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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. ) the purchase of insurance only. Answer! A
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") A situation or circumstance in which a loss is possible# regardless or whether a loss occurs# is called a A) deductible. B) loss exposure. C) loss avoidance. ) peril. Answer! B
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$) All of the following are risk management ob%ectives prior to the occurrence of loss &'C&() A) analysis of the cost of different techni*ues for handling losses. B) continuing operations after a loss. C) reduction of anxiety. ) meeting externally imposed obligations. Answer! B
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+) (reloss ob%ectives of risk management include which of the following, -. (reparing for potential losses in the most economical way. --. Reduction of anxiety. A) - only B) -- only C) both - and -) neither - nor -Answer! C
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". Re%da Principles of Risk Management and Insurance# )enth &dition /) A risk manager is concerned with -. -dentifying potential losses. --. 0electing the appropriate techni*ues for treating losses. A) - only B) -- only C) both - and -) neither - nor -Answer! C
Question Status: Revised

.) 0ources of information that can be used by a risk manager to identify pure loss exposures include all of the following &'C&() A) risk analysis *uestionnaires. B) currency exchange rates. C) physical inspections. ) past losses. Answer! B
Question Status: Revised

1) 2oss severity is defined as the A) probable si3e 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. ) probability that a liability %udgment may exceed a firm s net worth. Answer! A
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4) 2oss fre*uency is defined as the A) probable si3e 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.

) probability that a liability %udgment may exceed a firm s net worth. Answer! B
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Chapter $ -ntroduction to Risk 5anagement "1 6) )he worst loss that could ever happen to a firm is referred to as the A) maximum possible loss. B) maximum probable loss. C) fre*uency of loss. ) severity of loss. Answer! A
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17) )he worst loss that is likely to happen is referred to as the A) maximum possible loss. B) maximum probable loss. C) fre*uency of loss. ) severity of loss. Answer! B
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11) All of the following statements about avoidance are true &'C&() A) Certain loss exposures are never ac*uired. B) Certain loss exposures may be abandoned. C) )he chance of loss for certain loss exposures may be reduced to 3ero. ) -t can be used for any loss exposure facing a firm. Answer!
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1") Abandoning an existing loss exposure is an example of A) avoidance. B) retention. C) noninsurance transfer. ) insurance transfer. Answer! A
Question Status: Revised

"4 Re%da Principles of Risk Management and Insurance# )enth &dition 1$) 8hich of the following conditions is 9are) appropriate for using retention, -. 2osses are difficult to predict. --. )he worst possible loss is not serious. A) - only B) -- only C) both - and -) neither - nor -Answer! B
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1+) 8hich of the following statements about retention levels is 9are) true, -. A common rule of thumb is that a firms maximum retention can be e*ual to 177 percent of its earnings before taxes. --. A financially strong firm can have a higher retention level than a firm whose financial position is weak. A) - only B) -- only C) both - and -) neither - nor -Answer! B
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1/) All of the following statements about captive insurers are true &'C&() A) )hey may act as a profit center by insuring parties other than the parent company. B) )hey provide a way to obtain types of insurance that may be unavailable from commercial insurers. C) )hey increase the volatility of the parent companys earnings. ) )hey make it easier for a firm to have access to reinsurance. Answer! C
Question Status: Revised

1.) 8hich of the following statements about self-insurance is 9are) true, -. -t is a form of planned retention.

--. 0tate law usually prohibits its use for workers compensation. A) - only B) -- only C) both - and -) neither - nor -Answer! A
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Chapter $ -ntroduction to Risk 5anagement "6 11) All of the following are potential advantages of retention &'C&() A) lower expenses. B) increased cash flow. C) encouragement of loss prevention. ) protection from catastrophic losses. Answer!
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14) A restaurant owner leased a meeting room at the restaurant to a second party. )he 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. )he restaurant owners use of the hold-harmless agreement is an example of A) retention. B) self-insurance. C) insurance. ) noninsurance transfer. Answer!
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16) All of the following are disadvantages of noninsurance transfers &'C&() A) )he party to whom the potential loss is transferred may be unable to pay. B) )he transfer may fail because the contract language is ambiguous. C) )he only potential losses that can be transferred are those that are not commercially insurable. ) )he noninsurance transfer may be costly. Answer! C
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"7) ABC -nsurance retains the first :1 million of each property damage loss and purchases insurance for that part of any property loss that exceeds :1 million. )he insurance for property losses above :1 million is called A) excess insurance. B) liability insurance. C) coinsurance. ) primary insurance. Answer! A
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$7 Re%da Principles of Risk Management and Insurance# )enth &dition "1) 8hich of the following statements about the use of deductibles is 9are) true, -. )hey represent risk retention by insurance purchasers. --. )hey tend to increase the cost of ad%usting small claims. A) - only B) -- only C) both - and -) neither - nor -Answer! A
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"") 8hich of the following statements about an excess insurance plan is true, A) )he insurer does not participate in a loss until it exceeds the amount the firm has decided to retain. B) )he insurer pays first up to some specified level; the insured then pays all losses exceeding the insurers retention level. C) 2osses in excess of a specified amount are not covered. ) )he insured and insurer share e*ually in any loss that occurs. Answer! A
Question Status: Revised

