Topic 27: Insurance Companies and Pension Funds 1. Major parts of the current health insurance system in the United States most closely parallel: (a) a compulsory national savings plan. (b) a benefit tax to pay for national defense. (c) an automobile insurance policy that covers such standard maintenance as lube, oil and filter changes. (d) Social Security taxes and benefits. (e) mergers and acquisitions during the “Age of the Robber Barons.” 2. The insurance provided to many U.S. citizens for prescriptions that costs taxpayers billions every year is known as: (a) Blue-Cross Blue-Shield. (b) Medicare and Medicaid. (c) the Federal Medical Insurance Administration. (d) Social Security. 3. The primary benefit of including a deductible in an insurance company is that: (a) it helps combat moral hazard. (b) it insures clients only against specifically stated perils. (c) it defers some of the costs onto stockholders. (d) deductibles are not taxed income. (e) plans with deductibles are more attractive to potential clients. 4. Those who review and approve policies written by insurance agents are called: (a) closers. (b) underwriters. (c) screeners. (d) brokers. (e) risk managers. 5. By obtaining reinsurance, an insurance company shifts some of its risk to another firm in exchange for: (a) a corporate bond of equal present value. (b) a portion of the premium. (c) some of that company’s risk, which is a technique that facilitates diversification. (d) restrictive provisions. (e) common stock. (f) profit-sharing. 6. All of the following are fundamental principles of insurance except: (a) all losses must be quantifiable. (b) the probability of a loss occurring must be calculable. (c) there must be some relationship between the insured and the beneficiary. (d) the beneficiary is responsible for furnishing full and accurate information to the insurance company at the outset. (e) on average, the insured must not have an expectation of profit from coverage. 7. An insurance policy that tends to be most beneficial for people who live significantly longer than expected is a/an: (a) open-peril policy. (b) annuity. (c) certainty equivalent policy. (d) defined-contribution plan. (e) open-peril policy. 8. The Employee Retirement Income Security Act (ERISA) provided, among other things, that: (a) employees who switch jobs may transfer credits from their previous employer to their new one. (b) regulatory oversight of pension funds is the responsibility of the Department of Commerce. (c) pension plans must have maximum vesting requirements. (d) the government may issue individual retirement accounts (IRAs). 9. The practice of sharing losses between the insurance company and the policyholder is: (a) reinsurance. (b) screening. (c) coinsurance. (d) principal-agent sharing. (e) underwriting. 10. All of these methods are used to reduce the risk an insurance company bears except: (a) reinsurance. (b) underwriting. (c) requiring a deductible. (d) overfunding. 11. A named-peril policy is another name for a/an: (a) open-peril policy. (b) casualty insurance policy. (c) defined-contribution policy. (d) defined-benefit plan. (e) private pension plan. 12. As a general rule, if a third party compensates an insured person for a loss, then: (a) the insurance policy becomes null and void. (b) the insurance company is still obligated to compensate for the full value of the loss. (c) the third party takes legal responsibility for the entire loss. (d) the insurance policy is said to be underfunded. (e) the insurance company’s obligation is diminished by the amount of compensation. 13. In the long run, adoption of the proposal to at least partially privatize Social Security is least likely to: (a) increase the level of national debt. (b) boost the income shares of people at the top of the pyramid, while reducing the shares of low- income people. (c) significantly increase post-retirement real incomes for most senior citizens. (d) raise interest rates paid very short-term U.S. Treasury bonds and other federal debt. (e) intensify moral hazard problems because if prospective retirees are confident that a senior citizen voting bloc will bail out people whose investments fail, they are likely to engage in excessively risky investment strategies. (f) the size of a federal bureaucracy because some agency will screen investments to identify those suitable for potential retirees. (g) increase the level of the stock market and drive down the rate of return for financial investors. (h) boost the relative incomes of mutual firm managers and stock brokerage firms. 14. The least likely of the following possible consequences of privatization of the Social Security system would be an increase in the: (a) average rate of return realized by investors in “blue chip” common stocks. (b) overall riskiness of people’s pension portfolios. (c) interest rate paid on U.S. Treasury bonds. (d) average rates of return on savings realized by economics majors who have graduated from college. (e) inequality of the distribution of income and wealth in the United States. 15. The employee of an insurance company who uses historical data in an attempt to predict the probabilities of events is an: (a) actuary. (b) underwriter. (c) agent. (d) claims representative. (e) adjuster. 