A little more detail_2

So what is moral hazard?
Moral hazard is the risk that the behaviour of policyholders changes once they have entered into an insurance contract in a way that makes the risk event more likely to happen. For example, a car owner may drive less carefully once they have insurance that passes the risk of the car being damaged on to an insurer. Moral hazard can result in more claims than the insurance company expected based on its underwriting and could result in premiums increasing for all policyholders if it is not managed effectively. This is why it is important for the terms and conditions of insurance contracts to be tightly worded.

And what does adverse selection mean?
Adverse selection is a situation in which higher risk individuals are more likely to take out insurance. One of the objectives of underwriting is to avoid this by identifying relevant risk factors and setting premiums to correctly reflect the risks. For example, if smokers and non-smokers are offered life insurance at the same price (based on the average life expectancy for both groups), the premium will be better value for smokers — who can be expected to have a higher than average mortality rate — than for non-smokers. As a result, more smokers than non-smokers are likely to take out the insurance. The insurer will then end up with a higher than average mortality rate (and hence higher claims) than it anticipated when it was pricing the product, which will affect its reserves or the premiums it then charges. However, by taking smoking into account as a rating factor in the underwriting process, insurers can offer lower life insurance premiums for non-smokers than smokers.

And finally, what is reinsurance?
Put simply, reinsurance is insurance for insurers. Similarly to insurance, reinsurance reduces an insurer’s risk of loss by sharing the risk with one or more reinsurers. Reinsurance generally works by either transferring a portion of a particularly large risk that has been taken on by an insurance company (facultative reinsurance), or by transferring a portion of all the pool (or book) of risks (treaty reinsurance) to a reinsurer in return for a share of the original premium. In the event of a claim, the reinsurer compensates the insurer for its share of the risk. The financial compensation that would be required in the event of a commercial airline plane crash, for example, could be too great for a single insurer, so reinsurance is sought to share the loss. Alternatively, a certain level of the risk from, say, an insurer’s motor or life insurance business could be transferred to a reinsurer. The underwriting process benefits policyholders. The more information held about an individual risk, the more the premium can be tailored to that risk. If the insurer’s freedom to underwrite and price is restricted, either the pricing and availability of the policies or the insurer’s profitability is affected.