Adverse selection in disability income insurance is best described as:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Adverse selection describes the tendency of persons most likely to experience a loss to apply for coverage in disproportionate numbers. In disability insurance, individuals who anticipate a greater chance of disability, because of health conditions, hazardous work, or other risk factors, are more motivated to purchase coverage, while low-risk individuals are less inclined to buy. If the insurer cannot identify and rate these differences, the claim experience of the block worsens and premiums must rise for everyone. Underwriting, including medical and occupational questions, exists largely to detect and price this selection effect.
Why the other options are wrong
- B) The insurer selecting healthy applicants is the result of underwriting, not adverse selection; adverse selection originates with the applicant's behavior.
- C) A change of occupation after a claim is a claim-eligibility issue, not the market-wide phenomenon adverse selection describes.
- D) Requiring medical exams is an underwriting tool used to control adverse selection, not adverse selection itself.
Memory hook
Adverse selection = the sick and risky knock first and hardest. Underwriting exists to identify and price accordingly.