South Carolina Life Insurance Practice Exam

What is it called when risks with a higher probability of loss seek insurance more often than other risks?

1. Risk pooling

2. Adverse selection

3. Underwriting

4. Claims frequency

The correct answer is: Adverse selection

The situation described occurs when individuals or entities that have a higher likelihood of needing insurance are more inclined to obtain it compared to those who pose a lower risk. This scenario is known as adverse selection. In essence, adverse selection arises because people with a greater awareness of their risk profile may be more motivated to purchase insurance, which can lead to an imbalance in the risk pool. Insurers may find themselves covering a higher proportion of high-risk individuals than expected based on their general underwriting standards. This can result in increased costs for the insurance company, as they may face more claims than anticipated. Risk pooling refers to the practice of gathering together numerous risks to spread out the potential financial losses among all insured parties. Underwriting is the process insurers use to evaluate the risks of applicants and determine policy terms, prices, and eligibility. Claims frequency pertains to how often claims are made, which is different from the motivation behind purchasing insurance. Understanding adverse selection is crucial for insurance companies in managing their risk exposure effectively.