Purpose of Selection of Risk in Life Insurance

The selection of a risk is a process whereby inferior lives are “weeded out”. The function of the selection process is to determine whether the degree of risk presented by applicant for insurance is commensurate with the premium established for persons in his category or some additional premium should be charged or the applicant should be rejected the insurance.

Purpose of Selection of Risk

(i) The first and the foremost purpose of the selection of risk is to determine whether the proposal should be accepted or not.

(ii) The second objective of the selection is to determine the rate of premium to be charged from the assured. The premium depends upon the amount of risk.

Higher is the risk the more will be amount of premium. Each and every proposal should be evaluated to determine the amount of risk for calculation of premium. The evaluation of risk is also known as the selection of risk.

(iii) Since there are various degrees of risk to a person and so theoretically at least , all the persons should be charged different premiums, but it is not practicable to charge so many premiums as many applicants are.

Therefore, for practical purpose the risks are classified and premiums are determined accordingly.

Insurance risk may be classified into standard or sub-standard on the basis of selection. It is possible to determine what risks are to be accepted at normal rate of premium and what extra premium what not to be accepted at all.

(iv) The fourth aim of selection is to avoid any discrimination on the part of the lives assured. Since the degree of risk is not the same to all the persons, different premiums should be charged from different groups.

If one premium is charged from all the proposers, it would be unjustified. For instance, it would be wrong, to charge the same premium from the persons who are engaged in the hazardous occupation and from the persons who are enjoying robust health and conducive occupation.

(v) The selection risk is also essential to avoid adverse-selection. Selection risk is very essential to check the anti-selection or adverse-selection which means selection of the persons for instance who are not insurable and charging of lesser premium for those who are to be charged higher premium.

The persons in adversity of insurance, i.e., the person who are imminent to death may try to purchase insurance at any cost to gain.

If It is permitted not only the insurer will be losing, but the honest insured would be required to pay more premium to meet the total loss of the insurer.

If they accept the higher premium they are purchasing insurance at higher cost, and if they are not going to purchase the policy, the insurer will be losing sounding business and would be again at loss.

Therefore, it is very essential to select standard risk at standard cost and sub-standard risk at extra premium to avoid inequality of cost and unfavourable selection of risk.