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CHAPTER- 3

Atwell Insurance Company has the following expenses:


Dividends $50,000
Claim staff salaries $90,000
Agents' commissions $180,000
Advertising costs $30,000
Rent and utilities $40,000
What is the amount of Atwell Insurance Company's acquisition expenses?
A. $210,000
B. $260,000
C. $310,000
D. $410,000

A financial analyst determines that the combined ratio for the DEF Insurance Company was 112 percent for the prior year. Which
one of the following statements best describes how the analyst can interpret this information for the year?
A. The insurer's net profit had to be negative.
B. The insurer had a loss ratio that was over 100 percent.
C. The insurer had an underwriting loss.
D. The insurer's expense ratio exceeded its loss ratio.

On November 1, Mammoth Insurance Company issued a one-year business auto policy to Mid-State Painting Company with a
premium of $24,000. What was the unearned premium for this policy as of December 31?
A. $4,000
B. $6,000
C. $20,000
D. $24,000

Which one of the following is true with regard to nonadmitted assets?


A. Regulators allow them to be shown on insurers' financial statements.
B. They can be readily converted to cash at or near their market value.
C. They help prevent an insurer from overstating its true financial condition.
D. Regulators assume that they are readily available for paying claims.

An analyst in the financial department for an insurer has calculated the loss ratio to be 1.03. This result indicates that the insurer
is
A. Collecting approximately $1.03 in premium for every $1.00 it pays in claim-related expenses.
B. Collecting approximately $1.03 in premium for every $1.00 it pays in claim-related and underwriting expenses.
C. Paying out approximately $1.03 in claim-related and underwriting expenses for every $1.00 it collects in premium.
D. Paying out approximately $1.03 in claim-related expenses for every $1.00 it collects in premium.

An insurer's net underwriting gain or loss provides a better measure of the insurer's marketing, underwriting, and claims skills
than its overall gain or loss from operations. This is true because the overall gain or loss from operations includes investment
gains or losses that
A. Vary over time.
B. Are inversely related to how well the insurer conducts its marketing, underwriting, and claims activities.
C. Are not directly related to how well the insurer conducts its marketing, underwriting, and claims activities.
D. Are generally not subject to income tax.

The financial report for LMN Insurance contains the following information:
Earned premiums $8,000,000
Written premiums $10,000,000
Incurred losses $6,000,000
Incurred underwriting expenses $4,000,000
What is LMN Insurance's expense ratio?
A. 40%
B. 50%
C. 60%
D. 100%

The financial report for Hometown Insurer contains the following information:
Earned premiums $4,000,000
Written premiums $5,000,000
Net investment income $1,000,000
Incurred Losses $3,000,000
Incurred underwriting expense $2,000,000

What is Hometown Insurer's expense ratio?


A. 20%
B. 40%
C. 50%
D. 75%

Which one of the following is the correct formula for an insurer's overall operating ratio?
A. Loss ratio + Expense ratio
B. Combined ratio Dividend ratio
C. Loss ratio + Dividend ratio
D. Combined ratio Investment income ratio

Earned premiums are the portion of written premiums that


A. Apply to the part of the policy period that has already occurred.
B. Are available to generate investment income.
C. Are billed at the beginning of the policy period.
D. Apply to the part of the policy period that follows a loss.

All of the following appear on an insurer's balance sheet, EXCEPT:


A. Assets
B. Liabilities
C. Net income
D. Policyholders' surplus

Which one of the following is the correct formula for net investment income?
A. Investment income + change in investment expenses
B. Investment income - investment expenses
C. Change in investment expenses - investment income
D. Investment expenses + investment income

The investment income ratio indicates the


A. Cost of running an insurer's investment department.
B. Percentage of written premium represented by net investment income.
C. Degree of success achieved by the insurer in controlling losses.
D. Degree of success achieved by the insurer in its investment activities.

Which one of the following best explains why underwriting expenses are divided by written premiums rather than earned
premiums in order to calculate an insurer's expense ratio?
A. Loss adjustment expenses are incurred evenly throughout the policy period.
B. The expense ratio does not take into account an insurer's investment income.
C. Many underwriting expenses are incurred at the beginning of the policy period.
D. Insurance coverage is provided evenly throughout the policy period.

