What will happen to the
insurance market after this test is developed? Who will benefit
from this development?
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A. Insurance and Adverse Selection
Assume that there are two types of people: Type As who are more
likely to get a disease, and Type Bs who are less likely to get a
disease. 1. Assume first that people do not know what type they
are. Will people purchase insurance? Why? 2. Now assume that people
know what type they are but insurance companies are unable to find
out this information. Will both types be likely to purchase equal
amounts of insurance? Is there an adverse selection problem? Will
Type As buy insurance? Type Bs? 3. Now assume that insurance
companies can determine an individual’s type by administering an
inexpensive test. Will there be an adverse selection problem? Who
will benefit from this change? 4. Now assume a widely available
inexpensive test is developed that determines with certainty
whether an individual will get sick or not. What will happen to the
insurance market after this test is developed? Who will benefit
from this development?
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