ABC Appliance offers a warranty requiring an annual fee.The warranty may be purchased at the time of sale or at any time within the first year after the appliance was purchased.The warranty fee after the date of purchase is twice the time-of-purchase fee.When asked why the fee was higher after the date of purchase,ABC's president said,"Buying a warranty is voluntary.We've noted that those who buy the warranty after the purchase date have a greater need for service." Charging the same rate or a lower rate after the date of purchase would expose ABC to what problem that also impacts private insurers?

Question

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Charging the same rate or a lower rate after the date of purchase would expose ABC to adverse selection, which also impacts private insurers. Adverse selection is the phenomenon where those who are more likely to make claims are the ones who are more likely to purchase insurance. By charging a higher fee for those who purchase the warranty after the date of purchase, ABC is attempting to mitigate adverse selection by ensuring that those who are more likely to need service are paying a higher fee. If they charged the same rate or a lower rate after the date of purchase, they would attract customers who need service and are more likely to make claims, which would expose ABC to greater financial risk.

ABC Appliance Offers a Warranty Requiring an Annual Fee