AD Banker Comprehensive Practice Exam

What can an insurer do to address adverse selection legally?

1. Limit the amount of coverage issued

2. Raise the premium higher than most people can afford to pay

3. Establish and enforce sound underwriting practices

4. Not offer policies to those over age 55

The correct answer is: Establish and enforce sound underwriting practices

An insurer can address adverse selection by establishing and enforcing sound underwriting practices. Underwriting is the process through which an insurer assesses the risk of insuring an individual or entity. By developing rigorous underwriting guidelines, an insurer can better evaluate the risks associated with providing coverage to applicants. This helps to ensure that applicants are priced appropriately based on their risk level, which ultimately allows the insurer to maintain solvency and stability. Good underwriting practices involve analyzing various factors that might affect a person’s likelihood of filing a claim, such as age, health, lifestyle, occupation, and other related risk indicators. By creating a thorough and consistent underwriting process, insurers can avoid taking on excessive risk and mitigate the effects of adverse selection, which occurs when those most likely to need coverage are the ones most likely to seek it. In contrast, limiting the amount of coverage issued, raising premiums excessively, or denying coverage to specific age groups may not effectively address the underlying issue of adverse selection and could result in unfair discrimination or loss of business opportunities. Effective underwriting practices foster a more balanced risk pool and contribute to the overall health of the insurance market.