Adverse Selection Essay

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Adverse selection is a precontractual problem that arises from hidden information about risks, quality, or character in transactions where one party is more informed than the other (Froeb, McCann, Shor & Ward, 2018). A prime example of adverse selection is that of the falsification of a person’s residential address in order to obtain a lower rate of auto insurance. Undenounced to the insurance company, a person may actually live in a highly populated high crime area but instead reports that they live in a low crime suburb. This can be applied to any other type of insurance as well. For instance, if an applicant, in an attempt to pay a lower premium, manages to veritably report that he works in a one-story office when, in truth, he is a large-scale construction worker, the insurance company would be making an adverse selection by approving his application (Adverse Selection, n.d.). Thus, such falsification protects the insured person from paying a high premium while putting the insurance company at a higher risk.
In order for the insurance company to protect itself from adverse selection, …show more content…

Insured customers exercise less care because they have less incentive to do so (Froeb, McCann, Shor & Ward, 2018). In the case of dental insurance, those who are uninsured have a greater motivation to take better care of their teeth as dental work can be particularly expensive, especially without insurance. Therefore, the financial ramifications of not being insured and needing an intensive dental treatment can prompt a person to take better care of their teeth. On the other hand, those who are insured have less of an incentive to take precautionary steps in order to ensure that they do not necessitate additional dental care. Additionally, it is worth to mention that certain other factors play into incentivizing both insured and uninsured patients; non-monetary

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