Final answer:
The incontestable clause in insurance policies limits the time period the insurer can dispute the applicant's statements on the application.
Step-by-step explanation:
The incontestable clause in insurance policies is a provision that limits the time period the insurer can dispute the applicant's statements on the application. Once this time period has passed, typically within two years of the policy being issued, the insurer cannot challenge the validity of the information provided by the policyowner.
This clause provides protection to the policyowner by ensuring that their coverage cannot be revoked or denied based on statements made on the application after the specified time period.
When looking at the broader context of insurance practices, setting premiums at an actuarially fair premium for a group as a whole, rather than for subgroups based on risk, may lead to the insurance company experiencing adverse selection.
Higher-risk individuals would be more likely to take up the insurance offer because they would receive more generous coverage than warranted by their risk level, while lower-risk individuals might choose not to purchase insurance or seek coverage elsewhere where their lower risk is recognized with lower premiums.
State insurance regulators sometimes enforce rules to keep premiums low for consumer protection; however, this can result in insurers avoiding high-risk individuals or withdrawing from the market entirely if profitability is threatened. An example is when insurance companies ceased operations in New Jersey following such regulatory measures aimed at keeping auto insurance premiums low.