Chartered Life Underwriter Exam 2025 – 400 Free Practice Questions to Pass the Exam

Adverse selection refers to a phenomenon where individuals who are more likely to experience a loss or risk are also more inclined to purchase insurance, while those who are at lower risk may choose not to buy coverage. This creates an imbalance within the insurance pool.

When individuals with a high risk of claiming insurance are more likely to purchase coverage, it leads to a situation where the insurer faces a disproportionate number of claims relative to premium income. This can result in an overall increase in the cost of insurance, as insurers may need to raise premiums to compensate for the higher likelihood of payouts. Adverse selection can undermine the sustainability of insurance products if not properly managed.

In contrast, the other options describe different scenarios not associated with adverse selection: individuals avoiding insurance (low-risk), market share miscalculations, or adjustments for inflation, none of which directly relate to the dynamics of risk pooling that characterize adverse selection.