Income Protection Insurance Assessment - Essay Example

Income Protection Insurance AssessmentPart I: Income protection Insurance (IPI)Explain how information asymmetry may lead to adverse selection. Illustrate your answer using the dealings between Mr. Farid and Prudent Insurance Inc.Information asymmetry is a situation in which the economic agents involved in a transaction have different information. For instance a private motorcycle seller may have more information about the quality of the motorcycle he is selling than the prospective purchaser.

Adverse selection is a form of asymmetric information used in the explanation of the insurance market theory. It is considered a form of market failure in economics. Adverse selection is a situation where one party in a transaction is more informed about its own characteristics. It knows something about itself that the other party doesn’t. Adverse selection is often referred to as hidden information problem in the market, where for instance, sellers may know more about a product than a customer.

In the case of Mr. Farid and Prudent Insurance, Mr. Farid faced different probabilities of his insurable event occurring, some at least under his control. Prudent Insurance therefore assumed Farid was either a low risk or high risk of the insured event happening. However, it could not individually classify Mr.Farid. Therefore when he fell sick, Prudent Insurance ascertained truth by sending him a claims form. This was in an attempt to solve the problem of adverse selection. If you were the underwriter, would you approve Mr.

Farid’s application for income protection insurance? ExplainI would not approve Mr.Farid’s claim for insurance for income protection. Mr. Farid had a heart valve disorder and this had the potential to present problems in future. It is an element of risk that I could not afford to look as an underwriter. By accepting his application claim, it means Mr.Farid had the motive of using this policy to claim for healthcare expenses. In other words, there was an element of moral hazard. Should Prudent Insurance Inc.

pay the claim or deny it? ExplainPrudent Insurance should deny the claim. The reason Mr. Farid could not work a year after taking cover was because of his state of poor health. This was due to the heart valve disorder. This disorder was not covered in the policy given to Mr. Farid and thus, he could not claim. Also the claims form indicates Mr. Farid spent less than an hour on the activities of lifting and carrying heavy items. These two had the biggest risk compared to driving and climbing ladders.

Part II: Household items InsuranceHow would the information about Mr. Green’s earlier convictions affect the insurer’s underwriting decision on Mr. Green’s application? ExplainInformation about Mr.Green’s earlier convictions are important in determining the underwriting decision in that, if it is a restriction by the company, then Mr. Green did not act in good faith to inform the insurance of his past criminal activities. Though he was asked in the application form, he claims to have stated it orally to the broker, a fact the broker denies. Thus Mr. Greens past convictions would enable the insurance company to know the extent of the convictions and their effect on the policy claim.

A criminal or someone who has convicted before is considered to be riskier than his law abiding neighbor. If you were appointed as an independent adjustor, what would be a fair solution for the dispute between Mr. Green and the insurer? (Hint: Examine (a) information withheld in relation to adverse selection, (b) industry practice regarding incomplete client formsAs an independent adjustor the fair solution would be to deny Mr. Green the claim. This is considering that Mr. Green withheld important information that was crucial to the company’s decision on whether to grant him a policy.

Though the form stated he should fill that part he intentionally left it blank and instead thought by telling the broker it would be okay. As an insurance industry practice, a company may legitimately deny reimbursement of claims if the claim form is inaccurate, incomplete or insufficiently submitted. ReferencesGibson, H.R. (1987). Asymmetric Information in Insurance Markets: A Situation of Moral Hazard