"$) <actors a risk manager must consider in selecting an insurer include which of the following, -. )he availability of risk management services. --. )he financial strength of the insurer.

A) - only B) -- only C) both - and -) neither - nor -Answer! C


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"+) An insurance policy specifically written and designed to meet the needs of an insurance purchaser is called a9n) A) manuscript policy. B) bureau policy. C) standard policy. ) excess policy. Answer! A
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Chapter $ -ntroduction to Risk 5anagement $1 "/) All of the following are disadvantages of using insurance in a risk management program &'C&() A) )here is an opportunity cost because premiums must be paid in advance. B) Considerable time and effort must be spent selecting and negotiating coverages. C) -t results in considerable fluctuations in earnings after a loss occurs. ) Attitudes toward loss control may become lax when losses are insured. Answer! C
Question Status: Revised

".) 8hich of the following types of loss exposures may be appropriately handled through the purchase of insurance, -. =igh-fre*uency# low-severity --. 2ow-fre*uency# high-severity A) - only B) -- only C) both - and -) neither - nor -Answer! B
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"1) 8hich of the following types of loss exposures are best handled by the use of avoidance, A) low-fre*uency# low-severity B) low-fre*uency# high-severity C) high-fre*uency# low-severity ) high-fre*uency# high-severity Answer!
Question Status: Revised

"4) 2ow-fre*uency# low-severity loss exposures are best handled by A) avoidance. B) retention. C) insurance. ) noninsurance transfer. Answer! B
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$" Re%da Principles of Risk Management and Insurance# )enth &dition "6) All of the following statements about the administration of a risk management program are true &'C&() A) )he risk manager is an important part of a firms management team. B) A risk management policy statement can be used to educate top executives about the risk management process. C) -f a risk management program is properly designed# periodic review of the program is unnecessary. ) -n order to properly identify loss exposures# the risk manager needs the cooperation of other departments. Answer! C
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$7) Cal was %ust hired as '>? Companys first risk manager. Cal would like to employ the risk management process. )he first step in the process Cal should follow is to A) evaluate potential losses faced by '>? Company. B) formulate a treatment plan for '>? Companys loss exposures. C) identify potential losses faced by '>? Company.

) implement and administer a risk management plan for '>? Company. Answer! C
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$1) 5embers of 5id-0outh (etroleum istributors# a trade group# had trouble obtaining affordable pollution liability insurance. )he members formed a group captive that is exempt from many state laws that apply to other insurers. )his group captive is called a9n) A) reinsurance pool. B) 2loyd s association. C) alien insurer. ) risk retention group. Answer!
Question Status: Revised

Chapter $ -ntroduction to Risk 5anagement $$ $") Acme Company has three identical manufacturing plants# one on the )exas @ulf Coast# one in southern Alabama# and one in <lorida. &ach plant is valued at :/7 million. Acmes risk manager is concerned about the damage which could be caused by a single hurricane. )he 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. 8hat is the maximum probable loss associated with a single hurricane, A) :7 million B) :/7 million C) :177 million ) :1/7 million Answer! B
Question Status: Revised

$$) Acme Company has three identical manufacturing plants# one on the )exas @ulf Coast# one in southern Alabama# and one in <lorida. &ach plant is valued at :/7 million. Acmes risk manager is concerned about the damage which could be caused by a single hurricane. )he 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. 8hat is the maximum possible loss associated with a single hurricane, A) :7 million B) :/7 million C) :177 million ) :1/7 million Answer!
Question Status: Revised

