Delaware Property & Casualty Insurance License Exam — All Questions

Which type of risk is insurable by a property and casualty insurer?

• a.Speculative risk, since it carries a chance of gain
• b.Market risk, since price movements are predictable
• c.Pure risk, since it carries only a chance of loss✓
• d.Dynamic risk, since it shifts with the economy

Insurers cover pure risk, which is a situation with only two possible outcomes: a loss or no loss, with no possibility of gain. Speculative risk (such as gambling or investing) includes a chance of gain and is not insurable, because insurance is meant to restore a loss, not create profit. Market and dynamic risks generally involve speculative elements and broad economic change that are not suited to insurance pooling.

A hazard that arises from a person's carelessness or indifference to a loss because insurance exists is called a:

• a.Legal hazard
• b.Physical hazard
• c.Moral hazard
• d.Morale hazard✓

A morale hazard is an attitude of carelessness or indifference to loss because the person knows insurance will pay (for example, leaving a car unlocked). A physical hazard is a tangible condition that increases the chance of loss, such as an oily rag pile. A moral hazard involves dishonesty, such as intentionally causing a loss to collect. Distinguishing morale from moral hazard is a common exam point: morale is carelessness, moral is dishonesty.

The principle of indemnity is best described as:

• a.Guaranteeing the insured a small profit after a loss
• b.Replacing property with new items regardless of its age
• c.Restoring the insured to the position held just before the loss✓
• d.Paying out the full policy limit for every covered loss

Indemnity means restoring the insured to the approximate financial condition they were in just before the loss, so they are made whole but do not profit. Paying the full limit regardless of the actual loss would violate indemnity by allowing gain. Property insurance is built on indemnity, which is why concepts like actual cash value, deductibles, and other-insurance clauses exist to prevent overpayment.

For a property insurance claim to be valid, the insured must have an insurable interest in the property:

• a.Only when the policy is renewed
• b.At the time of the loss✓
• c.At no particular time; ownership is enough
• d.Only when the policy is first purchased

In property and casualty insurance, insurable interest must exist at the time of the loss, because the purpose is to indemnify an actual financial loss. This differs from life insurance, where insurable interest must exist only when the policy begins. A person who has sold the covered property before a loss no longer has an insurable interest and cannot collect.

An insurance contract is described as a contract of adhesion. This means:

• a.Both parties negotiate and draft the wording together
• b.Either party may change the wording at any later time
• c.Only the insured makes a legally enforceable promise
• d.One party writes it and the other accepts it as written✓

A contract of adhesion is prepared by one party (the insurer) and offered to the applicant on a take-it-or-leave-it basis, with no negotiation of terms. Because the insured did not write the wording, any ambiguity is generally interpreted in favor of the insured. This is separate from the contract being unilateral (only the insurer makes a legally enforceable promise) and aleatory (an unequal exchange of value dependent on chance).

A restaurant owner faces the chance that a kitchen fire destroys the building and the chance that a second location earns or loses money. An underwriter will consider only the fire exposure because:

• a.the earnings exposure is a peril the policy defines away
• b.the fire exposure is a pure risk, holding out loss or no loss✓
• c.the earnings exposure is a physical hazard, not a real risk
• d.the fire exposure is a speculative risk a large pool absorbs

Insurers underwrite pure risk, where the only outcomes are a loss or no loss. The second location is a speculative risk because it can also produce a gain, and paying for that would turn insurance into an investment. Calling the earnings exposure a physical hazard confuses a tangible condition that raises the chance of loss with a business decision taken for profit.

An insurer that writes 60,000 similar small commercial buildings predicts its yearly fire losses far more closely than one writing 600. The reason is:

• a.the law of large numbers, which sharpens the loss forecast✓
• b.the principle of indemnity, which caps what a claim can pay
• c.the doctrine of utmost good faith binding both of the parties
• d.adverse selection, which pulls poorer risks to a pool

The law of large numbers says that as the number of similar, independent exposure units grows, actual results move closer to the predicted results, which is what lets an insurer price a class. Adverse selection describes who buys coverage, not how accurately losses can be forecast. Indemnity limits recovery to the amount of loss and has nothing to do with forecasting accuracy.

