The starting point for any analysis of insurance classification is an

Question

The starting point for any analysis of insurance classification is an obvious but fundamental fact: insurance is only one of a number of ways of satisfying the demand for protection against risk. With few exceptions, insurance need not be purchased; people can forgo it if insurance is too expensive. Indeed, as the price of coverage rises, the amount purchased and the number of people purchasing will decline. Instead of buying insurance, people will self-insure by accumulating saving to serve as a cushion in the event of loss, self-protect by spending more on loss protection, or simply use the money not spent on insurance to purchase other goods and services. An insurer must compete against these alternatives, even in the absence of competition from other insurers.

One method of competing for protection dollars is to classify potential purchasers into groups according to their probability of loss and the potential magnitude of losses if they occur. Different risk classes may then be charged different premiums, depending on this expected loss. Were it not for the need to compete for protection dollars, an insurer could simply charge each individual a premium based on the average expected loss of all its insureds (plus a margin for profit and expenses), without incurring classification costs. In constructing risk classes, the insurer’s goal is to calculate the expected loss of each insured, and to place insureds with similar expected losses into the same class, in order to charge each the same rate.

An insurer can capture protection dollars by classifying because, through classification, it can offer low-risk individuals lower prices. Classification, however, involves two costs. First, the process of classification is costly. Insurers must gather data and perform statistical operations on it; marketing may also be more costly when prices are not uniform. Second, classification necessarily raises premiums for poor risks, who purchase less coverage as a result. In the aggregate, classification is thus worthwhile to an insurer only when the gains produced from extra sales and fewer pay-outs outweigh classification costs plus the costs of lost sales. Even in the absence of competition from other insurers, an insurer who engages in at least some classification is likely to capture more protection dollars than it loses.

When there is not only competition for available protection dollars, but competition among insurers for premium dollars, the value of risk classification to insurers becomes even clearer. The more refined (and accurate) an insurer’s risk classifications, the more capable it is of “skimming” good risks away from insurers whose classifications are less refined. If other insurers do not respond, either by refining their own classifications or by raising prices and catering mainly to high risks, their “book” of risks will contain a higher mixture of poor risks who are still being charged premiums calculated for average risks. These insurers will attract additional poor risks, and this resulting adverse selection will further disadvantage their competitive positions.    1 
 1. Which one of the following best identifies the main topic of the passage?

(A) reduction of competition in the insurance business
(B) classification of potential insurance purchasers
(C) risk avoidance in insurance sales
(D) insurance protection and premiums
(E) methods of insurance classifying

2 
 2. The passage mentions all of the following as possible or certain costs of classifying EXCEPT the cost of

(A) collecting facts
(B) conducting statistical analyses
(C) selling insurance at different prices
(D) a decrease in purchases by poor risks
(E) larger, albeit fewer, claims

3 
 3. Which one of the following is closest to the author’s expressed position on competition in the insurance business?

(A) It has a significant influence on most aspects of the insurance industry.
(B) It is a relevant factor, but it has little practical consequence.
(C) It is a basic but not very apparent element of the insurance business.
(D) It provides a strong incentive for insurers to classify potential customers.
(E) It is influential in insurance marketing practices.

4 
 4. The passage suggests that if all insurers classified risk, who among the following would be adversely affected?

(A) all insurance purchasers
(B) insurance purchasers who would be classified as poor risks
(C) individuals who self-insured or self protected
(D) insurers who had a high proportion of good risks in their “book” of risks
(E) insurers with the most refined risk classifications

5 
 5. Given the discussion in the first paragraph, what is the distinction, if any, between “insurance” and “self-protection”?

(A) There is very little or no distinction between the two terms.
(B) Insurance is a kind of self-protection.
(C) Self-protection is a kind of insurance.
(D) Insurance and self-protection are two of several alternative means to a specific end.
(E) Insurance and self-protection are the only two alternative means to a specific end.

6 
 6. Which one of the following is most closely analogous to the process of classification in insurance, as it is described in the passage?

(A) devising a profile of successful employees and hiring on the basis of the profile
(B) investigating the fuel efficiency of a make of automobile and deciding whether or not to buy on that basis
(C) assessing an investor’s willingness to take risks before suggesting a specific investment
(D) making price comparisons on potential major purchases and then seeking discounts from competing dealers
(E) comparing prices for numerous minor items and the selecting one store for future purchases

sumitkrocks · Answer

1. Which one of the following best identifies the main topic of the passage?

Central theme of writing the passage is risk avoidance and classification is one if the ways which is emphasized

(A) reduction of competition in the insurance business
(B) classification of potential insurance purchasers
 (C) risk avoidance in insurance sales 
(D) insurance protection and premiums
(E) methods of insurance classifying

C is the best in capturing the theme with B being second closer

2. The passage mentions all of the following as possible or certain costs of classifying EXCEPT the cost of

(A) collecting facts
(B) conducting statistical analyses
(C) selling insurance at different prices
(D) a decrease in purchases by poor risks
 (E) larger, albeit fewer, claims 
 
E is the answer as not mentioned in the passage IMO

3. Which one of the following is closest to the author’s expressed position on competition in the insurance business?

(A) It has a significant influence on most aspects of the insurance industry.
(B) It is a relevant factor, but it has little practical consequence.
(C) It is a basic but not very apparent element of the insurance business.
 (D) It provides a strong incentive for insurers to classify potential customers. 
(E) It is influential in insurance marketing practices.

