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Practice test · 34 questions
Insurance Basics and Contract Law Practice Test (Part 2 of 2)
Part 2 continues the insurance basics and contract law question bank with 34 new questions. Answer each one to see the correct choice and a full explanation; your progress is saved in this browser.
Questions
34
Suggested time
41 min
Difficulty mix
7 / 20 / 7
Passing target
70%
Subtopics in this part: Insurance contract characteristics, Adhesion and ambiguity, Insurable interest, Representations and warranties, Concealment, misrepresentation, and fraud, Waiver and estoppel, Parol evidence rule, Policy structure, Named-peril vs open-peril forms, Valuation methods, Deductibles and limits, Other-insurance clauses and more.
0 of 34 answered
Insurance contract characteristics · Recall
Leila pays a $1,200 annual premium, and a covered fire later causes $250,000 in damage to her home. The large gap between what each party gave and received reflects which characteristic of insurance contracts?
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Correct answer: C. Aleatory
An aleatory contract involves an unequal exchange of values that depends on an uncertain event. Leila could pay premiums for years and collect nothing, or pay one premium and collect far more. Unilateral means only the insurer makes an enforceable promise, conditional means the insured must meet policy conditions to collect, and personal means the contract insures a person rather than the property.
Why is a property or casualty insurance policy described as a unilateral contract?
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Correct answer: C. Only the insurer makes a legally enforceable promise to perform
In a unilateral contract, only one party makes an enforceable promise. The insurer promises to pay covered losses, but the insured does not promise to keep paying premiums; if premiums stop, the coverage simply ends. A contract drafted entirely by one party is a contract of adhesion, a different characteristic, and insurers as well as insureds may cancel under the policy terms.
Malik's policy requires prompt notice of loss and cooperation with the investigation. After a theft, he ignores the insurer's requests for information for months, seriously hampering its investigation. Which characteristic of insurance contracts explains why the insurer may deny the claim?
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Correct answer: A. It is a conditional contract
Insurance is a conditional contract: the insurer's duty to pay depends on the insured meeting the policy's conditions, such as giving notice and cooperating after a loss. When an insured fails to perform a condition and the insurer is harmed as a result, payment may be denied. Aleatory refers to the unequal exchange of values, and adhesion refers to the insurer drafting the policy.
When wording in a standard insurance policy is genuinely ambiguous, courts generally interpret it in favor of the insured. Which characteristic of insurance contracts is the main reason for this rule?
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Correct answer: A. Insurance policies are contracts of adhesion drafted by the insurer
In a contract of adhesion, one party drafts the terms and the other must accept them as written. Because the insurer chose the words, courts apply contra proferentem and construe genuine ambiguities against the drafter, which usually favors the insured. When policy language is clear, however, courts generally enforce it as written rather than rewriting the contract.
Omar sold his rental duplex outright and was paid in full, but he forgot to cancel his property policy. A week later, the duplex is damaged by fire. Why is Omar unable to collect under his policy?
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Correct answer: B. Property insurance requires an insurable interest at the time of the loss
For property insurance, the insured must have an insurable interest when the loss occurs. After transferring full title and being paid, Omar suffers no financial loss from the fire, so paying him would violate indemnity. The rule that interest need exist only at inception applies to life insurance. Coverage also does not pass to a buyer, since assignment requires the insurer's consent.
Which statement correctly distinguishes a representation from a warranty in insurance law?
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Correct answer: A. A representation need only be substantially true; a warranty is traditionally guaranteed to be literally true
Representations are statements an applicant makes to induce the insurer to issue coverage; they must be substantially true, and only a material misrepresentation lets the insurer void the policy. A warranty is a statement or promise made part of the contract and, under traditional common law, had to be strictly true or complied with even if not material. Many courts now soften strict warranty enforcement.