A roofing contractor with three large liability claims shops hard for coverage while claim-free roofers renew quietly. An underwriter who prices the whole class alike is exposed to:

• a.adverse selection, drawing worse risks at an average price✓
• b.moral hazard, since the poor risks may stage their claims
• c.a catastrophe exposure, since one storm strikes every roofer
• d.the law of large numbers, which levels the results out again

Adverse selection is the tendency of applicants with a higher-than-average chance of loss to seek insurance most eagerly, so a single average price attracts the worst risks and repels the best. Underwriting and classification exist to counter it. Moral hazard is a different problem: dishonesty by an insured who wants a loss to happen, not a pricing distortion in who applies.

A survey of an older warehouse finds brittle wiring and a blocked exit door. In insurance terms these two conditions are:

• a.physical hazards that raise the chance a loss will occur✓
• b.perils, because they are the direct cause of any later fire
• c.moral hazards, since the owner might profit by a fire
• d.morale hazards created by the owner's indifference to safety

A peril is the cause of loss itself, such as fire; a hazard is a condition that makes the loss more likely or more severe. Brittle wiring and a blocked exit are tangible conditions, so they are physical hazards. Morale hazard is carelessness that grows out of having insurance, and moral hazard is outright dishonesty such as arson, neither of which is a physical condition of the building.

A trucking firm carries a large self-insured retention because minor cargo scuffs happen weekly and each one costs very little. This choice is best described as:

• a.reduction, which cuts the severity of any one loss when it happens
• b.avoidance, which drops the exposure out of the business entirely
• c.retention, which suits high-frequency, low-severity losses✓
• d.transfer, which is the right answer for small and frequent losses

Retention means funding losses internally, and it fits exposures that are frequent but small, because such losses are predictable and cheap to absorb while insuring them would cost more in expense loading than the losses themselves. Transfer through insurance is reserved for the opposite profile, low frequency and high severity. Avoidance would mean giving up the hauling operation altogether.

Which characteristic of a loss exposure makes it hard for a private insurer to insure?

• a.a loss that is definite in time, place, cause and amount
• b.a loss large enough to create real hardship for the insured
• c.a loss that happens by chance rather than by the insured's design
• d.a loss that would strike an enormous number of insureds at once✓

An insurable risk should not be catastrophic to the insurer, because a peril that hits a huge share of the book at the same moment destroys the pooling on which pricing depends; that is why such exposures move to reinsurance, pools or federal programs. The other three are requirements an insurable exposure should meet: losses must be definite and measurable, accidental, and significant enough to be worth insuring.

Describing an insurance policy as an aleatory contract means that:

• a.one side writes the wording and the other takes it as offered
• b.the insurer alone makes a promise a court enforces
• c.the amounts the two sides exchange may be very unequal✓
• d.the insured must satisfy stated duties before a claim is paid

Aleatory describes an exchange of unequal value that turns on an uncertain event: a small premium may buy a very large claim payment, or produce no payment at all. The description of only one enforceable promise is what makes the contract unilateral, the duties-before-payment description is what makes it conditional, and the take-it-as-written description is adhesion. All four labels fit an insurance policy, but each names a different feature.

An insurance policy is called a unilateral contract. The practical consequence is that:

• a.the insured can be sued for failing to pay the renewal premium
• b.only the insurer has made a promise the other side can enforce✓
• c.the insured is bound to keep the coverage for the full term
• d.each side has promised the other something of equal money value

Only the insurer gives a legally enforceable promise, namely to pay covered losses; the insured merely pays premium and can stop at any time, which is why an insured cannot be sued for declining to renew. The equal-value description contradicts the aleatory nature of the contract. Note that the promise is still conditional, since the insurer owes nothing until the policy conditions are met.

