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How will improved forecasts of individual lifetimes affect underwriting?
1Heriot-Watt University, Riccarton, Edinburgh, UK.
Summary
Underwriting and adverse selection increase insurance costs, especially when individuals seek higher coverage amounts. This study quantifies these adverse selection costs in diverse populations.
Area of Science:
- Actuarial science
- Risk management
- Insurance mathematics
Background:
- Adverse selection poses a significant challenge in insurance markets with heterogeneous populations.
- Underwriting aims to mitigate risks but can interact complexly with selection behaviors.
Purpose of the Study:
- To analyze the combined impact of underwriting and adverse selection.
- To quantify the financial costs associated with adverse selection in insurance.
Main Methods:
- Utilized a straightforward Markov model to simulate population dynamics.
- Incorporated heterogeneous population characteristics into the model.
Main Results:
- Demonstrated that adverse selection can lead to substantial insurance costs.
- Identified above-average sums assured as the primary driver of these costs.
Conclusions:
- Effective underwriting is crucial for managing adverse selection.
- Insurance pricing must account for the tendency of higher-risk individuals to seek greater coverage.