16. The difference between a whole life insurance policy and a term life policy is: (a) a term life policy acquires a cash value. (b) a whole life policy can be converted to a term life policy, but a term life policy cannot be converted to a whole life policy. (c) a term life policy can be converted to a whole life policy, but a whole life policy cannot be converted to a term life policy. (d) the implicit interest rate for a whole life policy tends to be high. (e) a whole life policy accumulates cash value, but a term life policy does not. 17. Risk aversion is most clearly manifested when people invest financially in: (a) US government bonds. (b) whole- life or universal life insurance policies. (c) the state lottery. (d) indexed mutual funds. (e) municipal bonds. 18. A typical insurance agent is likely to be happiest when an individual client buys a competitively-priced $250,000: (a) health insurance policy. (b) whole life policy. (c) auto collision and liability insurance policy to cover possible accidents while driving his gold-plated Hummer. (d) term life insurance policy. 19. Policies intended to reduce moral hazard for insurance companies do not include: (a) offering insurance to groups. (b) deductibles. (c) restrictive provisions. (d) coinsurance. (e) limiting the amount of insurance coverage. 20. NOT among reasons why most life insurance is purchased through employer or other group plans is: (a) the relative ease of the process. (b) decreased cost, because of economies of scale in marketing for insurance companies. (c) the relative scarcity of independent insurance agents. (d) screening by trusted committees (of, e.g., employees), thereby reducing the research costs for the individual buyer. 21. The reason most large organizations offer group life and health insurance to employees and their families and that few such employees instead buy similar insurance privately and personally is that: (a) premiums on group insurance plans are tax deductible. (b) insurance companies charge lower premiums for group policies because economies of scale reduce their transaction costs in marketing. (c) firms offering group programs are subsidized by the selected insurers. (d) most major insurers strongly prefer not to deal with people who do not work for large organizations. 22. Insurance companies reduce moral hazard by their policyholders by: (a) having “co- pays” and deductibles. (b) rejecting clients who are not creditworthy. (c) making clients take a polygraph (d) charging high premiums. (e) not covering diseases their policyholders had before becoming policyholders. 23. Of the following financial intermediaries, the least liquid asset portfolios tend to be those held by: (a) property and casualty insurance companies. (b) commercial banks. (c) investment bankers. (d) life insurance companies. (e) money market mutual funds. 24. Detailed historical data are used to create estimates of the probabilities of events for insurance companies by: (a) actuaries. (b) underwriters. (c) agents. (d) claims representatives. (e) adjusters. 25. After adjusting for marketing and administrative costs and then an allowance for normal expected returns on their investments, insurance companies tend to set their premiums so that the probability of an event occurring multiplied by the expected pay-out roughly equals the premium charged because: (a) federal regulations require actuarial bases for insurance policies. (b) state regulators limit insurance company profits to normal rates of return. (c) the insurance industry is extremely competitive. (d) most insurance companies are organized as mutual funds owned by the insured individuals. 26. The process by which one insurance company allocates a portion of risk to another insurer by paying a portion of the premium is known as: (a) hedging insurance. (b) reinsurance. (c) option insurance. (d) coinsurance. (e) distributed insurance. 27. A deductible is: (a) used by the insurance companies for the sole purpose of making the insured pay at least something for their medical care. (b) one way insurance companies combat moral hazard. (c) charged because it is the only way insurance companies can make a profit. (d) always given directly to the doctor and his staff for transactions costs. 28. Old Mac Donald’s wife just went and bought the farm but three years earlier the couple had dumped her _______________ insurance to use the cash value to buy stock while good times were rolling. However, their broker neglected to tell them to ______________ so Mac Donald is left with nothing following the tech market crash. (a) term life; hedge (b) universal life; pay taxes (c) named peril; hedge (d) universal life; diversify 29. To determine specific premiums for specific policies, insurance company actuaries rely primarily on estimates of what can be characterized as: (a) fuzzy risk. (b) precise probabilities. (c) Knightian uncertainty. (d) precise uncertainty. (e) Knightian risk. 30. Compared to the premium an insurance company charges, the actuarial probability of an event occurring multiplied by the expected payoff is: (a) equal to the premium. (b) less than the premium. (c) greater than the premium. (d) unrelated to the premium. 31. The law of large numbers says that when many people are insured, the probability distribution of the pay-outs will ultimately facilitate accurate predictions by taking the form of a: (a) normal distribution [a standard bell curve]. (b) stable standard deviation. (c) Poisson function. (d) student- T- distribution. (e) uniform distribution. 32. Whole-life and universal- life policies are really combinations of: (a) casualty insurance and term life insurance. (b) “long-term” term insurance policies and low- interest rate saving plans. (c) disability insurance and life insurance. (d) comprehensive liability insurance and casualty insurance. 