Utah Life Producer Practice Exam

What is one way insurers protect themselves from adverse selection?

1. Through selective marketing campaigns

2. A profitable distribution of exposures

3. High premium rates for all policies

4. Lower coverage limits across policies

The correct answer is: A profitable distribution of exposures

Insurers use a profitable distribution of exposures as a strategy to mitigate the effects of adverse selection. Adverse selection occurs when individuals who are at a higher risk of filing claims are more likely to seek insurance, leading to a disproportionate number of high-risk policyholders. By achieving a balanced and diversified mix of insured parties - which includes low, moderate, and high-risk individuals - insurers can manage and spread risk more effectively. A profitable distribution of exposures enables insurers to maintain premiums that reflect the true risk of the entire pool of insureds rather than overcharging low-risk customers to compensate for higher-risk individuals. This balance helps ensure the overall financial stability of the insurance company, as the premiums collected from lower-risk policyholders complement those collected from higher-risk ones. Thus, this approach is vital for keeping the insurance system sustainable and preventing significant losses that could arise from overexposure to high-risk groups. Other approaches, like selective marketing campaigns, may also help target specific demographics but do not directly address the underlying risk distribution. High premium rates for all policies can drive away lower-risk customers, potentially leading to higher adverse selection. Similarly, implementing lower coverage limits could limit potential losses but does not fundamentally address the issue of risk diversity in the policyholder pool.