Concealment, misrepresentation, and fraud · Application
Kwame applies for a homeowners policy an hour after a wildfire evacuation order is issued for his neighborhood. The agent never asks about wildfire activity, and Kwame says nothing about the order. Which doctrine best describes Kwame's conduct?
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Correct answer: B. Concealment
Concealment is the intentional failure to disclose a material fact the applicant knows the insurer would consider important. Kwame answered no question falsely, so this is not a misrepresentation, but an active evacuation order is plainly material. Because insurance rests on utmost good faith, an insurer that proves material concealment may be able to void the contract.
Concealment, misrepresentation, and fraud · Challenging
To get a lower rate, Sofia lists her car as garaged at her parents' rural home, though it stays full time near her city apartment. On his own application, Marcus mistakenly lists his car's color as blue instead of gray. Which statement is correct?
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Correct answer: C. Only Sofia's misstatement is material and may let the insurer void her policy
A misrepresentation is material when the truth would have led the insurer to decline the risk or charge a different premium. Garaging location affects auto rating, so Sofia's false statement is material. The color of Marcus's car does not change the insurer's decision or price, so his error is immaterial and does not give grounds to void coverage.
Concealment, misrepresentation, and fraud · Application
Which element distinguishes fraud from an innocent misrepresentation on an insurance application or claim?
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Correct answer: B. The false statement was made knowingly, with intent that the insurer rely on it
Fraud requires a false statement of fact made knowingly or recklessly, with intent that the other party rely on it, followed by reasonable reliance and resulting harm. An innocent misrepresentation may be equally false but lacks that knowledge and intent. Fraud can occur before or after a loss, and forms such as the HO-3 deny coverage when an insured engages in fraudulent conduct.
Which statement best distinguishes waiver from estoppel as those doctrines apply to insurance contracts?
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Correct answer: D. Waiver is giving up a known right; estoppel bars a contrary position after another party's reasonable reliance
Waiver is the intentional, voluntary relinquishment of a known right, such as an insurer knowingly excusing a proof-of-loss requirement. Estoppel arises when one party's words or conduct lead another to reasonably rely on them to its detriment, so the first party is barred from asserting a contrary position. Barring oral evidence is the parol evidence rule, and construing ambiguity against the drafter is contra proferentem.
After a loss, Beatriz argues that before she signed, the agent orally agreed to a $250 deductible, but her complete written policy clearly states a $1,000 deductible. Which legal rule generally bars using that earlier oral agreement to change the written terms?
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Correct answer: C. Parol evidence rule
The parol evidence rule generally prevents prior or contemporaneous oral or written agreements from being used to contradict or vary a complete written contract, which is presumed to contain the parties' final agreement. Exceptions exist, such as when the written language is ambiguous, but a clearly stated deductible normally controls over an earlier oral promise.
Which section of a property policy shows the named insured, policy period, insured location, limits of insurance, deductible, and premium?
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Correct answer: C. Declarations
The declarations personalize the policy with the specific facts of the risk: who is insured, where, for what period, at what limits and deductibles, and for what premium. Adjusters usually check them first. The insuring agreement states the insurer's promise to pay, conditions set out the parties' duties, and definitions explain the meaning of key policy terms.
A homeowners policy's main form excludes earthquake damage, but the insured bought an earthquake endorsement that is attached to the policy. After an earthquake damages the home, which provision controls?
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Correct answer: A. The endorsement, because it modifies the policy form
An endorsement is a written change attached to the policy that adds, removes, or modifies coverage. When an endorsement conflicts with the main policy form, the endorsement takes precedence because it reflects the parties' specific agreement. Here the earthquake endorsement overrides the standard exclusion, subject to the endorsement's own terms, limits, and deductible.
Water damage of unclear origin is found in a building. Comparing coverage under a named-peril form with coverage under an open-peril (special) form, which statement about the burden of proof is generally correct?
