Question

Describe adverse selection. What are its consequences? Give examples or real life experiences of anyone known to you or from knowledge gained from media.

Answer 1

Adverse selection is when sellers have informationthat buyers do not have ,or vice versa,about some aspects of produt quality.It is thus the tendencyof those in dangerous job or high-risk lifestyles to purchase life or disability insurance where chances are greater they will collect on it

consequences of adverse selection

-due to poor information and difficulty selecting customers ,there will be a higher overall price as firms have to take into account relatively higher payouts to high-risk customers taking out insurance.It happens in health insurance when sicker people or those who present a higher risk to the insurer,buy health insurance while healthier people do not buy it.adverse selection puts the insurer at a higher risk of losing money through claims than it had predicted

-low -risk customers may not want to buy because it is too expensive for their needs-leading to a missing market

-firms may invest considerable time in identifying which group of consumers are higher risk

example

an example of adverse selection in regard to life or health insuance coverage is a smoker who successfully manage to obtain insurance coverage as a non smoker.smoking is a key identified risk factor for life insurance,so a smoker must pay higher premiums to obtain the same coversge level as a nonsmoker.By concealing their behavioural choice to smoke,an applicant is leading the insurancecompany to make decisions on coverage or premium costs that are adverse to the insurance company's management of financial risks