CFP CFP Risk Management and Insurance Planning: practice questions with answers

Question 1

Oriana Rhodes drives a 12-year-old car worth about $3,200 and has had no claims in many years. Her auto policy includes collision coverage with a $1,000 deductible. She decides to drop the collision coverage and pay for any damage to her own car herself. Which risk management technique is she using?

1. A Risk avoidance
2. B Risk reduction
3. C Risk retention
4. D Risk transfer

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Answer: C. The risk management matrix links frequency and severity to a technique:

| | Low severity | High severity |
|---|---|---|
| High frequency | Reduce | Avoid |
| Low frequency | Retain | Transfer (insure) |

The most she could lose is about $3,200 (only $2,200 more than the deductible), which she can absorb, so dropping collision coverage is a sensible retention of the risk.

Question 2

Kwabena Osei has a $2 million personal umbrella policy that requires underlying auto liability limits of $300,000 per person. To save money, he lowered his auto bodily injury limit to $100,000 per person. He is later found liable for $1,250,000 of bodily injury to one person in an auto accident. Assuming the umbrella insurer honors its policy, how much of the judgment must Kwabena pay himself?

1. A $0
2. B $200,000
3. C $300,000
4. D $1,150,000

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Answer: B. An umbrella policy pays as if the required underlying coverage were in force.

- Auto policy pays its limit: $100,000.
- Umbrella pays the excess over the required $300,000: $1,250,000 - $300,000 = $950,000.
- Kwabena pays the gap: $300,000 - $100,000 = $200,000.

Lesson: always keep underlying limits at the umbrella's requirements.

Question 3

Hollis Ashdown was disabled by a back injury, satisfied his policy's 90-day elimination period, and received benefits for eight months before returning to full-time work. Four months later the same back condition disables him again. His individual policy has a recurrent disability provision with a six-month window. How is the second disability treated?

1. A A new 90-day elimination period must be met before any benefits are paid for the second disability.
2. B It is treated as a continuation of the first claim, so benefits resume with no new elimination period.
3. C Benefits resume only if he had been back at work for at least six months before the disability recurred.
4. D It is excluded as a pre-existing condition, because the back injury began before he returned to work.

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Answer: B. A recurrent disability provision treats a disability from the same or a related cause that recurs within a stated period after the insured returns to work (often six months) as a continuation of the earlier claim. No new elimination period applies, and the remaining benefit period carries on. A recurrence after the window is treated as a new claim with a new elimination period. The provision encourages a return to work.

Question 4

Osvaldo Wichterle, age 54, bought a nonqualified deferred annuity in 2015 with a single premium of $100,000. In 2026 the contract is worth $160,000 and he withdraws $80,000, with no surrender charge and no annuitization. How much must he include in gross income for 2026, and what additional tax applies?

1. A $80,000 included; $8,000 additional 10% tax
2. B $60,000 included; $6,000 additional 10% tax
3. C $30,000 included; $3,000 additional 10% tax
4. D $60,000 included; no additional tax

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Answer: B. For contracts entered into after 13 August 1982, withdrawals before annuitization are treated as coming from earnings first (IRC Section 72(e), LIFO).

Gain in the contract = $160,000 - $100,000 = $60,000
Taxable part of the $80,000 withdrawal = lesser of the withdrawal and the gain = $60,000
Additional tax under Section 72(q) (owner under 59 1/2, no exception) = 10% x $60,000 = $6,000

The other $20,000 is a tax-free recovery of premium, leaving $80,000 of basis in a contract now worth $80,000.

Question 5

When her husband died in 2026, Yolanda Pruett was the beneficiary of his $400,000 life insurance policy. Instead of a lump sum, she chose a settlement option that pays her $46,000 a year for 10 years. How much of each annual payment is included in her gross income?

1. A $6,000
2. B $0
3. C $46,000
4. D $40,000

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Answer: A. Under IRC Section 101(d), when life insurance proceeds are paid in installments, the amount held by the insurer at death is prorated over the payment period and excluded; the rest of each payment is interest and is taxable.

Excludable each year = $400,000 / 10 = $40,000
Taxable each year = $46,000 - $40,000 = $6,000

(Over the 10 years she receives $460,000, of which $60,000 is taxable interest.)

Question 6

Raising the collision deductible on Griselda Ostergaard's car from $500 to $2,000 would cut her annual premium by $340. She expects one collision claim, larger than $2,000, about once every eight years. Ignoring the time value of money, what is her expected annual net saving from the higher deductible?

1. A $90.00
2. B $152.50
3. C $220.00
4. D $340.00

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Answer: B. Expected annual claim probability = 1 / 8 = 12.5%.

Extra amount retained per claim = $2,000 - $500 = $1,500.

Expected extra retained loss = 12.5% x $1,500 = $187.50 a year.

Expected net saving = $340 - $187.50 = $152.50 a year.

The higher deductible pays off as long as claims occur less often than $340 / $1,500 = 22.7% a year, and as long as she can absorb a $2,000 loss from her emergency fund.