Insurance and Risk Management Spring 2015 FINAL EXAM. Multiple Choice

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1 FIN 322 Prof. Thistle Insurance and Risk Management Spring 2015 FINAL EXAM Multiple Choice 1. C 26. A 2. d 27. C 3. A 28. C 4. C 29. S 5. C 30. A 6. D 31. A 7. A 32. A 8. C 33. B 9. B 34. C 10. D 35. C 11. A 36. C 12. C 37. A 13. B 38. C 14. A 39. B 15. C 40. D 16. A 41. D 17. C 42. C 18. B 43. C 19. C 44. C 20. C 45. C 21. C 46. A 22. C 47. D 23. C 48. B 24. S 49. D 25. B 50. C

2 Part B. Essay (10 pts each) WRITE ALL ANSWERS IN THE EXAM BOOK Please write legibly (If I can t read it, it s wrong). 51. ABC Company insured its building for $1,400,000 under a replacement cost policy that included an 80 percent coinsurance clause. The policy includes an earthquake endorsement with a 15 percent deductible. The building had a replacement cost of $2 million when it sustained $540,000 in damage from a windstorm. (a) Assuming there is no deductible, how much will ABC recover from its insurance company? Explain why. (b) Suppose that the damage was due to a sinkhole rather than wind. How much will ABC recover from its insurance company? Explain why. (a) The 80 percent coinsurance clause requires the insured to carry at least $1,600,000 of property insurance to avoid a coinsurance penalty (80% $2,000,000). The building, however, is insured for only $1,400,000, or seven-eighths of the required amount. Thus, only seven-eighths of the loss will be paid, or $472,500. This can be illustrated by the coinsurance formula: Amount of insurance carried loss amount paid Amount of insurance required 1,400, , ,500 1,600,000 (a) Sinkholes (earth movement) are normally an excluded peril under property insurance policies. However, ABC has an earthquake endorsement and is able to recover. If the building were fully insured, ABC would recover 85% of the loss or $459,000. Under the coinsurance clause, ABS will recover seven-eighths of that amount or $401,625

3 52. A participating ordinary life insurance policy in the amount of $200,000 is issued to an individual aged thirty five. The following cost data are given. Assume a 6 % discount rate and a 20 year time horizon. Annual Premium $890 Annual Dividend $0 annually, years1 5 $100 annually, years 6 20 Cash value at 20 years $11418 (a) Compute the cost of the policy using the surrender cost index. (b) Compute the cost of the policy using the net payment cost index. (a) Surrender Cost Index Future Value of Premiums $34, Less Future Value of Dividends -2, Less Cash Value -11, Net Future Value $20, FVAD interest factor Annual Cost $ (b) Net Payment Cost Index Future Value of Premiums $34, Less Future Value of Dividends -2, Net Future Value $32, FVAD interest factor Annual Cost $830.31

4 53. Brittany, age 28, purchased a individual major medical insurance policy with a lifetime limit of $1 million, a calendar year deductible of $3500, a 10 percent coinsurance provision. Brittany had emergency surgery for an inflamed appendix. Covered medical expenses are $35,000. Brittany also lost $1000 in wages because she could not work for one week. (a) What is the amount paid by insurer? (b) What is the amount paid by the Brittany? (c) What is the amount paid by the insurer if the policy has an annual stop loss limit of $7,000? (a)covered medical expenses are $35,000. Brittany must meet a $3500 deductible. In the absence of a stop-loss provision, the insurer would pay 90 percent of $31.500, or $28,350. A major medical policy does not cover the loss of wages. (b)brittany must meet a $3500 deductible. In the absence of a stop-loss provision, Brittany would pay 10 percent of $31,500, or $3,150. Brittany spends a total of $6,650. (c) Since Brittany s out-of-pocket expenditures of $6,650 are under the stop=loss limit of $7,000, the insurer pays $28, Describe the underwriting principles employed in group insurance. Certain underwriting principles are followed in group insurance to obtain favorable loss experience: (a) Insurance must be incidental to the group. (b) There should be a flow of persons through the group. (c) The benefits should be automatically determined by some formula that precludes individual selection of insurance amounts. (d) A minimum percentage of eligible employees should participate in the plan. (e) There should be a third-party sharing of costs. (f) There should be simple and efficient administration.

5 55. Megan has her home insured with an unendorsed HO 3 (special form) homeowners policy. In each case, indicate whether the loss is covered or not covered. If the loss is not covered, explain why it is not covered. Treat each situation separately. (a) Megan accidentally spills a gallon can of paint while painting a bedroom. The wall to wall carpeting in the bedroom is badly damaged and must be replaced. (b) Water backs up from a clogged drainpipe, partially flooding the basement. Books and furniture stored in the basement are damaged. (c) Meganʹs house is destroyed by a tornado. Megan is unharmed, but her valuable Doberman Pinscher dog is killed in the tornado. (d) Defective wiring in the attic causes a fire, extensively damaging the house. Megan is forced to move into a furnished apartment for three months while the house is repaired. (e) Meganʹs 20 year old son, Bob, is home from college for Christmas. His X Box is stolen from his dorm room during his absence. (a) Covered. Wall-to-wall carpeting is part of the dwelling. Since the loss is not excluded, it is covered. (b) Not covered. Damage from water that backs up through sewers or drains is excluded. (c) The dwelling is covered for windstorm. Animals are excluded under personal property. (d) Covered. The additional living expense is covered under Coverage D. The fire loss to the dwelling is covered under Coverage A (e) Covered. However, there is a $1500 limit on the theft of jewelry, $200 limit on money, and a $1500 limit on tickets. FORMULAS 1 PV FV (1 r) T 1 1 PVA C 1 r (1 r) 1 T T FVA C (1 r) 1 PV ( 1 r FV ) r T PVAD ( 1 r) PVA FVAD (1 r) FVA