Free Canadian Risk Management CRM56 — Risk Financing Practice Questions

Sample Practice Questions

Try these 10 sample questions from the Canadian Risk Management CRM56 — Risk Financing practice bank. Each includes the answer and explanation. Continue with the interactive practice above to review the full question set.

1. 1What is the central purpose of a risk financing plan?

   1. A.Arrange funds to meet liabilities arising from riskCorrect answer: A
   2. B.Remove the physical causes of all insured events
   3. C.Identify hazards before measuring their severity
   4. D.Determine fault before each exposure is accepted

   Explanation: The source states: "Risk financing is a plan for covering liabilities" The plan addresses how financial obligations will be funded. Physical prevention, hazard identification and fault determination serve different risk management functions.

   Reference: Insurance Information Institute — Background on Risk-financing — Opening overview

2. 2A risk manager is choosing an exposure base for estimating future hazard losses. Which combination of characteristics is most useful?

   1. A.A readily counted base that has little relationship to loss costs
   2. B.A cost-related base that cannot be measured or verified reliably
   3. C.A cost-related base that is practical to measure and verifyCorrect answer: C
   4. D.A widely used base selected without checking the firm's exposures

   Explanation: The source states: "bears a strong relationship to the cost of risk transfer or risk retention and is practical" A useful base combines cost relevance with practical measurement. A sacrifices relevance, B sacrifices verifiability, and D substitutes popularity for an exposure-specific relationship.

   Reference: ASB ASOP No. 53 — Future Cost Estimates — 3.6 Exposure Base

3. 3Under the principle of indemnity, what is the general purpose of an insurance recovery for a property loss?

   1. A.Give the insured the full policy limit after any damage
   2. B.Pay the insured's annual premium back after a claim
   3. C.Increase the insured's financial position beyond the loss
   4. D.Restore approximately the insured's financial position before the lossCorrect answer: D

   Explanation: The NAIC glossary states: "restored to the approximate financial position he or she was in prior to the loss" Indemnity compensates loss rather than creating a gain, automatically paying a limit or refunding premiums. Actual recovery remains subject to the policy terms.

   Reference: NAIC — Glossary of Insurance Terms — I — Indemnity, Principle of

4. 4Which loss pattern generally makes a self-insurance plan more financially manageable?

   1. A.Infrequent losses with virtually unlimited possible severity
   2. B.Reliably predictable losses within the organization's financial capacityCorrect answer: B
   3. C.Unknown losses with no available exposure information
   4. D.Highly correlated catastrophes larger than available resources

   Explanation: The source states: "Risk retention can work well when losses are reliably predictable and occur in financially manageable amounts" Predictability and manageable size help a plan budget for retained losses. Unbounded severity, missing information and catastrophes beyond resources undermine that financing capacity; self-insurance does not make those exposures disappear.

   Reference: Insurance Information Institute — Background on Risk-financing — II. Self-insurance and risk retention

5. 5What distinguishes a retrospective rating plan from a plan that uses past experience to price a future policy period?

   1. A.The plan uses industry-wide prior losses as its final premium basis
   2. B.The plan uses this period's losses only to price the next policy period
   3. C.The plan uses actual losses to adjust premium for that same periodCorrect answer: C
   4. D.The plan fixes final premium from expected losses before coverage begins

   Explanation: The source states: "during the policy period as the basis for determining the premium for that same period." Retrospective pricing uses actual experience of the period being priced. A is an industry historical basis, B prices a later period, and D is a prospective fixed-price approach.

   Reference: CAS — Basic Ratemaking — Chapter 15, Retrospective Rating, printed p. 305

6. 6What is the defining risk financing relationship in a captive insurer?

   1. A.An insurance company is established to insure risks of its owner or ownersCorrect answer: A
   2. B.A broker places unrelated clients' risks without assuming insurance liabilities
   3. C.A bank lends money after losses without issuing an insurance policy
   4. D.An adjuster handles claims without the authority to insure exposures

   Explanation: The source states: "to insure the risks of its owner or owners." The captive is an insurer linked to the insured owners. Brokerage, lending and claims administration alone do not establish this ownership-and-insurance relationship.

   Reference: Insurance Information Institute — Background on Captive Insurance — Opening overview

7. 7A supplier agrees to protect a customer against specified losses under an indemnification agreement. In that agreement, what is the supplier's role?

   1. A.The insurer
   2. B.The certificate holder
   3. C.The indemnitee
   4. D.The indemnitorCorrect answer: D

   Explanation: The source states: "The party that agrees to provide this protection is the “indemnitor.”" The supplier gives the indemnity and is the indemnitor; the protected customer is the indemnitee. Giving an indemnity does not itself make the supplier an insurer or merely a certificate holder.

   Reference: CNA Canada — Risk Transfer Suggested Practices — Ask legal counsel to review hold harmless/indemnity agreements, p. 4

8. 8A Canadian importer wants a single exchange of CAD for a fixed USD payment on a known future date, at a rate agreed now. Which instrument provides that arrangement?

   1. A.A spot currency exchange settled immediately
   2. B.An unhedged deposit held only in Canadian dollars
   3. C.A foreign exchange forward for the future payment dateCorrect answer: C
   4. D.An interest rate swap on the company's domestic borrowing

   Explanation: The source states: "on a specific future date at a fixed rate agreed upon on the inception of the contract" A foreign exchange forward fixes the future conversion rate. A spot exchange settles now rather than on the required future date; an unhedged CAD deposit and a domestic interest-rate swap do not fix the currency conversion.

   Reference: CFTC — Futures Glossary — Foreign Exchange Forward

9. 9How does a catastrophe bond transfer hazard risk to capital markets?

   1. A.It raises ordinary equity whose payoff is unrelated to disaster triggers
   2. B.It packages specified disaster risk into securities funded by investorsCorrect answer: B
   3. C.It supplies a loan that the sponsor must repay after every disaster
   4. D.It purchases conventional reinsurance without securities investors

   Explanation: The source states: "Depending on how the cat bond is structured, if losses reach the threshold specified in the bond offering, the investor may lose all or part of the principal or interest." Investors bear specified catastrophe losses through the bond terms, linking securities capital to hazard risk. Ordinary equity without catastrophe triggers, repayable borrowing and conventional insurer-to-insurer reinsurance are different funding structures.

   Reference: Insurance Information Institute — Background on Risk-financing — V. Catastrophe bonds

10. 10An organization allocates a fixed insurance cost using each division's proportion of fleet mileage. Which allocation approach is this?

    1. A.A loss-based allocation
    2. B.A retrospective premium adjustment
    3. C.An exposure-based allocationCorrect answer: C
    4. D.A performance-score allocation

    Explanation: Milliman's allocation guidance states: "costs are allocated based on percentage of total exposure" Fleet mileage is the selected exposure measure. The allocation is not based on actual losses, a retrospective insurance formula or a performance score.

    Reference: Milliman — The Basics of an Effective Insurance Cost Allocation — Exposure-based allocation