Adverse Selection Gone Awry
When an insurance contract is first forged between an insurer and a customer, both parties assume some form of risk. The insurer is taking on the risk that the newly insured might submit a large number of claims. It will have to pay out much more in benefits than the amount of money it receives back in premiums. In turn, the insured faces the risk of never experiencing a single loss. Thus receiving nothing in return for his premium payments. You are going to learn more about this known as adverse selection below.
While both parties must assume risk in an insurance transaction, the insurer often has a significant advantage. The insurer is able to analyze the risk that it’s about to take on. For example, many large insurers have entire departments devoted to determining which risks should be accepted. They also determine ideal premium that should be charged for an accepted risk. Single people purchasing individual insurance coverage has little more than their expertise to rely on when purchasing coverage.
What is Adverse Selection And How Does It Affect You
These unleveled abilities to analyze the risk involved in establishing an insurance policy. Can help partially explain the insurance industry phenomenon known as “adverse selection”. Adverse selection refers to the tendency of those who have a sudden need for insurance. They purchase it more often than those who have no such sudden need. A person who has recently fallen ill, is more likely to purchase health insurance. A healthy person has no worry of contracting an illness and no hurry to buy insurance.
Those who have a sudden need for insurance represent an increased risk for insurers. There’s a likelihood they will request more in benefits than they pay back in premiums. Thus, insurance professionals are trained to look out for cases of adverse selection, and rate those risks accordingly. If a person is likely to submit a high number of claims upon being granted insurance, they may be charged higher premiums or denied coverage altogether.
Certain mechanisms also exist within the insurance industry to automatically combat adverse selection. Returning to our example of health insurance, most health policies contain what is known as a “preexisting condition exclusion period.” This means that for a certain period following purchase of health insurance (usually six months), the insurer will not pay any benefits relating to conditions for which the newly insured had previously been treated or sought medical advice. This forces those who have a sudden need for medical attention to pay for it out-of-pocket for a certain period, which helps alleviate the insurer’s burden of immediate claims poised by adverse selection.
Does Not Completely Prevent The Problem
Nevertheless, this does not completely prevent individuals from resorting to trickery in order to get around the mechanisms designed to combat this phenomenon. Perhaps no other example better illustrates such trickery than a story recently reported out of Philadelphia:
A Philadelphia woman was arrested last Friday on allegations that immediately following a car accident and while still in an ambulance, she called her insurer to add comprehensive collision coverage to her insurance policy. According to the criminal complaint, the defendant—who did not have comprehensive or collision insurance for her vehicle—was involved in a four-vehicle accident in October 2011.
The charges state that in an ambulance on the way to the hospital, the defendant allegedly called her insurance company to add comprehensive, collision and rental coverage to her auto policy for the vehicle that had just been involved in the accident. Authorities said that following the accident, she allegedly reported a claim to her insurance company in an attempt to have damages to her vehicle paid and lied to the company about when the accident occurred, saying that it happened after she obtained the additional coverage to her policy.
Penalties Are In Place
Fortunately for the insurance industry, penalties are in place to punish those who commit such obvious examples of insurance fraud. The woman was charged with one count of insurance fraud and one count of criminal attempt to commit theft.
However, this example represents an extreme case of adverse selection gone awry. While most insurance customers are not out to commit outright fraud, they are still participating in an industry that is at all times affected by those who purchase coverage in hopes of earning immediate insurance benefits. It is important for those with a sudden need for insurance to keep in mind that they may not earn a return on their investment right away.
Oh yeah, trying to increase insurance coverage while inside an ambulance is generally frowned upon.
This post was written by Nate Rothwell.