be satisfied in insurance rate making?
b. What are the major business objectives?

Ques 9:
Explain the meaning (in context: rate making):
a. Rate
b. Exposure unit
c. Pure premium
d. The loading
e. The gross rate
f. Gross premium

Ques 10:
Briefly describe the following methods for determining a class rate:
a. Pure premium method
b. Loss ratio method

Ques 11:
Explain merit rating:
a. Schedule rating
b. Experience rating
c. Retrospective rating
 Chapter 9: Fundamental Legal Principles

Question 1:
a. Explain the principle of indemnity.
b. Identify three ways that the principle of indemnity is enforced in a property insurance contract.

Question 2: Explain the difference between indemnity value and replacement value.

Question 3:
a. Explain the meaning of an insurable interest.
b. Why is an insurable interest required in every insurance contract?

Question 4:
a. Explain the principle of utmost good faith.
b. What are its historical roots?

Question 5: In property insurance, indemnification is based on the actual cash value. Give examples of
different methods used in other types of insurance.

Question 6: List the four requirements that must be met to form a valid insurance contract.

Question 7:
Insurance contracts have certain legal characteristics that distinguish them from other contracts.
Explain the following legal characteristics of insurance contracts:
a. Aleatory contract
b. Unilateral contract
c. Conditional contract
d. Personal contract
e. Contract of adhesion

Question 8:
Explain the general rules of agency that govern the actions of agents and their relationship to insureds.

Question 9: Identify three sources of authority that enable an agent to bind the principal.

Question 10: Explain the meaning of:

a. Waiver
b. Estoppel

Application: 1. Jake borrowed $800,000 from Gateway Bank to purchase a fishing boat. He
keeps the boat at a dock owned by Harbor Company. He uses the boat to earn income by fishing.
Jake also has a contract with White Shark Fishing Company to transport tuna from one port to
another.

a. Do any of the following parties have an insurable interest in Jake or his property? If an
insurable interest exists, explain the extent of the interest.

1. Gateway Bank
2. Harbor Company
 3. White Shark Fishing Company

b. If Jake did not own the boat but operated it on behalf of the White Shark Fishing Company,
would he have an insurable interest in the boat? Explain.

Application 2. Jane has a bike that was stolen. The bike cost €2,000 when it was purchased 2
years ago. A similar bike today can be purchased for €2,400. Assuming that the bike was 25
percent depreciated at the time the theft occurred, what is the actual cash value (ACV) of the
loss?

Application 3. Xiao bought a new tea set for 1,000 CNY and insured all their home assets on an
actual cash value basis. The set was destroyed during a huge flood four years later. The
property’s value had depreciated by 40 percent at the time of loss. Because of 10 percent
inflation, all prices increase in this range, including prices of similar tea sets. Ignoring any
deductibles, how much will Xiao collect from her insurer? Explain your answer.

Application 4. John owns a house. He insured it for £150,000 with the clause of replacement
cost insurance. The house is 10 years old and has a useful life of 100 years. Its market fair value
is £140,000. How much will John collect for his loss, if his house is totally destroyed in tornado?
Explain your answer.

Application 5. A drunk driver ran a red light and smashed into Kristen’s car. The cost to repair
the car is $8,000. She has collision insurance on her car with a $500 deductible.

a. Explain how the principle of subrogation would be relevant in the above case.

b. Explain how subrogation supports the principle of indemnity.

6. One requirement for the formation of a valid insurance contract is that the contract must be for
a legal purpose.

a. Identify three factors, other than the legal purpose requirement, that are essential to the
formation of a binding insurance contract.

b. Explain how each of the three requirements in part (a) is fulfilled when the applicant applies
for an auto insurance policy.

Chapter 10: Insurance Contracts

Question 1:
a. What are the basic parts of an insurance contract?
b. Which part is considered “the heart” of an insurance contract? Why?

Question 2:
a. Describe the major types of exclusions typically found in insurance contracts.
b. Why are exclusions used by insurers?

Question 3:
a. Define the term “conditions.”
b. Does the insurer have to pay an otherwise covered loss if the insured fails to comply with the
policy conditions? Explain your answer.

Question 4:
a. What is the meaning of “insuring agreement?”
b. There are two basic forms of insuring agreement in property insurance. List them and describe
briefly.

Question 5:
a. What is an endorsement or rider?
b. If an endorsement conflicts with a policy provision, how is this problem resolved?

Question 6:
a. Describe the following types of deductibles:

1. Straight deductible
2. Calendar-year deductible
3. Aggregate deductible
b. Explain the purposes of deductibles in property insurance contracts.

Question 7: Explain the rationale of co-insurance in a property insurance contract.

Question 8: Explain how a section of definitions influences an insurance policy.

Question 9:
a. What is the purpose of other-insurance provisions?
b. Give an example of the pro-rata liability clause.

Question 10: Explain the meaning of primary insurance and excess insurance.

Application 1. George has a big house on an island on a small lake. There is no bridge
connecting his island with the land; thus, the only way to reach his house is by using a boat or
helicopter. He owns a boat that he uses every day. As an insurance, he feels that his boat should
be covered just like any other personal property he owns. However, his insurer informs him that
boats are excluded as personal property under his homeowner’s policy.

a. Give some other examples of property that are usually excluded from homeowner’s policy.

b. Are they uninsurable? Explain your answer.

Application 2.
a. A manufacturing firm incurred the following insured losses, in the order given, during the
current policy year.

 Loss | Amount of Loss

o A | $2,500
o B | $3,500
o C | $10,000
How much would the company’s insurer pay for each loss if the policy contained the following
type of deductible?

1. $1,000 straight deductible

2. $15,000 annual aggregate deductible

b. Explain the coordination-of-benefits provision that is typically found in group medical

expense plans.

Application 3. Tom has a bookstore near a river, which is insured for €120,000 under a
commercial property insurance policy. The policy contains a 75 percent coinsurance clause.
Tom’s bookstore suffered a loss worth €80,000 due to floods. The replacement cost of the
warehouse at the time of loss is €200,000.

a. What is the insurer’s liability, if any, for this loss? Show your calculations.

b. Assume that Tom carried €250,000 of property insurance on the bookstore at the time of loss.
If the amount of loss is €50,000, how much will he collect?

Application 4. Andrew owns a commercial office building that is insured under three property
insurance contracts. He has $100,000 of insurance from Company A, $200,000 from Company
B, and $200,000 from Company C.

a. Assume that the pro rata liability provision appears in each contract. If a $100,000 loss occurs,
how much will Andrew collect from each insurer? Explain your answer.

b. What is the purpose of the other-insurance provisions that are frequently found in insurance
contracts?

Application 5. Assume that a $300,000 liability claim is covered under two liability insurance
contracts. Policy A has a $500,000 limit of liability for the claim, while Policy B has a $125,000
limit of liability. Both contracts provide for contribution by equal shares.

a. How much will each insurer contribute toward this claim? Explain your answer.

b. If the claim were only $50,000, how much would each insurer pay?

Application 6. Ashley has an individual medical expense insurance policy with a $1,000
calendar-year deductible and an 80–20 percent coinsurance clause. Ashley had outpatient surgery
to remove a bunion on her foot and incurred medical bills of $10,000. How much will Ashley’s
insurer pay? How much will Ashley have to pay?

Application 7. Angelique has a small plane. Its replacement cost is £150,000. She wants to
insure it in a local company (Insurer A), as she owns some stocks in this company. However, this
insurer covers planes with a maximum limit of £100,000. Her insurance broker advises her to
place another £50,000 with a second company (Insurer B). The broker also mentions that she has
three options of provisions to use: pro rata liability, contribution by equal shares, and primary
and excess insurance. Since she can make some profits on her stocks, she opts for the cheapest
solution from Insurer A. How would you advise her, taking into account partial loss of £75,000?
Explain your answer.
 CHAP 1 (PART I -1 ở slide): Review Q1-2-3-4

Ques 1:

a. Explain the historical definition of risk? => Slide đầu tiên của Definition of risk thuộc
PART I.
 Risk = Uncertainty + Possibility of Loss
b. What is a loss exposure
 A loss exposure is any situation or circumstance in which a loss is possible,
regardless of whether a loss actually occurs.
c. Objective risk differ from subjective risk? => Định nghĩa trong slide PART I.

Objective Subjective
Measurable using statistical tools such as Can be measured using statistical tools
standard deviation or coefficient of such as standard deviation or
variation. coefficient of variation.
Decreases as the number of exposure Decreases when the number of exposure
units increases, thanks to the effect of the units increases, due to the effect of the
law of large numbers. law of large numbers.
Extremely useful in the insurance Highly useful in the insurance industry
industry and corporate risk management and corporate risk management
because it can be calculated and because it can be calculated and
predicted. predicted.

