LO 9.1.7.D

Learning Objective: Describe how the uses of artificial intelligence and machine learning by the insurance industry could affect both moral hazard and adverse selection problems.

Review

• Moral hazard

In the insurance industry, moral hazard occurs when insured parties take more risks in the knowledge that their insurance coverage protects them from losses. Moral hazard can be reduced when AI and ML applications are used to timely adapt insurance fees in accordance with the changing behavior of policyholders.

• Adverse selection problems

Adverse selection occurs when insurers extend insurance coverage to applicants whose actual risk is substantially higher than the risk known by the insurers. Adverse selection risks can be reduced when AI and ML applications are used to create tailor-made insurance policies that take into account the particular characteristics of the insuree.