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Answer: A health insurance company is mandated by government to offer the same price (premium cost) to all new customers so that it cannot increase the relative price of riskier customers and consequently it attracts more high-risk customers
The example of **adverse selection** is **D**. ### Why D is adverse selection When an insurer must charge the same premium to all customers, riskier people are more likely to buy the policy because the price does not fully reflect their higher risk. This causes the insurer to attract a pool of disproportionately high-risk customers, which is classic **adverse selection**. ### Why the others are moral hazard - **A**: After buying insurance, the person uses more health care because they are insured. That is **moral hazard**. - **B**: The phone owner becomes less careful after buying insurance. That is **moral hazard**. - **C**: The bank takes more risk because it is protected by deposit insurance. That is **moral hazard**. So the correct answer is **D**.
Author: Manit Arora
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Q-703.2. Two of the key risks facing insurance companies are moral hazard and adverse selection. Three of the following examples are illustrations of moral hazard, but one is an example of adverse selection. Which is the example of adverse selection?
A
An individual buys health insurance and consequently increases their demand for health care services
B
A cell phone owner buys a "total equipment protection" insurance plan and, consequently, becomes more careless with the phone
C
Because it is backed by a government-sponsored deposit insurance plan, a bank is less worried about losing depositors and consequently it takes on more risks
D
A health insurance company is mandated by government to offer the same price (premium cost) to all new customers so that it cannot increase the relative price of riskier customers and consequently it attracts more high-risk customers
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