Adverse selection versus moral hazard
Describe either an adverse selection or moral hazard problem a company is facing. What is the source of the asymmetric information? Who is the less-informed party? Are there any wealth-creating transactions not consummated as a result of the asymmetric information? If so, could you consummate them? What advice/recommendations would you give the company?
The healthcare debate has been characterized as an argument between those who believe that moral hazard is the primary problem with healthcare market, and those who believe the biggest issue is adverse selection (The Economist, 2007).
The issue of pre-existing health conditions is often used as a defense to the thought that adverse selection is not the culprit of those deemed uninsurable (an example of unconsummated wealth) by carriers. “Adverse selection requires asymmetric information, namely that I know more about my brain tumor than does my potential insurance company. The more likely problem is that the tumor is common knowledge, or would be if I applied for insurance, and the company won 't sell a policy for any price cheaper than the costs of treatment. There is no asymmetry of information, rather insurance simply is no longer possible (The Economist, 2007).”
When information asymmetry is eliminated – the insurer will know who is high-risk and who is low-risk, you eliminate adverse selection. The Affordable Care Act uses the approach that because it stipulates that everyone must buy insurance, the low-risk category cannot exit the market (Froeb, 2012).
“The real problem is not that people have some sort of excellent secret knowledge about their health that will produce adverse selection; the problem is that some people can 't afford to pay the cost of medical care for diseases that have already occurred. This is no more or less of an issue than the fact that some people cannot afford to replace the contents of their home after it burns down (The Economist, 2007).”
The problem, then, is whether
The healthcare debate has been characterized as an argument between those who believe that moral hazard is the primary problem with healthcare market, and those who believe the biggest issue is adverse selection (The Economist, 2007).
The issue of pre-existing health conditions is often used as a defense to the thought that adverse selection is not the culprit of those deemed uninsurable (an example of unconsummated wealth) by carriers. “Adverse selection requires asymmetric information, namely that I know more about my brain tumor than does my potential insurance company. The more likely problem is that the tumor is common knowledge, or would be if I applied for insurance, and the company won 't sell a policy for any price cheaper than the costs of treatment. There is no asymmetry of information, rather insurance simply is no longer possible (The Economist, 2007).”
When information asymmetry is eliminated – the insurer will know who is high-risk and who is low-risk, you eliminate adverse selection. The Affordable Care Act uses the approach that because it stipulates that everyone must buy insurance, the low-risk category cannot exit the market (Froeb, 2012).
“The real problem is not that people have some sort of excellent secret knowledge about their health that will produce adverse selection; the problem is that some people can 't afford to pay the cost of medical care for diseases that have already occurred. This is no more or less of an issue than the fact that some people cannot afford to replace the contents of their home after it burns down (The Economist, 2007).”
The problem, then, is whether
References: Froeb, L.M., McCann, B.T., Ward, M.R. , & Shor, M. (2014) Managerial Economics: A Problem Solving Approach (third edition). Mason, OH: Cengage Learning. The Economist (February 7, 2001) It’s adverse, but is it selection? Retrieved from: http://www.economist.com/blogs/freeexchange/2007/02/its_adverse_but_is_it_selectio