PSI FINAL EXAM — INSURANCE ECONOMICS
Chamberlain College of Nursing | 2026/2027
Practice Questions with Verified Solutions & Detailed Rationales
75 Multiple-Choice Questions | Single-Best-Answer Format
,DOMAIN 1: Principles of Risk & Insurance (Q1–Q10)
1. Which of the following best defines the concept of pure risk as distinguished from
speculative risk?
A) A situation involving only the possibility of loss or no change
B) A situation offering both the possibility of gain and loss
C) Any uncertainty regarding future financial outcomes
D) A deliberate assumption of risk for potential profit
Correct Answer: A
Rationale: Pure risk involves only the chance of loss or no loss at all, with no possibility of gain.
This is the only type of risk that is generally considered insurable. Speculative risk involves the
possibility of gain, loss, or no change, such as investing in stocks or gambling.
2. In the risk management process, what is the correct sequence of steps after risk
identification?
A) Risk control, risk financing, risk monitoring, goal setting
B) Risk evaluation, risk control techniques, risk financing, implementation and
monitoring
C) Risk avoidance, risk reduction, risk retention, risk transfer
D) Loss prevention, loss reduction, insurance procurement, claims management
Correct Answer: B
Rationale: The risk management process follows: (1) identify risks, (2) evaluate risks (measure
frequency and severity), (3) select appropriate risk control and risk financing techniques, (4)
implement the chosen strategies, and (5) monitor and revise the program over time. Goal setting
precedes identification.
3. Adverse selection occurs in insurance markets when which of the following conditions is
present?
A) Insurers deliberately select only the lowest-risk applicants for coverage
B) Individuals with a higher-than-average probability of loss are more likely to seek
insurance than those with average or below-average risk
C) Insurance companies adjust premiums based on aggregate industry loss data rather than
individual risk factors
D) Government regulations require insurers to accept all applicants regardless of risk profile
Correct Answer: B
Rationale: Adverse selection describes the tendency for higher-risk individuals to be more
motivated to purchase insurance than lower-risk individuals. This occurs because the higher-risk
person has more to gain from the risk transfer. Left unmanaged, it leads to higher-than-expected
claims, premium increases, and potential market failure.
4. Which of the following best distinguishes a moral hazard from a morale hazard?
A) A moral hazard involves an increase in the probability or severity of loss due to the
insured person's intentional actions, while a morale hazard involves carelessness or
indifference after obtaining insurance
B) A moral hazard refers to a physical condition that increases loss likelihood, while a morale
hazard refers to the emotional state of the claimant
C) A moral hazard is an objective risk factor, while a morale hazard is a subjective risk factor
assessed through psychological evaluation
D) There is no practical difference; both terms describe the same phenomenon
Correct Answer: A
Rationale: Moral hazard involves intentional or reckless behavior by the insured because they are
protected from financial consequences (e.g., committing arson for insurance proceeds). Morale
, hazard involves a more subtle increase in carelessness, such as leaving doors unlocked because
insurance will cover theft losses.
5. A peril is best defined as:
A) The financial loss that results from an insured event
B) The cause of a loss, such as fire, windstorm, or theft
C) A condition that increases the likelihood or severity of a loss
D) A deliberate action taken to reduce the probability of loss
Correct Answer: B
Rationale: A peril is the actual cause of a loss event. Common perils include fire, lightning,
windstorm, hail, theft, and flood. A hazard, by contrast, is a condition that increases the
probability or severity of loss from a given peril. For example, faulty wiring is a hazard that
increases the likelihood of the peril of fire.
6. Which risk management technique involves deliberately choosing not to insure a risk
because the potential loss is considered too small or too predictable to warrant premium
expense?
A) Risk avoidance
B) Risk reduction
C) Risk retention
D) Risk transfer
Correct Answer: C
Rationale: Risk retention is the practice of accepting and self-funding a potential loss. It is
appropriate when the potential loss is relatively small, highly predictable, or when insurance
premiums are disproportionately high relative to the risk. Deductibles are a common form of
planned risk retention.
7. The law of large numbers is fundamental to insurance operations because it enables
insurers to:
A) Predict individual loss events with certainty
B) Predict aggregate loss experience with increasing accuracy as the number of
exposure units increases
C) Eliminate all risk from the insurance portfolio
D) Charge the same premium to all policyholders regardless of risk classification
Correct Answer: B
Rationale: The law of large numbers states that as the number of exposure units increases, the
actual loss experience will increasingly approximate the expected loss experience. This statistical
principle allows insurers to price premiums with confidence and maintain financial stability.
8. Risk transfer through insurance differs from risk transfer through hedging in that
insurance involves:
A) The transfer of pure risk to a third party in exchange for premium payment
B) The use of financial derivatives to offset speculative investment losses
C) A contractual agreement between two parties to share proportional losses
D) The government-mandated assignment of liability to a specific party
Correct Answer: A
Rationale: Insurance transfers pure risk from the insured to the insurer through a contract of
indemnity in exchange for premium payments. Hedging, by contrast, transfers speculative
financial risk using derivatives such as options and futures contracts.
