Texas General Lines — Life, Accident, Health and HMOGeneral InsuranceHard
An insurance company's agent is explaining the concept of 'adverse selection' to a new hire. Which of the following best illustrates adverse selection in the context of health insurance?
- AIndividuals with a higher risk of illness being more likely to purchase health insurance.
- BAn insurer refusing to cover a healthy applicant due to their occupation.
- CAn insurance company offering lower premiums to individuals with healthy lifestyles.
- DA policyholder cancelling their health insurance after recovering from a serious illness.
Show answer & explanationAnswer & explanation
Correct answer: A. Individuals with a higher risk of illness being more likely to purchase health insurance.
Adverse selection occurs when those who are most likely to suffer a loss (and thus file a claim) are also the most likely to seek and buy insurance. In health insurance, this means individuals with pre-existing conditions or higher health risks disproportionately purchase coverage.
Why the other options are wrong
- B. This describes a form of underwriting or potential unfair discrimination, not adverse selection.
- C. This describes risk classification or preferred rates, which is a method insurers use to combat adverse selection, not adverse selection itself.
- D. This describes policy termination, which is a normal policy action, not adverse selection.
Adverse Selection
The tendency of individuals with a higher-than-average risk of loss to seek out or continue insurance coverage more often than those with an average or lower-than-average risk.
- Leads to higher claims for insurers, potentially higher premiums for all.
- Insurers use underwriting, deductibles, and waiting periods to manage it.
- Common in health insurance where unhealthy individuals are more motivated to buy.
Memory trick: Adverse selection: the sickest sign up, making the pool adverse.