Chapter 3 : Introduction to Risk Management

1) Risk management is concerned with

A) the identification and treatment of loss exposures.
B) the management of speculative risks only.
C) the management of pure risks that are uninsurable.
D) the purchase of insurance only

2) A situation or circumstance in which a loss is possible, regardless of whether a loss occurs, is

called a
A) deductible.
B) loss exposure.
C) loss avoidance.
D) peril

3) Which of the following is a post-loss risk management objective?

A) treating loss exposures in the most economical way
B) continuing operations
C) reduction of anxiety
D) meeting externally imposed legal obligations

4) Preloss objectives of risk management include which of the following?

I. Preparing for potential losses in the most economical way
II. Reduction of anxiety
A) I only
B) II only
C) both I and II
D) neither I nor II
5) A risk manager is concerned with which of the following?
I. Identifying potential losses
II. Selecting the appropriate techniques for treating loss exposures
A) I only
B) II only
C) both I and II
D) neither I nor II

6) Which of the following is a source of information a risk manager could use to help identify
pure loss exposures?
A) commodity prices
B) physical inspections
C) currency exchange rates
D) interest rate movements

7) Loss severity is defined as the

A) probable size of the losses which may occur during some period.
B) probable number of losses which may occur during some period.
C) probability that any particular piece of property may be totally destroyed.
D) probability that a liability judgment may exceed a firm's net worth

8) Loss frequency is defined as the

A) probable size of the losses that may occur during some period.
B) probable number of losses that may occur during some period.
C) probability that any particular piece of property may be totally destroyed.
D) probability that a liability judgment may exceed a firm's net worth
9) The worst loss that could ever happen to a firm is referred to as the
A) maximum possible loss.
B) probable maximum loss.
C) frequency of loss.
D) severity of loss.

10) The worst loss that is likely to happen is referred to as the

A) maximum possible loss.
B) probable maximum loss.
C) frequency of loss.
D) severity of loss

11) All of the following statements about avoidance are true EXCEPT
A) Certain loss exposures are never acquired.
B) Certain loss exposures may be abandoned.
C) The chance of loss for certain loss exposures may be reduced to zero.
D) It can be used for any loss exposure facing a firm

12) Abandoning an existing loss exposure is an example of

A) avoidance.
B) retention.
C) noninsurance transfer.
D) insurance transfer

13) Which of the following conditions is (are) appropriate for using retention?
I. Losses are difficult to predict.
II. The worst possible loss is not serious.
A) I only
B) II only
C) both I and II
D) neither I nor II

14) Which of the following statements regarding the use of retention is (are) true?
I. Retention is best used for loss exposures that have a low frequency and a high severity.
II. A financially strong firm can have a higher retention level than a firm whose financial
position is weak.
A) I only
B) II only
C) both I and II
D) neither I nor II

15) Which of the following statements about the use of a captive insurance company by a
parent firm is true?
A) The captive may not write outside, non-parent company, business.
B) Captives are not permitted to use reinsurance, so any business insured by the captive stays
with the captive.
C) The captive may be used to insure loss exposures that the parent firm is finding difficult to
insure with private insurers.
D) Business placed with the captive is always considered retained risk and is never considered
transferred risk

16) Which of the following statements about self-insurance is (are) true?

I. It is a form of planned retention.
II. State law usually prohibits its use for workers compensation.
A) I only
B) II only
C) both I and II
D) neither I nor II
17) All of the following are potential advantages of retention EXCEPT
A) lower expenses.
B) increased cash flow.
C) encouragement of loss prevention.
D) protection from catastrophic losses

18) A restaurant owner leased a meeting room at the restaurant to a second party. The lease
specified that the second party, not the restaurant owner, would be responsible for any liability
arising out of the use of the meeting room, and that the restaurant owner would be "held
harmless" for any damages. The restaurant owner's use of the hold-harmless agreement in the
lease is an example of
A) retention.
B) self-insurance.
C) insurance.
D) noninsurance transfer

19) All of the following are disadvantages of noninsurance transfers EXCEPT

A) The party to whom the potential loss is transferred may be unable to pay.
B) The transfer may fail because the contract language is ambiguous.
C) The only potential losses that can be transferred are those that are not commercially insurable.
D) The noninsurance transfer may be costly.

20) ABC Insurance retains the first $1 million of each property damage loss and purchases
insurance for that part of any property loss that exceeds $1 million. The insurance for property
losses above $1 million is called
A) excess insurance.
B) liability insurance.
C) coinsurance.
D) primary insurance

21) Which of the following statements about the use of deductibles is (are) true?
I. They represent risk retention by insurance purchasers.
II. They tend to increase the cost of adjusting small claims.
A) I only
B) II only
C) both I and II
D) neither I nor II

22) Which of the following statements about an excess insurance plan is true?
A) The insurer does not participate in a loss until it exceeds the amount the firm has decided to
retain.
B) The insurer pays first up to some specified level; the insured then pays all losses exceeding
the insurer's retention level.
C) Losses in excess of a specified amount are not covered.
D) The insured and insurer share equally in any loss that occurs

23) Factors a risk manager must consider in selecting an insurer include which of the following?
I. The availability of risk management services
II. The financial strength of the insurer
A) I only
B) II only
C) both I and II
D) neither I nor II

24) An insurance policy specifically written and designed to meet the needs of an insurance
purchaser is called a(n)
A) manuscript policy.
B) bureau policy.
C) standard policy.
D) excess policy.

