Basic Insurance Concepts and Contract Law — practice questions

17.3% of the exam ≈26 real questions 18 free questions here

Risk, peril and hazard, the law of large numbers, contract elements and the Insurance Code's rules on concealment, representations and warranties: about 26 of the 150 combined questions, split across both line exams.

Where people lose points

• Concealment, even unintentional, lets the injured party rescind (Ins. Code 331).
• Materiality is judged by its likely influence on the insurer, not by what caused the loss (334).
• A representation may be withdrawn before the insurance takes effect, not after (355).
• Morale hazard is carelessness; moral hazard is dishonesty.

Questions and answers, explained

All 10 questions above, with the correct answer and why it is correct. Everything here is on basic insurance concepts and contract law.

1. Under California Insurance Code section 22, insurance is a contract in which one party undertakes to:

   • AIndemnify another against loss, damage or liability from a contingent or unknown eventCorrect
   • BShare in the business profits of another
   • CGuarantee a profit to another on an investment made with a licensed broker or financial institution
   • DLend money to another at a fixed rate of interest

   Why: Section 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 transfers pure risk; it does not guarantee investment gains.

   Reference Cal. Ins. Code 22 — CA objectives I.A.1

2. In insurance terms, what is a peril?

   • AA condition that makes a loss more likely or more severe, such as a dangerous hobby
   • BThe cause of a loss, such as death, illness or accidentCorrect
   • CThe amount the insured pays before coverage begins
   • DThe insurer's estimate of future losses

   Why: A peril is the immediate cause of loss, such as death, sickness or injury. A hazard is a condition that increases the chance or severity of a loss.

   Reference CA objectives I.A.4-5

3. A person buys a life insurance policy so that an insurer will bear the financial loss of her death. Which risk management technique is this?

   • AReduction
   • BTransferCorrect
   • CRetention, keeping the risk and paying any loss out of her own savings
   • DAvoidance

   Why: Buying insurance transfers the financial consequences of a risk to the insurer. Avoidance eliminates the activity, reduction lowers the chance or size of loss, retention keeps it, and sharing spreads it among several parties.

   Reference CA objectives I.A.9; II.A.4

4. An insurance contract is said to be a contract of utmost good faith. This means:

   • AThe agent guarantees the insurer's solvency
   • BEach party relies on the other's honesty and full disclosureCorrect
   • CThe insured may change the terms at any time
   • DThe insurer must pay any claim the insured submits, even ones the policy clearly excludes

   Why: Utmost good faith means both parties are expected to deal honestly and disclose material facts. That is why concealment and misrepresentation allow rescission under the California Insurance Code.

   Reference CA objectives I.A.13

5. In a life insurance contract, what does the applicant give as consideration?

   • AThe application and the initial premiumCorrect
   • BThe agent's commission
   • CA promise to stay healthy and to report every future medical visit to the insurer
   • DNothing; only the insurer gives consideration

   Why: The applicant's consideration is the statements in the application plus payment of the initial premium; the insurer's is its promise to pay benefits.

   Reference CA objectives I.B.2.d

6. The insurer pays a claim only if the insured meets requirements such as paying premiums and submitting proof of loss. This makes insurance a(n):

   • AContract of adhesion
   • BAleatory contract, because the outcome depends on chance and unequal values
   • CConditional contractCorrect
   • DVoid contract

   Why: A conditional contract obligates the insurer to perform only when the insured meets certain conditions, such as paying premium and giving notice and proof of loss.

   Reference CA objectives I.B.3.b

7. A policyowner prepays a year of premium and the policy is canceled after four months. The premium for the remaining eight months is called:

   • AGross premium
   • BEarned premium, because the insurer received it at the start of the policy year
   • CRate
   • DUnearned premiumCorrect

   Why: Earned premium is the part that covers time already elapsed; unearned premium covers time not yet elapsed and is returned when a policy is canceled. A rate is the price per unit of coverage.

   Reference CA objectives I.B.9.c

8. Which principle holds that insurance should restore the insured to the same financial position as before a loss, but not better?

   • AIndemnityCorrect
   • BInsurable interest, which requires the policyowner to suffer a loss if the insured dies
   • CLaw of large numbers
   • DAdhesion

   Why: The principle of indemnity aims to make the insured whole without profit. Life insurance is valued rather than strictly indemnity, because a life cannot be priced exactly, so the face amount is paid.

   Reference CA objectives I.A.13

9. A family's dependence on one parent's paycheck creates the possibility of financial loss if that parent dies. In insurance terms this possibility is a:

   • ARider
   • BLoss exposureCorrect
   • CDeductible
   • DSpeculative risk that the family could profit from if the parent's employer goes out of business

   Why: A loss exposure is any situation or circumstance in which a loss is possible, whether or not a loss occurs. Identifying exposures is the first step in managing risk.

   Reference CA objectives I.A.8, I.A.10

10. What is the main purpose of insurance underwriting?

    • ATo pay claims quickly
    • BTo select and classify risks so premiums match the riskCorrect
    • CTo approve every applicant who is willing to pay, so the insurer grows as fast as possible
    • DTo recruit and train new agents

    Why: Underwriting evaluates applicants, decides whether to accept them and at what rate, and so protects against adverse selection and keeps premiums fair for each risk class.

    Reference CA objectives I.A.14

Topics inside this domain

• California contract law: concealment, representations and warranties
• California licensing, appointments and continuing education
• California's protections for senior insurance buyers

Drill other domains

• The Insurance Marketplace, Licensing and Ethics (9.3%)
• Life Insurance Basics, Underwriting and Claims (7.3%)
• Types of Life Policies and Group Life (8%)
• Annuities (5.3%)
• The Life Insurance Contract and Riders (9.3%)
• Replacement, Cancellation, Taxation and Social Security Disability (5.3%)

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