Risk Management Flashcards
16 cards from real Financial Management for Project Managers practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 16 Risk Management flashcards as text
Retention comes in a variety of forms, known as .
Answer: 2; active and passive
In risk management, retention refers to the strategy of accepting the financial burden of a risk rather than transferring it to another party. The two primary forms of retention are active retention, where a company consciously decides to bear a known risk, and passive retention, where a company unknowingly or unintentionally retains a risk due to oversight or lack of awareness.
Which of the following describes the spreading of losses suffered by a select few across the entire group, replacing actual loss with average loss as a result?
Answer: pooling
Pooling is a fundamental principle of insurance where the losses of a few are shared among many. This mechanism replaces the actual, potentially large, loss for an individual with an average loss, making it more manageable and predictable for all participants. It's the core idea behind how insurance works to mitigate individual financial risk.
The _____________ level is largely responsible for regulating insurance.
Answer: state
In the United States, insurance regulation is primarily handled at the state level, not federal. Each state has its own department of insurance responsible for licensing insurers, approving policy forms, regulating rates, and ensuring solvency to protect policyholders. This decentralized approach allows for regulations tailored to local market conditions and consumer needs.
A(n) ____________ insurer is one that is owned by a parent company with the intention of covering the loss exposures of the parent company.
Answer: captive
A captive insurer is an insurance company established and owned by a parent company or group of companies, primarily to insure the risks of its owner(s). Instead of purchasing insurance from commercial insurers, the parent company essentially self-insures through its captive. This allows for greater control over coverage, claims, and potentially lower costs for specific risks.
What qualifies as a feature of an insurance contract and which of the following does not?
Answer: equal value exchange
Insurance contracts are characterized by an unequal exchange of values, making 'equal value exchange' not a feature. The insured pays a relatively small premium, but the insurer promises to pay a much larger sum if a covered event occurs, or nothing at all if it doesn't. This aleatory nature, where the outcome depends on an uncertain event, distinguishes it from typical commercial contracts.
Atlanta and Memphis both have 100,000 vehicles that are covered by an insurance. Each city has a 3% chance of having an accident. Atlanta recorded 350, 300, and 250 accidents from 2006 to 2009, compared to 300, 280, and 320 accidents in Memphis. Which city carries more risk?
Answer: Atlanta
Risk is often associated with the variability or dispersion of outcomes around an expected value. While both cities have a 3% chance of an accident (expected 300 accidents), Atlanta's accident numbers (350, 300, 250) show greater fluctuation from the expected 300 compared to Memphis's (300, 280, 320). This higher variability in Atlanta's actual losses indicates greater risk.
Which of the following are instances of retention, transfer, and commercial insurance?
Answer: risk financing
Risk financing refers to the methods used to pay for losses that occur. Retention (keeping the risk and paying for losses out of pocket) and transfer (shifting the financial burden of risk to another party, like an insurer through commercial insurance) are both primary strategies within risk financing. They address how an organization funds potential losses, rather than controlling the likelihood or severity of the loss itself.
In an insurance contract, the values transferred may not be equal and instead depend on an uncertain event. Due to this, the insurance contract is
Answer: aleatory
An insurance contract is considered aleatory because the values exchanged by the parties are unequal and depend on the occurrence of an uncertain event. The insured pays a fixed premium, but the insurer's payout is contingent upon a covered loss occurring, which may or may not happen. This contrasts with commutative contracts where parties exchange items of relatively equal value.
Which of the following describes uncertainty based on a person's mental state or state of mind?
Answer: subjective risk
Subjective risk refers to an individual's perception of risk, which is based on their mental state or attitude. It can influence how a person behaves in the face of uncertainty, even if the objective probability of an event remains the same. For example, someone might perceive flying as riskier than driving, despite statistical evidence suggesting the opposite.
Which of the following claims about the difference between insurance and gambling is untrue?
Answer: insurance creates a new risk
The claim that 'insurance creates a new risk' is untrue. Insurance deals with existing risks that are inherent in life and business, such as the risk of fire, theft, or illness. In contrast, gambling creates a new, artificial risk where none existed before, simply for the purpose of a wager. Insurance aims to mitigate or transfer existing risks, not to generate new ones.
What phrase best captures the phenomena where the real loss experience will resemble the expected loss experience the more exposure units there are?
Answer: law of large numbers
The law of large numbers states that as the number of exposure units increases, the actual loss experience will more closely approximate the expected (or theoretical) loss experience. This principle is fundamental to insurance, allowing insurers to predict future losses with greater accuracy when they have a large pool of similar policyholders. It enables them to set appropriate premiums and maintain solvency.
Which is not an insurance benefit?
Answer: expense loadings
Expense loadings are a component of an insurance premium that covers the insurer's operating costs, such as administrative expenses, marketing, and commissions. While necessary for the insurer's operation, they represent a cost to the policyholder, not a benefit. Benefits of insurance include indemnification for loss, enhancement of credit, and providing a source of investment funds.
Which of the following is not a prerequisite for a risk that can, in theory, be insured?
Answer: losses should be catastrophic in nature
For a risk to be insurable, losses should generally NOT be catastrophic in nature for a large number of insureds simultaneously. If many policyholders suffer losses from the same event (e.g., a widespread natural disaster), it could bankrupt the insurer. Instead, insurable losses should ideally be accidental, measurable, determinable, and not catastrophic to the insurer's entire portfolio.
In order to persuade Rex to buy the coverage, Rex's insurance agent offers him a discount on the premium. This is an illustration of the unethical behavior referred to as .
Answer: rebating
Rebating is an illegal practice where an insurance agent offers a portion of their commission or something else of value not specified in the policy as an inducement for a client to purchase insurance. This practice is prohibited because it can lead to unfair discrimination among policyholders and undermine the integrity of the insurance market.
_____________ is excellent for high-frequency, low-severity losses.
Answer: loss prevention/loss reduction
Loss prevention and loss reduction strategies are excellent for high-frequency, low-severity losses because they aim to reduce the occurrence or impact of these common, but individually small, events. Implementing measures like safety training or regular maintenance can significantly decrease the total cost of these frequent losses, making it a cost-effective approach. These methods directly address the frequency and severity of such risks.
Which of the following is not a risk management pre-loss goal?
Answer: survival of the firm
Survival of the firm is a crucial post-loss goal, meaning it's what the firm aims to achieve *after* a loss has occurred to continue operations. Pre-loss goals, on the other hand, focus on preparing for losses before they happen. These include reducing anxiety, meeting legal obligations, and preparing for losses in an economical way.