25) All of the following are disadvantages of using insurance in a risk management program
EXCEPT
A) There is an opportunity cost because premiums must be paid in advance.
B) Considerable time and effort must be spent selecting and negotiating coverages.
C) It results in considerable fluctuations in earnings after losses occur.
D) Attitudes toward loss control may become lax when losses are insured

26) Which of the following types of loss exposures may be appropriately handled through the
purchase of insurance?
I. High-frequency, low-severity loss exposures
II. Low-frequency, high-severity loss exposures
A) I only
B) II only
C) both I and II
D) neither I nor II

27) Which of the following types of loss exposures are best handled by the use of avoidance?
A) low-frequency, low-severity loss exposures
B) low-frequency, high-severity loss exposures
C) high-frequency, low-severity loss exposures
D) high-frequency, high-severity loss exposures
28) Low-frequency, low-severity loss exposures are best handled by
A) avoidance.
B) retention.
C) insurance.
D) noninsurance transfer

29) All of the following statements about the administration of a risk management program are
true EXCEPT
A) The risk manager is an important part of a firm's management team.
B) A risk management policy statement can be used to educate top executives about the risk
management process.
C) If a risk management program is properly designed, periodic review of the program is
unnecessary.
D) In order to properly identify loss exposures, the risk manager needs the cooperation of other
departments

30) Cal was just hired as XYZ Company's first risk manager. Cal would like to employ the risk
management process. The first step in the process Cal should follow is to
A) evaluate potential losses faced by XYZ Company.
B) formulate a treatment plan for XYZ Company's loss exposures.
C) identify potential losses faced by XYZ Company.
D) implement and administer a risk management plan for XYZ Company

31) Members of Mid-South Petroleum Distributors, a trade group, had trouble obtaining
affordable pollution liability insurance. The members formed a group captive that is exempt
from many state laws that apply to other insurers. This group captive is called a(n)
A) reinsurance pool.
B) Lloyd's association.
C) alien insurer.
D) risk retention group
32) Acme Company has three identical manufacturing plants, one on the Texas Gulf Coast, one
in southern Alabama, and one in Florida. Each plant is valued at $200 million. Acme's risk
manager is concerned about the damage which could be caused by a single hurricane. The risk
manager believes there is an extremely low probability that a single hurricane could destroy
two or all three plants because they are located so far apart. What is the probable maximum
loss
associated with a single hurricane?
A) $0 million
B) $200 million
C) $400 million
D) $600 million

33) Acme Company has three identical manufacturing plants, one on the Texas Gulf Coast, one
in southern Alabama, and one in Florida. Each plant is valued at $200 million. Acme's risk
manager is concerned about the damage which could be caused by a single hurricane. The risk
manager believes there is an extremely low probability that a single hurricane could destroy two
or all three plants because they are located so far apart. What is the maximum possible loss
associated with a single hurricane?
A) $0 million
B) $200 million
C) $400 million
D) $600 million

34) Laura Evans is risk manager of LMN Company. Laura decided to retain certain property
loss exposures. Which of the following is a method that Laura can use to fund the retained
property losses?
A) current net income
B) private insurance
C) noninsurance transfer
D) high deductibles
35) Parker Department Stores has been hurt in recent months by a large increase in shoplifting
losses. Parker's risk manager concluded that while the frequency of shoplifting losses was high,
the severity is still relatively low. What is (are) the appropriate risk management technique(s) to
apply to this problem?
A) retention
B) loss control and retention
C) transfer through insurance
D) avoidance

36) Barb, who is self-employed, is the main breadwinner for her family. Barb does not have
disability income insurance because she has never stopped to consider the impact of a long-
term disability upon her family. Barb's treatment of the risk of disability is best described as
A) risk transfer.
B) passive retention.
C) risk avoidance.
D) active retention

37) Ryan decided to review his personal risk management program. His car is 10 years old, and
he would receive little money from his insurer if the car was damaged or destroyed. Ryan
decided to drop the physical damage insurance on the car. From a risk management perspective,
dropping the physical damage insurance on the car is best described as
A) increasing the use of avoidance in the risk management program.
B) increasing the use of noninsurance transfer in the risk management program.
C) increasing the use of retention in the risk management program.
D) increasing the use of risk control in the risk management program

38) To better understand her company's operations, a risk manager asked a production manager
to draw a diagram tracing the steps in the production and distribution of the company's
products. Such a diagram, which is useful in risk identification, is called a
A) financial statement.
B) risk management matrix.
C) flowchart.
D) risk management audit

39) In reviewing his company's operations, a risk manager noticed that all of the company's
finished goods were stored in a single warehouse. The risk manager recommended that the
finished goods be divided among three warehouses to prevent all of the finished goods from
being destroyed by the same peril. Dividing the finished goods among three warehouse
illustrates
A) risk avoidance.
B) risk control.
C) insurance.
D) noninsurance transfer.