If an insurer's admitted assets stayed the same but its liabilities increased significantly, its policyholders' surplus would
A. Either stay the same or decrease.
B. Increase.
C. Decrease.
D. Either stay the same or increase.

Which one of the following is the best measure of the amount of insurance provided for a given period?
A. Earned premium
B. Paid premium
C. Written premium
D. Unearned premium

On January 1, 2005, the XYZ Insurance Company issued a policy with a one-year policy period. The premium for this policy was
$1,200. What was the unearned premium for this policy as of May 1, 2005?

A. $ 400
B. $ 600
C. $ 800
D. $1,200

If an insurer's losses and expenses exceed its written premiums and investment income, which one of the following must the
insurer use to meet its obligations?
A. Unearned premiums
B. Policyholders' surplus
C. Nonadmitted assets
D. Policyholder dividends

A policy provides coverage starting on April 1 with an annual premium of $800. How much premium is earned as of June 30?
A. $100
B. $200
C. $600
D. $800

The financial report for Hometown Insurer contains the following information:
Earned premiums $4,000,000
Written premiums $5,000,000
Net investment income $1,000,000
Incurred losses $3,000,000
Incurred underwriting expenses $2,000,000
What was the Hometown Insurer's combined ratio?
A. 75%
B. 95%
C. 105%
D. 115%

Expenses associated with an insurer's underwriting activity include all of the following, EXCEPT:
A. Investment expenses
B. Payment for losses
C. Loss adjustment expenses
D. Premium taxes, licenses, and fees

Which one of the following is considered to be an acquisition expense for an insurance company?
A. Dividends
B. Sales commissions
C. Losses
D. Guarantee fund expenses

On November 1, Peafowl Insurance Company issued a one-year business auto policy to Tri-State Painting Company with a
premium of $24,000. What was the written premium for this policy as of December 31?
A. $ 4,000
B. $ 6,000
C. $20,000
D. $24,000

ABC Insurance Company's combined ratio is 102. Its operating ratio is 98. These ratios indicate that
A. ABC's underwriting performance is offsetting the lack of investment earnings.
B. ABC's earned premium is greater than the sum of losses and expenses from its underwriting operations.
C. ABC's return on investments is offsetting the unprofitable underwriting performance.
D. ABC is not generating a profit from its core operations.

Compared to its net underwriting gain or loss, an insurer's overall gain or loss from operations gives a
A. Distorted picture of an insurer's profitability.
B. Less complete picture of an insurer's profitability.

C. More complete picture of an insurer's profitability.


D. More conservative picture of an insurer's profitability.

All of the following are categories of liabilities found on an insurer's balance sheet, EXCEPT:
A. Loss and loss expense reserves
B. Unearned premium reserves
C. "All other" liabilities
D. Policyholders' surplus

An insurer's loss expense reserve is


A. An asset designated to pay the cost of settling the claims included in the loss reserve.
B. An asset designated to pay claims for losses that have occurred.
C. A liability designated to pay the cost of settling the claims included in the loss reserve.
D. A liability designated to pay claims for losses that have occurred.

An insurer's balance sheet can best be described as a


A. Relationship between revenue and liabilities.
B. Relationship between assets and expenses.
C. Summary of premiums written.
D. Snapshot of its financial position.

Which one of the following is part of written premiums?


A. Investment income
B. Policyholders' surplus
C. Unearned premiums
D. Underwriting expenses

All of the following are true with regard to the unearned premium reserve, EXCEPT:
A. It equals the admitted portion of unearned premium minus the nonadmitted portion of unearned premium.
B. It represents premiums prepaid by insureds for services that the insurer has not yet rendered.
C. It represents the total premium refunds the insurer would owe its policyholders if it were to immediately cancel all policies.
D. It is the total of an insurer's unearned premiums on all policies at a particular time.

Which one of the following is a nonadmitted asset?


A. Stocks
B. Real estate
C. Premium balances due in less than ninety days
D. Office equipment

The two major sources of an insurer's investment funds are policyholders' surplus and
A. Reserves for loss expenses.
B. Acquisition expenses.
C. Premiums received but not yet used to pay claims.
D. Reserves for unearned premiums.

