FRM Part I · FRM Exam Part I · Insurance Companies and Pension Plans
An insurer offers a car policy with no deductible and finds that insured drivers become less careful after buying coverage, raising the average claim cost. Which term describes this behavior?
The behavior is moral hazard: after buying coverage with no deductible, drivers take less care because the insurer bears the loss. Adverse selection would instead describe high-risk people being more likely to buy the policy in the first place, before any change in behavior.
- AMoral hazardCorrect
- BAdverse selection
- CBasis risk
- DLongevity risk
Explanation
Moral hazard is the change in behavior after insurance is bought, because the insured bears less of the loss. Adverse selection concerns who buys coverage before the contract, not behavior afterward.
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