is one of those life insurance terms that fits
better in a textbook than rolling off the tongue of
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
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.
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).
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
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
life insurance plan.