What is the term for the decision to reinsure loss exposures that are undesirable due to their increased probability of loss?

The decision to reinsure loss exposures that are undesirable due to their increased probability of loss is known as adverse selection. This term refers to a situation where an insurer is more likely to attract high-risk individuals because those individuals are more aware of their own risk levels than the insurer. In this context, companies may find themselves with an overwhelming concentration of high-risk policies, leading to potential financial strain.

Adverse selection highlights the necessity of reinsuring these risks to help stabilize the insurer’s portfolio and mitigate potential losses associated with a high proportion of high-risk clients. By identifying and reinsuring these undesirable loss exposures, insurers can effectively manage and distribute risk, making their operations more sustainable.

Understanding adverse selection is crucial for insurers because it shapes how they develop their underwriting guidelines and create their reinsurance strategies in order to maintain profitability and solvency in a competitive market.