40) Which of the following statements about a personal risk management program is (are) true?
I. Insurance and retention are the only techniques used to handle potential losses.
II. The steps in a personal risk management process are the same steps used by businesses.
A) I only
B) II only
C) both I and II
D) neither I nor II

41) Bev lives in the suburbs and works downtown. She drives to work, and her most direct route
to work would require her to pass through an area where carjackings and drive-by-shootings are
common. Bev does not drive through this area. Instead, she uses a route which adds 10
minutes to her commute. Which risk management technique is Bev using with respect to the
risk of injury while driving through the dangerous area?
A) noninsurance transfer
B) avoidance
C) passive retention
D) loss reduction

42) Brenda identified all of the pure loss exposures her family faces. Then she analyzed these
loss exposures, developed a plan to treat these risks, and implemented the plan. The process
Brenda conducted is called
A) personal insurance programming.
B) personal estate planning.
C) personal financial planning.
D) personal risk management

43) Which statement about a company's cost of risk is (are) true?

I. Cost of risk includes insurance premiums and retained losses.
II. Reducing the cost of risk increases profitability.
A) I only
B) II only
C) both I and II
D) neither I nor II

44) A useful measure for an organization is the total of the organization's expenditures for
treating loss exposures including retained losses, loss control expenses, insurance premiums,
and other related expenses. This measure is called the organization's
A) cost of capital.
B) cost of goods sold.
C) cost of risk.
D) cost of equity

45) Mark owns a 1998 sedan. The last time Mark renewed his auto insurance, he decided to
drop the physical damage insurance on this vehicle. How is Mark dealing with the auto physical
damage exposure in his personal risk management program?
A) risk transfer
B) passive retention
C) avoidance
D) active retention

46) Purchasing health insurance illustrates the use of which personal risk management
technique?
A) avoidance
B) risk transfer
C) risk control
D) risk retention

47) Which of the following statements about captive insurance companies is (are) true?
I. A captive insurance company established by a U.S. company must be domiciled in the United
States.
II. A captive insurance company may be owned by several parents.
A) I only
B) II only
C) both I and II
D) neither I nor II

48) Which of the following is least likely to occur during a "hard" insurance market period?
A) difficulty in obtaining insurance
B) tightening underwriting standards
C) higher insurer profits
D) increasing premiums
49) Which of the following statements concerning the selection of risk management techniques
and insurance market conditions is (are) true?
I. It's easier to purchase affordable insurance during a "soft " market than during a "hard"
market.
II. Retention is used more during a "soft" market than during a "hard" market.
A) I only
B) II only
C) both I and II
D) neither I nor II

50) Discount Department Stores is a national retail chain. The company had one large, central
warehouse. At the suggestion of the risk manager, the company decided to build four smaller
regional warehouses so that a loss at the central warehouse would not be a catastrophic blow
to the company's distribution system. Splitting the inventory between four regional
warehouses
illustrates which risk management technique?
A) loss prevention
B) risk transfer
C) loss reduction
D) risk avoidance

51) Each accounting period, Harris Company Department Store charges a bookkeeping account
for its estimated shoplifting losses. The method that Harris Company Department Store uses to
fund its retained shoplifting losses is a(n)
A) private insurance policy.
B) captive insurer.
C) credit line.
D) unfunded reserve

52) Morris Company self-insures its workers compensation loss exposure. The risk manager of
Morris Company is concerned about the possible impact of a single catastrophic claim. She
decided to set a retention limit of $500,000 per-claim, and to purchase insurance that will be
begin to pay once Morris Company has paid $500,000 on a single claim. The insurance the risk
manager purchased is called
A) captive insurance.
B) excess insurance.
C) primary insurance.
D) umbrella insurance

53) When he became risk manager of Boller Company, Derrick Huang noticed that the company
did not have a clear set of risk management objectives and a clearly-stated risk management
philosophy. Derrick developed a written document stating the company's risk management
objectives and risk management philosophy. This document is called a risk management
A) policy statement.
B) manuscript policy.
C) matrix.
D) binder.

54) David never stopped to consider => passive the possible consequences of a long-term,
permanent, disability. So David did not include disability income insurance in his personal risk
management program. David is dealing with the risk of disability through
A) passive retention.
B) active retention.
C) risk control.
D) risk avoidance
55) The property and liability insurance industry fluctuates between periods of increasing
insurance rates and tight underwriting standards, and decreasing insurance rates and loosening
underwriting standards. Profitability in the industry follows these cyclical movements. What is
this pattern of fluctuations called?
A) the claims cycle
B) the underwriting cycle
C) the business cycle
D) the accounting cycle

56) The U.S. government is concerned that terrorists might try to crash a vehicle filled with
explosives into a U.S. embassy in a foreign country. Inside the gate to the embassy, they installed
steel and cement posts in the road. These posts can be raised up from the ground to form a barrier
against suicide bombers. The posts can be lowered back into the ground to allow safe vehicles to
pass. This physical barrier system illustrates which risk management technique?
A) risk avoidance
B) insurance transfer
C) loss prevention
D) noninsurance transfer