Post a reply on what you think about the discussion below. Adverse selection occ
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Question
Post a reply on what you think about the discussion below.
Adverse selection occurs when buyers have better information than the seller and it has a possibility to distort the usual market process. This asymmetrical, or unfair information leads to the buyer It can lead to missing markets as firms do not find it profitable to sell a good, or the finances as they relate to healthcare at this time. According to Adverse Selection Explained,it shows specific examples about life insurance. It shows that selling life insurance typically searches for people with higher risks of death because they’re the people that typically take out life insurance policies. Life insurance companies make their money off of not only the people with a higher risk of death, but the healthy people that pay into life insurance for years. These companies charge more to the people that have an increased chance of death because the company knows that they will have to pay a sum to the family in the near future, but the healthier policy holders will continue to pay monthly and make up the difference. This also leads to negative consequences for the policy holders that will be paying into their policy for longer periods of time, however usually at a lower rate, whereas obtaining a policy at a late stage in your life will cost you a larger monthly fee.
There are three principal actions that insurance companies can take to protect themselves from adverse selection. The first is accurate identification and quantification of risk factors, such as lifestyle choices that increase or lessen an applicant's risk level. The second is to have a well-functioning system in place to verify information provided by insurance applicants. A third step is to place limits, or ceilings, on coverage, referred to in the industry as aggregate limits of liability, that put a cap on the insurance company's total financial risk exposure. Insurance companies institute standard practices and systems to implement protection from adverse selection in all three of these areas.
Moral hazard refers to managers taking serious personal risks when they cause their firms to engage in excessive risk-taking with the expectation that the firm will be bailed out by the government. Moral hazard is a common explanation for any excessive risk-taking.
Explanation / Answer
Adverse selection is a major problem in many sectors where either the seller or the buyer has lesser information about the quality of the product or some other vital information ,than the other . We can site another example , that of risk faced during employing a worker . An employer can never fully predict the innate abilities of a worker before hiring him . The only way to select candidates most efficiently is to examine them through various tests and interviews and checking their past records if available . In the discussion we study about the adverse selection problem of insurance companies . They face such a problem regarding crime prone areas too . Areas which are prone to crimes more than areas which are safe . People living in crime prone areas are likely to get insured more .
Moral hazard on the other hand occurs when a person reduces taking care of himself once he buys an insurance . Once I know that my car is 100% insured it will take lesser care of my car .