Which statement about adverse selection and underwriting is incorrect?

• A. Adverse selection occurs when higher-risk individuals seek insurance.
• B. Underwriting helps identify and price risk.
• C. Health insurers have unlimited power to set underwriting provisions.
• D. Premiums can reflect expected costs after underwriting.

Answer: (C)

Adverse selection and underwriting hinge on information asymmetry: individuals know their own health risks, while insurers must rely on risk signals to price coverage. Higher-risk people are more inclined to buy insurance if they expect costly medical care, which is why adverse selection matters and underwriting is used to identify and price risk appropriately.

The statement that health insurers have unlimited power to set underwriting provisions ignores real-world limits. In practice, underwriting is constrained by regulation, market dynamics, and policy design that often restricts how risks can be screened and priced. Systems with guaranteed issue or community rating, for example, limit how much pricing can diverge based on risk, helping to balance access and costs.

Premiums can reflect expected costs after underwriting, which is precisely why underwriting is performed: to align pricing with anticipated health care costs.