9. Which statement correctly describes the relationship between risk and insurance?
A) Insurance eliminates all forms of risk for the policyholder
Chamberlain College of Nursing | 2026/2027
Practice Questions with Verified Solutions & Detailed Rationales
75 Multiple-Choice Questions | Single-Best-Answer Format
,DOMAIN 1: Principles of Risk & Insurance (Q1–Q10)
1. Which of the following best defines the concept of pure risk as distinguished from
speculative risk?
A) A situation involving only the possibility of loss or no change
B) A situation offering both the possibility of gain and loss
C) Any uncertainty regarding future financial outcomes
D) A deliberate assumption of risk for potential profit
Correct Answer: A
Rationale: Pure risk involves only the chance of loss or no loss at all, with no possibility of gain.
This is the only type of risk that is generally considered insurable. Speculative risk involves the
possibility of gain, loss, or no change, such as investing in stocks or gambling.
2. In the risk management process, what is the correct sequence of steps after risk
identification?
A) Risk control, risk financing, risk monitoring, goal setting
B) Risk evaluation, risk control techniques, risk financing, implementation and
monitoring
C) Risk avoidance, risk reduction, risk retention, risk transfer
D) Loss prevention, loss reduction, insurance procurement, claims management
Correct Answer: B
Rationale: The risk management process follows: (1) identify risks, (2) evaluate risks (measure
frequency and severity), (3) select appropriate risk control and risk financing techniques, (4)
implement the chosen strategies, and (5) monitor and revise the program over time. Goal setting
precedes identification.
3. Adverse selection occurs in insurance markets when which of the following conditions is
present?
A) Insurers deliberately select only the lowest-risk applicants for coverage
B) Individuals with a higher-than-average probability of loss are more likely to seek
insurance than those with average or below-average risk
C) Insurance companies adjust premiums based on aggregate industry loss data rather than
individual risk factors
D) Government regulations require insurers to accept all applicants regardless of risk profile
Correct Answer: B
Rationale: Adverse selection describes the tendency for higher-risk individuals to be more
motivated to purchase insurance than lower-risk individuals. This occurs because the higher-risk
person has more to gain from the risk transfer. Left unmanaged, it leads to higher-than-expected
claims, premium increases, and potential market failure.
4. Which of the following best distinguishes a moral hazard from a morale hazard?
A) A moral hazard involves an increase in the probability or severity of loss due to the
insured person's intentional actions, while a morale hazard involves carelessness or
indifference after obtaining insurance
B) A moral hazard refers to a physical condition that increases loss likelihood, while a morale
hazard refers to the emotional state of the claimant
C) A moral hazard is an objective risk factor, while a morale hazard is a subjective risk factor
assessed through psychological evaluation
D) There is no practical difference; both terms describe the same phenomenon
Correct Answer: A
Rationale: Moral hazard involves intentional or reckless behavior by the insured because they are
protected from financial consequences (e.g., committing arson for insurance proceeds). Morale
, hazard involves a more subtle increase in carelessness, such as leaving doors unlocked because
insurance will cover theft losses.
5. A peril is best defined as:
A) The financial loss that results from an insured event
B) The cause of a loss, such as fire, windstorm, or theft
C) A condition that increases the likelihood or severity of a loss
D) A deliberate action taken to reduce the probability of loss
Correct Answer: B
Rationale: A peril is the actual cause of a loss event. Common perils include fire, lightning,
windstorm, hail, theft, and flood. A hazard, by contrast, is a condition that increases the
probability or severity of loss from a given peril. For example, faulty wiring is a hazard that
increases the likelihood of the peril of fire.
6. Which risk management technique involves deliberately choosing not to insure a risk
because the potential loss is considered too small or too predictable to warrant premium
expense?
A) Risk avoidance
B) Risk reduction
C) Risk retention
D) Risk transfer
Correct Answer: C
Rationale: Risk retention is the practice of accepting and self-funding a potential loss. It is
appropriate when the potential loss is relatively small, highly predictable, or when insurance
premiums are disproportionately high relative to the risk. Deductibles are a common form of
planned risk retention.
7. The law of large numbers is fundamental to insurance operations because it enables
insurers to:
A) Predict individual loss events with certainty
B) Predict aggregate loss experience with increasing accuracy as the number of
exposure units increases
C) Eliminate all risk from the insurance portfolio
D) Charge the same premium to all policyholders regardless of risk classification
Correct Answer: B
Rationale: The law of large numbers states that as the number of exposure units increases, the
actual loss experience will increasingly approximate the expected loss experience. This statistical
principle allows insurers to price premiums with confidence and maintain financial stability.
8. Risk transfer through insurance differs from risk transfer through hedging in that
insurance involves:
A) The transfer of pure risk to a third party in exchange for premium payment
B) The use of financial derivatives to offset speculative investment losses
C) A contractual agreement between two parties to share proportional losses
D) The government-mandated assignment of liability to a specific party
Correct Answer: A
Rationale: Insurance transfers pure risk from the insured to the insurer through a contract of
indemnity in exchange for premium payments. Hedging, by contrast, transfers speculative
financial risk using derivatives such as options and futures contracts.
9. Which statement correctly describes the relationship between risk and insurance?
A) Insurance eliminates all forms of risk for the policyholder