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Correct answer: D. Named-peril: insured proves a listed peril caused it; open-peril: insurer proves an exclusion applies
A named-peril form covers only listed causes of loss, so the insured generally must show that one of them caused the damage. An open-peril form covers direct physical loss unless an exclusion applies, so once a covered loss is shown, the insurer generally bears the burden of proving an exclusion. This shift is one reason open-peril coverage is considered broader.
A covered windstorm destroys a 12-year-old roof with an expected useful life of 20 years. A new roof of like kind and quality costs $15,000. If actual cash value equals replacement cost minus straight-line depreciation and the deductible is $1,000, what does the insurer pay on an ACV basis?
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Correct answer: A. $5,000
The roof has used 12 of its 20 years, so depreciation is 60% of $15,000, or $9,000. Actual cash value is $15,000 minus $9,000, which equals $6,000. Subtracting the $1,000 deductible leaves a payment of $5,000. The $14,000 figure would apply only on a replacement cost basis, which makes no deduction for depreciation.
Hana insures a restored 1967 convertible for an agreed value of $48,000. The car is stolen and never recovered, and at the time of the theft its actual cash value is $41,000. Ignoring any deductible, how much does the insurer pay?
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Correct answer: D. $48,000
With agreed value coverage, the insurer and insured settle the property's value when the policy is written, so a total loss pays that amount without depreciation or a new valuation. Hana receives $48,000. Paying the lesser of a declared amount or actual cash value describes stated amount coverage, which would have limited her recovery to $41,000.
A business insures a delivery truck with stated amount coverage of $30,000. The truck is totaled in a covered collision when its actual cash value is $24,500, and repairs would cost more than that. Ignoring the deductible, what is the most the insurer will pay?
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Correct answer: B. $24,500
Stated amount coverage pays the least of the stated amount, the actual cash value, or the cost to repair or replace. The stated amount is a ceiling, not a guaranteed payment. Actual cash value of $24,500 is lower than both the $30,000 stated amount and the repair cost, so the insurer pays $24,500. Agreed value coverage, by contrast, would pay the full agreed figure.
A liability policy has a $1,000,000 each-occurrence limit and a $2,000,000 general aggregate limit. The insurer has already paid $1,700,000 in covered damages this policy period, all subject to the aggregate. A new covered occurrence produces $600,000 in damages also subject to the aggregate. How much will the insurer pay for it?
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Correct answer: B. $300,000
The each-occurrence limit caps payment for any single occurrence, while the aggregate limit caps the total paid for all such damages during the policy period. Only $300,000 of the $2,000,000 aggregate remains ($2,000,000 minus $1,700,000), so the insurer pays $300,000 even though the $600,000 claim is within the occurrence limit. The insured must look elsewhere for the remaining $300,000.
Aisha's building is covered for the same fire loss by two property policies: Policy A with a $300,000 limit and Policy B with a $200,000 limit. Each has a pro rata other-insurance clause. Ignoring deductibles, if the covered loss is $60,000, how much does Policy B pay?
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Correct answer: A. $24,000
Under a pro rata clause, each insurer pays the share of the loss that its limit bears to the total insurance covering the loss. Total insurance is $500,000, so Policy B's share is $200,000 divided by $500,000, or 40%, and 40% of $60,000 is $24,000. Policy A pays the other $36,000. Splitting the loss equally at $30,000 each would be contribution by equal shares, a different method.
A loss is covered by two liability policies. Policy A applies as primary insurance with a $100,000 limit. Policy B states that it is excess over any other valid and collectible insurance and has a $500,000 limit. If covered damages total $160,000, how much does Policy B pay?
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Correct answer: B. $60,000
An excess clause makes a policy pay only the part of the loss that remains after the other applicable insurance has paid. Policy A pays its full $100,000 limit first, and Policy B pays the remaining $60,000. Sharing in proportion to limits would be the pro rata method ($133,333 for B), and $80,000 each would be contribution by equal shares.
What is the general difference between cancellation and nonrenewal of a property or casualty insurance policy?
