Final answer:
Insurers' underwriting policies are influenced by factors such as adverse selection, investment income, administrative costs, and the variability of risk among groups as well as government regulations, which can force insurers to adapt or withdraw from markets.
Step-by-step explanation:
The factors affecting the formation of an insurer's underwriting policy include adverse selection, investment income on reserves, administrative costs, and the variability of risk among different groups. Adverse selection is a critical concern for insurers, as it occurs when individuals with higher risks are more likely to purchase insurance, potentially leading to unsustainable costs if not enough low-risk individuals enter the pool to balance the premiums versus the claims. Additionally, insurers need to ensure that premiums collected cover the cost of claims, operational expenses, and allow for profits, which is a fundamental law of insurance. Regulations by state insurance regulators can complicate matters, as they might pass rules to keep premiums low, which can cause insurance companies to avoid high-risk parties or withdraw from markets entirely, such as some companies did in New Jersey in the 1990s and 2000s, or State Farm's withdrawal from selling property insurance in Florida in 2009.
Another key factor is how insurers address the risk variations among the insured population. This may involve sorting insurance buyers into different risk groups and charging them accordingly, or requiring that individuals purchase insurance, even if it means paying more than is actuarially fair for their group. Government laws and regulations can also play a significant role in shaping insurance markets and the underwriting policies of insurance firms.