World Insurance Company has the following assets (all figures in '000s):
Cash $50,000
Stocks $400,000
Bonds $200,000
Real estate $500,000
Furniture and office equipment $70,000
Premium balance due in less than ninety days $20,000
Premium overdue more than ninety days $10,000
What is the amount of World's total admitted assets?
A. $ 450,000
B. $ 650,000
C. $1,170,000
D. $1,250,000

Insurers carefully evaluate the interaction between premiums and loss ratio and how changes in each affect profit. Which one of
the following statements concerning the relationship between premium and loss ratio is true?
A. If premiums increase by a greater percentage than incurred losses increase, the loss ratio will decrease.
B. If incurred losses increase at a faster rate than premiums, the loss ratio will improve.
C. If premiums decrease at a faster rate than losses increase, the loss ratio will decrease.
D. If losses decrease at a faster rate than premiums decrease, the loss ratio will increase.

Which one of the following is the correct formula for calculating an insurer's combined ratio?
A. Investment income ratio + overall operating ratio
B. Investment income ratio + premium income ratio
C. Loss ratio + expense ratio
D. Loss ratio + underwriting ratio

Unity Insurance Company (UIC) has an operating ratio of 0.98, a combined ratio of 1.02, and a loss ratio of 0.77. Considering
these ratios, which one of the following statements is true for UIC?
A. UIC's investment income is offsetting losses and expenses from its underwriting operation, allowing an operating profit.
B. UIC is collecting enough premium to allow a profit from its underwriting operations.
C. UIC is collecting enough premium exclusive of investment income to allow an operating profit.
D. UIC's favorable financial basis expense ratio is offsetting losses, allowing an underwriting profit.

A decrease in incurred losses will generally cause a decrease in all of the following, EXCEPT:
A. Combined ratio
B. Expense ratio
C. Overall ratio
D. Loss ratio

Most of the income an insurer receives is either from underwriting or


A. Nonadmitted assets.
B. Losses.
C. Policyholders' surplus.
D. Investments.

Which one of the following measures the amount an insurer would owe its policyholders in premium refunds if it were to
immediately cease operations?
A. Policyholders' surplus
B. Nonadmitted assets
C. "All other" liabilities
D. Unearned premium reserve

A combined ratio of 1.05 indicates that an insurer is


A. Profitable overall.
B. Not profitable on an underwriting basis.
C. Not profitable overall.
D. Profitable on an underwriting basis.

The financial report for Hometown Insurer contains the following information:
Earned premiums $4,000,000
Written premiums $5,000,000
Net investment income $1,000,000
Incurred losses $3,000,000
Incurred underwriting expense $2,000,000
What is Hometown Insurer's investment income ratio?
A. 10%
B. 20%
C. 25%
D. 50%

Earned premium for XYZ Insurance (XYZ) for the year was $500 million and incurred losses were $400 million. Incurred
underwriting expenses were $60 million. XYZ had a net investment gain of $40 million for the year. Which one of the following
is XYZ's overall gain or loss from operations?
A. $80 million gain
B. $80 million loss
C. $200 million gain
D. $200 million loss

Which one of the following is shown on the balance sheet of an insurer?


A. Cash and short-term investments
B. Incurred losses
C. Acquisition expenses
D. Net investment income

Admitted assets are types of property that regulators allow insurers to show as assets on their financial statements because they
are
A. Very stable in value.
B. Never subject to decreases in value.
C. Generally increasing in value.
D. Easily converted to cash at or near their market value.

The largest expense category for most insurers is payment for


A. Additions to loss reserves.
B. Acquisition expenses.
C. Losses arising from claims.
D. Loss adjustment expenses.

Which one of the following is an admitted asset?


A. Premium balances due in more than ninety days

B. Furniture
C. Supplies
D. Real estate

An increase in earned premiums with no change in written premiums or any other financial figures will generally cause a
decrease in all of the following, EXCEPT:
A. Dividend ratio
B. Combined ratio
C. Expense ratio
D. Investment income ratio

Earned premium for ABC Insurance (ABC) for the year was $400 million and incurred losses were $500 million. Incurred
underwriting expenses were $60 million. ABC had a net investment gain of $40 million for the year. Which one of the following
is ABC's overall gain or loss from operations?
A. $120 million gain
B. $120 million loss
C. $200 million gain
D. $200 million loss

Underwriting income (or loss) is calculated by subtracting losses and expenses from
A. Paid premium.
B. Written premium.
C. Earned premium.
D. Unearned premium.

