Adverse selection in life insurance


Adverse selection is a financial term that means that one party to a transaction has information that the other party does not. For example, if you sell a car knowing the starter is faulty and neglect to disclose that information, the Adverse Selection Principle means you could get more money for the car than it is worth. .

What does adverse selection insurance mean for the life insurance industry? According to Laura Adams, insurance expert, “When it comes to life insurance, ‘adverse selection’ is industry jargon which means that an insurer thinks an insured is less risky than it is. actually is.

What is adverse selection?

Adverse selection can be a problem for insurers who sell life, auto, health and other insurance.

Insurance companies determine your premium rate by looking at all of the variables in your claim. The more likely it is that you will make a claim on your policy, the higher your premium will be.
With life insurance, even a small lie about your claim can be considered adverse selection. “For example,” says Adams, “if you take out a life insurance policy but do not disclose that you are a smoker, you may have to pay a lower non-smoking rate. Because smokers are at greater risk for disease than the general population, you receive a lower rate than you would have obtained if you had been honest in your application.

It may seem like a small thing, but giving incorrect information or omitting important details when purchasing a policy is never a good idea. “If the insurer finds out that you have completed your claim fraudulently, it may have the legal right to deny payment to your beneficiaries,” Adams said.

Lying about your claim can also cause the company to deny coverage if the lie is discovered. If you’re a smoker, for example, even if you neglect to mention it on your application, the company may find out the truth when they receive your doctor’s statement later in the pricing process. This lie is likely to make them wonder if insuring is a good idea.

“Always be honest with your life insurance company and make sure your loved ones are financially protected after you die,” Adams says.

How adverse selection impacts the life insurance industry

Life insurance against adverse selection can cause insurers to charge less for policies than they otherwise would. The cost of your policy is determined by algorithms that insurers have access to to determine the likelihood of your death while the policy is in force. If this risk is low, so is your premium.

But due to adverse selection, the industry must take into account that some people commit fraud or omit information in their applications, which will result in low premiums but higher risk of death. This means that the business has to pay more claims.

To account for this, insurers pass this cost on to you, the policyholder, by charging a little more for premiums to counter the increase in claims they have to pay on accounts with undetected adverse selection. So even if you are honest in your application, you might be paying for those who are not.

How insurance companies collect information

During the underwriting process, your insurer collects information in several ways, which serve as a mutual check to ensure accuracy. These means may include:

  • The initial request: You will be asked for basic information about yourself, your health, your work and your hobbies. While you can get away with leaving something out of the claim, it could be discovered later in the process – and result in a denial of coverage.
  • Paramedical examination: The insurer sends a health care professional to your home or office for an exam. Any inconsistency in your application will be noted. For example, if you’ve lost twenty pounds of weight on your app, the paramedic should detect it.
  • Doctor’s statement: If the underwriter has questions about your health, they will request a statement from your primary care physician. If, for example, the paramedical examination led to the suspicion that you are a smoker when you have said you are not, the underwriter may ask your doctor in detail about your smoking habits.
  • List of prescriptions: The subscriber can also access information about medications that you are currently taking or that you have taken in the recent past. This can shed light on a chronic illness or a past illness that would increase your risk of death.
  • List of the Medical Information Office: This industry organization collects information that you have submitted on previous life, health, auto, or other insurance claims. If it does not match what you said in the current request, it will raise suspicion.
  • Motor Vehicle Report: The underwriter will also pull a report on your driving activities from your state’s DMV. If you haven’t honestly recorded the fact that you are a high risk driver or have serious infractions on your record, that may work against you as it will be clear from the data the DMV is collecting on you.

All of this information gives the underwriter a complete picture of who you are and the type of risk you would present to the insurer. The app is just the first of several ways the company collects information about you.

If, after all of this, an untruth creeps into the process, it is called a misrepresentation. You can congratulate yourself on having succeeded, but don’t be sure. If this information is revealed later and the insurer can prove that it was an intentional lie, you have committed fraud.

Some life insurance policies have a two-year period, called a contestable period, during which the policy can be terminated in the event of a misrepresentation. Even if the lie is detected after this period, your insurer may be reluctant to pay death benefits if your death is caused by something you knew but did not disclose in your claim.

The bottom line

Ultimately, honesty is the best policy when applying for life insurance. Insurers have trained staff who can spot lies and inconsistencies, and some even work with investigators to prove fraud after the fact. All of your premium payments may be void if a lie on your claim results in a denial of payment or a reduction in payment upon your death.


Martin E. Berry

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