An applicant who has just been diagnosed with a degenerative condition rushes to buy a disability income policy with the maximum monthly benefit. This behavior illustrates which underwriting concern?
Select an option to reveal the answer and the full 3-part explanation — free, no signup.
Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Adverse selection occurs when individuals who perceive themselves as high risk seek insurance more aggressively than low-risk individuals. Here the applicant knows about a newly diagnosed condition and immediately applies for maximum coverage, acting on information the insurer lacks at application. Underwriting exists precisely to detect such situations through medical history, attending physician statements, and MIB reports, allowing the insurer to rate, limit, or decline the risk. This protects the premium pool from becoming overpopulated with high-risk insureds and keeps premiums aligned with the true risk of the group.
Why the other options are wrong
- B) Moral hazard refers to a change in the insured's behavior after coverage is in force, such as becoming careless or exaggerating a claim. Applying for coverage in response to a known diagnosis is a pre-contract selection problem, not moral hazard.
- C) The law of large numbers lets insurers predict losses across a large, stable pool. It explains how underwriting statistics work, but it does not describe why this applicant is buying maximum coverage immediately after diagnosis.
- D) Indemnification is the principle that benefits restore a financial loss, not a description of the applicant's buying behavior. The applicant's conduct reflects asymmetric information about risk, which is the signature of adverse selection.
Memory hook
Buying insurance after bad news is adverse selection; underwriting exists to catch it.