Chapter 13, Problem 2Q

To determine

How insurance companies protect themselves against losses due to adverse selection and moral hazard?

Context Introduction:

In the context of insurance, adverse selection explains the fact that people who are aware that they are particularly more prone to an accident or loss or are at a bad risk level are more inclined to take out insurance than those who are more secured and face good risks. Adverse selection is sometimes called “self-selection” or “anti-selection”.

In the context of insurance, moral hazard describes the fact that a policyholder may act in a way that makes the insured event more likely because they have insurance or have the event covered. Moral hazard makes insurance more expensive. It may even push the price of insurance above the maximum premium that a person is prepared to pay.