Underwriting helps prevent adverse selection by:

• A. Allowing every applicant to be insured at standard rate.
• B. Selecting and pricing risk to reflect expected losses.
• C. Cancelling policies after a loss.
• D. Providing free coverage to high-risk individuals.

Answer: (B)

Underwriting is the process of evaluating each applicant’s risk and setting premiums that reflect the expected losses from that risk. By classifying applicants into risk groups and pricing them accordingly, insurers keep the premium collection aligned with the actual likelihood and cost of claims. This prevents adverse selection, where high-risk individuals would be more likely to buy insurance or file more claims if everyone paid the same rate or if coverage were offered indiscriminately. When underwriting effectively, low-risk buyers pay less, high-risk buyers pay more, and the insurer maintains a balanced, financially stable pool.

If everyone were insured at a standard rate regardless of risk, high-risk individuals would be drawn to the policy, raising average losses and forcing premiums up or the insurer to withdraw. Cancelling policies after a loss or giving free coverage to high-risk would distort incentives and undermine risk pooling, rather than address the core issue of aligning price with risk.