Question

Provide a discussion of the two issues, Adverse Selection and Moral Hazard, and how these two behaviors raise the cost within a health care system.

Answer 1

Adverse selection describes an undesired result due to the situation where one party of a deal has more accurate and different information than the other party. The party with less information is at a disadvantage to the party with more information. The asymmetry causes a lack of efficiency in the price and quantity of goods and services.

moral hazard occurs when a party provides misleading information and changes his behavior when he does not have to face consequences of the risk he takes.
(1) People come in different types:
High risk/Low risk, Careful/sloppy, healthy/unhealthy.
The customers know something the company doesn’t.
= ADVERSE SELECTION
(2) People take actions the company does not see:
Drive carefully/not, Exercise/not, work hard/not.
The customers do something the company doesn’t.
= MORAL HAZARD

In Health insurance that suffers both from adverse selection and from moral hazard, and often it is difficult to differentiate the two. Here are some examples:

• The insured person may choose to conceal certain unhealthy habits or genetic traits that make the insurance attractive for the person but unprofitable for the company. This is an example of adverse selection: The person getting insured has more information about the quality of his or her health than the insurance company.
• After getting insured, the person is more careless about health. For instance, he/she may take fewer dietary precautions, smoke or drink more, or indulge in physical activities dangerous to the health. This is an example of moral hazard.

There is some fuzziness between the problem of concealing a habit prior to getting insured, and becoming more reckless after getting insured.