Adverse Selection Information Problem in Insurance Companies

Adverse Selection Information Problem in Insurance Companies
Student's Name
Institutional Affiliation
Course Code and Title
Professor's Name
Due Date
Adverse Selection Information Problem in Insurance Companies
An insurance information problem is an adverse selection problem in the real world that occurs when one party (insured) in a contract has relevant information that the other party (insurer) does not have. There is asymmetric information because the insurance company makes uninformed decisions that can cause adverse consequences since the insured is more knowledgeable or gives incomplete or inaccurate details. This research paper highlights health insurance schemes' adverse selection information problem and possible solutions.
Information asymmetry occurs because the insured can know of significant risks involved in the insurance coverage, but the insurance company may be unaware of those risks. Therefore, the insurer would incur higher insurance coverage costs because the insured's actual risks are significantly higher than the reported risk (Maverick, 2019). Consequently, the insurer incurs adverse effects since the insured gains insurance coverage at a lower cost than their actual level of risk, and the insurance coverage costs are higher than the premiums the insured pays and the real risks exposure, causing an adverse selection information problem. Hayes et al. (2022) explained that insurance companies make financial losses since they pay more claims than the insured should benefit from due to the high covered risks and the fewer premiums paid.
Different researchers have studied adverse selection information in insurance companies to highlight the significant impacts of the issue and develop viable solutions. The research paper titled "Adverse Selection in Community-Based Health Insurance among Informal Workers in Bangladesh: An EQ-5D Assessment" by Ahmed, Sarker, Sultana, Chakraborty, Hasan, Mirelman, and Khan (2018) studied and assessed the adverse selection problem using the EuroQuol-5 dimensions (EQ-5D) questionnaire in Community Based Health Insurance (CBHI) schemes. The study focused on insurance schemes that offered financial risk coverage to informal and low-income workers in Bangladesh. The survey highlighted an evident adverse selection information problem between the insured and the insurer in the CBHI scheme. Some insured knew their disease risks better than the insurance companies, causing an asymmetry information issue. As a result, high-risk members purchased insurance at a lower premium than their actual disease risk would indicate (Ahmed et al., 2018). Such adverse selection issues compromise the financial sustainability of insurance companies.
Insurance companies can minimize adverse selection information problems in various ways. They can enroll only low-risk individuals or cherry-pick, increase the waiting time for the insured to access healthcare following their enrollment, and set different premium amounts for different risks (Ahmed et al., 2018). Cherry-picking offers insurance coverage to low-risk individuals, preventing adverse selection information because all the insured individuals would know that the coverage is only meant for those with low risks (Ahmed et al., 2018)...