Car insurance adverse selection

Adverse selection occurs when there's a lack of symmetric information prior to a deal between a buyer and a seller. whereas moral hazard occurs when there is asymmetric information between two parties and change in behavior of one party after a deal is struck. Moral hazard and adverse selection are two terms used in economics, risk management and insurance to describe situations where one party is at a disadvantage.

Adverse selection describes an undesired result due to the situation where one party of a deal has more accurate and different information than the other party. The party with less information is at a disadvantage to the party with more information. The asymmetry causes a lack of efficiency in the price and quantity of goods and services.

For example, assume there are two sets of people in the population, those who smoke and do not exercise and those who do not smoke and do exercise. It is common knowledge that those who smoke and don't exercise have shorter life expectancies than those who don't smoke and do exercise. Suppose there are two individuals who are looking to buy life insurance. one that smokes and does not exercise and one that doesn't smoke and exercises daily. However, the insurance company cannot differentiate between the individual who smokes and doesn't exercise and the other person.

The insurance company asks the individuals to fill out questionnaires to distinguish them. However, the individual that smokes and doesn't exercise knows that answering truthfully means higher insurance premiums. so he lies and says he doesn't smoke and exercises daily. This leads to adverse selection. where the life insurance company is at a disadvantage and then charges the same premium to both individuals. However, the insurance is more valuable to the nonexercising smoker than the exercising nonsmoker because one party has more to gain.

Conversely, moral hazard occurs when a party provides misleading information and changes his behavior when he does not have to face consequences of the risk he takes. For example, assume a homeowner does not have home insurance or flood insurance and lives in a flood zone. The homeowner is very careful and subscribes to a home security system that helps prevent burglaries. When there are storms, he prepares for floods by clearing the drains and moving furniture to prevent damage.

However, the homeowner is tired of always having to worry about potential burglaries and preparing for floods, so he buys home and flood insurance. After his house is insured, his behavior changes and he is less attentive, leaves his doors unlocked, unsubscribes to the home security system and does not prepare for floods. In this case, the insurance company is faced with the consequences and risks of floods and burglaries, and the problem of moral hazard arises.

Learn about the differences between adverse selection and moral hazard in economics, and how blocking price signals causes. Read Answer >>

An idea that a party that is protected in some way from risk will act differently than if they didn't have that protection. Read Answer >>

Learn the difference between morale hazard and moral hazard, and discover how a person might experience each type of hazard. Read Answer >>

Discover when moral hazard occurs, what it means in different arenas, and effective tools for lenders, insurers, and employers. Read Answer >>

Find out how economists define moral hazard, and learn about some of the most common explanations offered for instances of. Read Answer >>

Find out why the Affordable Care Act increases moral hazard in health insurance by pushing consumers farther and farther. Read Answer >>

Related Posts

Car insurance agency utah

Utah's no-fault insurance system requires that every driver buy $3,000 in personal injury prot...

Car insurance agent brandon fl

Brandon, FL enjoys its status as a quiet retreat away from the hustle of Tampa and the Hillsbo...

Car insurance and the law uk

More restrictive car insurance rules have come into effect as the government seeks to clamp do...

Car insurance and weather warnings

September 11, 2014 By Nicole Markle https://blog.allstatetropical-we...

Car insurance armed forces discount

If you are part of our forces community, this website is for you! Serving personnel a...

Car insurance auburn hills mi

Meemic offers savings on a wide range of coverages for your car, home and more. Auto In...

Car insurance auto insurance & insurance quotes progressive

Progressive insurance is one of the larger insurance companies in the United States, and thank...

Car insurance bankruptcy

Contact moneysupermarketat Moneysupermarket House, St David's Park, Ewloe, Flintshire, CH5 3UZ...

Car insurance bardstown ky

While there's a serene quality to Kentucky's landscape, accentuated by rolling blue grass hill...

Car insurance based on chassis number

The car you drive affects the insurance premium you pay. In fact, when getting insurance quote...

Car insurance based on income

For those drivers with a low income. car insurance can be pa...

Car insurance bc vs alberta

You may think so, because it is what you are told predominantly. People tend to general...