Question

​The adverse selection problem as related to the insurance industry means that people who have insurance are less likely to suffer losses than people who do not have insurance. True or false

Answer 1

TRUE

REASON :

Individuals vary in their need for risk protection and in their knowledge of risks and risk tolerance. Insurance companies might have even less knowledge of individual circumstances. If insurance companies fail to distinguish between high-risk and low-risk customers, meaning they are unable to perform effective actuarial processes, then the average premium charged to a consumer might be so high that the low-risk customers drop out of the market.

One of the reasons that most state governments in the United States mandate that all drivers purchase automobile insurance is to avoid the problem of "adverse selection," or the process by which the most risky insurance customers force out the least risky. If prices cannot adjust based on individual risk, the most expensive insurance customers drive up the average premiums and make it uneconomical for the least risky to buy. Adverse selection is also why American adults were, through the 2018 tax year, mandated to purchase health insurance through Obamacare. There are economic arguments for these compelled purchases, but real-life examples show that theory and practice often differ.