Hidden Information in insurance markets is the only explanation for high prices of insurance (in terms...

Hidden Information in insurance markets is the only explanation for high prices of insurance (in terms of their relationship with accident probabilities) even in competitive markets True or False

d) If a risk-neutral individual buys insurance for his home from a particular company we know her risk-averse neighbor will most definitely prefer to spend her money in something else True or False

Expert Solution

1.The statement is False. It states that hidden information forms the only reason for the rising prices of insurance premiums. Although the possibility of rising premium is dependent on the hidden information of people, it does not for the solo explanation for the rise in the premium rates of insurances. The following statements supports the reasoning

· Hidden information refers to the inability of the insurer to observe the risk characteristics of the customers. For example, consider a customer who works with explosives, but the insurance company is unaware of it. Since the customer is more prone to death, the insurance sector may be affected by this hidden information, Due to this, the insurance provider fixes the premium based on customer averages and thus results in increased premium rates.

· Although the above forms a reason for rising premiums, there are many other reasons like rising medical prices in the health sector which leads to rising health costs and forms a major reason for the rise in the premium rates.

d. The statement is false. The following forms the explanation

· A risk neutral individual refers to an individual who evaluates various investment opportunities and focus on the potential gains regardless of the risk involved. They seem to evaluate the reward without the thought of risk, which may prove even more risky.

· A risk-averse individual refers to such an individual who prefer to avoid risky situations. In order to avoid such situations, they will be willing to pay extra amount also.

· In relation to the investments in insurance sector, a risk-averse individual is expected to invest more in the sector as they are willing to pay more to avoid risky future.

· Hence if the risk-neutral individual buys an insurance policy, then the risk averse individual would have more chances of buying it.

Rahul Sunny answered 2 years ago

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