Ques 2:
a. Define Chance of loss? => Slide def chance of Loss thuộc PART I
b. What is the difference: ob prob – Sub Prob? => Def in Slide Chance of loss thuộc Part I.

Ob prob Sub Prob

Can be determined by deductive reasoning. Need not coincide with objective
These probabilities are called a priori probability.
probabilities (ex: the probability of getting a In addition, a person’s estimate of a loss
head from the toss of a perfectly balanced may differ from objective probability
coin is 1/2 because there are two sides, and because there may be ambiguity in the way
only one is a head. Likewise, the probability in which the probability is perceived.
of rolling a 6 with a single die is 1/6, since
there are six sides and only one side has six
dot.)
Can be determined by inductive reasoning
rather than by deduction

Ques 3:

a. Different: Peril – Hazard? => Slide peril and hazard (đầy đủ) Part I.
b. Define từng loại của hazard => trong slide (nt).

Ques 4:
 a. Difference: Pure risk – Speculative risk => Slide khái niệm (Classification of risk)

Pure risk Spec

The only possible outcomes are adverse Betting on a horse race, investing in real
(loss) and neutral (no loss). Including: estate, and going into business for yourself.
premature death, jobrelated accidents
1. Private insurers generally concentrate on pure risks and do not emphasize the
insurance of speculative risks. (enterprise risk management (discussed later) is
another important exception where certain speculative risks can be insured)
2. The law of large numbers can be applied more easily to pure risks than to speculative
risks (In opposite way: More difficult to apply the law of large numbers to speculative
risks to predict future loss experience).
3. Society may benefit from a speculative risk even though a loss occurs, but is harmed
if a pure risk is present and a loss occurs.

b. Diversifiable risk – non diversifiable risk? => Def in Slide Part I.

Diver (Car theft, house fires) Non (Rapid inflation, cyclical

It can be reduced or eliminated through unemployment, war)
diversification. It cannot be eliminated through
Also known as nonsystematic risk or diversification.
particular risk. Also known as systematic risk or
The impact is localized, meaning only fundamental risk.
those individuals or businesses directly Often requires government intervention
experiencing the loss are affected. such as social insurance programs,
subsidies, or public insurance schemes.

CHAP 2 (Part I-2 ở slide): Review Q 1-2-3-8-9-10, Application: Q 3

Ques 1:

a. What is the definition of insurance? => Trong Slide Part I phần 2.

b. From the def -> identify 4 basic characteristics of insurance? => SLIDE (nt)
Pooling of losses – Payment of fortuitous losses – risk transfer – Indemnification.

Ques 2: Explain the law of large numbers:

The first requirement of an insurable risk is a large number of exposure units. Ideally,
there should be a large group of roughly similar, but not necessarily identical, exposure units
that are subject to the same peril or group of perils. For example, a large number of wood frame
dwellings in a city can be grouped together for purposes of providing property insurance on the
dwellings. The purpose of this first requirement is to enable the insurer to predict losses based
on the law of large numbers. Loss data can be compiled over time, and losses for the group as a
whole can be predicted with some accuracy. The loss costs can then be spread over all insureds
in the underwriting class.
Ques 3: Pure risks ideally should have certain characteristics to be insurable by private insurers.
List the six characteristics of an ideally insurable risk (Slide Part I)

1. There must be a large number of exposure units. (Full ở Ques 2 – Chap 2)

2. The loss must be accidental and unintentional.
The loss should be unforeseen and unexpected by the insured and outside of the insured’s
control. Thus, if an individual deliberately causes a loss, he or she should not be indemnified
for the loss.
3. The loss must be determinable and measurable: The loss should be definite as to cause, time,
place, and amount
4. The loss should not be catastrophic: A large proportion of exposure units should not incur
losses at the same time (Pooling is the essence of insurance. If most or all of the exposure units
in a certain class simultaneously incur a loss, then the pooling technique breaks down and
becomes unworkable. Premiums must be increased to prohibitive levels, and the insurance
technique is no longer a viable arrangement by which losses of the few are spread over the
entire group)
5. The chance of loss must be calculable: The insurer must be able to calculate both the average
frequency and the average severity of future losses with some accuracy
6. The premium must be economically feasible: The insured must be able to afford the premium.
In addition, for the insurance to be an attractive purchase, the premiums paid must be
substantially less than the face value, or amount, of the policy

Ques 8: What are the two major differences between insurance and hedging?

 Trong slide “Insurance and Hedging compared” Part I, phần 2.

Ques 9: Why does non-life insurance typically use the term “property and casualty insurance”
rather than “property and liability insurance” (Slide Types of Insurance: def of xxx)

 Property and liability insurance is also called property and casualty insurance. In
practice, nonlife insurers typically use the term property and casualty insurance to
describe the various coverages and operating results. Chép thêm ở phần trong slide.

Ques 10:

a. Explain how a society benefits from loss prevention? (Slide Costs of Insurance to
society)
Insurance companies are actively involved in numerous loss-prevention programs and
also employ a wide variety of loss-prevention personnel, including safety engineers and
specialists in fire prevention, occupational safety and health, and products liability. Some
important loss-prevention activities that property and casualty insurers strongly support
include the following:
- Highway safety and reduction of auto accidents and deaths
- Fire prevention
- Reduction of work-related injuries and disease
- Prevention of auto thefts
- Prevention and detection of arson losses
 - Prevention of defective products that could injure the user
- Prevention of boiler explosions
- Educational programs on loss prevention

The loss-prevention activities reduce both direct and indirect, or consequential, losses.
Society benefits, because both types of losses are reduced.

Application 3: Numerous government insurance programs are in operation at the present time.
However, social insurance is usually treated as a part of social policy with each country having
different solutions. List the major social insurance programs in your country. Take into
consideration both obligatory and voluntary solutions as well as public and private plans?

In Vietnam, the major social insurance programs include:

1. Compulsory Social Insurance (Bảo hiểm xã hội bắt buộc):

o For employees: Covers pension, sickness, maternity, and work-related accidents.

o For employers: Includes obligations to contribute to the insurance for their

employees.

o This is mandatory for all workers in formal employment and covers a wide range
of social benefits.

2. Voluntary Social Insurance (Bảo hiểm xã hội tự nguyện):

o This allows self-employed individuals or those who do not fall under the
compulsory system to participate.

o Benefits include pension coverage and some other social welfare provisions, but
individuals must contribute voluntarily.

3. Health Insurance (Bảo hiểm y tế):

o Obligatory health insurance: Covers citizens who are employed, including

public sector workers and others within the system.

o Voluntary health insurance: Available to self-employed individuals or others

who want to opt for additional health coverage.

4. Unemployment Insurance (Bảo hiểm thất nghiệp):

o This is part of the compulsory system for employees who have signed labor
contracts with employers. It provides support for those who lose their jobs under
certain conditions.

5. Private Insurance Plans (Kế hoạch bảo hiểm tư nhân):

o These are optional and provided by private insurance companies, covering various
areas such as health, life, and property insurance.
 o Some individuals choose private plans for enhanced coverage and more tailored
services.

These programs aim to provide basic financial support for individuals during life’s uncertainties,
such as sickness, old age, or unemployment.

CHAP 5 (Part II – 1): Review Q 1-4-6, Application 3.

Ques 1: Describe the basic characteristics of stock insurers (Slide Part II – Types of..)

A stock insurer is a corporation owned by stockholders. The objective is to earn profits

for the stockholders. The stockholders elect a board of directors who, in turn, appoint executive
officers to manage the corporation. The board of directors has ultimate responsibility for the
corporation’s financial success. If the business is profitable, dividends can be declared and paid
to the stockholders; the value of the stock may also increase. Likewise, the value of the stock
may decline if the business is unprofitable.

Ques 4: Explain the basic characteristics of Lloyd’s of London.

(Slide Part II – Types of…. Full)

Ques 6: Why are some mutual insurers referred to as “assessment mutuals”?

An assessment mutual has the right to assess policyholders an additional amount if the
insurer’s financial operations are unfavorable. Relatively few assessment mutual insurers exist
today, partly because of the practical problem of collecting the assessment. Those insurers that
still market assessable policies are smaller insurers that operate in limited geographical areas,
such as a state or county, and the coverages offered are limited.

They can assess policyowners if premiums are insufficient to pay losses and expenses.