An insurer's loss reserve is a(n)


A. Asset designated for paying claims for losses that have already occurred.
B. Liability designated for paying claims for losses that have already occurred.
C. Asset designated for paying claims for losses that might happen in the future.
D. Liability designated for paying claims for losses that might happen in the future.

The financial report for Hometown Insurer contains the following information:
Earned premiums $4,000,000
Written premiums $5,000,000
Net investment income $1,000,000
Incurred losses $3,000,000
Incurred underwriting expenses $2,000,000
What is Hometown Insurer's loss ratio?
A. 20%
B. 30%
C. 50%
D. 75%

Loss reserves are amounts designated by insurers to pay claims for losses that have
A. Not yet occurred but are likely to occur in the future.
B. Already occurred and the amount to be paid has been agreed.
C. Not yet occurred but are likely to be reported in the future.
D. Already occurred but are not yet settled.

Loss reserves are often the largest liability on an insurer's balance sheet. Loss reserves include
A. All loss amounts paid for the year.
B. Claim expenses paid for the year.
C. Unpaid loss amounts for claims not yet settled.
D. All loss amounts paid for the year, excluding expenses not yet settled.

For a one-year policy covering losses that take several years to develop, all of the following ratios are likely to be revised for
several years following the policy period, EXCEPT:
A. Expense ratio
B. Combined ratio
C. Loss ratio

D. Overall operating ratio

An insurer's income statement can best be described as a financial statement that shows the
A. Relationship between revenue and liabilities.
B. Relationship between assets and income.
C. Relationship between revenues, expenses, and net income.
D. Relationship between revenues and incurred losses.

If an insurer's admitted assets stayed the same but its liabilities decreased significantly, its policyholders' surplus would
A. Either stay the same or decrease.
B. Increase.
C. Decrease.
D. Either stay the same or increase.

A financial analyst determines that the combined ratio for the DEF Insurance Company was 112 percent for the prior year. Which
one of the following statements best describes how the analyst can interpret this information for the year?
A. The insurer's net profit had to be negative.
B. The insurer had a loss ratio that was over 100 percent.
C. The insurer had an underwriting loss.
D. The insurer's expense ratio exceeded its loss ratio.

The financial report for Apex Insurance contains the following information (all figures in '000s):
Admitted assets $500,000
Nonadmitted assets $400,000
Liabilities $300,000
What is the amount of Apex Insurance's policyholders' surplus?
A. $100,000
B. $200,000

C. $400,000
D. $600,000

Answers

A. $210,000

C. The insurer had an underwriting loss.


A combined ratio over 100 percent indicates that the insurer had an underwriting
loss

C. $20,000
The unearned premium was $20,000 because ten months of coverage remained.
10/12 X $24,000 = $20,000

C. They help prevent an insurer from overstating its true financial condition.
Because nonadmitted assets cannot be readily converted to cash at or near their market value,
regulators do not allow them to be shown on insurer's financial statments, which helps prevent
an insurer from overstating its true financial condtion.

D. Paying out approximately $1.03 in claim-related expenses for every $1.00 it


collects in premium.

C. Are not directly related to how well the insurer conducts its marketing,
underwriting, and claims activities.

A. 40%

B. 40%
Hometown Insurer's expense ratio is its incurred underwriting expenses
($2,000,000) divided by its written premiums ($5,000,000), or 40%.

D. Combined ratio - Investment income ratio

A. Apply to the part of the policy period that has already occurred.

C. Net income

B. Investment income - investment expenses

D. Degree of success achieved by the insurer in its investment activities.

C. Many underwriting expenses are incurred at the beginning of the policy period.
Many underwriting expenses, such as producer's commissions, are incurred at the beginning of
the policy period. Therefore, using written premiums rather than earned premiums for the
denominator provides a better match for camparing revenues to expenses when calculating the
expense ratio.

C. Decrease
Policyholders' surplus is admitted assets minus liabilities. Any increase in a liability
without an increase in admitted assets decreases policyholders' surplus.

A. Earned premium
Earned premiums are the portion of written premiums that apply to the part of the
policy period that has already occurred.

C. $800
May = 5th month so 4 months earned and 9 uneared, 8 X 100/month = $800 of
unearned premium.

B. Policyholders' surplus
The insurer must use its policyholders' surplus, which represents a cushion for
absorbing adverse results.

