Question

True or False:

1. A life insurance company must be concerned about the possibility that the people who buy life insurance may tend to be less healthy than those who do not. This is an example of adverse selection.

2. . An insurance company must be concerned about the possibility that someone will buy fire insurance on a building and then set fire to it. This is an example of adverse selection.

Answer 1

1 True

Advers selection which means the company know customer of insurance earned insurance amount at any cost but they are under a pariticular amount of risk. That means we consider the situation, All life insurance company know about one who buy insurance they are under atleast a small amount of risk means unhealthy people buy life insurance mainly, normally one who feel perfect health they didnot willing to buy life insurance. There is exist risk while buy insurance. So that, this is the best example of advers selection.

2. False

In this situation exist asymmetric information,means buyer has complete information. In this situation insurance company completely aware about the possibility that someone will buy fire insurance on a building and then set fire to it. Here one partys behaviour make complete burden or cost impossed to another person or insurance company. So these type of insurance, two parties earn different incentives. That means if we have fire insurance we need to take care risk factors in any case we set fire it ,there is a chance of repudiation of insurance amount. In this situation about an risk expectation.So that this situation is an example of Moral Hazard.