Question

How is risk classified?

___ = average risk: exposure in normal range
___ = lower risk of loss: premiums discounted due to favorable risk factors (ex. healthy lifestyle, low-risk occupation)
___ = above average risk: due to health, type of occupation, habits
a) Preferred Risk
b) Standard
c) Substandard Risk

Answer 1

Risk is classified into Preferred Risk, Standard, and Substandard Risk, based on factors such as lifestyle, occupation, and habits, to achieve actuarial fairness and cover insurance company costs and profits.

Step-by-step explanation:

Risk is classified into different categories based on an individual's likelihood of filing a claim. The classifications are as follows:

1. Preferred Risk = lower risk of loss: premiums discounted due to favorable risk factors (e.g., healthy lifestyle, low-risk occupation).
2. Standard = average risk: exposure in the normal range.
3. Substandard Risk = above average risk: due to health, type of occupation, habits, etc.

These categories ensure that the average person's payments into insurance cover the average person's claims, the costs of running the company, and leave room for the firm's profits. Classifying individuals into these risk groups is part of achieving actuarial fairness but can be controversial due to problems like moral hazard and adverse selection, arising from variances in individuals' risk profiles.