Skip to content

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

A motor insurer notices that after policyholders buy fully comprehensive cover, they park less carefully and skip routine vehicle maintenance. Which term best describes this behaviour, and when does it arise?

This is moral hazard. The policyholder changes behaviour after taking out cover because the insurer, not the insured, bears the cost of losses. Adverse selection, by contrast, concerns which people choose to buy insurance before the contract starts.

  1. AAdverse selection, arising before the contract is signed
  2. BMoral hazard, arising after the contract is in forceCorrect
  3. CAdverse selection, arising after a claim is made
  4. DMoral hazard, arising only because of asymmetric information about the insurer's solvency
  5. Basis risk, arising from imperfect hedging

Explanation

Moral hazard is a change in the insured's behaviour after cover is obtained, because the insured no longer bears the full cost of loss. Adverse selection concerns who buys cover, which happens before the contract. So the first option has the wrong stage and the second is correct.

Did you get it right without looking?

One question tells you little. A timed set on Role of insurance in reducing or removing risk shows your real accuracy, how long you take and where you lose marks.

Practise Role of insurance in reducing or removing riskFree diagnostic mock

More Role of insurance in reducing or removing risk questions