Florida 2-20 General Lines Agent (Property, Casualty, Commercial Lines and Florida Law)General InsuranceHard
A General Lines Agent in Florida is explaining the concept of 'adverse selection' to a potential client. Which scenario best describes adverse selection in insurance?
- AOnly individuals who live in high-crime areas applying for theft insurance.
- BA policyholder cancelling their insurance after experiencing no losses for several years.
- CAn insurance company raising premiums across the board for all policyholders.
- DAn insurer refusing to cover a high-risk individual due to their past claims history.
Show answer & explanationAnswer & explanation
Correct answer: A. Only individuals who live in high-crime areas applying for theft insurance.
Adverse selection occurs when those most likely to suffer a loss are also the most likely to seek and obtain insurance. If only individuals in high-crime areas apply for theft insurance, the insurer will have a disproportionately high number of high-risk insureds, leading to higher losses than anticipated.
Why the other options are wrong
- B. This is a lapse in coverage due to perceived low risk, not adverse selection.
- C. This is a general rate adjustment, not specifically adverse selection, though adverse selection could contribute to the need for it.
- D. This is an underwriting decision to mitigate adverse selection, not adverse selection itself.
Adverse Selection
The tendency of individuals with a higher-than-average risk of loss to seek and obtain insurance coverage, leading to a disproportionate concentration of high-risk individuals in an insured group.
- Occurs when information asymmetry exists
- Leads to higher-than-expected claims for insurers
- Underwriting and risk classification are used to combat it
Memory trick: Adverse Selection: A for AVOID (the good risks), A for ATTRACT (the bad risks).