Insurance Broker Certification Practice Exam

What characteristic is associated with adverse selection in insurance?

1. Insuring low-risk individuals

2. Insuring high-risk individuals

3. Encouraging diversification

4. Offering discounts for safe practices

The correct answer is: Insuring high-risk individuals

Adverse selection occurs when there is an imbalance of information between buyers and sellers in the insurance market, leading to a situation where those most likely to make claims are the ones most inclined to purchase insurance. This characteristic is specifically associated with insuring high-risk individuals. In scenarios where individuals understand their own risk levels better than the insurance provider does, those who perceive themselves as high-risk are more likely to seek insurance coverage. For example, a person with a serious health condition may be more motivated to buy health insurance compared to a generally healthy individual. Insurers facing adverse selection often struggle, since they may end up with a pool of policyholders who are more likely to use their services, resulting in increased costs that can ultimately affect the viability of the insurance model. The other choices do not align with the concept of adverse selection. Insuring low-risk individuals would typically improve the insurer's risk pool. Encouraging diversification and offering discounts for safe practices are strategies aimed at mitigating risks and encouraging policyholders to engage in less risky behavior, which contrasts with the principles of adverse selection.