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 reduction in the company's interest earnings and an increase in administrative expenses
When a policyholder chooses to pay premiums quarterly instead of annually, the insurance company experiences a reduction in its interest earnings on the premium funds due to the shorter investment period. Additionally, the administrative costs associated with processing more frequent payments increase, which justifies the higher total premium.
A) greater adverse selection
While adverse selection refers to the phenomenon where higher-risk individuals are more likely to seek insurance, it does not directly relate to the payment frequency of premiums. Therefore, this option does not adequately explain the reason for the higher total premium associated with quarterly payments.
B) an increase in the company's loss experience
An increase in loss experience would imply that the company is paying out more in claims, which is not inherently tied to the payment frequency of premiums. This option fails to address the specific impact of quarterly payment arrangements on the company's financial management.
C) an increase in the number of dividend payments
The number of dividend payments is not directly linked to the frequency of premium payments. This option does not provide a valid explanation for why quarterly payments would lead to higher premiums, as dividends are determined by the company's profitability and not by payment schedules.
D) a reduction in the company's interest earnings and an increase in administrative expenses
This option accurately identifies the financial implications of quarterly premium payments. The company cannot invest the premiums for as long, leading to reduced interest earnings. Furthermore, processing more frequent payments incurs additional administrative costs, justifying the higher premiums for quarterly payers.
Conclusion
The correct answer, D, highlights the financial effects of payment frequency on insurance companies, specifically the reduction in interest earnings and increased administrative costs associated with quarterly payments. Other options do not sufficiently relate to the reasons for higher premiums, making them incorrect in this context. Thus, option D stands out as the only option that directly addresses the issue presented in the question.