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Questions and Answers of
Corporate Finance
Provide an example of an internal and external risk for a large automaker.
Consider the losses resulting from a large fire loss to a commercial building. Provide two examples of direct losses commonly associated with a fire, as well as two examples of indirect losses.
List and briefly describe the three broad categories of hazard risks.
Define and provide two examples of tangible and intangible property.
Provide two examples of situations in which risk managers are concerned about damage to the property of others.
What differentiates torts from liability for criminal acts and breach of contracts?
List and briefly describe the four requirements that a plaintiff must prove when suing a defendant in a negligence case.
Describe the difference between compensatory and punitive damages.
Explain how risk identification has changed in recent years, as well as the reasons for the change.
Using your answers from Question 7 and Question 9, use convolution to find the average loss.
Al’s Toy Store faces the following probability distribution of fire losses in its store over the next year:
Refer to Question 11. Assume that Al pools his losses with Ed’s store, which has an identical loss distribution. Ed’s losses are independent of Al’s. Al and Ed agree to split the total losses
Refer to Questions 11 and 12. Calculate the expected value and standard deviation of the pooled mean losses.In questions Al’s Toy Store faces the following probability distribution of fire
Insurers combine a large number of exposure units in the process of risk pooling. Describe the effect of increasing the size of the risk pool on the mean loss of the pool and on the standard
Describe the shape of the normal distribution, indicating the statistical relationship between its mean and its standard deviation.
Describe the concept of a risk charge as the term is used in the calculation of insurance premiums. Is the risk charge affected by an increase in the number of exposure units in a risk pool?
List and briefly describe two examples of loss exposures that are not well suited to risk pooling, and explain the reasons why risk pooling is not effective for these loss exposures.
Show the physical damage loss distribution for Scary Airline’s planes.
Show the calculations for the variance and the standard deviation, as described in footnote 3.
Describe the difference between loss severity and loss frequency. In your answer, give an example of a loss control technique (as described in Chapter 2, “Risk Identification”) that can be used
Use the information in the table to estimate a probability distribution for the frequency distribution of losses per worker in a year.
Use the information in the table to estimate a probability distribution for the loss severity per claim.
How is loss prevention different from loss reduction? Give some examples of each.
Describe the benefits associated with using captive insurers as a loss-financing technique.
Describe the conditions in which avoidance is an appropriate risk-handling technique.
What is OSHA, and how does it relate to a firm’s risk-management program?
Describe how firms use contractual transfer methods to handle risk. Provide two examples.
Describe how firms can use limited liability as a means to protect themselves from risk.
Describe the advantages and disadvantages of using insurance as a loss-financing technique.
Describe the role of deductibles in insurance contracts.
How does self-insurance differ from risk assumption as an internal loss-financing technique?
What are the potential advantages (and disadvantages) of a self-insurance program?
Risk-bearing financial institutions diversify risk by combining a large number of exposure units in a risk group. Describe the types of exposure units found in the risk groups of an insurer, a mutual
Discuss why perils like earthquake damage or unemployment are not insured easily by private insurers.
Looking beyond risk diversification, discuss some of the additional benefits that risk-bearing financial institutions offer their customers.
What is the difference between output price risk and input price risk?
What are the types of loss that are dealt with through the use of hedging in financial risk management?
From the viewpoint of the option holder, what is the difference between a call option and a put option?
Based on Equation 5-3, explain why hedging is a useful risk-handling technique.
Explain why insurance risk pooling is most efficient when the losses from the policyholders in the risk pool are distributed independently.
The term insurance can be defined in both financial and legal terms. How do these definitions differ?
Describe four types of life and health insurance. In your answer, describe the personal risk that is insured by each type of insurance.
List the four building blocks of an insurance premium. Why are investment earnings included in the calculations?
What are the definitions for the loss ratio and the expense ratio? Describe what each ratio measures.
How does insurance redistribute the costs of losses?
What is the difference between a hazard and a peril? Give examples of each.