A commercial applicant does not mention an earlier fire loss that a court found was deliberately set, and the application does not ask about it. Failing to volunteer that fact is:

• a.a waiver by the insurer, which did not ask about it
• b.concealment, a breach of the duty of utmost good faith✓
• c.an innocent misstatement the insurer is required to overlook
• d.a warranty breach, since every application fact is warranted

Concealment is the silent withholding of a material fact that the applicant knows and the insurer would want, and because insurance is a contract of utmost good faith it can give the insurer grounds to void the policy even though no question was asked. Treating the insurer's silence as a waiver misstates waiver, which is the intentional giving up of a known right by the insurer, not the applicant's own choice to stay quiet.

On a commercial application, how does a warranty differ from a representation?

• a.a warranty is believed true as far as the applicant knows
• b.a warranty is guaranteed true and becomes part of the contract✓
• c.a warranty covers statements made after policy issue
• d.a warranty may be withdrawn by the applicant before any claim arises

A warranty is a statement guaranteed to be true that is written into the contract, so even a small untruth can give the insurer grounds to void coverage. A representation is only offered as true to the best of the applicant's knowledge, and it must be both false and material before the insurer can act on it. The belief-based description therefore defines a representation, not a warranty.

A company sells its warehouse in March but leaves the property policy in force, and the building burns in June. The claim fails because insurable interest in property must exist:

• a.at the time of the loss, whatever was true when it was written✓
• b.when the policy is applied for and underwritten, and no later
• c.continuously from the application through the end of the term
• d.at the moment of application and again at each renewal date

Property insurance indemnifies a financial stake, so the insured must stand to lose something when the loss happens; the seller who no longer owns the warehouse suffers no loss and collects nothing. Requiring the interest only at issue would let a policy pay someone who has since walked away, which is exactly the wagering that the rule prevents. Life insurance takes the opposite approach, testing the interest at inception.

Which of these settlement features is an exception to the principle of indemnity?

• a.an actual cash value settlement, taken after depreciation
• b.replacement cost coverage, which pays without a deduction for age✓
• c.subrogation, which recovers the payment from a liable third party
• d.a coinsurance clause, which penalizes an underinsured building

Indemnity aims to restore the insured to the same financial position as before the loss and no better, and an actual cash value settlement does exactly that by subtracting depreciation. Replacement cost pays for new property without that deduction, so the insured can end up better off, making it a recognized exception. Subrogation and coinsurance support indemnity rather than defeat it, one by preventing a double recovery and the other by policing the amount carried.

After a water loss, an insured signs a release of the plumbing contractor that caused it, then files the claim. The insurer may:

• a.pay in full and still sue the released contractor
• b.reduce or deny the claim, since its recovery right is gone✓
• c.pay in full and then bill the insured for the recovery it lost
• d.void the policy from its start date for material concealment

Subrogation lets the insurer step into the insured's place and pursue the party at fault, and policy conditions require the insured to do nothing after a loss that impairs that right. A release given to the responsible contractor destroys the right, so the insurer can reduce or deny the claim to that extent. Suing the contractor anyway is not open to the insurer, because it can have no better claim than the insured it stands in for.

An adjuster accepts a late proof of loss, inspects the damage and negotiates for weeks, then denies the claim because the proof was late. The insurer is most likely barred by:

• a.estoppel, after conduct that waived the filing requirement✓
• b.utmost good faith, which obliged the insured to file on time
• c.adhesion, which reads an unclear wording in the insurer's favor
• d.subrogation, which moves the loss to the party truly at fault

Waiver is the voluntary giving up of a known right, and estoppel prevents a party from taking back a position that the other side reasonably relied on to its detriment; by handling the claim as though the late proof were acceptable, the insurer gave up that defense. Adhesion is described backwards here, because ambiguous wording drafted by the insurer is construed against the insurer and in favor of the insured.

