Page | 1
CFP - INSURANCE PLANNING
QUESTIONS WITH DETAILED VERIFIED
ANSWERS
Distinguish between pure risk and speculative risk Ans: 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. Ans:
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. Ans: 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. Ans: 1. Determining the
objectives of the risk management program.
, Page | 2
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 Ans: 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 Ans: High severity & Low Frequency: Transfer - disability,
premature death, damage to personal home.
High severity & High Frequency: Avoidance - drunk driving and smoking
in bed.
, Page | 3
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. Ans: Fire,
Storm, Theft, Collision, Hail, Flood, Falling object, Contact w/ bird,
Earthquake, Windstorm.
Identify typical perils covered under a personal homeowner's policy.
Ans: Fire, Lightening, Windstorm, Hail, Riot, Falling Objects, Weight of
Ice or snow, Smoke, Explosion, Theft
Differentiate between moral, morale and physical hazards. Ans: 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 Ans: 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 -
, Page | 4
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 Ans: 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 Ans: 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.
CFP - INSURANCE PLANNING
QUESTIONS WITH DETAILED VERIFIED
ANSWERS
Distinguish between pure risk and speculative risk Ans: 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. Ans:
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. Ans: 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. Ans: 1. Determining the
objectives of the risk management program.
, Page | 2
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 Ans: 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 Ans: High severity & Low Frequency: Transfer - disability,
premature death, damage to personal home.
High severity & High Frequency: Avoidance - drunk driving and smoking
in bed.
, Page | 3
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. Ans: Fire,
Storm, Theft, Collision, Hail, Flood, Falling object, Contact w/ bird,
Earthquake, Windstorm.
Identify typical perils covered under a personal homeowner's policy.
Ans: Fire, Lightening, Windstorm, Hail, Riot, Falling Objects, Weight of
Ice or snow, Smoke, Explosion, Theft
Differentiate between moral, morale and physical hazards. Ans: 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 Ans: 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 -
, Page | 4
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 Ans: 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 Ans: 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.