Application 3: A luncheon speaker stated that “the number of life insurers has declined sharply
during the past decade because of the increase in company mergers and acquisitions,
demutualization of insurers, and formation of mutual holding companies.”

a. Why have mergers and acquisitions among insurers increased over time?
 Mergers and acquisitions among insurers have increased for several reasons,
including the need to reduce costs, expand scale to achieve competitive advantages,
improve financial capacity, and enhance operational efficiency. Large insurance
companies can take advantage of opportunities to grow and consolidate their market
share by merging with other companies or acquiring smaller firms to maximize
resources and minimize risks.
b. What is the meaning of demutualization?
 Demutualization is the process of converting an insurance company from a mutual
insurance company (owned by policyholders) to a stock company (owned by
shareholders). This process usually occurs when the company wants to raise capital
from the public, list shares on the stock exchange, or expand operations. It also gives
 policyholders ownership rights in the form of shares and may help the company
compete more effectively in the industry.
c. Briefly explain the advantages of demutualization of a mutual life insurer?
 Easier capital raising: The company can issue shares and raise funds from the public,
which enhances financial capacity for expansion.
 Faster growth: By listing and selling shares, the company can enhance its
competitiveness and broaden its operations.
 Member benefits: Policyholders can receive shares, giving them ownership in the
company and enabling them to benefit from the increase in the value of shares.

d. What is a mutual holding company?

 A mutual holding company is an insurance company structured as a mutual, where
policyholders own the parent company. The mutual holding company may own one
or more subsidiary companies, which can include stock insurance companies or other
types of insurance companies. This structure allows the mutual insurance company to
maintain its mutual structure while also gaining the ability to raise capital and expand
business through subsidiaries.
e. What are the advantages of a mutual holding company to an insurer?
 Enhanced capital raising capabilities: The mutual holding company structure allows
the insurer to raise capital from shareholders without losing the mutual ownership
structure.
 Financial flexibility: The holding company can implement more flexible financial
strategies, including investment and business development strategies.
 Member benefits: Despite the subsidiaries operating as stock companies,
policyholders of the mutual holding company still retain ownership rights and benefits
from the mutual structure.

CHAP 6 (PART II – 2) Review Q 2, 7; Application 3

Ques 2:

a. Define the meaning of underwriting (Slide “Underwriting” Part II – 2).

b. Briefly explain the basic principles of underwriting. (Slide nt)
Bổ sung:
The primary objective of underwriting is to attain an underwriting profit. The objective is
to produce a profitable book of business. (slide).
The second principle is to select prospective insureds according to the company’s
underwriting standards. (Slide).
A final underwriting principle is equity among the policyholders. This means that (slide)
c. Identify the major sources of information available to underwriters? (Slide nt)

Ques 7:

a. What is the meaning of reinsurance? (Slide “Reinsurance” Part II – 2)

b. Briefly explain the reasons for reinsurance (Slide nt) – Bổ sung thêm từ sách.
1. Increase U capacity: Without reinsurance, the agent would have to place large
amounts of insurance with several companies or not accept the risk. This is awkward
and may create ill will on behalf of the policyholder. Reinsurance permits the primary
 company to issue a single policy in excess of its retention limit for the full amount of
insurance.
2. Stabilize profits: Reinsurance is used to stabilize profits. An insurer may wish to
avoid large fluctuations in annual financial results. Loss experience can fluctuate
widely because of social and economic conditions, natural disasters, and chance.
Reinsurance can be used to stabilize the effects of poor loss experience. For example,
it may be used to cover a large exposure. If a large, unexpected loss occurs, the
reinsurer would pay that portion of the loss in excess of some specified limit.
3. Reduce the unearned premium reserve: For some insurers, especially newer and
smaller companies, the ability to write large amounts of new insurance may be
restricted by the unearned premium reserve requirement. The unearned premium
reserve is a liability item on the insurer’s balance sheet that represents the unearned
portion of gross premiums on all outstanding policies at the time of valuation. In
effect, the unearned premium reserve reflects the fact that premiums are paid in
advance, but the period of protection has not yet expired. As time goes on, part of the
premium is considered earned, while the remainder is unearned. It is only after the
period of protection has expired that the premium is fully earned.
4. Provide protection against a Catastrophic: Insurers often experience catastrophic
losses because of hurricanes and earthquakes and other natural disasters, industrial
explosions, commercial airline disasters, and similar events. Reinsurance can provide
considerable protection to the ceding company that experiences a catastrophic loss.
The reinsurer pays part or all of the losses that exceed the ceding company’s retention
up to some specified maximum limit.
5. Other reasons for Reinsurance: An insurer can also use reinsurance to retire from
the business or from a given line of insurance or territory. Reinsurance permits the
insurer’s liabilities for existing insurance to be transferred to another carrier; thus,
policyholders’ coverage remains undisturbed. Finally, reinsurance allows an insurer
to obtain the underwriting advice and assistance of the reinsurer. An insurer may wish
to write a new line of insurance, but it may have little experience with respect to
underwriting the line. The reinsurer can often provide valuable assistance with respect
to rating, retention limits, policy coverages, and other underwriting details.

c. Explain the meaning of “securitization of risk. (Slide “Alternatives to traditional

reinsurance” – Part II 2)
- There is an increasing use of the securitization of risk to obtain funds to pay for a
catastrophe loss + Định nghĩa ở slide + Bổ sung: These instruments are also called
risk-linked securities that transfer insurance-related risks to the capital markets.
Insurers were among the first financial institutions to experiment with the
securitization of risk.

Application 3: Property Insurance Company is a new property insurer. The company is growing
rapidly because of a new homeowners policy that combines traditional homeowner coverages
with insurance that pays off the mortgage if the insured dies or becomes totally disabled.
Premiums written have increased substantially; new agents have been hired; and the company is
considering expanding into additional states. However, its growth has been hampered by
statutory accounting rules that require an insurer to write off immediately its first-year
acquisition expenses but do not allow full recognition of premium income until the policy period
has expired. In this case, explain how reinsurance will enable Property Insurance to continue to
grow in an orderly fashion.
  1. Statutory accounting rules require the entire gross premium to be placed in the
unearned premium reserve. An insurer's ability to grow may be restricted by the
unearned premium reserve, because the entire gross premium must be placed in the
unearned premium reserve when the policy is first written. However, the insurer
incurs relatively heavy first-year acquisitions expenses because of commissions, state
premium taxes, underwriting expenses, and other expenses in issuing the policy. In
determining the size of the unearned premium reserve, there is no allowance for these
first-year acquisition expenses, and the insurer must pay them out of its surplus. As a
result, a rapidly growing company may experience a surplus drain, and its ability to
write new business may eventually be impaired. Reinsurance reduces the level of the
unearned premium reserve required by law and temporarily increases the insurer's
surplus position. As a result, the ratio of policyholders' surplus to net written
premiums is improved, which permits the insurer to continue to grow.

CHAP 7 (PART II – 3): Review question 1-11

Question 1:

a. What are the three major sections of a balance sheet?

=> Slide Part II - 3 phần “Property and casualty insurers” -> Definition của balance sheet, asset -
Liabilities sectors phía trên.

b. What is the balance sheet equation? (Slide nt)

=> Total asset= Total L + Owner’s equity

Question 2: Briefly discuss the two principal types of financial reserves needed to be
maintained by property and casualty insurers.

=> Slide Part II - 3, thuộc “Property and casualty insurers” có đề mục Liabilities (gồm
loss reserve + Unearned reserve) - tờ nhờ GPT tóm gọn lại đoạn trong sách luôn.

Property and casualty insurers are required to maintain financial reserves to ensure they have
sufficient funds to meet their future obligations. These reserves are essential for the financial
stability of insurers and are mandated by law. Two principal types of financial reserves
maintained by property and casualty insurers are loss reserves and unearned premium
reserves.

1. Loss Reserves

Loss reserves represent one of the largest liability items on a property and casualty insurer’s
balance sheet. This reserve is an estimate of the amount the insurer expects to pay in the future
for claims that have already occurred but have not yet been fully settled. These include:

 Claims that have been reported and adjusted but not yet paid,
  Claims that have been reported but not yet adjusted,

 Claims for losses that have occurred but have not yet been reported (known as incurred-
but-not-reported or IBNR claims).

Loss reserves are especially significant in casualty insurance, where claims related to bodily
injury or property damage may take years to resolve, particularly when litigation is involved. On
the other hand, property insurance claims, such as auto collisions or home damage, are typically
settled faster, resulting in relatively smaller loss reserves.

There are several methods used to calculate loss reserves:

 Case reserves are established for individual claims using various methods:

o The judgment method relies on the expertise of claims adjusters or computer

programs that estimate reserves based on claim details.

o The average value method assigns a standard value to each claim and is often
used for high-frequency, low-cost claims such as minor auto damages.

o The tabular method is applied when claim values depend on factors like life
expectancy or disability duration. This is common for claims involving permanent
injuries or survivor benefits.

