Question

For each of the following kinds of insurance, give an example of behavior that can be called moral hazard and another example of behavior that can be called adverse selection.

A. Health insurance

B. Car insurance

C. life insurnace

Answer 1

Moral hazard refers to the incentives that a party has to use more resources as the costs of extra consumption will be borne by another party. On the other hand, adverse selection refers to the situation where one party has more indormation than the other party causing undesired result.

(a) An example of Moral hazard in health insurance could be the over overconsumption of medical facilities by insurers which they d not have done otherwise. When insurers purchase some procedures for their health checkup unneccesarily or insists on spending more nights in the hospital despite declared being fit by doctors, it is called moral hazards of health insurance.

When health insurance companies charges same prices from customers who smoke than the no smoking customers who are less prone to health risks causing the company to face losses due to failing to reflect the actual costs of medical treatments to those who have substantially higher health risks.

(b) Car insurance companies face moral hazards when their customers handle their cars recklessly for having car insurance which increases the chances of more car accidents, damage etc.

An example of adverse selection in car insurance occurs when an insurer living in areas with higher crime rates buy the same car insurance policy that are meant for insurers having low risks of car theft in their areas.

(c) People who are drunkard, smokers have higher risks to their lives which make them to pay more premiums for their life insurance. But when they do not reveal all their facts while buying the life insurance, it makes the insurance company to face losses as it needs to pay the assured amount to the insurer's family in case of his death which are paid to the other normal insurers due to asymmetric information.

When people with high risks for their lives due to working in dangerous working environment buy life insurance policies paying same premium like the other normal insurers concealing the actual truth brings adverse effect to the insurance company by causing greater probability of loss to the company