Define moral hazard and adverse selection in the context of health ins

Define moral hazard and adverse selection in the context of health insurance markets. Make sure to discuss why they are problems for health insurance markets.

What will be an ideal response?

ANSWER

Moral hazard is when an insured individual has some control over the events that trigger a payment from the insurance company. This is a problem for insurance companies because it drives up costs as the very act of getting insurance causes individuals to engage in more risk-taking (or engage in less risk prevention). Adverse selection occurs when those most likely to make insurance claims buy insurance while those who are least likely to make claims remain uninsured. If insurance companies do not have sufficient information about the likelihood of individuals making claims in the future they cannot charge them appropriate premiums. If the premiums are too high, those who are high risks will still purchase because to them it is a good deal while those who are low-risk will be discouraged from purchasing insurance by high prices. Thus adverse selection can drive up the cost of health insurance and greatly reduce the number of people who want to buy insurance.