Oklahoma Life Producer Practice Exam

Which of the following is often a concern with adverse selection?

1. It leads to lower payouts for high-risk individuals

2. It results in higher premiums for all policyholders

3. It minimizes the need for actuarial assessment

4. It encourages insurers to offer more diverse plans

The correct answer is: It results in higher premiums for all policyholders

Adverse selection refers to the tendency of individuals with higher risks to seek insurance more often than those with lower risks. This phenomenon occurs because those who perceive themselves to be at a higher likelihood of needing insurance coverage are more inclined to purchase it, while those who consider themselves at lower risk might opt out. When adverse selection occurs, insurance companies may struggle to maintain a balanced risk pool—meaning they end up covering more high-risk individuals relative to low-risk ones. This imbalance can lead insurers to increase premiums for all policyholders in an effort to offset the higher chance of claims stemming from the predominance of high-risk individuals. By raising rates, the insurer aims to ensure that they can still honor claims and remain financially viable while covering the potential losses incurred from the risks they have taken on. This situation highlights the importance of accurate risk assessment and pricing. Insurers seek to evaluate the risk of applicants carefully in order to avoid the pitfalls of adverse selection, which ultimately impacts the overall sustainability of insurance products.