Insurance and Adverse Selection

Insurance and Adverse Selection

Assume that there are two types of people: Type As who are more likely to get a disease, and Type Bs who are less likely to get a disease. 1. Assume first that people do not know what type they are. Will people purchase insurance? Why? 2. Now assume that people know what type they are but insurance companies are unable to find out this information. Will both types be likely to purchase equal amounts of insurance? Is there an adverse selection problem? Will Type As buy insurance? Type Bs? 3. Now assume that insurance companies can determine an individual’s type by administering an inexpensive test. Will there be an adverse selection problem? Who will benefit from this change? 4. Now assume a widely available inexpensive test is developed that determines with certainty whether an individual will get sick or not. What will happen to the insurance market after this test is developed? Who will benefit from this development?

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