 Loss ratio method is used for estimating aggregate reserves for a specific line of
coverage. It involves multiplying the expected loss ratio by the earned premiums and
subtracting losses already paid. This method is often used in workers’ compensation
insurance.

 IBNR reserves cover losses that occurred during the accounting period but have not yet
been reported. These are critical because not all accidents or claims are immediately
known or filed.

Proper estimation of loss reserves is essential because underestimation could leave the insurer
financially vulnerable, while overestimation could tie up capital unnecessarily.

2. Unearned Premium Reserves

The unearned premium reserve is another crucial liability that represents the portion of
premiums received by the insurer that corresponds to coverage extending into the future. Since
premiums are paid in advance, but coverage spans a future period, insurers must set aside
unearned premiums to ensure they can pay for any losses that occur during the policy period.

This reserve is important for several reasons:

  It guarantees that future claims during the policy term can be paid.

 It enables the insurer to issue premium refunds if a policy is canceled before its term
ends. For instance, if a policyholder or the insurer cancels coverage, the insurer must
return the unused portion of the premium.

 It also determines how much the insurer must transfer to reinsurers if it shares the risk of
the policy with another insurance company.

The annual pro rata method is commonly used to calculate unearned premium reserves. It
assumes policies are evenly issued throughout the year. For example, if policies are assumed to
start on July 1, then by December 31, half of the premium remains unearned for 1-year policies.

Together, loss reserves and unearned premium reserves are essential in ensuring that property
and casualty insurers remain financially sound and able to meet their future obligations to
policyholders. Accurate and adequate reserve management is a key component of responsible
insurance company operations.

Question 3:

a. What are the two major sources of revenue for a property and casualty insurance
company? (Slide Part II - 3, revenues: premiums + investment income)

=> Definition of Slide

=> Premiums are not considered wholly earned until the period of time for which the premiums
were paid has passed. The premiums written that appear on the income and expense statement
reflect the premiums for coverage that was placed on the books during the year. Earned
premiums represent the portion of the premiums for which insurance protection has been
provided. Insurance premiums are paid in advance for a specified period of protection. With the
passage of time, an insurer “earns” the premium and can claim it as income under insurance
accounting rules.

=> The second major source of income is investment income. Given the size of ABC’s bond
portfolio, it is not surprising that interest income is the major source of investment income. The
company also received dividend income on stocks owned and rental income on real estate the
company owned. The company also sold some securities for more than the original purchase
price and realized a capital gain

b. What are the major expenses of a property and casualty insurance company?

Definition of expenses (slide Part II - 3, expenses)

The major expenses for ABC Insurance Company were the cost of adjusting claims and paying
the insured losses that occurred. Underwriting expenses are the other major category of
expenses. These expenses consist of commissions that ABC paid agents for selling the
company’s products, premium taxes, and general expenses.

Question 4: Identify the various ways of measuring profit or loss for an insurance company.

(Slide part II - 3, loss ratio - expense ratio - combined ratio) => definition in slide

=> Combined= loss + expense

Lưu ý thêm các công thức:

Investment income ratio: compares net investment income - underwriting loss

Overall operating ratio: The company’s total performance (underwriting and investments)

Question 5: What are technical provisions and why are they important? (k thấy in4 - chat GPT)

Technical provisions (also known as insurance reserves) are the estimated amounts that
an insurance company sets aside to cover its future obligations to policyholders (Technical
provisions are the foundation of trust in insurance — they ensure that when something
happens, the insurer will have the money to keep their promise.). These obligations arise from:

 Claims that have already been reported but not yet settled (RBNS – reported but not
settled)
 Claims that have been incurred but not yet reported (IBNR – incurred but not reported)
 Future claims from current insurance contracts (e.g., unearned premiums, life insurance
payouts)

Why important?

They ensure the insurer has enough funds to pay out claims when they arise — even far into the
future (especially for long-term insurance like life or health). Technical provisions are key to
measuring an insurance company's solvency. Regulators require insurers to calculate and hold
sufficient reserves to remain financially healthy. Under frameworks like Solvency II (EU) or
Vietnam's Circular 50/2017/TT-BTC, technical provisions are a legal requirement. If under-
reserved, the company may face penalties or restrictions. Accurate technical provisions ensure
the company's financial statements present a true and fair view of its liabilities, supporting
transparency for investors and regulators.

Question 6: What risks should be taken into account when calculating a life (re)insurer’s
solvency capital requirements (SCR)?

1. Underwriting risks: Risks related to the assumptions used in pricing and reserving life
insurance policies (Mortality risk, longevity risk, morbidity risk, lapse risk, expense risk).
2. Market risk: Interest rate + equity + property + currency + Spread risk
3. Credit risk (Default risk): Risk that reinsurers, banks, or other counterparties fail to
meet their financial obligations
4. Operational risk: Risk of losses due to failed internal processes, systems, human
errors, fraud, or external events (e.g., cyberattacks).
5. Catastrophe risk: For certain life reinsurers, especially those covering mass event risks
(e.g., pandemics).

Question 7: What are the major categories of expenses for a life insurance company?

Life insurance company claims payments are a major expense for a life insurance company.
Payments consist of death benefits paid to beneficiaries, annuity benefits paid to annuitants,
matured endowments paid to policyholders, and benefits paid under health insurance policies.
Those policyholders who choose to terminate their cash-value life insurance coverage are paid
surrender benefits, another expense for life insurers. Increased reserves, general insurance
expenses, agents’ commissions and licenses, premium taxes, and fees round out the list of
important expenses.

Question 8:

a. What are the major regulatory objectives that must be satisfied in insurance rate
making?

The first regulatory requirement is that rates must be adequate. This means the rates charged by
insurers should be high enough to pay all losses and expenses. If rates are inadequate, an insurer
may become insolvent and unable to pay claims.

The second regulatory requirement is that rates must not be excessive. This means that the rates
should not be so high that policyholders are paying more than the actual value of their protection.
Exorbitant insurance prices are not in the public interest.

The third regulatory objective is that the rates must not be unfairly discriminatory. This means
that exposures that are similar with respect to losses and expenses should not be charged
significantly different rates.

b. What are the major business objectives?

The rating system should meet all of these objectives: simplicity, responsiveness, stability, and
encouragement of loss control.
 1. The rating system should be easy to understand so that producers can quote premiums
with a minimum amount of time and expense. This is especially important in the personal
lines market, where relatively small premiums do not justify a large amount of time and
expense in the preparation of premium quotations. In addition, commercial insurance
purchasers should understand how their premiums are determined so that they can take
active steps to reduce their insurance costs.
2. Rates should also be responsive over time to changing loss exposures and changing
economic conditions. To meet the objective of rate adequacy, the rates should increase
when loss exposures increase. For example, as a city grows, auto insurance rates should
increase to reflect greater traffic and increased frequency of auto accidents. Likewise,
rates should reflect changing economic conditions. Thus, if inflation causes liability
awards to increase, liability insurance rates should rise to reflect this trend
3. Rates should be stable over short periods of time so that consumer satisfaction can be
maintained. If rates change rapidly, insurance consumers may become irritated and
dissatisfied. They may then look to government to control the rates or to enact a
government insurance program.
4. Finally, the rating system should encourage losscontrol activities. Loss-control efforts are
designed to reduce the frequency and severity of losses. This point is important because
loss control tends to keep insurance affordable. Profits are also stabilized. As you will see
later, certain rating systems provide a strong financial incentive for the insured to engage
in loss control.

Question 9: Explain meaning (in context: rate making)

a. Rate: the price per unit of insurance

b. Exposure unit: the unit of measurement used in insurance pricing. (it varies by line of
insurance)

c. Pure premium: refers to that portion of the rate needed to pay losses and loss-adjustment
expenses

d. The loading refers to the amount that must be added to the pure premium for other
expenses, profit, and a margin for contingencies

e. The gross rate consists of the pure premium and a loading element

f. Gross premium: paid by the insured consists of the gross rate multiplied by the number
of exposure units.

Question 10: Briefly describe the following methods for determining a class rate: (Slide part II -
3, rate making… -> class rating).

a. Pure premium method

Pure premium = (Incurred losses + loss adjustment expenses) /Number of exposure units

Gross rate = Pure rate premium/(1-expense ratio)

The pure premium is that portion of the gross rate needed to pay losses and loss-adjustment
expenses. The pure premium can be determined by dividing the dollar amount of incurred losses
and loss-adjustment expenses by the number of exposure units. Incurred losses include all losses
paid during the accounting period, plus amounts held as reserves for the future payment of losses
that have already occurred during the same period. Thus, incurred losses include all losses that
occur during the accounting period whether or not they have been paid by the end of the period.
Loss-adjustment expenses are the expenses incurred by the company in adjusting losses during
the same accounting period.

