CFP EXAM -- FP512 QUESTIONS AND ANSWERS WITH
COMPLETE SOLUTIONS VERIFIED GRADED A++
Insurance
* A device used to manage risk by having a large pool of people share in the financial
losses suffered by members of the pool
* Risk is transferred to an insurance company
* The more group members, the greater the probability that an actual loss will equal the
expected loss
Risk
* A condition where there is a possibility of an adverse deviation from the desired
outcome
* Outcome is indeterminate
* At least two outcomes, and at least one of those is undesirable
Peril
The cause of a financial loss
Hazards
* Physical: Physical characteristics of the person or property that increase the chance of
loss (ex. high blood pressure)
* Moral: The chance of loss from dishonesty (ex. person intentionally causes a loss)
* Morale: Indifference to loss, which creates carelessness and increases the chance of
a loss occurring (ex. failing to lock car doors)
,Deductible
A stated amount of money the insured is required to pay on a loss before the insurer will
make any payments under the policy
Exclusions
Perils that are not covered in a policy (ex. War, Earthquake, Flood)
Riders/Endorsements
* Used interchangably with one another
* Describe written additions to an insurance contract
* Provide a means to correct a policy in the case of a conflicting term
Classification of Risks
* Financial: Exposure to risk that may cause financial loss
* Non-Financial: Exposure to a risk that does not cause financial loss (ex. pain +
suffering)
* Static: Loss caused by factors other than change in the economy, always present (ex.
natural disaster)
* Dynamic: Result of the economy changing, and is generally not insurable (ex.
recession, inflation)
* Fundamental: Impacts a large group of people
* Speculative: Involves a gain or a loss, cannot be insured (ex. gambling)
Risk Management
* A process of focusing on pure risks that can be identified and evaluated
* Includes insurance planning because it manages both insurable and uninsurable risks
,* Insurance should be justified on basis of a cost-benefit analysis and should only be
used as a last resort
Risk Management Process
1) Identify + Establish risk management goals
2) Gather pertinent data to determine exposures
3) Analyze + Evaluate the information to identify exposures
4) Develop a risk management plan
5) Communicate the recommendations
6) Implement the recommendations
7) Monitor the recommendations
Risk Management Methods
* Risk Avoidance: Risk may be avoided if the person refuses to engage in the activity
that creates a risk (ex. refusing to fly)
* Risk Retention: No action is taken to avoid, transfer, or reduce the risk (ex. self-
insurance, deductibles, coinsurance)
* Risk Transfer: May be transferred, either through an individual or an insurance
contract
* Risk Reduction: May be reduced through loss prevention methods and/or safety
improvements (ex. installing guard rails)
Insurable Risk (4 Elements)
1) There must be a sufficiently large and similar sample of individuals or events to make
the losses reasonably predictable
2) The loss must be measurable and definite
, 3) The loss must be accidental
4) The loss cannot be catastrophic to society
Adverse Selection
* The likelihood that people with the highest risk of loss are also the most likely to
purchase insurance
* Also includes higher-risk persons seeking insurance coverage at the standard rates
* More common in insurance policies with premiums that increase with age
Social Insurance
* Mandatory insurance administered by the government with benefits that are mandated
by law
* The purpose is to protect people from large fundamental risks
* Examples: Social Security, Medicare, Workers' Compensation, Medicaid
Public Insurance
* Seeks to enhance public trust in financial institutions
* Usually mandatory and administered by the government or quasi-governmental
institutions
* Examples: Federal Deposit Insurance Corporation (FDIC), Pension Benefit Guaranty
Corporation (PBGC), Securities Investor Protection Corporation (SIPC)
Private Insurance
* Marketed by private companies
* Examples: Life Insurance, Health Insurance, Disability Insurance, LTC Insurance,
Property Insurance, Liability Insurance
National Association of Insurance Commissioners (NAIC)
COMPLETE SOLUTIONS VERIFIED GRADED A++
Insurance
* A device used to manage risk by having a large pool of people share in the financial
losses suffered by members of the pool
* Risk is transferred to an insurance company
* The more group members, the greater the probability that an actual loss will equal the
expected loss
Risk
* A condition where there is a possibility of an adverse deviation from the desired
outcome
* Outcome is indeterminate
* At least two outcomes, and at least one of those is undesirable
Peril
The cause of a financial loss
Hazards
* Physical: Physical characteristics of the person or property that increase the chance of
loss (ex. high blood pressure)
* Moral: The chance of loss from dishonesty (ex. person intentionally causes a loss)
* Morale: Indifference to loss, which creates carelessness and increases the chance of
a loss occurring (ex. failing to lock car doors)
,Deductible
A stated amount of money the insured is required to pay on a loss before the insurer will
make any payments under the policy
Exclusions
Perils that are not covered in a policy (ex. War, Earthquake, Flood)
Riders/Endorsements
* Used interchangably with one another
* Describe written additions to an insurance contract
* Provide a means to correct a policy in the case of a conflicting term
Classification of Risks
* Financial: Exposure to risk that may cause financial loss
* Non-Financial: Exposure to a risk that does not cause financial loss (ex. pain +
suffering)
* Static: Loss caused by factors other than change in the economy, always present (ex.
natural disaster)
* Dynamic: Result of the economy changing, and is generally not insurable (ex.
recession, inflation)
* Fundamental: Impacts a large group of people
* Speculative: Involves a gain or a loss, cannot be insured (ex. gambling)
Risk Management
* A process of focusing on pure risks that can be identified and evaluated
* Includes insurance planning because it manages both insurable and uninsurable risks
,* Insurance should be justified on basis of a cost-benefit analysis and should only be
used as a last resort
Risk Management Process
1) Identify + Establish risk management goals
2) Gather pertinent data to determine exposures
3) Analyze + Evaluate the information to identify exposures
4) Develop a risk management plan
5) Communicate the recommendations
6) Implement the recommendations
7) Monitor the recommendations
Risk Management Methods
* Risk Avoidance: Risk may be avoided if the person refuses to engage in the activity
that creates a risk (ex. refusing to fly)
* Risk Retention: No action is taken to avoid, transfer, or reduce the risk (ex. self-
insurance, deductibles, coinsurance)
* Risk Transfer: May be transferred, either through an individual or an insurance
contract
* Risk Reduction: May be reduced through loss prevention methods and/or safety
improvements (ex. installing guard rails)
Insurable Risk (4 Elements)
1) There must be a sufficiently large and similar sample of individuals or events to make
the losses reasonably predictable
2) The loss must be measurable and definite
, 3) The loss must be accidental
4) The loss cannot be catastrophic to society
Adverse Selection
* The likelihood that people with the highest risk of loss are also the most likely to
purchase insurance
* Also includes higher-risk persons seeking insurance coverage at the standard rates
* More common in insurance policies with premiums that increase with age
Social Insurance
* Mandatory insurance administered by the government with benefits that are mandated
by law
* The purpose is to protect people from large fundamental risks
* Examples: Social Security, Medicare, Workers' Compensation, Medicaid
Public Insurance
* Seeks to enhance public trust in financial institutions
* Usually mandatory and administered by the government or quasi-governmental
institutions
* Examples: Federal Deposit Insurance Corporation (FDIC), Pension Benefit Guaranty
Corporation (PBGC), Securities Investor Protection Corporation (SIPC)
Private Insurance
* Marketed by private companies
* Examples: Life Insurance, Health Insurance, Disability Insurance, LTC Insurance,
Property Insurance, Liability Insurance
National Association of Insurance Commissioners (NAIC)
