CFP: Insurance Planning ACTUAL
UPDATED Questions and CORRECT
Answers
Distinguish between pure risk and speculative risk - CORRECT ANSWER Pure Risk: The
chance of a loss or no loss occurring. With pure risk, there is no chance of experiencing a gain.
Pure risk is insurable. Ex.) Either your car is in an accident and damaged or it is not.
Speculative Risk: Chance of loss, no loss or a profit. Speculative risk is the risk that an investor
takes when buying a stock or an entrepreneur when starting a business. Insurance is not available
for speculative risk.
Identify the difference between subjective and objective risks. - CORRECT
ANSWER Subjective Risk: Differs based upon an individual's perception of risk. An
example would be: two guys go out drinking, five drinks each, one gets pulled over for DUI.
Next time out, the guy that got pulled over has 1 drink and calls a cab. The other guy has 5
drinks again and drives home. Subjective risk is how you perceive the actual risk.
Objective Risk: Does not depend on an individual's perception. Objective risk measures the
difference between an actual loss from expected loss. Example: Before you can start your car,
you blow into a breathalyzer. If you are below the legal limit, your car will start. If you are over
the legal limit, your car will not start. Objective risk is measurable.
Determine why the law of large numbers is useful for insurance companies. - CORRECT
ANSWER The law of large numbers is a principal that states that actual outcomes will
approach the mean probability as the sample size grows. This is useful for insurance companies
because the larger the insured pool, the more likely actual losses will approach the expected
losses, thereby reducing forecasting error and objective risk. This results in insurance premiums
that are more efficient and thus are less costly to the insured.
Explain the Risk Management Process. - CORRECT ANSWER 1. Determining the
objectives of the risk management program.
,2. Identifying the risk to which the individual is exposed.
3. Evaluating the identified risks for the probability and severity of the loss.
4. Determining the alternative for managing risk: Retaining, reducing, avoiding, transferring
5. Implementing the risk management plan selected
6. Periodically evaluating and reviewing the risk management program.
Describe the four responses to pure risks - CORRECT ANSWER Risk Reduction: The
process of reducing the likelihood of a pure risk that is high in frequency and low in severity.
Example: Car doors dings, common cold.
Risk Transfer: Involves transferring a low frequency and high severity risk to a third party.
Example: disability, premature death, damage to home.
Risk Avoidance: Used for any risks that are high in frequency and high in severity. Activities that
will very frequently result in severe financial consequences should be avoided, such as drunk
driving and smoking in bed.
Risk Retention: Accepting some or all of the potential loss exposure for risks that are low in
frequency and low in severity. Example: minor property damage to a personal residence or
personal auto. Deductibles and co-payment are a form of risk retention where the insured is
sharing in the first dollar of a financial loss. Risk retention is an appropriate risk management
strategy for risks that are low in frequency and low in severity.
Identify the most appropriate risks to insure based on loss severity and loss frequency -
CORRECT ANSWER High severity & Low Frequency: Transfer - disability, premature
death, damage to personal home.
High severity & High Frequency: Avoidance - drunk driving and smoking in bed.
,Low severity & Low frequency: Retention - minor auto and property damage (car ding)
Low severity & High Frequency: Reduction - common cold
Identify typical perils covered under a personal auto policy. - CORRECT ANSWER Fire,
Storm, Theft, Collision, Hail, Flood, Falling object, Contact w/ bird, Earthquake, Windstorm.
Identify typical perils covered under a personal homeowner's policy. - CORRECT
ANSWER Fire, Lightening, Windstorm, Hail, Riot, Falling Objects, Weight of Ice or
snow, Smoke, Explosion, Theft
Differentiate between moral, morale and physical hazards. - CORRECT ANSWER Moral:
based on a character flaw, such as:
Filing a false claim.
Morale: the indifference created because the person is insured, such as leaving car unlocked
Physical Hazard: a tangible condition that increases the probability of a peril occurring, such as
icy roads, poor lighting, defective equipment
Identify the requisites for an insurable risk - CORRECT ANSWER 1. A large number of
homogenous exposure units - Homeowners insurance for FL residents should be separate from
other states because of their unique risks (hurricane).
2. Losses must be accidental from insured's view -
Cannot insure moral hazards, premiums would skyrocket.
3. Losses must be measurable and determinable -
It is easy to determine the value of a house or auto, it is difficult to determine the amount of cash
in a wallet, therefore coverage is limited in terms of both money and time.
, 4. Losses must not pose a catastrophic risk for the insurer -
An insurer cannot provide coverage that would cause it to become financially insolvent.
5. Premiums must be reasonable and affordable.
Identify the elements of a valid contract - CORRECT ANSWER Mutual Consent
Offer and Acceptance
-Signing an insurance application and paying the first premium is an example.
Performance or Delivery
-In order for a contract to be enforceable, the party to a contract must perform a duty under the
contract.
Lawful Purpose
-Insurance contracts that promote actions contrary to public interest are invalid
Legal Competency of all Parties
- Must be 18 years old, otherwise contract is voidable by the minor at any time.
Define Conditional acceptance - CORRECT ANSWER Conditional acceptance applies if
the insured pays the 1st premium along with the application, typically with auto insurance, but
before the policy is issued.
A good example involves life insurance.
Referred to as conditional receipt, if the insured is deemed to be "insurable" by the insurance
company, then coverage begins on the date the insured receives the conditional binding receipt.
Typically, the insured must submit a premium payment and a completed acceptable application
in order for the insured to obtain the receipt.
