In: Economics
The insurer will prefer to charge a high premium from the
consumers who might default and will agree to charge a low premium
from the consumers who have a lower chance of defaulting. Now, if
the insurer doesn't know whether which type of customers are
coming, then he will only agree to charge the premium, which is
higher between two, so to reduce the chance of losses. The same
thing applies to the consumers, the consumer who might default will
agree to take the insurance even at a higher price, and the
consumer who is not going to default will only be willing to buy at
a lower premium price. Now, the breakeven point for such a
situation will be at the position where the insurer agrees to
charge his minimum premium. Now, this premium will be higher one,
which is equal to what he is willing to give to a faulty consumer,
as the insurer will not take a risk.
With such a premium, only the faulty consumers will buy the
policies, and the non-default consumers will not but it. Now, in
the long run, the equilibrium premium will be equal to the premium
at which the insurer is agreed to sell the policy to the faulty
consumer, and only the consumers who are going to default will buy
this policy.