90. An insurance company may charge a higher total premium to an insured who pays a policy quarterly rather than annually because the quarterly payment results in:
Answer: D
A higher total premium for quarterly payments is due to increased administrative expenses and reduced interest earnings.
When an insured opts for quarterly payments rather than an annual payment, the insurance company incurs additional administrative costs and loses potential interest earnings on the premium amount that remains unpaid for longer periods. This combination justifies the higher total premium.
A) greater adverse selection
Adverse selection refers to the tendency of higher-risk individuals to seek insurance more than lower-risk individuals. While this can impact insurance pricing, it is not directly related to the payment frequency. Therefore, this option does not explain the reason for the higher premium associated with quarterly payments.
B) an increase in the company's loss experience
An increase in the company's loss experience would suggest that the insurer is paying out more in claims. However, this is not a direct consequence of payment frequency. Thus, this option does not appropriately address the higher premium charged for quarterly payment plans.
C) an increase in the number of dividend payments
The frequency of premium payments does not directly correlate with dividend payments. Dividends are typically based on the insurer's profitability and performance rather than the payment schedule of individual policies. As such, this option is irrelevant to the context of premium pricing based on payment frequency.
D) a reduction in the company's interest earnings and an increase in administrative expenses
This option accurately captures the reasons behind the higher premiums for quarterly payments. Quarterly payments require more administrative work and delay the full payment, meaning the insurer cannot earn interest on that premium amount for as long as they could with an annual payment.
Conclusion
The rationale for charging a higher premium for quarterly payments is primarily due to increased administrative expenses and the loss of interest earnings on premiums that are not paid upfront. Options A, B, and C do not directly address these financial impacts, making D the only correct choice that explains the insurance company's pricing strategy related to payment frequency.