Bills employer offers a new health insurance benefit which c

Bill’s employer offers a new health insurance benefit which covers preventive and cosmetic dental services, including orthodontic care, for employees and their family members. If Bill knows his children need extensive orthodontic care, he will buy the policy. This is an example of moral hazard (True/False)

Solution

FALSE!

The above situation is the most common example of Adverse Selection!

Let me explain you about Moral Hazard and Adverse Selection.

Moral Hazard: It occurs when one person (usually the insured) takes more risks because he is insured and someone else bears the burden of those risks. A moral hazard may occur where the actions of one party may change to the detriment of another after a financial transaction has taken place. Now suppose, you have a full insurance of your car and if it is stolen or it meets with an accident you will get 100% price you paid for the car, now it is very likely that you may not take good care of the car and you may drive rashly, don’t lock the car, etc knowing it is insured. This is moral hazard.

Adverse Selection: It is a situation where an individual\'s demand for insurance is positively correlated with the individual\'s risk of loss. What that means is: The people who are most likely to be the victim/sufferer/bearer of any loss are the ones who are most likely to get the insurance. Suppose in your family almost all the family members had a history of cancer, now you are most likely to get yourself insured. This is called Adverse Selection.

I hope my solution solves your query.