A producer has no written power to bind a certain commercial line, but has bound it for years while the insurer accepted the business and paid commissions. A court would most likely find:

• a.implied authority, which covers routine office tasks
• b.no authority at all, because the agency contract omitted the line
• c.apparent authority, created by the insurer's own conduct✓
• d.express authority, from a later change to the contract

Apparent authority arises when the insurer's conduct leads a reasonable applicant to believe the producer holds powers the written contract never granted, and the insurer is bound by acts within that appearance. Express authority is what the agency agreement states in words, and implied authority is what is incidental to carrying out the express grant, such as ordering supplies or paying office staff.

In the traditional legal distinction between the two, a broker differs from an agent because a broker:

• a.holds binding authority that an insurer's own agent would lack
• b.is appointed by an insurer to accept applications on its behalf
• c.represents the applicant when placing business with an insurer✓
• d.may collect the premium but owes the buyer no duty of care

A broker is legally the representative of the client and shops the market for that client, while an agent represents the insurer under an agency contract and can commonly bind coverage for it. Saying a broker is appointed by the insurer describes an agent instead. Both are licensed producers who owe duties to the people they serve, so the idea that a broker owes the buyer nothing is wrong.

A producer deposits client premiums into the agency's general operating account and pays the office rent out of it. This conduct breaches:

• a.the duty of utmost good faith owed to a commercial applicant
• b.the rule against rebating any part of a quoted premium
• c.the conditions of the agency's errors and omissions policy
• d.the fiduciary duty owed on premium money held in trust✓

Premiums collected by a producer belong to the insurer or the client, not to the agency, so they are trust funds and the producer holds them as a fiduciary; spending them on agency overhead is commingling and conversion. Rebating is a different offense, the giving of value not stated in the policy to induce a sale, and it says nothing about how collected money is banked.

A contractor must show proof of property coverage today, although the policy itself will not be issued for three weeks. A binder issued by the producer:

• a.commits the insurer to issue the policy on the terms shown
• b.is only a quotation and starts no coverage until money is paid
• c.must be in writing, since an oral binder carries no legal effect
• d.gives temporary coverage until the policy is issued or declined✓

A binder is temporary evidence of real coverage that bridges the gap before the policy is delivered, and it ends when the policy is issued or when the insurer declines the risk. Coverage under a binder does not wait for the premium to be paid, and a binder may be oral where the producer holds binding authority, although prudent practice is to confirm it in writing. The insurer can still decline and issue nothing.

The structural difference between a stock insurer and a mutual insurer is that the mutual insurer:

• a.issues assessable policies in each and every line that it writes
• b.pays out its underwriting profit as stock dividends
• c.is owned by shareholders who elect its board members
• d.is owned by its policyholders, who may receive dividends✓

A mutual insurer is owned by the policyholders it insures, and any divisible surplus is returned to them as policyholder dividends rather than paid out to investors. A stock insurer is owned by shareholders who elect the board and receive stock dividends, which is the description offered in two of the wrong answers. Assessable policies exist in some mutuals but are not a feature of every mutual line.

A group of subscribers agree to exchange insurance among themselves, and the arrangement is managed for them by an attorney-in-fact. This insurer is:

• a.a fraternal benefit society, which operates through a lodge system
• b.a captive insurer set up by one parent to fund its own risks
• c.a reciprocal exchange, unincorporated and owned by members✓
• d.a risk retention group, which its members own for liability lines

A reciprocal is an unincorporated group of subscribers who insure one another, run by an attorney-in-fact who handles underwriting and claims for the group. A captive is formed by a parent organization to insure that parent's own exposures, and a risk retention group is a member-owned insurer restricted to liability coverage for members in a similar business, so neither uses an attorney-in-fact structure.

In the property and casualty market, Lloyd's is best described as:

• a.a rating bureau that files loss costs for its members
• b.a large mutual insurer owned by its policyholders
• c.a reinsurance pool run by the British government
• d.a marketplace in which syndicates of its members accept risk✓

Lloyd's is not an insurance company but an organized marketplace in which syndicates, backed by their members, underwrite risks brought to them by brokers; the liability sits with the members of each syndicate rather than with Lloyd's itself. It is often used for unusual or hard-to-place exposures. A rating bureau does something different, gathering loss data and filing loss costs that insurers may use.