The final step is to add a loading for expenses, underwriting profit, and a margin for
contingencies. The expense loading is usually expressed as a percentage of the gross rate and is
called the expense ratio. The final gross rate can be determined by dividing the pure premium by
one minus the expense ratio.

b. Loss ratio method: the actual loss ratio is compared with the expected loss ratio, and the
rate is adjusted accordingly.

Rate change = (Actual loss ratio - expected loss ratio)/ expected loss ratio.

Under the loss ratio method, the actual loss ratio is compared with the expected loss ratio, and
the rate is adjusted accordingly. The actual loss ratio is the ratio of incurred losses and loss-
adjustment expenses to earned premiums.14 The expected loss ratio is the percentage of the
premium that can be expected to be used to pay losses.

Question 11: Explain in merit rating:

a. Schedule rating

Under a schedule rating plan, each exposure is individually rated. A basis rate is determined for
each exposure, which is then modified by debits or credits for undesirable or desirable physical
features. Schedule rating is based on the assumption that certain physical characteristics of the
insured’s operations will influence the insured’s loss experience. Thus, the physical
characteristics of the exposure to be insured are extremely important in schedule rating. Schedule
rating is used in commercial property insurance for large, complex structures, such as an
industrial plant. Each building is individually rated based on several factors, including
construction, occupancy, protection, exposure, and maintenance.

b. Experience rating

Under experience rating, the class or manual rate is adjusted upward or downward based on past
loss experience. The most distinctive characteristic of experience rating is that the insured’s past
loss experience is used to determine the premium for the next policy period. The loss experience
over the last 3 years is typically used to determine the premium for the next policy year. If the
insured’s loss experience is better than the average for the class as a whole, the class rate is
reduced. If the loss experience is worse than the class average, the rate is increased. In
determining the magnitude of the rate change, the actual loss experience is modified by a
credibility factor based on the volume of experience.

Experience rating is generally limited to larger firms that generate a sufficiently high volume of
premiums and more credible loss experience. Smaller firms are normally ineligible for
 experience rating. The rating system is frequently used in general liability insurance, workers
compensation, commercial auto liability insurance, and group health insurance.

c. retrospective rating

Under a retrospective rating plan, the insured’s loss experience during the current policy period
determines the actual premium paid for that period. Under this rating plan, a provisional
premium is paid at the start of the policy period. At the end of the period, a final premium is
calculated based on actual losses that occur during the policy period. There is a minimum and a
maximum premium that must be paid. In practice, the actual premium paid generally will fall
somewhere between the minimum and maximum premium, depending on the insured’s loss
experience during the current policy period. Retrospective rating is widely used by large firms in
workers compensation insurance, general liability insurance, auto liability and physical damage
insurance, and burglary and glass insurance.

CHAP 9: Review 1 10, Application 1-6

Question 1. a. Explain the principle of indemnity.

The principle of indemnity states that the insurer agrees to pay no more than the actual amount of
the loss. This prevents the insured from profiting from a loss, which aligns with the core concept
of insurance as a risk-sharing mechanism. For example, if a property is insured for $200,000, but
it sustains a partial loss of $50,000, the insurer should only pay $50,000, not the full $200,000.
This helps prevent fraud or intentional damage.

b. Identify three ways that the principle of indemnity is enforced in a property insurance
contract. k

 Actual Cash Value (ACV): This method of indemnification considers the replacement cost of
the property minus depreciation, ensuring that the insured is compensated for the actual value lost,
not more.

 Replacement Cost Insurance: Some policies provide replacement cost coverage, where no
deduction is made for depreciation, but it still adheres to the principle of indemnity by covering
the cost of replacing the property without providing a profit.

 Valued Policy Laws: In some states, a valued policy law ensures that the insurer pays the full
face amount of insurance if a total loss occurs, but this still relates to actual replacement value
under specified circumstances .

Question 2. Explain the difference between indemnity value and replacement value.

 Indemnity value (often referred to as Actual Cash Value) is the amount of money paid to
cover the loss, considering both replacement cost and depreciation. It reflects the actual worth of
the property after accounting for depreciation.

 Replacement value refers to the cost of replacing the damaged property with a new one of
similar kind and quality, without any deductions for depreciation .
Question 3. a. Explain the meaning of an insurable interest: Insurable interest is the
requirement that the policyholder must have a financial interest in the property or life insured.
For instance, an individual has an insurable interest in their own home because they stand to lose
financially if the property is damaged.

b. Why is an insurable interest required in every insurance contract?

An insurable interest is required to prevent gambling, reduce moral hazard, and measure the
amount of the insured’s loss in property insurance. Without it, the insurance contract could be
seen as a gamble, which is not allowed by law. It also ensures that the insured is genuinely
affected by the loss, making the contract legitimate and fair .

Question 4. a. Explain the principle of utmost good faith: This principle requires both the
insurer and the insured to act with the highest level of honesty and disclosure in all matters
related to the insurance contract.

b. What are its historical roots? The principle of utmost good faith has its roots in marine
insurance, where underwriters had to rely on the statements of the applicant without physically
inspecting the goods being insured. This reliance was based on trust, especially when the insured
goods were far removed from the underwriters. Hence, a high degree of honesty was required
from the applicant to prevent fraudulent claims and ensure that both parties were fairly treated .

Question 5. In property insurance, indemnification is based on the actual cash value. Give
examples of different methods used in other types of insurance.

In property insurance, indemnification is often based on the actual cash value (ACV), which
accounts for the replacement cost of the damaged property minus depreciation. Other methods
used in different types of insurance include:

 Replacement cost insurance, where the insurer reimburses the full cost of replacing
damaged property without depreciation (e.g., for home insurance).
 Life insurance, which is a valued policy that pays the face value of the policy upon the
death of the insured, regardless of the actual cash value or replacement cost .

Question 6. List the four requirements that must be met to form a valid insurance contract.

 Offer and acceptance: There must be an offer made by the applicant and acceptance by the
insurer.

 Exchange of consideration: Both parties must exchange something of value; the insured
pays the premium, and the insurer promises to cover specific losses.

 Competent parties: The parties involved in the contract must be legally capable of entering
into the contract.

 Legal purpose: The contract must be for a legal purpose, and not involve any illegal activity .

Question 7. Insurance contracts have certain legal characteristics that distinguish them
from other contracts. Explain the following legal characteristics of insurance contracts.
a. Aleatory contract: An aleatory contract is one where the values exchanged between the insurer
and the insured may not be equal and depend on an uncertain event. For example, the insured
may pay a premium of $800 for a policy, but if the property is damaged, they could receive a
much higher payout, like $200,000, depending on the event of loss .

b. Unilateral contract: An insurance contract is unilateral because only the insurer makes a
legally enforceable promise to pay claims. The insured does not have to promise anything other
than to pay the premiums .

c. Conditional contract: The insurer’s obligation to pay a claim depends on whether the insured
or beneficiary has complied with all policy conditions. For example, a homeowner must report a
loss promptly to receive compensation .

d. Personal contract: This type of contract insures the person rather than the property itself. It is
unique to the individual insured and generally cannot be transferred to another party without the
insurer's consent .

e. Contract of adhesion: The insurance policy is drafted by the insurer, and the insured must
accept all its terms and conditions. Any ambiguities in the policy are interpreted in favor of the
insured.

Question 8. Explain the general rules of agency that govern the actions of agents and their
relationship to insureds.

 Agency Relationship: An agent represents the insurer (principal) and acts on their behalf,
with the relationship typically established through an agreement.

 Authority of the Agent:

 Express Authority: Explicitly granted by the insurer.

 Implied Authority: Necessary to carry out the duties.
 Apparent Authority: Authority the agent appears to have, even if not granted.

 Agent’s Duties:

 Good Faith: The agent must act honestly and fairly with the insured.
 Disclosure: Full disclosure of policy terms and conditions to the insured.
 Loyalty: Acting in the insurer’s best interest and avoiding conflicts.
 Following Instructions: The agent must comply with the insurer’s directives.

 Binding the Insurer: Agents’ actions within their authority (e.g., binding coverage,
collecting premiums) are legally binding on the insurer.

