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What is an actuarially fair insurance premium? How might adverse selection and moral hazard lead to inefficiency in insurance markets? What actions may insurance companies take to reduce these problems?

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  • Essay length: 789 words
  • Submitted: 29/01/2004
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University Degree Environmental Sciences

The first 200 words of this essay...

1. What is an actuarially fair insurance premium? How might adverse selection and moral hazard lead to inefficiency in insurance markets? What actions may insurance companies take to reduce these problems?

K&R 179

Adverse selection: K&R 564,567-572 Frank 213-4, Lecture notes 24/11/03

Moral Hazard: K&R 577-582, Frank 214, Lecture notes 28/11/03

Plan: Introduction

Definition of actuarially fair insurance premium, complete with diagram

Definition of adverse Selection

Why does A'S' lead to inefficiency?

Definition of Moral Hazard

Why does M'H' lead to inefficiency?

What actions may insurance companies take to reduce these problems?

Conclusion (m'h' & a's' both first studied in insurance mkt)

Definition of actuarially fair insurance premium, complete with diagram

Actuarially fair insurance is insurance where the premium is equal to the expected payout of the insurance provider. For an actuarially fair insurance policy, the premium for $1 worth of insurance is simply the probability of the bad state of the world occurring. For example if probability of a suit is 1/5 then you can buy $1 worth of insurance for $.20.

Below is the Budget constraint with actuarially fair insurance, were the slope of

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