Question

How does adverse selection affect the market for

health insurance? What are some ways we have

tried (or might try in the future) to address this

problem

Answer 1

Adverse selection: This problem occurs when buyers have more information than insurance sellers. This mainly happens in health insurance. In a free market with no regulation, adverse selection results in an under allocation of resources to health insurance services because the insurance company reduces the supply of insurance.

Example- If people start smoking after declaring as non smokers and get ill, insurance company will increase cost for insurance and then only people who are serious smokers will buy it and insurance liability will again increase.

Solutions to this problem:

1. Higher out of pocket payments: A customer if asked to pay more when problem occurs will declare in advance.

2. Direct govt. provision at no cost. Govt. may collect revenue through tax.

3. Other ways can be regulation and compulsory information provision.