Question

differentiate between risk selection and adverse selection. disscuss how we can deal with adverse selection

Answer 1

Ans) Difference between risk selection and adverse selection:

- Adverse selection occurs when buyers have better information than sellers, and this can distort the usual market process. It can lead to missing markets as firms do not find it profitable to sell a good.

- Adverse selection is when sellers have information that buyers do not have, or vice versa, about some aspect of product quality. It is also the tendency of those in dangerous jobs or high-risk lifestyles to purchase life insurance.

Risk selection: Insurance underwriter's determination of the class (such as preferred, standard, or substandard) to which a particular risk is deemed to belong, its acceptance or rejection, and (if accepted) the premium rate.

- Risk selection is one of the ways insurance companies screen insurance applicants. It involves classifying applicants using underwriting principles and determining the amount of premium they should offer to a given applicant.

- The way to eliminate the adverse selection problem in a transaction is to find a way to establish trust between the parties involved. A way to do this is by bridging the perceived information gap between the two parties by helping them know as much as possible.