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FRM Part I · FRM Exam Part I · Insurance Companies and Pension Plans

Which statement about the effect of moral hazard and adverse selection on property-casualty insurance underwriting is correct?

Deductibles and coinsurance reduce moral hazard because the policyholder bears part of any loss and so keeps an incentive to take care. Adverse selection occurs before contracting, when higher-risk applicants are more likely to buy, so it is a different problem from post-contract behavior.

  1. ADeductibles and coinsurance clauses reduce moral hazard by giving the policyholder a share of the lossCorrect
  2. BAdverse selection arises after the policy is issued because insureds take less care
  3. CMoral hazard is eliminated by charging all customers the same premium
  4. DAdverse selection is reduced when insurers cannot classify risks

Explanation

Deductibles and coinsurance leave part of the loss with the insured, so incentive to take care is retained. Adverse selection arises before the contract, as high-risk applicants are more likely to buy. Uniform pricing worsens adverse selection, not moral hazard.

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