In each of the following pairs, which situation (1) or (2) would pose the largest problems...

In each of the following pairs, which situation (1) or (2) would pose the largest problems regarding adverse selection?

a. (1) A policy covering accidents for all children attending YMCA camps or (2) A policy covering accidents for college students traveling abroad

b. (1) Basic medical services insurance package offered to students entering college or (2) Basic medical services package offered to professors seeking early retirement

Solutions

Expert Solution

Adverse Selection is a type of Market failure in which either the buyer or the seller does not have complete information about the good that is being traded between them. This information asymmetry can distort the market through faulty pricing. The buyer or the seller may withhold important information, which may be vital in deciding the price of the product being sold.

(A) policy covering accidents for college students travelling abroad

Reason : The policy covering college students travelling abroad may likely have an adverse selection. It is because it is not known where exactly the students will be travelling and what are the risks associated with going to that country. Again if we take the age factor in this as well, the camp of children is generally well regulated and monitored by group of adults, but the same cannot be said for the abroad trip of college students. Also depending on the number of students participating in the two scenarios, the risk factor may also vary. But going to a different country altogether, where it is not known , how the situation is likely to be, the risk of uncertainty is greater, which may not necessarily get reflected in the policy availed for the students participating in the college trip.

(B) Basic medical services insurance package offered to students entering college

Reason : In the second case, the package is of medical services and, not an insurance on medical services for the professors. Package of medical services can be any package covering a wide variety of medical services offered at lucrative rates as and when the need be. But in the first case the medical insurance is being provided to all the students entering the college. This entails basic medical services to all the students, irrespective of their medical history. This is were adverse selection may likely happen for the insurance company, which may not necessarily have complete medical information details of each and every students entering the college and availing their insurance facility.

Rahul Sunny answered 1 year ago

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