Mississippi Property & Casualty Practice Exam

What is the term used for the tendency of individuals with higher risks of loss to seek insurance coverage?

1. Adverse selection

2. Risk avoidance

3. Insurable interest

4. Underwriting

The correct answer is: Adverse selection

Adverse selection describes the phenomenon where individuals who are at a higher risk of experiencing a loss are more likely to seek insurance coverage than those who are at a lower risk. This occurs because those with a greater likelihood of filing a claim have a stronger incentive to obtain insurance, which can lead to an imbalance in the insurance pool. When insurers are unable to accurately assess the level of risk and set premiums accordingly, it may result in higher overall costs and can jeopardize the financial stability of the insurance provider. Understanding adverse selection is vital for both insurers and insured parties. Insurers implement measures such as underwriting, where they evaluate the risk level of applicants, to mitigate this issue. This ensures that they can evenly distribute risk within their pools, thereby maintaining fairness in premium pricing and sustainability in the insurance market.