Property and Casualty Insurance Practice Exam

Which of the following best describes adverse selection?

1. Underwriting high-value properties

2. Risk pooling among diverse demographics

3. Attracting high-risk individuals to insurance

4. Mitigating the impact of claims on premium rates

The correct answer is: Attracting high-risk individuals to insurance

Adverse selection refers to a situation in which individuals who perceive themselves to be at a higher risk of experiencing a loss are more likely to seek insurance coverage. This phenomenon occurs because insurance is more attractive to those who anticipate needing it, as they see it as a way to protect their potential losses. As a result, insurers may inadvertently attract a disproportionate number of high-risk policyholders who are more likely to file claims. This can lead to increased costs for the insurer, which may then result in higher premiums for all policyholders, making insurance less accessible for lower-risk individuals. The other choices do not accurately capture the essence of adverse selection. Underwriting high-value properties focuses on the assessment process for insuring high-value assets rather than the selection bias of risk. Risk pooling among diverse demographics aims to balance risk across a group, which counters the effects of adverse selection rather than describing it. Mitigating the impact of claims on premium rates addresses cost management and pricing strategies but does not delve into the underlying issue of attracting higher-risk individuals, which is the central concern of adverse selection.