Alabama Insurance Adjuster Practice Exam

When an insurer effectively reduces their potential loss from an applicant’s high risk by charging higher premiums, they are practicing?

1. Risk avoidance

2. Risk equalization

3. Risk management

4. Risk differentiation

The correct answer is: Risk differentiation

The practice described involves the insurer adjusting the premiums based on the assessed risk of the applicant. By charging higher premiums for applicants deemed high risk, the insurer aims to balance out or offset the increased likelihood of experiencing a loss. This approach recognizes that not all applicants represent the same level of risk, and premiums can be adjusted accordingly to reflect that variation. Risk differentiation is the correct term here, as it refers specifically to the practice of modifying insurance rates based on the level of risk associated with an individual or group. It allows insurers to create a more tailored approach to underwriting, ensuring that those who present a higher risk pay more, thereby maintaining the overall health of the insurer’s portfolio. This strategy contrasts with other risk management practices such as risk avoidance, where the insurer might choose not to provide coverage at all, or risk equalization, which would imply spreading risks evenly across all policyholders—both of which do not involve adjusting premiums based on individual risk assessments. Risk management encompasses a broader array of strategies, of which risk differentiation is a specific technique aimed at refining pricing models based on risk levels.