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Adverse Selection

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Adverse selection and life insurance plans

If it's too good to be true, it probably is

Adverse selection is one of those life insurance terms that fits better in a textbook than rolling off the tongue of someone shopping for life insurance.  What exactly does it mean?  Not only will we explain adverse selection but more importantly, how you can avoid the inevitable pitfalls it creates with life insurance (or any insurance for that matter) down the road.  Let's look closer at adverse selection in the market.

It's an insurance term (obviously) but it's effect can significantly impact the ability of your insurance policy to pay (life, health, property and casualty, etc) later on when you most need it.  Let's first define it in layman's terms.  I'll use a broader definition to mean any plan design, pricing, or option that degrades the ability of a given insurance plan to remain solvent and structurally intact.  It may sound counter-intuitive but adverse selection is any element of an insurance product that attracts bad risk.  That's it in a nutshell but we're concerned for ourselves...not for the life insurance companies.  What usually is bad for life insurance companies is good for us, right??  Up to a point and only for temporary period of time.  It's best to take some examples that we have actually seen in the market.

Pricing.  This is almost so common that I tend to think some carriers intentionally underprice their product in order to rapidly expand market share and the number of insured.  Maybe I'm cynical and a given insurance carrier has some hidden means to limit risk or a new pricing structure never before seen.  There's not much new under the sun with such a tested and conservative product such as term life insurance.  Most carriers have similar access to actuarial data and there's only so much squeezing any one company can accomplish with their overhead.  If the pricing for a given life insurance plan or company is significantly lower than similarly structured options, there might be a problem.  Term life is a commodity but only to some extent.  There's a health range of pricing that usually denotes a company is doing things correctly.  The carrier ratings can help indicate potentially problems (since pricing is half of the financial equation for a life insurance company with  claims being the other).  

Another form of adverse selection is the old "too good to be true" in terms of options/coverage.  This can mean a range of things.  An example would be a health insurance plan that has super rich maternity benefits (as compared to other carriers).  Guess what...people looking at future childbirths will go that direction and all of a sudden, the carrier's claims are skyrocketing.  The carrier either has to drive the premiums to match, reduce the benefit, or pull the plan all together from the market.  FYI...the last option is one taken by a major health insurance carrier we dealt with in the past.  That's not a good place to be especially if you're already pregnant (roughly 75% of our clients with this carrier were pregnant at the time the carrier notified us they were leaving the market).  What may seem like a wonderful benefit for the insured can be too good for the carrier to deliver on.  This is another form of adverse selection.

Faulty underwriting can also result in adverse selection for a life insurance company.  If a life company has very laxed underwriting requirements, without fail, people with health issues will flock this direction (for lack of an available alternative).  This can along almost any health or habit attribute that you can think of.  Worst yet is when a life insurance company is just generally more aggressive in overall underwriting to such an extent that it becomes adverse selection.  We're all for reasonable and even progressive underwriting to help more people qualify for coverage but not at the expense of financial stability and pricing/product jeopardy later on.  Again, there will be differences on the market but if pricing is significantly out of bounds, you can generally expect issues in the future as a result.  This is adverse selection and you want to avoid something that seems too good to be true...a surefire indication that it's taking place with your prospective life insurance plan.




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