D is the answer -Author mentions classification becomes more important when there is competition

4. The passage suggests that if all insurers classified risk, who among the following would be adversely affected?

(A) all insurance purchasers
 (B) insurance purchasers who would be classified as poor risks 
(C) individuals who self-insured or self protected
(D) insurers who had a high proportion of good risks in their “book” of risks
(E) insurers with the most refined risk classifications

B is the answer as Poor risk classified would need to pay corresponding higher premiums for same protection

5. Given the discussion in the first paragraph, what is the distinction, if any, between “insurance” and “self-protection”?

(A) There is very little or no distinction between the two terms.
(B) Insurance is a kind of self-protection.
(C) Self-protection is a kind of insurance.
 (D) Insurance and self-protection are two of several alternative means to a specific end. 
(E) Insurance and self-protection are the only two alternative means to a specific end.
 
D is the best 
 
6. Which one of the following is most closely analogous to the process of classification in insurance, as it is described in the passage?

(A) devising a profile of successful employees and hiring on the basis of the profile 
 Classifying potentially successful employees and hiring i.e negotiating salaries as per skill set in the same way as done in insurance premiums v/s risk

(B) investigating the fuel efficiency of a make of automobile and deciding whether or not to buy on that basis
 Whether or not to buy is not the right analogy; however, varying prices per fuel efficiency would be closer to analogy of Risk vs premiums  
(C) assessing an investor’s willingness to take risks before suggesting a specific investment
 Not relevant  
(D) making price comparisons on potential major purchases and then seeking discounts from competing dealers
 Not similar to high-risk high premium and vice versa  
(E) comparing prices for numerous minor items and the selecting one store for future 
 Not similar to high-risk high premium and vice versa

A is the Answer IMO

mSKR · Answer

1  C:  The whole passage talks about classification and why classification is important. This is done in order to increase insurance sales and reduce risks
A and E are far fetched ideas. B and C are talked but not the main purpose

2. A,B and C can be extracted form passage 2nd: First xxx, D is present in Second,,,xx( in 2nd para)
 Hence E is the correct answer

3. 
If we notice this line
 Even in the absence of competition from other insurers, an insurer who engages in at least some classification is likely to capture more protection dollars than it loses.
 
It clearly indicates that there are some areas in which competition doesn’t make any different 
 It matches our claim in A option . It is significant mostly

B and C are mentioned in opposite direction.
D is wrong because we classify customers on basis of risks not on basis of their potential 
E is wrong because classification is what important is 
 Hence A is correct

4 
Good risks: that are likely to be repaid
Poor risks: that have high chances of loss
Only B and D are in opposite direction.

D says: If insurers have good risks in their books they may not loss much.

It can be extracted from last 2 lines of passage, 
For B: Insurance purchases that have higher mixture of poor risks but they pay premiums calculated for average risks. 
B says: no insurers may want to select them as insurring such people woild have risk of loss money 
So these purchasers maybe adversely affected
( before they pay average but get more benefit in returns)
 Hence I would go with B

5 An insurer must compete against these alternatives 
It seems there are multiple alternatives.
  people will self-insure 
it seems it is alternate to insurance.

D matches our reasoning

6. Classify purchasers in terms of risk and then sell
A says: profiling and then hire

I would go with A  
B, C , D and E doesn’t go with thought mentioned above

RahulHGGmat · Answer

Hi  Sajjad1994

Please provide the OE for question number 1.

kntombat · Answer

I am not an expert at Reading Comprehension but I will give it a shot.

The answer to question 1 has to be B because if you see throughout the passages there are excerpts(paragraph 2, paragraph 3 and to some extent even paragraph 4) that point to the fact that how the classification of potential insurance purchasers would help the company decide what premium amounts to charge (Paragraph 2), Paragraph 3 talks about how the procedure to classify potential insurance purchasers is difficult, the drawbacks etc and then paragraph 4 builds on this by talking about due to competition amidst insurance providers how the providers who have done better classification can take away clients who possess good risks and eventually get their premium pricing also right, leaving the rest with poor risks and disproportionate premium pricing.

Ranasaymon · Answer

VeritasKarishma   Sajjad1994

I am having difficulty to reach the answer. Can you explain the reason behind the correct answer A? D seems a good contender.

Which one of the following is most closely analogous to the process of classification in insurance, as it is described in the passage?

(A) devising a profile of successful employees and hiring on the basis of the profile
(B) investigating the fuel efficiency of a make of automobile and deciding whether or not to buy on that basis
(C) assessing an investor’s willingness to take risks before suggesting a specific investment
(D) making price comparisons on potential major purchases and then seeking discounts from competing dealers
(E) comparing prices for numerous minor items and the selecting one store for future purchases

KarishmaB · Answer

Ranasaymon

"An insurer can capture protection dollars by classifying because, through classification, it can offer low-risk individuals lower prices."
The more refined (and accurate) an insurer’s risk classifications, the more capable it is of “skimming” good risks (low risk) away from insurers whose classifications are less refined. If other insurers do not respond, either by refining their own classifications or by raising prices and catering mainly to high risks, their “book” of risks will contain a higher mixture of poor risks (high risk) who are still being charged premiums calculated for average risks.

So the point of the the classification is to profile low risk individuals and offer them insurance at low cost. So the company would increase good risks (low risks) in its book. 
This would help in getting more protection dollars and premium dollars.

(A) devising a profile of successful employees and hiring on the basis of the profile

Correct. You devise a profile of the kind of people you want (low risk profile/successful employee) and then focus on bringing them on board.

None of the other options follow this model.

VerbalBot · Answer

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