California Life-Only & Accident and Health AgentGeneral InsuranceMedium
An insurance company receives an application from an individual with a known chronic illness, which significantly increases their likelihood of filing claims. The company's underwriting process aims to identify and manage such applicants to prevent a disproportionate number of high-risk individuals from obtaining coverage. This process is designed to combat:
- AInsurable Interest
- BRisk Avoidance
- CMoral Hazard
- DAdverse Selection
Show answer & explanationAnswer & explanation
Correct answer: D. Adverse Selection
Adverse selection is the tendency of less favorable insurance risks (like individuals with chronic illnesses) to seek or continue insurance coverage to a greater extent than more favorable risks. Underwriting processes are specifically designed to identify and mitigate adverse selection.
Why the other options are wrong
- A. Insurable interest is a financial stake, not a risk management problem for the insurer.
- B. Risk avoidance is eliminating exposure to a loss, not managing who gets coverage.
- C. Moral hazard relates to dishonesty or character that increases loss probability.
Adverse Selection
Adverse selection is the tendency of persons with a higher-than-average chance of loss to seek insurance coverage to a greater extent than persons with an average or lower-than-average chance of loss.
- Occurs when information asymmetry exists.
- Leads to higher-than-expected claims for insurers.
- Managed through underwriting, deductibles, waiting periods.
Memory trick: Underwriters fight Adverse Selection and Moral Hazard to keep risks balanced.