Question

Topic: Adverse Selection at FedEx:

Give an example of a situation that led (or could have) to adverse selection at your place of work. I currently work at FedEx.

(I asked this question before, and did not receive the correct answer)

Answer 1

Example of Adverse Selection

For example, assume there are two sets of people in the population: those who smoke and do not exercise, and those who do not smoke and who exercise. It is common knowledge that those who smoke and don't exercise have shorter life expectancies than those who don't smoke and choose to exercise. Suppose there are two individuals who are looking to buy life insurance, one who smokes and does not exercise, and one who doesn't smoke and exercises daily. The insurance company, without further information, cannot differentiate between the individual who smokes and doesn't exercise and the other person.

The insurance company asks the individuals to fill out questionnaires to identify themselves. However, the individual that smokes and doesn't exercise knows that by answering truthfully, they will incur higher insurance premiums. This individual decides to lie and says he doesn't smoke and exercises daily. This leads to adverse selection; the life insurance company will charge the same premium to both individuals. However, insurance is more valuable to the non-exercising smoker than the exercising non-smoker. The non-exercising smoker will require more health insurance more and will ultimately benefit from the lower premium.

Insurance companies reduce exposure to large claims by limiting their coverage or raising premiums. Insurance companies attempt to mitigate the potential for adverse selection by identifying groups of people who are more at risk than the general population and charging them higher premiums. The role of life insurance underwriters is to assess applicants for life insurance to determine whether or not to give them insurance or how much premiums to charge them. Underwriters typically evaluate any issue that may impact an applicant's health, including but not limited to an applicant’s height, weight, medical history, family history, occupation, hobbies, driving record, and smoking habits.

Other examples of adverse selection include the marketplace for used cars, where the seller may know more about a vehicle's defects and charge the buyer more than the car is worth. In the case of auto insurance, an applicant may falsely use an address in an area with a low crime rate in their application in order to obtain a lower premium when they actually reside in an area with a high rate of car break-ins.

In the case of FedEx, Not all FedEx locations accept dangerous goods, certain FedEx locations do not accept specific classes of dangerous goods and dangerous goods are not accepted to ship via all FedEx services. Shipments falling under the European Agreement concerning the International Carriage of Dangerous Goods by Road (ADR) need special transport arrangements and the Sender must contact FedEx for shipping confirmation/arrangements prior to shipping. FedEx reserves the right to refuse dangerous goods at any location where they cannot be accepted in accordance with applicable law. But sometime people tend to bring dangerous goods in the label of normal goods. And it is difficult for authorities to detect the same. This is an example of adverse selection.