A commercial account with a difficult exposure is placed through surplus lines. Compared with an admitted insurer, the surplus lines insurer:

• a.must still file every policy form with the insurance department
• b.carries the same guaranty fund protection as a licensed insurer
• c.is not licensed in the state, and its policy has no guaranty fund backing✓
• d.is licensed, but files its rates through a different bureau

A non-admitted insurer holds no certificate of authority in the state, so its policies fall outside the state guaranty fund and the insured bears the insolvency risk; in exchange it has far more freedom in rates and forms, which is what allows it to write hard-to-place exposures. Surplus lines placements are generally allowed only after a diligent search shows the admitted market has declined the risk.

A residual market mechanism such as an assigned-risk plan exists in order to:

• a.supply free coverage that a federal appropriation pays for
• b.insure only the layer of loss that sits above a large deductible
• c.cover applicants the standard market has declined to write✓
• d.reinsure admitted insurers against their worst catastrophe years

Residual markets are the market of last resort for applicants who cannot buy coverage in the voluntary market, and the burden is generally spread among the insurers writing that line, not funded by a federal appropriation. Coverage is real insurance that is paid for, usually at a higher price and sometimes with narrower terms. Reinsuring the industry against catastrophe years is a wholly separate function.

A primary insurer signs an agreement under which the reinsurer must take an agreed share of every commercial property risk in a defined class. This is:

• a.an excess policy the insured buys above its own primary limits
• b.a pooling agreement among competing primary insurers
• c.treaty reinsurance, which is accepted automatically by class✓
• d.facultative reinsurance, negotiated one risk at a time

Under a treaty the reinsurer agrees in advance to accept all business falling inside the defined class, so no risk is offered or judged individually. Facultative reinsurance is the opposite, with each risk submitted and the reinsurer free to decline it. Primary insurers buy either form to add capacity for large accounts, to smooth results, to guard against a catastrophe and to relieve pressure on surplus.

Under the McCarran-Ferguson Act, the business of insurance is:

• a.left to state regulation so long as the states regulate it✓
• b.regulated nationally by a single federal insurance commissioner
• c.regulated by the states for life lines and federally for others
• d.exempt from all federal law, including the criminal statutes

McCarran-Ferguson declares that regulating and taxing insurance is in the public interest as a matter for the states, and it holds most federal law back to the extent that a state actually regulates the subject. That is why licensing, rate filings and market conduct are state functions across all lines. It is not a blanket exemption from federal law, and there is no single federal insurance commissioner.

Rates are required to be adequate, not excessive, and not unfairly discriminatory. A rate meets the adequacy test when it:

• a.brings in enough to pay the expected losses and expenses of the class✓
• b.matches the rate filed by the largest insurer in that class
• c.is the highest price a competitive market will bear that year
• d.charges every insured in the line an identical premium

A rate is built from the expected loss cost plus expenses plus an allowance for profit and contingencies, so adequacy asks whether the price will fund the losses and costs of the class and keep the insurer solvent. Not excessive means the price is not unreasonably high for the coverage given, and not unfairly discriminatory means insureds with similar loss potential are charged similarly, which is not the same as charging everyone the same amount.

Premium equals the rate multiplied by the number of exposure units. Which exposure base is normally used to rate workers compensation?

• a.the total sales receipts the employer records for the term
• b.the count of full-time employees listed on the payroll register
• c.the square footage of the space the employer occupies
• d.payroll by class code, for each $100 of remuneration✓

Workers compensation is rated on payroll within each governing class code, priced per $100 of remuneration, because payroll tracks both the number of workers exposed and the time they spend at the work. Sales receipts and area are common exposure bases for general liability instead, and a simple headcount ignores wages, hours and the differing hazard of each job classification.