UPDATED Questions and CORRECT
Answers
Distinguish between pure risk and speculative risk - CORRECT ANSWER Pure Risk: The
chance of a loss or no loss occurring. With pure risk, there is no chance of experiencing a gain.
Pure risk is insurable. Ex.) Either your car is in an accident and damaged or it is not.
Speculative Risk: Chance of loss, no loss or a profit. Speculative risk is the risk that an investor
takes when buying a stock or an entrepreneur when starting a business. Insurance is not available
for speculative risk.
Identify the difference between subjective and objective risks. - CORRECT
ANSWER Subjective Risk: Differs based upon an individual's perception of risk. An
example would be: two guys go out drinking, five drinks each, one gets pulled over for DUI.
Next time out, the guy that got pulled over has 1 drink and calls a cab. The other guy has 5
drinks again and drives home. Subjective risk is how you perceive the actual risk.
Objective Risk: Does not depend on an individual's perception. Objective risk measures the
difference between an actual loss from expected loss. Example: Before you can start your car,
you blow into a breathalyzer. If you are below the legal limit, your car will start. If you are over
the legal limit, your car will not start. Objective risk is measurable.
Determine why the law of large numbers is useful for insurance companies. - CORRECT
ANSWER The law of large numbers is a principal that states that actual outcomes will
approach the mean probability as the sample size grows. This is useful for insurance companies
because the larger the insured pool, the more likely actual losses will approach the expected
losses, thereby reducing forecasting error and objective risk. This results in insurance premiums
that are more efficient and thus are less costly to the insured.
Explain the Risk Management Process. - CORRECT ANSWER 1. Determining the
objectives of the risk management program.
,2. Identifying the risk to which the individual is exposed.
3. Evaluating the identified risks for the probability and severity of the loss.
4. Determining the alternative for managing risk: Retaining, reducing, avoiding, transferring
5. Implementing the risk management plan selected
6. Periodically evaluating and reviewing the risk management program.
Describe the four responses to pure risks - CORRECT ANSWER Risk Reduction: The
process of reducing the likelihood of a pure risk that is high in frequency and low in severity.
Example: Car doors dings, common cold.
Risk Transfer: Involves transferring a low frequency and high severity risk to a third party.
Example: disability, premature death, damage to home.
Risk Avoidance: Used for any risks that are high in frequency and high in severity. Activities that
will very frequently result in severe financial consequences should be avoided, such as drunk
driving and smoking in bed.
Risk Retention: Accepting some or all of the potential loss exposure for risks that are low in
frequency and low in severity. Example: minor property damage to a personal residence or
personal auto. Deductibles and co-payment are a form of risk retention where the insured is
sharing in the first dollar of a financial loss. Risk retention is an appropriate risk management
strategy for risks that are low in frequency and low in severity.
Identify the most appropriate risks to insure based on loss severity and loss frequency -
CORRECT ANSWER High severity & Low Frequency: Transfer - disability, premature
death, damage to personal home.
High severity & High Frequency: Avoidance - drunk driving and smoking in bed.
,Low severity & Low frequency: Retention - minor auto and property damage (car ding)
Low severity & High Frequency: Reduction - common cold
Identify typical perils covered under a personal auto policy. - CORRECT ANSWER Fire,
Storm, Theft, Collision, Hail, Flood, Falling object, Contact w/ bird, Earthquake, Windstorm.
Identify typical perils covered under a personal homeowner's policy. - CORRECT
ANSWER Fire, Lightening, Windstorm, Hail, Riot, Falling Objects, Weight of Ice or
snow, Smoke, Explosion, Theft
Differentiate between moral, morale and physical hazards. - CORRECT ANSWER Moral:
based on a character flaw, such as:
Filing a false claim.
Morale: the indifference created because the person is insured, such as leaving car unlocked
Physical Hazard: a tangible condition that increases the probability of a peril occurring, such as
icy roads, poor lighting, defective equipment
Identify the requisites for an insurable risk - CORRECT ANSWER 1. A large number of
homogenous exposure units - Homeowners insurance for FL residents should be separate from
other states because of their unique risks (hurricane).
2. Losses must be accidental from insured's view -
Cannot insure moral hazards, premiums would skyrocket.
3. Losses must be measurable and determinable -
It is easy to determine the value of a house or auto, it is difficult to determine the amount of cash
in a wallet, therefore coverage is limited in terms of both money and time.
, 4. Losses must not pose a catastrophic risk for the insurer -
An insurer cannot provide coverage that would cause it to become financially insolvent.
5. Premiums must be reasonable and affordable.
Identify the elements of a valid contract - CORRECT ANSWER Mutual Consent
Offer and Acceptance
-Signing an insurance application and paying the first premium is an example.
Performance or Delivery
-In order for a contract to be enforceable, the party to a contract must perform a duty under the
contract.
Lawful Purpose
-Insurance contracts that promote actions contrary to public interest are invalid
Legal Competency of all Parties
- Must be 18 years old, otherwise contract is voidable by the minor at any time.
Define Conditional acceptance - CORRECT ANSWER Conditional acceptance applies if
the insured pays the 1st premium along with the application, typically with auto insurance, but
before the policy is issued.
A good example involves life insurance.
Referred to as conditional receipt, if the insured is deemed to be "insurable" by the insurance
company, then coverage begins on the date the insured receives the conditional binding receipt.
Typically, the insured must submit a premium payment and a completed acceptable application
in order for the insured to obtain the receipt.
