Net Income Loss Exposures and Personal Loss Exposures: 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 8, pp. 8.3-8.27.

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

Problem S5-24-1. Net income loss exposures associated with property losses exhibit five of the six characteristics of an ideally insurable loss exposure. Which one of the six characteristics might these loss exposures sometimes not exhibit? (If necessary, refer to Section 23 and to Nyce 2006, p. 8.21).

Solution S5-24-1. Net income loss exposures associated with property losses may sometimes not exhibit the property of being independent and non-catastrophic. For instance, if a company owns a large number of buildings in a particular town that gets struck by a windstorm, many of the buildings may be destroyed, and the damage may be catastrophic. This would greatly impair the company's ability to generate revenue in the future.

Problem S5-24-2. Why is no insurance offered on the market for net income loss exposures associated with liability losses? (If necessary, refer to Nyce 2006, pp. 8.21-8.22).

Solution S5-24-2. The time of a net income loss associated with liability is virtually impossible to determine. A liability claim against a company may do damage to its reputation and reduce its number of customers indefinitely into the future. It is not possible to objectively determine when the effect of such reputational damage has stopped being in operation. By contrast, restoration of damaged property provides a definite end time to net income losses due to property loss exposures.

Problem S5-24-3. Which of the following statements about personal loss exposures are true? More than one answer may be correct.

(a) Individuals may face liability loss exposures arising out of their real property, but not their personal property.
(b) Individuals may face liability loss exposures arising out of their behavior toward others.
(c) Some homeowners' insurers refuse to sell policies to individuals who own a certain kind of pet.
(d) Premises liability for individuals meets all six characteristics of an ideally insurable loss exposure.
(e) Automobile liability for individuals meets all six characteristics of an ideally insurable loss exposure.
(f) One characteristic of ideally insurable loss exposures that net income loss due to unemployment sometimes may not meet is the definite and measurable criterion.
(g) One characteristic of ideally insurable loss exposures that net income loss due to unemployment sometimes may not meet is the fortuitous nature of losses.

Solution S5-24-3. This question is based on the discussion in Nyce 2006, pp. 8.23-8.25.

The following answers are correct:
(b) Individuals may face liability loss exposures arising out of their behavior toward others.
(c) Some homeowners' insurers refuse to sell policies to individuals who own a certain kind of pet.
(d) Premises liability for individuals meets all six characteristics of an ideally insurable loss exposure.
(e) Automobile liability for individuals meets all six characteristics of an ideally insurable loss exposure.
(g) One characteristic of ideally insurable loss exposures that net income loss due to unemployment sometimes may not meet is the fortuitous nature of losses.

Choice (a) is incorrect; individuals may face liability loss exposures arising out of both their real property and their personal property.

Choice (f) is incorrect; net income loss due to unemployment is definite and measurable in virtually all cases, as the time of loss of employment, duration of employment, and salary/wages that the individual has lost due to unemployment are fairly easy to ascertain.

Problem S5-24-4. Explain how life, health, and retirement personal loss exposures might not be fortuitous. (If necessary, refer to Nyce 2006, pp. 8.25-8.26).

Solution S5-24-4.

From the standpoint of the individual, life loss exposures might not be fortuitous in cases where individuals commit suicide, over which they have control. Health loss exposures may not be fortuitous in cases where individuals either deliberately damage their health (moral hazard) or expose themselves to greater risk through negligent, indifferent, or careless behavior (morale hazard) in order to collect insurance benefits. Retirement loss exposures are typically fortuitous from the standpoint of the individual, as most people can choose whether and when they will retire, as well as how much they will save for retirement.

Problem S5-24-5. Which of the following statements about life, health, and retirement loss exposures are true? More than one answer may be correct.

(a) Of the three loss exposures, life loss exposures are least likely to be definite and measurable.

(b) Health insurance is typically not subject to the problem of adverse selection.

(c) Life is generally not considered a loss exposure, except in cases of loss of life to premature death.

(d) Losses due to retirement will necessarily be faced by all individuals who retire.

(e) One way to reduce one's health loss exposure is to refrain from unhealthy practices, such as smoking and excessive eating.

(f) Life loss exposures satisfy all six of the ideally insurable loss exposure characteristics only for a small minority of individuals.

Solution S5-24-5. This question is based on the discussion in Nyce 2006, pp. 8.26-8.27. The following answers are correct:

(c) Life is generally not considered a loss exposure, except in cases of loss of life to premature death.

(e) One way to reduce one's health loss exposure is to refrain from unhealthy practices, such as smoking and excessive eating.

Choice (a) is incorrect; of the three loss exposures, health loss exposures are least likely to be definite and measurable. It is sometimes difficult to determine when a health problem began and what the extent of its adverse impact on an individual's financial condition was and will be.

Choice (b) is incorrect; health insurance is subject to considerable adverse selection, as less healthy individuals will tend to pursue health insurance to a greater extent than healthier individuals.

Choice (d) is incorrect; if an individual has substantial savings or benefits from retirement plans, there may be no financial hardship due to retirement, in which case the individual will not face losses.

Choice (f) is incorrect; life loss exposures satisfy all six of the ideally insurable loss exposure characteristics for the majority of individuals - i.e., those who do not wish to commit suicide, do not work in especially hazardous occupations, and do not have life-threatening health conditions.

See other sections of The Actuary's Free Study Guide for Exam 5.