South Carolina Life Insurance Practice Exam

Which strategy do underwriters use to prevent adverse selection?

1. Offering discounts for low-risk clients

2. When the policy is delivered and the premium is paid

3. Issuing policies only to larger corporations

4. Conducting regular reviews of insured assets

The correct answer is: When the policy is delivered and the premium is paid

Underwriters use various strategies to mitigate adverse selection, and delivering the policy when the premium is paid is a crucial tactic. Adverse selection occurs when individuals with a higher risk of claiming insurance are more likely to seek coverage than those who are healthier or lower-risk. By requiring that the policy is delivered and the premium paid, underwriters ensure that individuals are committed to the insurance contract, which can act as a filter for riskier applicants. This timing helps create a situation where only those genuinely intending to insure themselves against potential losses will complete the transaction, thereby discouraging those who might otherwise apply solely because they anticipate needing to make a claim soon after obtaining the policy. It allows insurers to evaluate the risk more effectively and allows them to decline coverage to applicants who do not meet certain criteria. In contrast, other strategies, such as offering discounts to low-risk clients, may indeed attract healthier individuals but do not necessarily control the motivation of higher-risk individuals to apply in the first place. Issuing policies only to larger corporations might limit exposure but does not comprehensively address the issue of adverse selection across all applicants. Similarly, conducting regular reviews of insured assets doesn't sufficiently address the risk inherent in the selection process at the outset.