Which of the following actions best illustrates adverse selection?
A)A person purposely chooses bonds of corporations with high default risk because of the high returns.
B)A person dislikes losing $400 more than he likes winning $400.
C)After obtaining automobile insurance a person drives less carefully than before.
D)A person intending to take up dangerous hobbies applies for life insurance.

Question

Quizplus · Accepted Answer

Adverse selection is the situation where the high-risk individuals are more likely to acquire insurance, whereas low-risk individuals tend to opt-out. In this case, the person applying for life insurance with an intention to take up dangerous hobbies is an example of adverse selection. The insurer cannot differentiate between high-risk and low-risk applicants, and hence ends up insuring high-risk individuals at standard prices, leading to a potential loss for them.

Which of the Following Actions Best Illustrates Adverse Selection