FRM Part I · FRM Exam Part I · Insurance Companies and Pension Plans
A health insurer's policyholders who expect high medical costs are the most likely to buy generous coverage, while healthy individuals decline it. Which problem does this describe, and what is the usual insurer response?
This describes adverse selection, where higher-risk people self-select into coverage before the contract. Insurers respond with underwriting, screening and risk-based pricing. Deductibles and co-payments mainly address moral hazard, which is changed behavior after coverage is bought, not the self-selection described here.
- AMoral hazard; introducing deductibles and co-payments
- BAdverse selection; risk-based pricing and underwriting screeningCorrect
- CMoral hazard; risk-based pricing and underwriting screening
- DAdverse selection; introducing deductibles and co-payments to change behavior after purchase
Explanation
Adverse selection arises before the contract because high-risk individuals self-select into coverage when the insurer cannot observe risk. Insurers respond with underwriting, screening and risk-based pricing. Moral hazard is a change in behavior after buying cover, addressed by deductibles and co-payments, so the options pairing moral hazard with this scenario or pairing adverse selection with behavior-change tools are incorrect.
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