B. $200
Earned premiums is $200 because three months of coverage have been provided.
3/12 X $800 = $200

D. 115%
Hometown's combined ratio equals its loss ratio ($3,000,000/$4,000,000) or 75

percent, plus its expense ratio ($2,000,000/$5,000,000) or 40 percent, for a total of


115%.

A. Investment expenses

B. Sales commissions

D. $24,000
The written premiums was $24,000, the amount the insured was billed at the
beginning of the policy period.

C. ABC's return on investments is offsetting the unprofitable underwriting


performance.

C. More complete picture of an insurer's profitability.


An insurer's overall gain or loss from operations provides a more complete picutre
because it includes net investment gains (or losses), which help offset any
underwriting losses.

D. Policyholders' surplus
The major categories of liabilities found on an insurer's financial statements are loss
and loss expense reserves, unearned premium reserves, and "all other" liabilities.
Policyholders' surplus is not a liability category.

C. A liability designated to pay the cost of settling the claims included in the loss
reserve.
The loss reserve is a liability designated to pay claims for losses that have already
occurred.

D. Snapshot of its financial position.

C. Unearned premiums

A. It equals the admitted portion of unearned premium minus the nonadmitted portion of
unearned premium.

The unearned premium reserve represents prepaid premiums, premium refunds due if the
insurer were to cease operations, and the total of an insurer's unearened premiums on all
policies at a particular time. It does not equal the admitted minus the nonadmitted portion of
unearned premiums.

D. Office equipment
Office equipment is a nonadmitted asset because it cannot be readily converted to
cash at or near its market value.

C. Premiums received but not yet used to pay claims.

C. $1,170,000
Furniture and office equipment ($70,000) and premiums overdue more than ninety
days ($10,000) are nonadmitted assets; the total remaining assets are admitted and
total $1,170,000.

A. If premiums increase by a greater percentage than incurred losses increase, the


loss ration will decrease.

C. Loss ratio + expense ratio

A. UIC's investment income is offsetting losses and expenses from its underwriting
operation, allowing an opearting profit.

B. Expense ratio
A decrease in incurred losses would decrease the loss ratio, which is included in the
combined ratio and the overall operating ratio. The expense ratio would not
decrease.

D. Investments
Two major sources of insurer income are (1) the sale of insurance (underwriting) and
(2) the investment of funds (investment income).

D. Unearned premium reserve

B. Not profitable on an underwriting basis.


A combined ratio greater than 1 indicates that the insurer is not profitable on an underwriting
basis; however, when investment income is subtracted from the combined ratio, the overall
operating ratio may be less than 1, showing that the insurer is profitable overall.

C. 25%
Hometown's investment income ratio equals its net investment income
($1,000,000) divided by its earned premiums ($4,000,000), or 25%.

A. $80 million gain


XYZ's overall gain or loss from operations is
$500 million earned premiums
- $400 million incurred losses
-$60 million underwriting expenses
+$40 million net investment gain
= $80 million gain.

A. Cash and short-term investments


Cash and short-term investments are admitted assets that are shown on the
balance sheet of an insurer. The other items listed are shown on an insurer's income
statement.

D. Easily converted to cash at or near their market value.

C. Losses arising from claims.

D. Real estate

C. Expense ratio
The expense ratio uses written premiums rather than earned premiums as the
denominator; therefore, the expense ratio won't change. All the other ratios would
decrease because they use earned premiums as all or part of the denominator.

B. $120 million loss


ABC's overall gain or loss from operations is
$400 million earned premiums
- $500 million incurred losses

-$60 million underwriting expenses


+$40 million net investment gain
=$120 million loss

C. Earned premium

B. Liability designated for paying claims for losses that have already occurred.

D. 75%
Hometown Insurer's loss ratio is its incurred losses ($3,000,000) divided by its
earned premiums ($4,000,000), or 75%

D. Already occurred but are not yet settled

C. Unpaid loss amounts for claims not yet settled

A. Expense ratio

C. Relationship between revenues, expenses, and net income.

B. Increase.
Policyholder's surplus is admitted assets minus liabilities. Any decrease in a liability
without a change in admitted assets increases policyholders' surplus.

C. The insurer had an underwriting loss.

B. $200,000
Policyholders' surplus equals total admitted assets minus total liabilities, or
$200,000