Question

1) How does a defined benefit plan differ from a defined contribution plan? Is one better than the other?

2)Insurance companies deal with adverse selection. Why is it a problem? Are there any current day issues that you can relate this to?

Answer 1

Ans. ( 1 ) The main difference between a defined benefit scheme and a defined contribution scheme is that the former promises a specific income and the latter depends on factors such as the amount you pay into the pension and the fund's investment performance.

Ans.( 2 )

What Is Adverse Selection?

Adverse selection refers generally to a situation in which sellers have information that buyers do not have, or vice versa, about some aspect of product quality—in other words, it is a case where asymmetric information is exploited. Asymmetric information, also called information failure, happens when one party to a transaction has greater material knowledge than the other party.

Adverse selection generally refers to any situation where one party in a contract or negotiation, such as a seller, possesses information relevant to the contract or negotiation that the corresponding party, such as a buyer, does not have. This asymmetrical information leads the party lacking relevant knowledge to make decisions that cause it to suffer adverse effects.

In the insurance industry, adverse selection refers to situations in which an insurance company extends insurance coverage to an applicant whose actual risk is substantially higher than the risk known by the insurance company. The insurance company suffers adverse effects by offering coverage at a cost that does not accurately reflect its actual risk exposure.