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IAI Actuarial Core Principles · Economic Modelling · Role of insurance in reducing or removing risk

A health insurer offers one premium to all applicants without any underwriting. Which outcome is most consistent with adverse selection?

High-risk people disproportionately buy the cover, so claims exceed those priced into the uniform premium. The insurer raises premiums, low-risk people leave, and the pool deteriorates further. Reduced care after purchase would be moral hazard, not adverse selection.

  1. APremium falls over time as the risk pool becomes healthier
  2. BHigh-risk individuals buy more cover, pushing claims above those priced, so premiums rise and lower-risk people leaveCorrect
  3. CAll applicants take identical cover regardless of risk
  4. DInsured individuals take less care of their health after buying cover
  5. Claims become perfectly predictable because of pooling

Explanation

With a pooled premium, high-risk individuals find insurance a bargain and buy more, while low-risk ones find it poor value and drop out. Average claims rise, forcing a higher premium, which is the adverse selection spiral. Reduced care after purchase would be moral hazard.

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