Explanation:
Adverse selection occurs when the party with more information takes advantage of the party with less information. In this scenario, the elderly customers with pre-existing health conditions are more likely to claim insurance than the average person. This is because they know they have health issues, which is information not initially disclosed or factored in during the underwriting process, which leads to a higher-than-expected loss rate for the insurance company. This is a classic example of adverse selection.
Options B, C, and D are incorrect. Adverse selection specifically pertains to risks that arise due to asymmetrical information between the insurer and the insured before the agreement. Severe weather conditions, stock market performance, and IT breaches are all external factors not influenced by the policyholder's actions or choices and do not involve information asymmetry.
Q.1120 Suppose you are the chief risk officer of a growing insurance company, "SafeGuard Insurances Ltd." Recently, you noticed an increase in the number of claims. Digging deeper, you found that the claims primarily originated from policies bought in the last 6 months. You suspect adverse selection may be causing this increase in claims, and thus, you are conducting a thorough review to identify potential examples. Which of the following is most likely an example of adverse selection risk?
A
The company has seen a surge in life insurance policies sold to elderly customers with pre-existing health conditions.
B
There is an increase in car insurance claims due to severe weather conditions in areas where the company has a significant market presence.
C
The company's stock value has recently decreased, leading to a decline in market confidence.
D
The IT system of the company has been hacked, causing significant losses in digital assets.
No comments yet.