Understanding Contract Law Fundamentals

A contract that is legally binding only on one party is called:

• Bilateral

• Unilateral

• Conditional

• Adhesion

Answer explanation

A unilateral contract is legally binding on only one party, typically where one party makes a promise in exchange for an act by another. In contrast, bilateral contracts involve mutual obligations.

Which of the following is NOT a required element of a legal contract?

• Offer

• Acceptance

• Indemnity

• Consideration

Answer explanation

Indemnity is not a required element of a legal contract. The essential elements are offer, acceptance, and consideration, which establish a binding agreement between parties.

A company wants to introduce a new auto policy in Alabama. What must it do before marketing the policy?

• Begin selling immediately

• File the policy form and rates with the Alabama Department of Insurance for approval

• Only notify existing customers

• Advertise the policy on television

Answer explanation

Before marketing a new auto policy in Alabama, the company must file the policy form and rates with the Alabama Department of Insurance for approval to ensure compliance with state regulations.

An insurer is considering two applicants: one with a history of frequent claims and one with no claims history. How should the underwriter approach pricing for these applicants, and what evidence supports this approach?

• Charge both the same premium, as claims history is irrelevant

• Charge the applicant with frequent claims a higher premium, as claims history indicates higher risk

• Offer a discount to the applicant with frequent claims

• Deny both applicants coverage

Answer explanation

The underwriter should charge the applicant with frequent claims a higher premium, as their claims history indicates a higher risk of future claims, which justifies the increased cost.

What is the formula for calculating the loss ratio?

• Premiums earned ÷ Claims paid

• Claims paid ÷ Premiums earned

• Premiums written ÷ Claims paid

• Claims paid × Premiums earned

Answer explanation

The loss ratio is calculated by dividing claims paid by premiums earned. This ratio helps assess the profitability of an insurance company, making 'Claims paid ÷ Premiums earned' the correct formula.

Who is responsible for reviewing risk factors and determining eligibility and pricing in insurance?

• Policyholder

• Underwriter

• Agent

• Claims adjuster

Answer explanation

The underwriter is responsible for reviewing risk factors, determining eligibility, and setting pricing in insurance. They assess the risk associated with insuring a policyholder, unlike agents or claims adjusters.

If an underwriter is reviewing a homeowner’s location and claims history, what process are they performing?

• Claims adjustment

• Underwriting

• Policy renewal

• Premium collection

Answer explanation

The underwriter is assessing the homeowner's location and claims history to evaluate risk and determine coverage terms, which is the process of underwriting.

If a homeowner pays a higher premium due to living near the coast, which factor is influencing the premium?

• Deductible

• Coverage limit

• Risk factor

• Policy form

Answer explanation

The higher premium is influenced by the risk factor, as living near the coast poses greater risks such as flooding and storms, leading insurers to charge more to cover potential losses.

Why might two homeowners with identical houses pay different premiums?

• They have different policy numbers

• Their risk factors differ

• They use different payment methods

• Their agents work for different companies

Answer explanation

Homeowners may pay different premiums due to varying risk factors such as location, credit history, or claims history. These factors influence the likelihood of a claim, affecting the premium despite identical houses.

A homeowner’s policy has a high deductible and low coverage limits. How might this affect the premium, and why?

• The premium will be higher because the insurer’s risk is greater

• The premium will be lower because the policyholder assumes more risk

• The premium will not change

• The premium will be higher because of the deductible

Answer explanation

A high deductible means the policyholder pays more out-of-pocket before insurance kicks in, which reduces the insurer's risk. Consequently, the premium is lower as the policyholder assumes more financial responsibility.