Why is it the chance of loss, and not the loss itself, that creates the need for insurance?
How does a moral hazard differ from a physical hazard? Give examples of each.
Define the law of large numbers. What are its implications for an insurance system?
Explain the differences between social insurance and private insurance programs.
Which of the following exposures to loss would be a likely basis for an insurance system? Explain why the exposures would or would not qualify as a basis for insurance. a. The potential loss of
What is meant by incentive value in a risk classification scheme?
Why is it difficult for insurers to satisfy the social acceptability of risk classification criteria?
Explain why the legal organization of an insurance system is important to the consumer.
Describe the differences between stock insurers, mutual insurers, and reciprocal exchanges.
What is adverse selection? How do insurers try to prevent adverse selection?
Explain the statement that adverse selection causes subsidization.
Explain the four major principles of risk classification.
What duties do principals owe their agents? What duties do agents owe their principals?
Why do insurance companies hire independent loss adjustment bureaus?
Why must the underwriter be concerned about adverse selection?
What is the difference between a facultative and a treaty reinsurance arrangement?
What type of exposures would encourage a life insurance company to purchase catastrophe reinsurance?
Explain the basis for conflict between the insurance agent and the home office underwriter. In practice why are such conflicts often not a problem?
Describe the differences between an insurance agent and an insurance broker. Are these differences important to the insurance consumer?
Why do life insurance agents and property insurance agents have different grants of authority?
Describe the differences between an independent agent and a direct writer.
Evaluate the success of direct marketing and e-commerce in insurance marketing.
What purpose does a “reservation of rights” letter serve?
Should a good job of loss adjusting always involve the claims adjuster negotiating the lowest possible dollar amount of claims settlement?
What incentives does the insurer have to settle claims fairly?
Most markets consist of buyers and sellers. The chapter suggests that the insurance market has three participants. Who is the third participant, and what is its role in the market?
Describe the important factors to consider when choosing an insurance company.
Why is the lowest-priced insurance protection not necessarily the best one to buy?
What information do financial ratings firms provide? What are some potential problems with their ratings?
Explain three common-sense rules for choosing the proper amount of insurance.
What are the requirements for a perfectly competitive market? What is one of the main benefits of perfect competition?
Describe an aspect of insurance that is not consistent with the characteristics of competitive markets.
If insurers colluded and raised the price of insurance, what would you predict would be the effect on the quantity of insurance sold?
If the government made insurers lower the price of insurance 25 percent, what would you predict would be the effect on the quantity of insurance sold?
What is a FAIR plan? How does it work?
Explain the purpose of assigned risk plans and JUAs in automobile insurance.
Describe the problems caused by uninformed consumers in the insurance market.
How does the role of the courts differ from the role of the insurance commissioner in protecting the consumer?
What does the term insurance regulation mean?
How did the Gramm-Leach-Bliley Act (GLB) change the competitive landscape of insurance?
What are insurance company reserve requirements? How do they work to protect the consumer?
Explain the nature of the risk-based capital ratio.
Describe the main methods for regulating the investment activities of insurers.
Describe the differences between admitted insurers and nonadmitted insurers.
Describe surplus-lines markets and explain their role in serving the needs of insurance consumers.
Why is the solvency of insurers of such great importance to regulators?
What is meant by unequal knowledge and bargaining powers? Why do regulators have to protect the purchasers of homeowners insurance more than purchasers of large commercial insurance policies?
How does the pricing of an insurance policy for the insurer differ from a bologna manufacturer’s pricing its product? Why does the difference in pricing problems require that insurance pricing be
Why might the lowest-priced insurance policy be undesirable from the consumer’s standpoint?
Describe the two approaches to rate regulation in insurance.
What was the outcome of the Paul v. Virginia case?
What effect did McCarran-Ferguson Act have on insurance regulation? Why was it passed?
What is the role of the NAIC? What are its main functions?
How do binders differ from conditional receipts?
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