$+) 2aura &vans is risk manager of 25A Company. 2aura decided to retain certain property losses. All of the following are methods which 2aura can use to fund retained property losses &'C&() A) private insurance. B) current net income. C) funded reserve. ) borrowed funds. Answer! A
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$+ Re%da Principles of Risk Management and Insurance# )enth &dition $/) (arker epartment 0tores has been hurt in recent months by a large increase in shoplifting losses. (arkers risk manager concluded that while the fre*uency of shoplifting losses was high# the severity is still relatively low. 8hat is 9are) the appropriate risk management techni*ue9s) to apply to this problem, A) retention B) loss control and retention C) transfer through insurance ) avoidance Answer! B
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$.) 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. Barbs treatment of the risk of disability is best described as A) risk transfer. B) passive retention. C) risk avoidance.

) active retention. Answer! B


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$1) Ryan decided to review his personal risk management program. =is car is 17 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. <rom 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. ) increasing the use of risk control in the risk management program. Answer! C
Question Status: Revised

Chapter $ -ntroduction to Risk 5anagement $/ $4) )o better understand her companys operations# a risk manager asked a production manager to draw a diagram tracing the steps in the production and distribution of the companys products. 0uch a diagram# which is useful in risk identification# is called a A) financial statement. B) risk management matrix. C) flowchart. ) risk management audit. Answer! C
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$6) -n reviewing his companys operations# a risk manager noticed that all of the companys finished goods were stored in a single warehouse. )he risk manager recommended that the finished goods be divided among three warehouses to prevent all of the finished goods from being destroyed by the same peril. ividing the finished goods among three warehouses illustrates A) risk avoidance. B) risk control. C) insurance. ) noninsurance transfer. Answer! B
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+7) 8hich of the following statements about a personal risk management program is 9are) true, -. -nsurance and retention are the only techni*ues used to handle potential losses. --. )he steps in a personal risk management process are the same steps used by businesses. A) - only B) -- only C) both - and -) neither - nor -Answer! B
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$. Re%da Principles of Risk Management and Insurance# )enth &dition +1) Bev lives in the suburbs and works downtown. 0he drives to work# and her most direct route to work would re*uire her to pass through an area where car%ackings and drive-by-shootings are common. Bev does not drive through this area. -nstead# she uses a route which adds 17 minutes to her commute. 8hich risk management techni*ue is Bev using with respect to the risk of in%ury while driving through the dangerous area, A) noninsurance transfer B) avoidance C) passive retention ) loss reduction Answer! B
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+") Brenda identified all of the pure loss exposures her family faces. )hen she analy3ed these loss exposures# developed a plan to treat these risks# and implemented the plan. )he process Brenda conducted is called A) personal insurance programming. B) personal estate planning. C) personal financial planning. ) personal risk management. Answer!
Question Status: Revised

+$) 8hich statement about a companys cost of risk is 9are) true, -. Cost of risk includes insurance premiums and retained losses. --. Reducing the cost of risk increases profitability. A) - only B) -- only C) both - and -) neither - nor -Answer! C
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Chapter $ -ntroduction to Risk 5anagement $1 ++) A useful measure for an organi3ation is the total of the organi3ations expenditures for treating loss exposures including retained losses# loss control expenses# insurance premiums# and other related expenses. )his measure is called the organi3ations A) cost of capital. B) cost of goods sold. C) cost of risk. ) cost of e*uity. Answer! C
Question Status: Revised

+/) 5ark owns a 1664 sedan. )he last time 5ark renewed his auto insurance# he decided to drop the physical damage insurance on this vehicle. =ow is 5ark dealing with the auto physical damage exposure in his personal risk management program, A) risk transfer B) passive retention C) avoidance ) planned retention Answer!
Question Status: New

+.) (urchasing health insurance illustrates the use of which personal risk management techni*ue, A) avoidance B) risk transfer C) loss control ) risk retention Answer! B
Question Status: New

+1) 8hich of the following statements about captive insurance companies is 9are) true, -. A captive insurance company established by a B.0. company must be domiciled in the Bnited 0tates. --. A captive insurance company may be owned by several parents. A) - only B) -- only C) both - and -) neither - nor -Answer! B
Question Status: New