Chapter 21, Problem 17PS

Summary Introduction

To determine:

An example of adverse selection

Introduction:

Adverse selection is the tendency for any proposed deal to attract the type of party who would make the deal a losing proposition to the offering party.

In the insurance industry, adverse selection refers to situations where an insurer gives insurance coverage to an individual whose real risk is comparatively high than the risk known to the insurer. Thus, insurer suffers adverse effects by offering insurance at a cost that does not nearly reflect its actual risk.