Adverse Selection

Dear Editor:

I am eight years old.  Some of my friends say there is no adverse selection.  Papa says, “If you see if at RiskProf, it’s so.”  Please tell me the truth, is there Adverse Selection?

Virginia Hazard

Dear Virginia:

Adverse selection is getting to be like Santa Clause.  Everyone believes in it (), but evidence of its existence in insurance markets is hard to come by.  Alex Taborrok at MR provides a short literature review of the lack of empirical evidence of adverse selection in insurance and auto resale markets.  The comments, however, focusing mostly on health instance where the market is not exactly a free market do provide a lot of anecdotal evidence of its existence.  So Virginia, look to health markets.

One of the reasons we don’t see adverse selection is because insurers (and other potential counter parties to risky transactions such as lenders and purveyors of fine used previously owned certified special cars) have much better tools to underwrite or provide evidence of their risk characteristics than they did 30 years ago.  In fact, of all the market failures in insurance markets, adverse selection is likely the easiest to remedy without government intervention because there is a profit incentive for the insurer to do so.  In fact, we are seeing push back in the use of even better tools like credit scoring, genetic underwriting, and now possibly how close you live to a church.   

Comments

[Prof Yabut]

You know, just like Santa Claus, when adverse selection takes place, someone else pays the bill.

Next installment: Where have all the Cherry Pickers gone?