Question

A colleague tells you that he is purchasing a health insurance policy, but the premiums seem very high for the level of coverage.

Use the following table to classify each explanation for the high premiums as an instance of either adverse selection or moral hazard.

Explanation for High Premiums	Adverse Selection(yes or no)	Moral Hazard (yes or no)
The insurance company cannot determine which customers are healthy and which are unhealthy.
The insurance company believes that the health insurance will increase the likelihood that your friend will engage in dangerous, or unhealthy, behavior.

You advise your friend to sign a contract that allows the insurance company to withhold payment of benefits related to incidents involving risky behavior, such as illegal drug use.

Your advice is more likely to solve the problem of _______(Adverse selection/ moral hazard).

Answer 1

The insurance company cannot determine which customers are healthy and which are unhealthy. - Adverse selection

The insurance company believes that health insurance will increase the likelihood that your friend will engage in dangerous, or unhealthy, behavior- Moral hazard

Your advice is more likely to solve the problem of Moral Hazard.