Adverse selection is where an insurance company cannot distinguish between good and bad risks and offers the same price to everyone and inadvertently attracts more of the bad risks.

To overcome the adverse selection problem, an insurance company must try to understand the controls that exist within banks and the losses that have been experienced.

Option B is incorrect. Moral hazard describes the observation that an insured firm is likely to act differently in the presence of an insurance cover. In particular, traders might increasingly take high-risk positions in the knowledge that they are well protected from heavy losses. Without such an insurance policy, the traders would be more cautious and restricted in their trading behavior.

Option C is incorrect. Scenario analysis aims at estimating how a firm would get along in a range of scenarios, some of which have not occurred in the past. It’s particularly essential when modeling low-frequency high-severity losses, which are essential to determine the extreme tails of the loss distribution. The objective of the scenario analysis is to list events and create a scenario for each one.

Option D is incorrect. Internal selection risk is the risk that a company is exposed to in the process of assessing and evaluating employees as they move from one position to another through transfer and promotion.