 Agent-Insured Relationship:

 The agent has a fiduciary duty to act in the insured’s best interest within their authority.
 Agents can bind coverage and issue policies, but their actions are limited to the authority
given by the insurer.
 Termination: The agency relationship can be terminated by either party, with the insurer
notifying the insured if the agent’s authority is revoked.

Question 9. Identify three sources of authority that enable an agent to bind the principal.

 Express Authority: This is the authority explicitly given to the agent by the insurer, usually
defined in a written agreement or contract. It outlines the exact duties, rights, and responsibilities
that the agent has, such as the ability to sell policies, bind coverage, or collect premiums.

 Implied Authority: This is the authority that is not specifically granted in writing but is
assumed to be part of the agent's responsibilities to carry out their duties effectively. For
example, if an agent is authorized to sell a policy, they may also have implied authority to
explain the terms and conditions of the policy.

 Apparent Authority: This type of authority arises when the actions of the insurer give the
impression to third parties that the agent has the authority to act, even if the agent does not have
that authority in reality. For example, if an agent has consistently been allowed to negotiate
premiums on behalf of the insurer, a third party may assume the agent has the authority to do so,
even if this was never explicitly granted by the insurer.

Question 10. Explain the meaning of:

a. Waiver: Waiver happens when someone gives up a right on purpose. In insurance, if an

insurer knows that the insured hasn't followed a rule (like paying premiums on time) but still
decides to cover their claim, they are "waiving" their right to enforce that rule.

b. Estoppel: Estoppel means you can't go back on something you've already said or done if
someone else relied on it. In insurance, if an insurer has allowed something (like late payments)
for a long time, they can't suddenly change their mind and refuse to cover a claim just because
the rule says payments must be on time. They are "stopped" from doing that because the insured
relied on their actions.

Application 1. Jake borrowed $800,000 from the Gateway Bank to purchase a fishing boat.
He keeps the boat at a dock owned by the Harbor Company. He uses the boat to earn
income by fishing. Jake also has a contract with the White Shark Fishing Company to
transport tuna from one port to another.

a. Do any of the following parties have an insurable interest in Jake or his property? If an
insurable interest exists, explain the extent of the interest.

1. Gateway Bank: Gateway Bank does because they are the creditor. The boat serves as
collateral for the loan. Gateway Bank has an insurable interest in the amount of $800,000.

2. Harbor Company: The Harbor Company does because it is a bailee, and there may be
possible legal liability if Jake is negligent; they would lose rental income if the boat is damaged.

3. White Shark Fishing Company: The White Shark Fishing Company does because Jake is
acting as the company's agent, and an act of negligence by Jake creates potential legal liability.
b. If Jake did not own the boat but operated it on behalf of the White Shark Fishing Company,
would he have an insurable interest in the boat? Explain.

Yes. Jake is using the boat and has a potential legal liability as a bailee if he should damage the
boat. In addition, if the boat is damaged there may be a business income loss and the loss of
earnings.

Application 2. Jane has a bike that was stolen. The bike cost €2,000 when it was purchased
2 years ago. A similar bike today can be purchased for €2,400. Assuming that the bike was
25 percent depreciated at the time the theft occurred, what is the actual cash value (ACV)
of the loss?

Actual cash value (ACV) is the amount equal to the replacement cost minus depreciation of a
damaged or stolen property at the time of the loss.

1. Replacement Cost: The cost of the bike today is €2,400.

2. Depreciation: The bike was 25% depreciated, so we calculate 25% of the original cost.

Depreciation=0.25×2000=500

Now, subtract the depreciation from the replacement cost:

ACV=2400−500=1900

So, the Actual Cash Value (ACV) of the bike at the time of the theft is €1,900.

Application 3. Xiao bought a new tea set for 1,000 CNY and insured all their home assets
on an actual cash value basis. The set was destroyed during a huge flood four years later.
The property’s value had depreciated by 40 percent at the time of loss. Because of 10
percent inflation, all prices increase in this range, including prices of similar tea sets.
Ignoring any deductibles, how much will Xiao collect from her insurer? Explain your
answer.

Replacement cost = 1000 x 1.10 (inflation) = 1100

Depreciation = 1000x40%= 400

ACV = 1100 – 400 = 700

Application 4. John owns a house. He insured it for £150,000 with the clause of replacement
cost insurance. The house is 10 years old and has a useful life of 100 years. Its market fair value
is £140,000. How much will John collect for his loss, if his house is totally destroyed in tornado?
Explain your answer.

Given that John has replacement cost insurance, the amount he would collect for his total loss in
the tornado is based on the cost to replace the house, not its market value or depreciation.

Here’s how it works:

  Replacement cost is the cost to rebuild the house with similar materials and quality,
which would generally be higher than market value due to factors like labor and
construction costs.
 Depreciation doesn't directly impact replacement cost coverage (it would for actual cash
value policies).

Since John’s house is insured for £150,000, he would receive the full insured amount, provided
the replacement cost doesn't exceed that limit.

Thus, John would collect £150,000 for his loss.

Application 5. A drunk driver ran a red light and smashed into Kristen’s car. The cost to repair
the car is $8,000. She has collision insurance on her car with a $500 deductible.

a. Explain how the principle of subrogation would be relevant in the above case.

Subrogation refers to the insurer's right to pursue a third party responsible for a loss, after
compensating the insured for that loss. In this case, Kristen’s insurer will first pay for the
damages to her car, which is $8,000, minus the $500 deductible, so Kristen will receive $7,500.

After paying Kristen, the insurer has the right to subrogate, meaning they can try to recover the
amount of the claim from the drunk driver (or their insurance company) who caused the accident.
If the drunk driver is found to be liable, the insurer may be able to get reimbursed for the $7,500
(or a portion of it).

b. Explain how subrogation supports the principle of indemnity.

The principle of indemnity states that the insured should be restored to the same financial
position they were in before the loss, without profiting from the insurance claim.

Subrogation supports this principle by ensuring that the insurer can recover the claim amount
from the responsible party. If the drunk driver is liable, the insurance company may recover the
$7,500 it paid out to Kristen. This ensures that Kristen is not unjustly enriched by the insurance
payment, and that the insurer doesn't lose money due to the actions of a third party. Essentially,
the insurer seeks to "make whole" the insured, while ensuring the responsible party ultimately
bears the financial responsibility.

Application 6. One requirement for the formation of a valid insurance contract is that the
contract must be for a legal purpose.

a. Identify three factors, other than the legal purpose requirement, that are essential to the
formation of a binding insurance contract.

 Offer and Acceptance: There must be an offer made by one party (usually the insured) and
acceptance by the other party (the insurer).

 Consideration: Both parties must exchange something of value. In insurance, this usually
involves the insured paying a premium and the insurer agreeing to provide coverage.
 Competent Parties: Both parties must have the legal capacity to enter into a contract. This
means the insured must be of legal age and mentally competent, and the insurer must be licensed
to provide insurance.

b. Explain how each of the three requirements in part (a) is fulfilled when the applicant
applies for an auto insurance policy

- offer and acceptance: the applicant offers to pay the insurance provider a period sum in
exchange for compensation in case of damage or theft of the automobile
- consideration: once the offer is accepted, the applicant is required to pay periodic premiums.
This is his consideration. In exchange, the insurance provider compensates for financial losses in
case any event, that has been included in the contract, is to occur
- competent parties: the insurance provider must have necessary licenses and permissions to bee
able to enter into the aforementioned contract. similarly, the applicant should be legally
competent, meaning that her should not have been under the influence of alcohol while entering
into the contract, he should not be mentally unstable, etc.

Chap 10: review 1-10, application 2,5

Question 1. a. What are the basic parts of an insurance contract?

 Declarations: Information about the property or activity being insured, the insured's name,
the coverage amount, and premium.

 Definitions: Key terms used in the contract to clarify coverage.

 Insuring Agreement: The core of the contract, summarizing the insurer's promises.

 Exclusions: Specifies perils, losses, or property that are not covered.

 Conditions: Duties that the insured must fulfill for the insurer to pay claims.

 Miscellaneous Provisions: Other provisions that may include cancellation, subrogation, or

requirements if a loss occurs .

b. Which part is considered “the heart” of an insurance contract? Why?

The "heart" of an insurance contract is the Insuring Agreement. This section outlines the
insurer's commitment to provide coverage for specific risks, making it the essential part of the
policy.

Question 2. a. Describe the major types of exclusions typically found in insurance contracts.