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Correct answer: D. Cancellation ends coverage before the expiration date; nonrenewal declines to continue it after expiration
Cancellation terminates a policy midterm, before its scheduled expiration date, and may be initiated by the insured or, for permitted reasons, by the insurer. Nonrenewal is a decision not to continue the policy for another term once the current term ends. Unearned premium is generally refunded on cancellation, and policy terms and state laws set notice requirements for both actions.
Which statement correctly describes how a mutual insurance company is owned and how it shares profits?
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Correct answer: D. It is owned by its policyholders, who may receive policyowner dividends
A mutual insurer has no stockholders; its policyholders are the owners and, at least in theory, elect the board, and profits may be returned to them as policyowner dividends. A stock insurer is owned by stockholders seeking a return on their capital. An attorney-in-fact manages a reciprocal exchange, and member syndicates describe the Lloyd's market.
In one type of insurer, members called subscribers agree to insure one another, and an attorney-in-fact manages operations under powers of attorney from the members. What type of insurer is this?
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Correct answer: C. Reciprocal insurance exchange
A reciprocal insurance exchange is an unincorporated association whose subscribers exchange insurance contracts with one another. An attorney-in-fact, acting under each subscriber's power of attorney, runs daily operations such as issuing policies and handling claims. In the Lloyd's market, by contrast, members provide capital to syndicates that underwrite risks, and Lloyd's itself does not assume risks the way a typical insurer does.
An insurer is incorporated in Ohio and licensed to write property coverage in Texas. From the Texas Department of Insurance's point of view, how is this insurer classified?
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Correct answer: C. Foreign insurer
Insurers are classified by where they are incorporated. A domestic insurer is chartered in the state in question, a foreign insurer is chartered in another U.S. state, and an alien insurer is chartered in another country. The Ohio company is foreign in Texas, and because it is licensed there, it is an admitted insurer rather than a nonadmitted one.
A fireworks retailer cannot find property coverage from any insurer licensed in its state, so a licensed surplus lines broker places the risk with a nonadmitted insurer. Which statement is generally true about this placement?
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Correct answer: A. The policy is generally not protected by the state guaranty association
Surplus lines (nonadmitted) insurers may write risks that admitted insurers will not accept, through specially licensed surplus lines brokers. They generally are not subject to state rate and form approval, and their policyholders generally lack state guaranty association protection if the insurer fails. That trade-off is why surplus lines placements are limited to coverage the admitted market will not provide.
Lucia represents several unrelated insurers, pays her own agency expenses, and keeps the right to offer her clients' renewals to a different insurer if she stops representing one of them. Which type of producer is Lucia?
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Correct answer: D. Independent agent
An independent agent represents multiple insurers and typically owns the agency's expirations, meaning the right to solicit renewals belongs to the agent rather than the insurer. A captive or exclusive agent represents one insurer or affiliated group, and that insurer usually controls the business. An attorney-in-fact manages a reciprocal exchange and is not a sales producer.
An insurer terminates its agent, Victor, but leaves him with its binder forms and does not notify his clients. A longtime client calls Victor, who binds coverage on a new building, and a fire occurs before the insurer learns of it. Which basis would most likely hold the insurer to the binder?
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Correct answer: A. Apparent authority created by the insurer's conduct
Apparent authority exists when a principal's conduct leads a third party to reasonably believe an agent can act for it. By leaving Victor with binder forms and not telling clients of the termination, the insurer created that appearance. Express authority is granted in the agency contract, and implied authority is what is reasonably needed to carry out express duties; Victor's contract had ended.
An insurer is asked to write a $40,000,000 property policy on a single high-rise, far above its usual retention. It submits this one building to a reinsurer, which underwrites the risk and is free to accept or decline it. What type of reinsurance is this?
