Explanation:
Adverse selection occurs before a transaction takes place due to information asymmetry. When an insurer cannot distinguish between good and bad risks, charging a single average premium will discourage good risks from buying insurance while attracting more of the bad risks who find the premium comparatively cheap.
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Q.41 When an insurance company cannot distinguish between good and bad risks, it tends to offer the same price to everyone and inadvertently attracts more of the bad risks. This risk is known as:
A
Adverse selection.
B
Moral hazard.
C
Scenario analysis risk.
D
Internal selection risk.
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