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Chapter 16: Q. 17 (page 398)

How might adverse selection make it difficult for an insurance market to operate?

Short Answer

Expert verified

Owing to adverse selection, insurance companies charge high premiums to all types of customers, causing low-risk buyers to pay more, causing those purchasers to avoid purchasing insurance due to the high premium cost.

Step by step solution

01

definition of adverse selection in insurance.

Adverse selection in insurance occurs when persons who live a high-risk lifestyle are denied coverage.

02

Step 2.: Explanation of solution.

Adverse selection is a challenge for health insurers since purchasers have more information than insurance companies about whether they are high risk or low risk. For example, if a customer is informed that his or her family's medical condition is in danger, he or she should buy additional coverage without telling the company of the high risk. As a result, insurance companies will be forced to charge expensive insurance to all types of buyers, including those that are low-risk.

As a result of the lack of information on the insurance buyer, the insurance market is difficult to run, as insurance providers are unable to determine if the purchaser is a high- and low customer.

As a result of the lack of knowledge on insurance buyers, unfavorable selection causes challenges for the insurance industry.

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