AINS 21 Chapter Three Review Questions with Correct Answers
Question 1:
Identify and describe the 2 primary sources of an insurer's income.
Answer:
An insurer's income is primarily composed of underwriting income and investment income.
Question 2:
Describe the components of each of these types of insurer expenses: (1) underwriting activity
expenses and (2) investment activity expenses.
Answer:
(1) Underwriting activity expenses include the insurer's paid and incurred losses, loss
adjustment expenses, and other underwriting expenses including acquisition expenses, general
expenses (staffing and maintaining functional dept.), and premium taxes, licenses and fees. (2)
Investment activity expenses include staff salaries of professional investment managers and all
other expenses related to the investment dept.'s activities.
Question 3:
What financial components determine an insurer's net income before taxes?
Answer:
The financial components determining an insurer's net income before taxes: The sum of its
total earned premiums and investment income minus its total losses and other expenses in the
corresponding period, with any applicable adjustments.
Question 4:
The IT Dept. for QualitIn Insurance Company was concerned to learn that QualitIn had an
underwriting loss for the 3rd year in a row. What might the IT Dept. do to help improve
QualitIn's underwriting profitability? Identify the component(s) of income or expenses that
would be affected by the IT Dept.'s action(s).
Answer:
Because the IT Dept. is not involved in underwriting, which directly affects premiums, or in
claims, which directly affect losses and loss expenses, the best way for the IT Dept. to help
improve QualtIn's underwriting profitability is to look for ways to cut expenses within its own
dept. or to suggest ways to cut expenses for the entire organization. These expenses are
general expenses of the insurer, which are a component of "other underwriting expenses." Any
actions that reduce expenses will help lead to greater profitability.
, Question 5:
The balance sheet shows an insurer's financial position at a particular point in time and includes
what 3 financial components?
Answer:
The balance sheet includes the insurer's assets, liabilities, and policyholders' surplus.
Question 6:
Explain why an unearned premium reserve is an insurer's liability.
Answer:
The unearned premium reserve is an insurer's liability because it represents insurance
premiums prepaid by insureds for services that the insurer has not yet rendered. If the insurer
ceased operations and canceled all of its policies, the unearned premium reserve would
represent the total of premium refunds that the insurer would owe its current policyholders.
Question 7:
The income statement compares an insurer's revenue generated with the expenses incurred to
produce that revenue and includes which financial components?
Answer:
The income statement includes the insurer's revenue (earned premium), expenses (incurred
losses, loss adjustment expenses, and other underwriting expenses), net underwriting gain or
loss, net investment income, and net income before income taxes.
Question 8:
Before placing a new customer's commercial property insurance with Hallidy Insurance, a
company with which he was less familiar, Jerry asked his assistant to retrieve a current balance
sheet for Hallidy. The assistant returned a balance sheet dated four years prior to the current
date. Explain why Jerry should avoid basing his decision on placing coverage with Hallidy solely
on a four-year-old balance sheet?
Answer:
An insurer's balance sheet shows its assets and liabilities only as of a particular date. The figures
change constantly (e.g. insurers establish unearned premium reserves for premiums they
receive, the unearned premium reserve for
each policy declines over the passage of time, losses occur, new policies are written, old policies
expire or are not renewed). For these reasons Jerry should locate a more recent balance sheet
to help with his placement decision and he may also want an income statement for the
corresponding period(s).
Question 1:
Identify and describe the 2 primary sources of an insurer's income.
Answer:
An insurer's income is primarily composed of underwriting income and investment income.
Question 2:
Describe the components of each of these types of insurer expenses: (1) underwriting activity
expenses and (2) investment activity expenses.
Answer:
(1) Underwriting activity expenses include the insurer's paid and incurred losses, loss
adjustment expenses, and other underwriting expenses including acquisition expenses, general
expenses (staffing and maintaining functional dept.), and premium taxes, licenses and fees. (2)
Investment activity expenses include staff salaries of professional investment managers and all
other expenses related to the investment dept.'s activities.
Question 3:
What financial components determine an insurer's net income before taxes?
Answer:
The financial components determining an insurer's net income before taxes: The sum of its
total earned premiums and investment income minus its total losses and other expenses in the
corresponding period, with any applicable adjustments.
Question 4:
The IT Dept. for QualitIn Insurance Company was concerned to learn that QualitIn had an
underwriting loss for the 3rd year in a row. What might the IT Dept. do to help improve
QualitIn's underwriting profitability? Identify the component(s) of income or expenses that
would be affected by the IT Dept.'s action(s).
Answer:
Because the IT Dept. is not involved in underwriting, which directly affects premiums, or in
claims, which directly affect losses and loss expenses, the best way for the IT Dept. to help
improve QualtIn's underwriting profitability is to look for ways to cut expenses within its own
dept. or to suggest ways to cut expenses for the entire organization. These expenses are
general expenses of the insurer, which are a component of "other underwriting expenses." Any
actions that reduce expenses will help lead to greater profitability.
, Question 5:
The balance sheet shows an insurer's financial position at a particular point in time and includes
what 3 financial components?
Answer:
The balance sheet includes the insurer's assets, liabilities, and policyholders' surplus.
Question 6:
Explain why an unearned premium reserve is an insurer's liability.
Answer:
The unearned premium reserve is an insurer's liability because it represents insurance
premiums prepaid by insureds for services that the insurer has not yet rendered. If the insurer
ceased operations and canceled all of its policies, the unearned premium reserve would
represent the total of premium refunds that the insurer would owe its current policyholders.
Question 7:
The income statement compares an insurer's revenue generated with the expenses incurred to
produce that revenue and includes which financial components?
Answer:
The income statement includes the insurer's revenue (earned premium), expenses (incurred
losses, loss adjustment expenses, and other underwriting expenses), net underwriting gain or
loss, net investment income, and net income before income taxes.
Question 8:
Before placing a new customer's commercial property insurance with Hallidy Insurance, a
company with which he was less familiar, Jerry asked his assistant to retrieve a current balance
sheet for Hallidy. The assistant returned a balance sheet dated four years prior to the current
date. Explain why Jerry should avoid basing his decision on placing coverage with Hallidy solely
on a four-year-old balance sheet?
Answer:
An insurer's balance sheet shows its assets and liabilities only as of a particular date. The figures
change constantly (e.g. insurers establish unearned premium reserves for premiums they
receive, the unearned premium reserve for
each policy declines over the passage of time, losses occur, new policies are written, old policies
expire or are not renewed). For these reasons Jerry should locate a more recent balance sheet
to help with his placement decision and he may also want an income statement for the
corresponding period(s).
