General Insurance PrinciplesQuestion 223 of 531
A roofing contractor with three large liability claims shops hard for coverage while claim-free roofers renew quietly. An underwriter who prices the whole class alike is exposed to:
a.adverse selection, drawing worse risks at an average price
b.moral hazard, since the poor risks may stage their claims
c.a catastrophe exposure, since one storm strikes every roofer
d.the law of large numbers, which levels the results out again
Explanation
Adverse selection is the tendency of applicants with a higher-than-average chance of loss to seek insurance most eagerly, so a single average price attracts the worst risks and repels the best. Underwriting and classification exist to counter it. Moral hazard is a different problem: dishonesty by an insured who wants a loss to happen, not a pricing distortion in who applies.
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