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Correct answer: D. Facultative reinsurance
Facultative reinsurance is arranged one risk at a time, and both the ceding insurer and the reinsurer keep full decision-making power over each submission. Treaty reinsurance is a standing agreement under which policies in a defined class are reinsured automatically if they meet the treaty terms. Retrocession is a further reinsurance arrangement purchased by a reinsurer.
Kofi owns an older frame home in an area where several voluntary-market insurers have declined to write property coverage. He still needs basic property insurance to satisfy his mortgage lender. Which residual market mechanism is designed for this situation?
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Correct answer: A. A FAIR plan
FAIR (Fair Access to Insurance Requirements) plans provide basic property insurance to owners who cannot obtain it in the voluntary market, often because of location, age, or construction. Insurers in the state share the plan's results in proportion to their market share. Assigned risk plans are the auto liability counterpart, assigning hard-to-insure drivers to insurers in proportion to their market share.
When an admitted property and casualty insurer becomes insolvent, how does a state guaranty association generally obtain the money to pay the insolvent insurer's covered claims?
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Correct answer: A. Assessments on solvent insurers licensed in the state
State guaranty associations pay covered claims of insolvent member insurers, subject to limits set by state law. Licensed property and casualty insurers must belong, and when the failed insurer's remaining assets fall short, the association funds claims through mandatory assessments on solvent member insurers. This protection generally does not extend to policies written by surplus lines insurers.
After a covered collision, Imani's insurer pays her $9,000 for damage to her car. Before the insurer contacts the at-fault driver, Imani signs a release accepting $500 from that driver and giving up all further claims. What problem has Imani most likely created?
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Correct answer: D. She has impaired her insurer's subrogation rights
Subrogation transfers to the insurer the insured's right to recover from a responsible third party, up to the amount the insurer paid. Policies require insureds to do nothing after a loss that prejudices this right. By releasing the at-fault driver, Imani wiped out the claim her insurer would have pursued and may have to answer to the insurer for that lost recovery.
Tomas's car sustains $8,000 in covered collision damage. His insurer pays $7,000 after his $1,000 deductible, then recovers the full $8,000 from the at-fault driver's insurer through subrogation. How should the recovered $8,000 be distributed?
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Correct answer: C. Insurer keeps $7,000; Tomas receives $1,000
The insurer is subrogated only to the extent of its own payment, which was $7,000. The remaining $1,000 of the recovery represents Tomas's uninsured loss, his deductible, so it belongs to him. Letting the insurer keep all $8,000 would give it more than it paid and leave Tomas short of full indemnity even though the at-fault party paid in full.
A covered fire destroys a boat with an actual cash value of $22,000. The insurer pays the full $22,000, takes title to the wreck, and later sells it at auction for $3,500. Ignoring any deductible, what is the insurer's net cost for this claim?
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Correct answer: B. $18,500
Salvage is damaged property the insurer takes over after paying a total loss and then sells to reduce its cost. The insurer paid $22,000 and received $3,500 from the sale, so its net cost is $18,500. The insured cannot keep both the full payment and the salvage, because that would leave the insured better off than before the loss.
Yusuf sells his house to Grace and tells her she can simply take over his homeowners policy. Under the ISO HO 00 03 05 11, what is required for an assignment of Yusuf's policy to Grace to be valid?
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Correct answer: B. The insurer's written consent to the assignment
Property insurance is a personal contract: it protects a person against loss rather than insuring the property itself, and insurers care who owns the property. The HO-3 states that assignment of the policy will not be valid unless the insurer gives written consent. Coverage does not automatically pass to a buyer, so Grace normally needs her own policy or the insurer's approval.
Pick an answer and the correct choice appears with an explanation and the policy form, statute or FEMA document it comes from. Difficulty is labeled on each question: recall items test a definition, application items put the rule into a short claim scenario, and challenging items combine two rules or require a calculation.
Aim for at least 80% before moving on, since the real exam mixes these topics with state law under time pressure. When you are consistently above that line, take a full timed exam or the version for your state: Texas or Florida 6-20.