Our discussion of adverse selection and moral hazard include

Our discussion of adverse selection and moral hazard included many examples. For each of the scenarios listed below, tell me whether it is an adverse selection or moral hazard problem. Then, explain why the problem exists. Do not simply rewrite the statement, explain the asymmetric information problem.

When you have mortgage loan on your house, the lender requires you to have homeowners’ insurance.

When you apply for life insurance, you are required to pass a physical exam.

Solution

Case of a mortgage loan:
It is an example of moral hazard where home owners take the mortgage loan upon their home. If something happens to the home such as fire or some other damage, then the lender will suffer. To prevent this scenario, the lender asks the homeowners to take insurance so that any damage to the home is recovered.

Case of life insurance:
It is a case of adverse selection where insurer feels that there can be an asymmetry of information and an insurance company may not know the in-depth details of the health status of the individual. It means that there are difference in the information owned by the insurer and the person to be insured. In this scenario, the insurance company can ask the person to go for the physical examination and prove his fitness before a life insurance is issued to him.