You offer an extended warranty for your product that is purchased by a few customers.If the product typically fails 2% of the time,the claim rate will exceed 2% of warranty purchasers because
A)adverse selection will lead those who are more reckless to purchase the warranty
B)moral hazard will lead those who purchase to be more reckless
C)you systematically underestimate product failure rates
D)Both A&B

Question

​You offer an extended warranty for your product that is purchased by a few customers.If the product typically fails 2% of the time,the claim rate will exceed 2% of warranty purchasers because
A)​adverse selection will lead those who are more reckless to purchase the warranty
B)moral hazard will lead those who purchase to be more reckless
C)you systematically underestimate product failure rates
D)​Both A&B

Quizplus · Accepted Answer

Adverse selection refers to the situation where those who are more likely to have a claim (i.e., the "reckless" individuals in this case) are more likely to purchase the warranty, which would increase the claim rate. Moral hazard, on the other hand, refers to the situation where having a warranty can make the purchaser more reckless with the product, also leading to a higher claim rate. Therefore, both adverse selection and moral hazard can lead to a claim rate that exceeds the product's typical failure rate.

​You Offer an Extended Warranty for Your Product That Is

You Offer an Extended Warranty for Your Product That Is