Exchange of Unequal Amounts, Conditionality, and Restrictions on Transfer in Insurance: Practice Questions and Solutions

This section of the study guide is intended to provide practice problems and solutions to accompany the pages of Foundations of Risk Management and Insurance, cited below. Students are encouraged to read these pages before attempting the problems. This study guide is entirely an independent effort by Mr. Stolyarov and is not affiliated with any organization(s) to whose textbooks it refers, nor does it represent such organization(s).

Some of the questions here ask for short written answers based on the reading. This is meant to give the student practice in answering questions of the format that will appear on Exam 5. Students are encouraged to type their own answers first and then to compare these answers with the solutions given here. Please note that the solutions provided here are not necessarily the only possible ones.

Source:
Nyce, C.M. Foundations of Risk Management and Insurance (Second Edition). 2006. American Institute for Chartered Property Casualty Underwriters. Chapter 10, pp. 10.3-10.14.

Original Problems and Solutions from The Actuary's Free Study Guide

Problem S5-28-1. In insurance policies, what is the consideration offered by each party (the insurer and the insured)? Give an example of a situation in which the insured provides greater consideration than the insurer. Then give an example of a situation in which the insurer provides greater consideration than the insured.

Solution S5-28-1. This question is based on the discussion in Nyce 2006, p. 10.11.

In insurance policies, the consideration offered by the insured is the payment of premium. The consideration offered by the insurer is the indemnification of the insured in the event of a covered loss.

An example of a situation in which the insured provides greater consideration than the insurer is one in which the insured keeps paying a premium to the insurer, but no covered loss ever occurs, so the insurer is never required to make a payment.

An example of a situation in which the insurer provides greater consideration than the insured is one in which the insured pays a small premium (say, $100) for coverage and then shortly thereafter suffers a total loss of the covered property (say, a loss of $100,000), and the insurer indemnifies the insured for the entire loss.

Problem S5-28-2. Nyce 2006, p. 10.12, discusses three ways in which insurers can achieve an equitable distribution of risks costs. What are these ways, and how does each of them fulfill the goal of equitable distribution of risk costs?

Solution S5-28-2.

1. Rating plans: Rating plans are developed by actuaries to estimate expected loss costs and expenses for an insurance policy and to establish a premium that reflects these factors.

2. Coinsurance: In property insurance policies, coinsurance is a penalty for an insured who does not insure property to its full value or some proportion thereof. Coinsurance incentivizes the insured to have coverage for the entire loss exposure in question.

3. Subrogation: Subrogation is the insurer's recovery of payments for losses from third parties who caused those losses. Subrogation reduces the insurer's costs and facilitates payment for losses to be made by the parties responsible for those losses.

Problem S5-28-3. Insurance is often described as a conditional contract, in the sense that the insured must fulfill certain duties, such as allowing inspection of damaged property, before the insurer pays a claim. Is this always necessarily the case? If you answer affirmatively, explain why; if you answer negatively, give a counterexample.

Solution S5-28-3. This question is based on the discussion in Nyce 2006, p. 10.13.

It is not always necessarily the case that the insured has any duties to fulfill, in practice, before a claim is paid - especially when the insurer decides to waive those duties. For instance, an insurer can waive its right to inspect damaged property and simply pay the claim amount. This frequently takes place.

Problem S5-28-4. What parties typically may and what parties typically may not transfer an insurance policy to another party? Give three examples of situations in which insurance policies might be transferred.

Solution S5-28-4. This question is based on the discussion in Nyce 2006, p. 10.13.

Insurers are typically able to transfer insurance policies to other insurers, but insureds typically may not transfer insurance policies to other insureds. Three examples of situations in which insurance policies might be transferred are as follows:

1. An insurer is acquired by another insurer, and the acquired insurer transfers its book of business to the acquiring insurer.

2. An insurer sells its book of business to another insurer upon deciding to no longer do business in a particular area.

3. An insurer becomes insolvent, and the state insurance department transfers that insurer's book of business to other, more viable, insurers.

Problem S5-28-5. According to Nyce 2006, p. 10.14, what exception commonly exists for the rule that insurance policies are nontransferable by the insured?

Solution S5-28-5. For maritime insurance policies, an exception to the policy's nontransferable clause exists if ownership is transferred during a ship's voyage. It is common for seagoing vessels to change ownership while at sea. When this happens, the loss exposure does not fundamentally change until the ship reaches port. Thereafter, the new owner has to either achieve the insurer's consent for the transfer of the policy or apply for new insurance.

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