Georgia Property & Casualty Practice Exam

Which of the following is an example of adverse selection?

1. An applicant who just bought a new car and wants to buy the least expensive auto policy.

2. A homeowner who wants to meet with her agent to discuss her current coverages following some recent home improvements.

3. An applicant whose business was recently burglarized deciding he had better buy some commercial crime insurance coverage.

4. A business owner who decides to cancel his business owner's policy because he believes he can financially handle any losses that might occur.

The correct answer is: An applicant whose business was recently burglarized deciding he had better buy some commercial crime insurance coverage.

Adverse selection refers to a situation where individuals with a higher risk of loss are more likely to seek insurance coverage, while those with a lower risk may forgo it. This creates an imbalance in the insurance pool, as insurers may end up covering a larger proportion of high-risk individuals, leading to increased claims and potentially higher premiums for all insured. The correct example of adverse selection is the applicant whose business was recently burglarized and decides to purchase commercial crime insurance. This situation demonstrates adverse selection because the business owner has firsthand knowledge of the risks and vulnerabilities their business faces, which makes them more likely to seek out insurance coverage. This proactive response to a recent loss signifies an awareness of an increased risk of future losses, as opposed to someone who may not perceive such risks and thus opts not to secure insurance. In contrast, the other scenarios do not exemplify adverse selection as they do not involve individuals necessarily seeking insurance due to increased knowledge of their own risks. For example, the applicant who wants the least expensive auto policy may not be driven by a higher risk but rather by cost considerations. The homeowner discussing coverages after home improvements indicates a level of responsibility without necessarily linking to increased risk perception. Finally, the business owner who cancels his policy shows a decision