Question

I am sure you know that your car insurance premiums will be lower if you have had no moving violations for couple of years. Explain how this feature decreases the potential inefficiencies caused by adverse selection.

Answer 1

Moving violations refer to a situation when a traffic law is violated by a vehicle in motion . So causing no such violations for couple of years proves that the driver is quite careful and conscious during driving . This causes car insurance premiums to be lower . Adverse selection means that sellers have information that buyer do not and vice versa . In case of car insurance policies the potential adverse selection problem is predicting the level of efficiency as a driver . People who know that they tend to meet accidents more often usually opt for car insurance than those who know that they are very good drivers . So to reduce inefficiencies caused by adverse selection the insurance company has to check records such as moving violations caused in past couple of years . People with different records should be charged different premiums to cover the inefficiencies created by adverse selection problem .