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An insurance management tool to reduce moral hazard is to ____.
A) charge the same premium for different risks
B) limit the amount of insurance provided
C) reduce the deductible to zero
D) prohibit coinsurance
Answer: B
Diff: 1 Type: MC Page Ref: 277
Skill: Recall
Objective List: 12.1 Identify the important aspects of the insurance industry
How does the economic concept of adverse selection apply to the lending activities of
insurers? Provide an example.
Answer: In the case of an insurance policy, moral hazard arises when the existence of insurance
encourages the insured party to take risks that increase the likelihood of an insurance payoff. For
example, a person covered by burglary insurance might not take as many precautions to prevent
a burglary because the insurance company will reimburse most of the losses if a theft occurs.
Diff: 3 Type: SA Page Ref: 293
Skill: Recall
Objective List: 12.1 Identify the important aspects of the insurance industry
How does the economic concept of moral hazard apply to the lending activities of insurers?
Provide an example.
Answer: Adverse selection holds that the people most likely to receive large insurance payoffs
are the ones who will want to purchase insurance the most. For example, a person suffering from
a terminal disease would want to take out the biggest life and medical insurance policies
possible, thereby exposing the insurance company to potentially large losses.
Diff: 3 Type: SA Page Ref: 275 - 277
Skill: Recall
Objective List: 12.1 Identify the important aspects of the insurance industry
List insurance management practices for lowering adverse selection and moral hazard.
Answer: Insurance management practices include: information collection and screening of
potential policyholders, risk-based premiums, restrictive provisions, prevention of fraud,
cancellation of insurance, deductibles, coinsurance, and limits on the amount of insurance.
Diff: 2 Type: SA Page Ref: 275 - 277
Skill: Recall
Objective List: 12.1 Identify the important aspects of the insurance industry
What is coinsurance? Provide an example.
Answer: When a policyholder shares a percentage of the losses along with the insurer, their
arrangement is called coinsurance. For example, some medical insurance plans provide coverage
for 80 percent of medical bills, and the insured person pays 20 percent after a certain deductible
has been met.
Diff: 2 Type: SA Page Ref: 277
Skill: Recall
Objective List: 12.1 Identify the important aspects of the insurance industry