When an insurance company cannot observe the characteristics of potential clients and offers a contract that is accepted by bad risks, the company suffers from
A) adverse selection
B) moral hazard
C) pooling equilibrium

Question

Quizplus · Accepted Answer

This scenario describes adverse selection, where the insurance company is not able to distinguish between good and bad risks and ends up attracting mostly bad risks. This can lead to higher costs and lower profitability for the insurance company. Moral hazard refers to the situation where insured individuals may change their behavior to take advantage of the insurance coverage, but this is not the case here. Pooling equilibrium refers to a situation where all members of a pool face the same risk and pay the same premium, but this is not applicable in this scenario.

When an Insurance Company Cannot Observe the Characteristics of Potential