Washington Life Producer Practice Exam

People with higher loss exposure have the tendency to purchase insurance more often than those at average risk. This is called?

1. Risk segmentation

2. Adverse selection

3. Risk pooling

4. Underwriting

The correct answer is: Adverse selection

The phenomenon where individuals with higher loss exposure are more likely to purchase insurance is known as adverse selection. This occurs when there is a disparity in the information available to both the insurer and the insured about the risk level. Those who know they are at higher risks (such as individuals with unsafe lifestyles or pre-existing health conditions) are more motivated to seek insurance coverage. This can lead to an imbalance in the risk pool, as those with lower risks may opt out of purchasing insurance, believing they do not need it, which ultimately affects the insurance company’s ability to maintain sustainable premiums and payouts. The concept of adverse selection is crucial in the insurance industry because it highlights the necessity for insurers to accurately assess risk and manage their policies accordingly to avoid potential financial losses. This situation can lead insurers to implement measures like thorough underwriting processes or risk segmentation to maintain a balanced risk pool and ensure that premiums are reflective of the actual risks involved.