What is meant by 'risk segmentation' in life insurance?

Risk segmentation in life insurance refers to the process of categorizing applicants into different risk groups to ensure accurate pricing of insurance premiums. Insurance companies assess various factors such as age, health status, lifestyle choices, and occupation, among others, to determine the likelihood of a claim being made on a policy. By segmenting applicants in this way, insurers can charge premiums that reflect the level of risk associated with each group. This practice not only helps in maintaining financial stability for the company but also ensures that policyholders are fairly charged according to their specific risk profiles.

The methodology aids in reducing adverse selection, where higher-risk individuals are more likely to seek insurance, potentially leading to unsustainable losses for the insurer. By effectively segmenting risks, insurers can create tailored policies that fit the needs of diverse groups while staying financially viable.