An insurer's incurred losses run 68% of premium and its underwriting expenses run 29%. Its combined ratio and what that ratio shows are:

• a.97%, an underwriting loss that investment income must cover
• b.97%, an underwriting gain before any investment income✓
• c.68%, since expenses sit outside the combined ratio entirely
• d.39%, the gap between the loss ratio and the expense ratio

The combined ratio adds the loss ratio to the expense ratio, so 68% plus 29% gives 97%. A figure under 100% means the insurer collected more premium than it paid out in losses and expenses, which is an underwriting profit before investment income is counted; a figure above 100% would be the underwriting loss. Subtracting the two ratios has no meaning, and expenses are very much part of the calculation.

A producer is asked to add a newly bought warehouse to a commercial property policy, forgets to send the request, and the building burns uninsured. The producer faces:

• a.a claim under the agency's own general liability coverage
• b.a fidelity bond claim, which responds to dishonest agency acts
• c.an errors and omissions claim for the negligent service✓
• d.no exposure, because only the insurer can issue an endorsement

Failing to place or amend coverage that a client asked for is professional negligence, and errors and omissions insurance is the policy written for exactly that exposure. A general liability policy answers for bodily injury and property damage liability, not for the purely financial loss a professional mistake causes, so it would not respond. A fidelity bond covers dishonest acts such as theft by an employee, not an honest mistake in servicing an account.

Under 18 U.S.C. 1033, a person convicted of a felony involving dishonesty or a breach of trust may work in the business of insurance only if:

• a.at least ten years have run since the date of the conviction
• b.the person is kept in claims or clerical work rather than sales
• c.the employing insurer discloses the conviction to policyholders
• d.the person first obtains the written consent of an insurance regulator✓

The federal statute bars anyone convicted of a felony involving dishonesty or breach of trust from engaging in the business of insurance affecting interstate commerce unless written consent is granted by the appropriate insurance regulatory official, and it also penalizes any insurer that knowingly employs such a person. Simply waiting out a period of years, disclosing the conviction or moving the person to a back-office role does not satisfy it.

An insurer declines an application partly on the strength of information in a consumer report. The Fair Credit Reporting Act then requires the insurer to:

• a.tell the applicant of the adverse action and name the agency✓
• b.correct the information in dispute before it declines the applicant
• c.mail the applicant a free copy of the consumer report
• d.get the applicant's written consent before ordering it

When a consumer report contributes to an adverse decision such as a declination or a higher rate, the insurer must give the consumer an adverse-action notice identifying the reporting agency and explaining the right to obtain a copy and to dispute what it says. The agency, not the insurer, supplies the report to the consumer. Underwriting is a permissible purpose, so a separate written permission is not what the act demands here.

The Terrorism Risk Insurance Act obliges an insurer writing commercial property and casualty coverage to:

• a.build terrorism coverage into each policy at no extra premium
• b.make terrorism coverage available, which the insured may decline✓
• c.cede its whole terrorism exposure to a federal reinsurance pool
• d.exclude losses from certified acts of terrorism in every policy

The act's make-available requirement means the insurer must offer coverage for certified acts of terrorism on terms that do not differ materially from the rest of the policy, and it must disclose the premium for it; the buyer is then free to accept or reject the offer. Coverage is neither automatic and free nor forbidden, and the federal backstop shares losses after a certified event rather than taking the whole exposure by cession.

To close a sale, a producer offers to pay the client's first premium installment out of personal funds. This practice is:

• a.twisting, which induces a replacement through a misstatement
• b.rebating, giving value that the policy does not state✓
• c.coercion, forcing a purchase as a condition of getting credit
• d.unfair discrimination between insureds of the same class

Rebating is the offer of any inducement not specified in the policy, such as paying part of the premium or sharing a commission, to persuade someone to buy. Twisting is a different unfair practice, using misrepresentation to talk a policyholder into dropping one policy for another, and unfair discrimination is charging insureds of like risk different prices. All are unfair trade practices, but only one describes paying the client's premium.