Moral Hazard and Adverse Selection. How does opting for the insurance on the rental change a...

Moral Hazard and Adverse Selection. How does opting for the insurance on the rental change a person's perception of risk?

Expert Solution

There is asymmetric information in the market. Sometimes buyers know more (insurance buying) and sometimes sellers know more(second hand car selling).

In insurance it is possible that a person may change behavior after buying an insurance policy and thereby risking life/health. This will involve companies paying higher compensations.Eg. Non smoker turning in smoker. This is moral hazard

It should be noted that if there are many cases of moral hazard then insurance company increases premium and only risky people buy it as it becomes costlier and normal people buy it less. This again increases probability of claims . This is called as adverse selection as company ended up selecting risky customers.

Hence, insurance on the rental change a person's perception of risk and involve in taking high risk.

Rahul Sunny answered 2 years ago

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