Insurance contracts typically contain three main types of exclusions:

1. Excluded Perils:
Certain causes of loss are specifically not covered. For instance, homeowners insurance
commonly excludes floods, earthquakes, and nuclear radiation.
2. Excluded Losses:
Certain types of losses may be specifically excluded. For example, losses resulting from
 an insured’s failure to protect property after a loss, or liability arising from the operation
of an automobile under a homeowners policy.
3. Excluded Property:
Some property types are excluded or limited in coverage. For example, cars, planes, pets,
and certain valuables are typically excluded from homeowners policies.

b. Why are exclusions used by insurers?

Insurers include exclusions for several reasons:

 Uninsurable Perils: Certain risks are simply too unpredictable or catastrophic to be

commercially insurable (e.g., nuclear hazards, floods).
 Extraordinary Hazards: Risks that pose excessive danger or difficulty to insurers (e.g.,
aircraft hazards).
 Covered by Other Contracts: Avoiding duplication since specific risks may be covered
by specialized policies (e.g., automobile coverage under auto insurance rather than
homeowners insurance).
 Moral and Attitudinal Hazard Problems: To avoid insuring deliberate or careless
actions of the insured that increase risk (e.g., intentional damage).
 Coverage Not Needed by Typical Insureds: Exclusions help insurers tailor policies to
the common needs of most customers, avoiding unnecessary coverage and costs

Question 3. a. Define the term “conditions.”

Conditions are provisions in an insurance policy that impose duties on the insured and set limits
on the insurer's responsibility. They outline the obligations the insured must fulfill for coverage
to apply, such as promptly reporting a loss or cooperating with the insurer during a claim.

b. Does the insurer have to pay an otherwise covered loss if the insured fails to comply with the
policy conditions? Explain your answer.

No, if the insured doesn't comply with these conditions, the insurer has the right to deny
payment. For example, if the insured fails to immediately report a loss, the insurer can refuse the
claim because this is a violation of the policy conditions.

Question 4. a. What is the meaning of “insuring agreement?”

The insuring agreement is the core section of an insurance policy, summarizing the major
promises made by the insurer, including which losses are covered and the insurer’s obligations,
like providing legal defense in lawsuits.

b. There are two basic forms of insuring agreement in property insurance. List them and describe
briefly.

 Named-perils coverage: Only covers perils explicitly listed in the policy. If a peril isn't
named, it isn't covered. For instance, a homeowners policy might list fire and windstorm
but exclude flood damage.
 Open-perils coverage (formerly "all-risks"): Covers all losses except those explicitly
excluded. This type offers broader protection, placing the burden on the insurer to show
that a loss is specifically excluded if denying a claim.
Question 5. a. What is an endorsement or rider?

An endorsement (in property and casualty insurance) or rider (in life and health insurance) is a
provision that modifies, adds, or deletes terms in the original insurance policy. These terms are
used interchangeably.

b. If an endorsement conflicts with a policy provision, how is this problem resolved?

If there is a conflict, the endorsement takes precedence over the policy provision, thus overriding
the original policy terms.

Question 6. a. Describe the following types of deductibles:

1. straight deductible: Requires the insured to pay a specific amount for each loss before the
insurer pays the rest. Example: $1,000 deductible means the insured pays the first $1,000 on each
claim.

2. calendar-year deductible: Aggregate deductible applied annually, typically used in medical

policies. Once expenses exceed the deductible in a year, the insurer pays remaining claims fully
within that year.

3. aggregate deductible: Losses accumulated over a policy year count toward the deductible.
Once the total deductible amount is reached, subsequent losses within the same policy year are
fully covered by the insurer.

b. Explain the purposes of deductibles in property insurance contracts.

 Eliminate small claims that are costly to process.

 Reduce insurance premiums by shifting some risk to the insured.

 Reduce moral and attitudinal hazard by encouraging insureds to be more cautious, as they
must bear part of the loss themselves.

Question 7. Explain the rationale of co-insurance in a property insurance contract.

 Coinsurance in property insurance requires the insured to insure the property to a specified
percentage of its actual insurable value.

 If the insured fails to meet this requirement at the time of a loss, the insured shares the loss
proportionally as a coinsurer.

 Purpose: Ensures fairness ("equity in rating"), as premiums are based on full value coverage.
Without coinsurance, policyholders could insure property for less than its actual value and pay
lower premiums, which would lead to inequity and higher premiums for fully insured
policyholders.

Question 8. Explain how a section of definitions influence on insurance policy.

 The definitions section clarifies essential words and phrases within the policy.
 Terms such as “insured,” “you,” “your,” “we,” and “us” are clearly defined to eliminate
ambiguity and clarify coverage.

 Purpose: Allows both parties (insurer and insured) to accurately determine the scope of
coverage provided by the policy, minimizing disputes and misunderstandings.

Question 9. a. What is the purpose of other-insurance provisions?

Other-insurance provisions ensure that when multiple policies cover the same loss, the insured
cannot profit from insurance. They uphold the principle of indemnity by preventing an insured
from receiving payments exceeding the actual loss amount.

b. Give an example of the pro-rata liability clause.

Pro-rata liability applies when multiple policies cover the same insurable interest. Each insurer
pays a share based on the ratio of its coverage amount to the total insurance in force.
Example: Jacob has a building insured by three companies:

 Company A: $300,000
 Company B: $100,000
 Company C: $100,000
Total: $500,000
If Jacob suffers a loss of $100,000, the insurers pay proportionately:
 Company A: 60% ($60,000)
 Company B: 20% ($20,000)
 Company C: 20% ($20,000).

Question 10. Explain the meaning of primary insurance and excess insurance.

Primary insurance:
Primary insurance is coverage that pays first when a claim arises. It must exhaust its policy limits
before any other applicable policy is required to contribute. For instance, if someone borrows
another person's car, the insurance covering the car typically serves as primary coverage.

Excess insurance:
Excess insurance only pays after the primary policy's limits have been fully used. Using the auto
insurance example again: if damages exceed the primary coverage limit, the driver's own
insurance would then provide excess coverage, paying the remaining amount up to its own limits

Application 1. George has a big house on an island on a small lake. There is no bridge
connecting his island with the land; thus, the only way to reach his house is by using a boat or
helicopter. He owns a boat that he uses every day. As an insurance, he feels that his boat should
be covered just like any other personal property he owns. However, his insurer informs him that
boats are excluded as personal property under his homeowner’s policy.

a. Give some other examples of property that are usually excluded from homeowner’s policy.

 Motor vehicles (including motorcycles and cars): These are usually excluded because they
are covered under separate auto insurance policies.
 Aircraft: Planes and helicopters are often excluded from standard homeowner’s policies
because they typically require specialized insurance.

 Boats and watercraft: Similar to aircraft, boats are excluded under a standard homeowner’s
policy but can be insured separately with a boat or watercraft insurance.

 Flood damage: Many homeowner’s policies exclude flood coverage. Homeowners in flood-
prone areas often need a separate flood insurance policy.

 Earthquake damage: Earthquakes are typically excluded from standard homeowner’s

policies, with separate earthquake insurance available in areas prone to seismic activity.

 Valuable collections (e.g., art, jewelry, antiques): Expensive or high-value items may not
be fully covered under a homeowner’s policy unless specifically scheduled or insured with an
additional rider.

b. Are they uninsurable? Explain your answer.

No, these properties are not uninsurable, but they are often excluded from a standard
homeowner's policy for several reasons, primarily related to the increased risk associated with
these types of property.

 Specialized coverage: Many of the excluded properties, such as boats, vehicles, and
aircraft, can be insured through separate specialized insurance policies designed for that
specific type of property. These policies offer coverage that is more tailored to the unique
risks involved, such as collision or liability for vehicles, or damage and theft for boats.
 Risk management: Insurers exclude certain risks from homeowner’s policies because
they are considered higher risk, and covering them under a standard homeowner's policy
would likely increase premiums. Instead, specialized policies are used to manage the risk
more effectively, and offer coverage at appropriate rates.

Application 2: A manufacturing firm incurred the following insured losses, in the order given,
during the current policy year:

Loss Amount of Loss

A $2,500
B $3,500
C $10,000

a. How much would the company’s insurer pay for each loss if the policy contained the
following type of deductible?

1. $1,000 straight deductible

2. $15,000 annual aggregate deductible

b. Explain the coordination-of-benefits provision that is typically found in group medical

expense plans.

a. Amount paid by the insurer under different deductibles:

 Loss $1,000 Straight
Loss $15,000 Annual Aggregate Deductible
Amount Deductible

A $2,500 $1,500 ($2,500 - $1,000) $0 (Insured pays full amount)

B $3,500 $2,500 ($3,500 - $1,000) $0 (Insured pays, aggregate unmet)

$1,000 (Insured has met aggregate after paying

C $10,000 $9,000 ($10,000 - $1,000)
$6,000 for Loss C)

Explanation for $15,000 Annual Aggregate Deductible:

 Loss A: Insured pays the entire $2,500, deductible balance = $12,500 remaining.
 Loss B: Insured pays entire $3,500, deductible balance = $9,000 remaining.
 Loss C: Insured pays $9,000 (remaining deductible), insurer pays the remainder ($1,000).

b. Coordination-of-benefits provision: The coordination-of-benefits provision in group

medical expense plans prevents duplication of benefits if the insured is covered under multiple
health insurance plans. It determines the primary plan that pays first, with the secondary plan
paying the remaining eligible expenses (up to the limits of coverage), ensuring that total
reimbursements do not exceed 100% of the actual medical expenses incurred.

