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1. Under California law, insurance is best defined as a contract whereby one party undertakes to:

California Insurance Code §22 defines insurance as a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event. Insurance is about indemnification for a contingent loss, not guaranteeing profit, paying annuities, or pooling savings.

2. A small business owner asks her broker to insure her chance of profit on a new restaurant venture. The broker should explain that this exposure is not insurable because it is:

Insurers will only write pure risk — situations involving the chance of loss or no loss. The chance of profit on a business venture is speculative risk because it also includes the chance of gain, and speculative risk is uninsurable as a matter of underwriting and public policy.

3. A homeowner buys a comprehensive policy and immediately stops locking his front door because he reasons that any theft will be covered. This change in behavior is BEST described as:

A morale or attitudinal hazard is the careless behavior that grows because the insured knows coverage is in place. It differs from a moral hazard, which involves dishonesty or intent to file a fraudulent claim, and from a physical hazard, which is a tangible condition like a broken lock.

4. The principle that allows actuaries to predict losses with reasonable accuracy as the number of similar exposure units grows is:

The law of large numbers is the statistical foundation of insurance: as the number of similar exposure units observed grows, actual losses approach the predicted average. Indemnity, utmost good faith, and adhesion describe legal features of the contract, not a statistical prediction tool.

5. An auto insurer notices that drivers with three recent at-fault losses are far more likely to apply for a new policy than drivers with clean records. This pattern is BEST described as:

Adverse selection is the tendency of higher-than-average risks to seek insurance more aggressively than the general public. Underwriting standards, including the right to decline or surcharge, exist precisely to control adverse selection so the pool stays balanced.

6. Which of the following is NOT one of the four essential elements of an insurance contract?

The four contract elements are offer and acceptance, consideration, legally competent parties, and a legal purpose. Notarization is not required; insurance contracts may be formed by oral binders and accepted applications without a notary.

7. An insured pays a $900 annual premium and suffers a $300,000 fire loss in the first month of the policy. The fact that the value exchanged is unequal and depends on chance makes the insurance contract:

An aleatory contract is one in which the values exchanged are unequal and depend on a chance event. The insured may pay a small premium and collect a very large sum, or pay premium for years and collect nothing. Unilateral, conditional, and bilateral describe different features of the contract.

8. An ambiguous exclusion appears in a homeowners policy. Under California law, the ambiguity will most likely be construed:

Insurance policies are contracts of adhesion drafted by the insurer and offered take-it-or-leave-it. Under long-standing California case law, any ambiguity in the contract is construed against the drafter, which means against the insurer and in favor of coverage for the insured.

9. A homeowner sells her house on April 1 but forgets to cancel her fire policy. The house burns on May 15. Under California property insurance law, the seller can recover:

California Insurance Code §286 requires that an insurable interest in property exist at the time of the loss. Because the seller transferred ownership before the fire, she had no insurable interest when the loss occurred and may not recover anything under the policy. This is a key contrast with life insurance, where insurable interest need only exist at policy inception.

10. A commercial applicant fails to disclose that he was non-renewed by two prior carriers for arson suspicions. Under California law, the failure to disclose this material fact is:

Under California Insurance Code §§330–334, concealment is the failure to communicate a material fact one knows and ought to communicate. The injured party (typically the insurer) is entitled to rescind the policy, whether or not the concealment was intentional. The insurer does not have to prove fraud to rescind based on concealment.

11. An insurer pays its insured $40,000 for collision damage caused entirely by a negligent third-party driver. The insurer then sues the at-fault driver to recover the $40,000. This action is BEST described as:

Subrogation is the right of the insurer, after paying its insured, to step into the insured's shoes and pursue any third party legally responsible for the loss. Subrogation enforces the indemnity principle by preventing the insured from collecting twice and shifting the loss back to the at-fault party. Coinsurance and reinsurance address different problems.

12. A California homeowner suffers a fire loss to a 15-year-old roof. The policy provides Actual Cash Value coverage. Under §2051 the insurer will pay:

Cal. Ins. Code §2051 defines Actual Cash Value (ACV) for most California property losses as the replacement cost at the time of loss minus depreciation. A 15-year-old roof is paid at its depreciated value, not at the new-roof cost. Replacement Cost with a depreciation holdback is a separate, optional coverage (§2051.5).

13. A commercial building has a replacement cost of $500,000 and a policy with an 80% coinsurance clause. The insured carries only $300,000 of insurance. After a $100,000 partial loss (ignore deductible), how much will the insurer pay?

Required insurance = 80% × $500,000 = $400,000. The insured carries $300,000. Payment = (Carried ÷ Required) × Loss = ($300,000 ÷ $400,000) × $100,000 = 0.75 × $100,000 = $75,000. The coinsurance penalty applies because the insured failed to insure to value, even though the loss is less than the policy limit.

14. Two policies cover the same warehouse: Policy A with a $400,000 limit and Policy B with a $600,000 limit, each containing a pro-rata other-insurance clause. A covered $200,000 loss occurs. Policy A will pay:

Under a pro-rata other-insurance clause, each insurer pays the proportion that its limit bears to the total insurance in force. Total = $400,000 + $600,000 = $1,000,000. Policy A's share = $400,000 ÷ $1,000,000 = 40% × $200,000 = $80,000. Policy B pays the remaining 60% = $120,000.

15. A California earthquake endorsement carries a 15% deductible on a $400,000 dwelling limit. After a covered earthquake causes $90,000 in damage, the deductible the insured must absorb is:

A percentage deductible is a percent of the dwelling (Coverage A) limit, not a percent of the loss. 15% × $400,000 = $60,000 deductible. The insurer would then pay the remaining $30,000 of the $90,000 loss. Percentage deductibles are common on California earthquake and on hurricane policies elsewhere because they significantly reduce insurer exposure to catastrophic events.