Question

factors that cause increase in adverse selection

Answer 1

The concept of adverse selection is an economic term related with risk factor mainly in insurance.

It is such a market process where risk factor plays a pivotal role. In such a market situation both buyers and sellers use their private knowledge in regards to product or service as per the risk factor involved.Each party( buyer and seller) tries to maximise its outcome during transaction ,at the expense of other party.Adverse selection is also called anti selection.

FACTORS CAUSING INCREASE IN ADVERSE SELECTION----

* In case of health insurance, the insurance company will charge high rate of premium to a smoker as he is at high risk of disease. The reason is ,the company knows ,it has to pay early claim and premium collected will be much less than the claims paid ,this way the company would suffer losses.

* In case of life insurance ,people with diabetes ,heart diseases are charged more rate of premium due to the same reason.

* In case of crime prone area ,the car insurance company will charge high rate of premium, as the probability of risk of theft is higher in that region.

* When there is asymmetry of information,for example,when one party has more information than the other.For example,a second hand car dealer has more information regarding the risk involved .so he will be willing to take insurance at higher premium.

* Case of death spiral --- It is also a factor causing high adverse selection. It occurs when the insurance company raises the premium price due to increased likelihood of risk prone persons,.there is every possibility that some people ( insured) but at low risk may waive their policy, it will lead to a big chain of claimants with high risk.It is called death spiral .so, indirectly, it is also a reason of increase in adverse selection.