33. The types of life insurance policies that tend to have the lowest cost per dollar of coverage are: (a) whole life policies. (b) universal life policies. (c) term life policies sold to employees or members of organizations that offer group insurance. (d) the policies that yield the highest cash-surrender value at maturity. (e) term policies sold to you by your best friend. 34. The proceeds from insurance policies are tax- free, which provides incentives for firms to: (a) provide health insurance for executives, but not employees. (b) self- insure because premium surcharges compensate for the moral hazards to firms. (c) buy life insurance on employees if premiums are tax-deductible as business expenses. (d) pool their assets to take advantage of lower premiums for group rates as the group gets larger. (e) protect this unreliable revenue source by adopting stringent occupational safety and health standards. Pension Funds 35. The dominant predictable economic problem posed by the expected wave of retirements by baby-boomers is that: (a) Social Security assets are projected to decrease below its income by 2034. (b) the government will be unable to generate funds to pay for Social Security. (c) the ratio of population to labor force is projected to increase dramatically as baby boomers start to retire. (d) the surplus funds in Social Security from past years have evaporated. (e) Social Security assets generate very low rates of return. 36. The investment decisions of pension fund administrators would be least comprehensible and most clearly inconsistent with the objectives of those whose funds they manage if they invested heavily in: (a) investment grade tax free municipal bonds. (b) a highly diversified portfolio of junk bonds. (c) blue chip corporate stocks. (d) U.S. Treasury bonds. (e) a seasoned issue of bonds being marketed by a reputable investment banker. 37. The difference between a private pension plan and a public pension plan is: (a) if an individual holds a private placement plan, they tend to be less riskier because they deal with fewer individuals. (b) a public pension plan is sponsored by a governmental authority or body. (c) a public pension plan tends to be invested in corporate bonds issued by the treasury and governmental securities. (d) a private pension plan includes social security regulated by the government. 38. Some recent proposals for privatization of Social Security would allow workers to personally manage parts of their “Social Security” savings. Advocates of these proposals assert that retirees would gain because of the higher average rates of return from private sector investments relative to the current Social Security fund’s portfolio of Treasury securities. NOT among the possible drawbacks of such a proposal is that such privatization would tend to: (a) increase the interest rate on national debt. (b) reduce the rate of return on non-Treasury financial assets in which private savers would be allowed to invest. (c) decrease the actual rate of saving in the United States relative to GDP. (d) increase the riskiness of the average retiree’s income. 39. Private pension plans: (a) were developed in the mid 1960s for individuals who would not be covered by Medicare. (b) are offered by the employer to only select employees who qualify. (c) have grown rapidly as people have become more concerned about the viability of Social Security and more sophisticated about preparing for retirement. (d) are pension plans available only to employees of the government. 40. Privatization of social security would be unlikely to increase the: (a) amounts of moral hazard people exhibit when considering how much to save for retirement. (b) ability of workers to control the structure of their savings portfolios. (c) relative wealth of smart and/or lucky financial investors. (d) levels of investment in Treasury securities and reduce aggregate default risk. (e) extent of inequality in the distribution of income and wealth in the United States. 41. The LEAST likely consequence of privatization of Social Security as proposed by President Bush would be: (a) relatively increased disparities in the distribution of after-tax income in the United States. (b) relative gains for astute and lucky investors who converted their Social Security accounts into private accounts. (c) reductions in the US Treasury’s interest costs of national debt. (d) some relatively small gains in the rate of capital accumulation and economic growth because families with higher incomes save relatively larger proportions of their incomes. (e) mora l hazard inducing excessively risky investments by individuals who reason that even if they lose because they convert their Social Security funds into government-approved private financial investments, political pressures will force the federal government to bail them out. 42. Pension plans are plagued by potential problems of asymmetric information, which led to the establishment of: (a) FDIC. (b) FED. (c) Underwriters Laboratories. (d) FHLBS. (e) ERISA. (f) Social Security Administration 43. Adverse selection in which biases in pension plans favoring only top managers of firms were frequently misrepresented persuaded the US Congress to establish the: (a) Federal Depository Insurance Corporation. (b) Social Security Administration. (c) Pension Insurance Administration. (d) Employee Retirement Income Security Administration (ERISA). 44. Administrators of pension plans know, in an actuarial sense, when payouts will occur, and how much payments are likely to be, so they invest in illiquid assets. Consequently, they often buy big blocks of new issues of: (a) municipal bonds. (b) US Treasury bills and bonds. (c) junk bonds. (d) revenue bonds and convertible bonds. (e) corporate stocks and corporate bonds.