Application 3. Tom has a bookstore near a river, which is insured for €120,000 under a
commercial property insurance policy. The policy contains a 75 percent coinsurance clause.
Tom’s bookstore suffered a loss worth €80,000 due to floods. The replacement cost of the
warehouse at the time of loss is €200,000.

a. What is the insurer’s liability, if any, for this loss? Show your calculations.

A coinsurance clause means that the insured must carry insurance equal to a certain percentage
of the property’s replacement cost to receive full compensation in the event of a loss. In this
case, the clause specifies 75% coinsurance.

 Coinsurance requirement:
The replacement cost of the bookstore is €200,000.
o Coinsurance requirement = 75% of the replacement cost = 0.75 × 200,000 =
€150,000.
 Amount insured by Tom: Tom’s bookstore is insured for €120,000.

 Calculating the insurer’s liability: To determine the insurer's liability, we compare the
amount insured with the coinsurance requirement: If Tom had insured his bookstore for
€150,000 or more (the required amount), the insurer would pay the full amount of the loss.
Since Tom only insured it for €120,000 (less than the required €150,000), the insurer will
apply the following formula to determine the payment:

Insurer’s payment= (Amount insuredCoinsurance requirement)×Loss - Deductible =

(120,000/150,000)×80,000=0.8×80,000=€64,000
b. Assume that Tom carried €250,000 of property insurance on the bookstore at the time of loss.
If the amount of loss is €50,000, how much will he collect?

 Coinsurance requirement: The replacement cost of the bookstore is €200,000, and the
coinsurance clause requires Tom to insure the property for 75% of the replacement cost.
 Amount insured: Tom carries €250,000 in insurance, which is greater than the
coinsurance requirement of €150,000 (75% of 250k)
 How much Tom will collect: Since Tom has insured his bookstore for more than the
required coinsurance amount, the insurer will cover the full loss, but limited to the actual
loss amount.

o Loss = €50,000
o Amount insured = €250,000
o Coinsurance requirement = €150,000

Since the amount Tom insured (€250,000) is greater than the coinsurance requirement, he is fully
covered for the €50,000 loss.

So, Tom will collect the full loss of €50,000, which is exactly the amount of the damage.

Application 4. Andrew owns a commercial office building that is insured under three property
insurance contracts. He has $100,000 of insurance from Company A, $200,000 from Company
B, and $200,000 from Company C.

a. Assume that the pro rata liability provision appears in each contract. If a $100,000 loss occurs,
how much will Andrew collect from each insurer? Explain your answer.

A. There is $500,000 of total insurance. Company A has $100,000 of the $500,000 or 1/5 of the
coverage. Company B and C have $200,000 of the $500,000 or 2/5 of the coverage each.
Company A covers 1/5 of the $100,000 or $20,000. Company B and C each cover 2/5 of the
$100,000 or $40,000 each.

b. What is the purpose of the other-insurance provisions that are frequently found in insurance
contracts?

B. The purpose of the provision is to make sure individuals do not make a gain from a loss. If
each company paid for the total loss then Andrew would have made a large profit from the
accident. In other words, the principle of indemnity would be violated.

Application 5: Assume that a $300,000 liability claim is covered under two liability insurance
contracts. Policy A has a $500,000 limit of liability for the claim, while Policy B has a $125,000
limit of liability. Both contracts provide for contribution by equal shares.

a. How much will each insurer contribute toward this claim? Explain your answer.

Under contribution by equal shares, each insurer pays an equal share until their limits are
exhausted. Both companies have an equal share contribution. First, Company A and Company B
will each contribute $125,000 toward the loss. At that point, Company B's policy is exhausted.
Company A will pay the remaining $50,000. Company A pays a total of $175,000 and Company
B pays $125,000.
b. If the claim were only $50,000, how much would each insurer pay?

Both insurers again pay equally. Each pays $25,000. Since this amount is within both insurers'
limits, they share equally without reaching either policy's limit.

Application 6. Ashley has an individual medical expense insurance policy with a $1,000
calendar-year deductible and an 80–20 percent coinsurance clause. Ashley had outpatient surgery
to remove a bunion on her foot and incurred medical bills of $10,000. How much will Ashley’s
insurer pay? How much will Ashley have to pay?

Step 1: Subtract the deductible

 Total medical bills: $10,000

 Deductible: $1,000

After applying the deductible: Remaining amount=10,000−1,000=9,000

Step 2: Apply the coinsurance clause: After the deductible, the remaining amount is $9,000.
With an 80-20% coinsurance:

 Insurer’s share: 80% of $9,000: 9,000×0.80=7,200

 Ashley’s share: 20% of $9,000: 9,000×0.20=1,800

Step 3: Total amounts paid: Ashley’s total payment: Ashley has to pay the $1,000 deductible
plus her $1,800 coinsurance share:

Total Ashley pays=1,000+1,800=2,800

Insurer’s total payment: The insurer pays $7,200 for the medical bills.

Application 7. Angelique has a small plane. Its replacement cost is £150,000. She wants to
insure it in a local company (Insurer A), as she owns some stocks in this company. However, this
insurer covers planes with a maximum limit of £100,000. Her insurance broker advises her to
place another £50,000 with a second company (Insurer B). The broker also mentions that she has
three options of provisions to use: pro rata liability, contribution by equal shares, and primary
and excess insurance. Since she can make some profits on her stocks, she opts for the cheapest
solution from Insurer A. How would you advise her, taking into account partial loss of £75,000?
Explain your answer.

The Three Provisions:

1. Pro rata liability:

o This method allocates the loss proportionally between the two insurers based on
their coverage limits.
o Insurer A covers up to £100,000, and Insurer B covers £50,000.
o Total insurance coverage = £150,000.
o The loss of £75,000 is shared proportionally:

Insurer A’s share=100,000/150,000×75,000=50,000 (Insurer A pays £50,000

 Insurer B’s share=50,000/150,000×75,000=25,000 (Insurer B pays £25,000)

o Total paid = £75,000 (Insurer A pays £50,000, Insurer B pays £25,000).

2. Contribution by equal shares:
o In this method, both insurers contribute equally to the loss, regardless of their
coverage limits.
o Since the loss is £75,000, both insurers would pay half:

Insurer A’s share=75,000/2=37,500{Insurer A's share

Insurer B’s share=75,000/2=37,500{Insurer B's share}

Total paid = £75,000 (Insurer A pays £37,500, Insurer B pays £37,500).

3. Primary and excess insurance:

o Under this arrangement, one insurer is designated as the primary insurer, and the
second insurer acts as the excess insurer, covering any loss exceeding the primary
insurer’s limit.
o Typically, Insurer A would be the primary insurer because it offers the larger
coverage limit (£100,000).
o Insurer A would pay for the loss up to its limit of £100,000. Since the partial loss
is £75,000, Insurer A would cover the full £75,000.
o Insurer B would not pay anything, as the loss is entirely covered by the primary
insurer (Insurer A) within its £100,000 limit.

Analysis of Angelique’s Best Option:

 Pro rata liability: This would result in Insurer A covering £50,000 and Insurer B
covering £25,000. This option allows both insurers to share the loss according to their
respective limits.
 Contribution by equal shares: This method leads to an equal split of £37,500 each
between the insurers. This could be seen as fair, but it means Insurer B would contribute
more than its £50,000 limit, which might be problematic if the loss were greater.
 Primary and excess insurance: In this scenario, Insurer A pays the entire £75,000
because the loss is under its £100,000 limit. This would be the most straightforward and
efficient option for Angelique, especially since she is aiming for the cheapest solution.

Advice to Angelique: Since Angelique is looking for the cheapest solution, the primary and
excess insurance option would be the most suitable for her, given that: Insurer A will cover the
entire loss of £75,000, which is well within its £100,000 limit. She doesn’t need to pay any
additional premiums or deal with complex sharing of the loss, and her primary insurer (Insurer
A) covers the full loss up to its limit, which is the least complicated and most cost-effective
solution.