Final answer:
The corridor in a Universal Life Insurance policy raises the death benefit to offset losses incurred by insuring individuals at higher risks, preventing adverse selection. It ensures that the insurance company can cover the costs while still encouraging low or medium-risk individuals to purchase insurance.
Step-by-step explanation:
The corridor in a Universal Life Insurance policy raises the death benefit to avoid a consequence called “adverse selection.” Adverse selection refers to the situation where people who are at a higher risk of dying are more likely to purchase life insurance, while those who are at a lower risk are less likely to purchase it. By raising the death benefit, the insurance company can offset the losses incurred by insuring individuals with higher risks.
For example, let’s say an insurance company sells a policy with a $100,000 death benefit. If a client passes away, the company must pay the beneficiary the full $100,000. However, if the company offers a policy with a $200,000 death benefit, the premiums charged for that policy will be higher. This allows the insurance company to cover the costs associated with insuring individuals at higher risks.
The corridor is essential in preventing adverse selection from negatively impacting the insurance company. It ensures that the cost of insuring high-risk individuals is covered without discouraging low or medium-risk individuals from purchasing insurance.