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Week 8 Makeup
Student`s Name
Institution of Affiliation
Adverse selection is a concept used in economics, insurance, and risk management to describe a situation where there is lack of symmetric information before a contract between a buyer and a seller. It occurs when buyers have more information than the seller, which distorts the market process. One party usually has more accurate and different information than the other party, which means that the party with less information is at a disadvantage than the other. Consequently, this entails a lack of efficiency in the market price and quantity since the most of the information in the market is transferred through prices (Keane and Stavrunova, 2016). Adverse selection leads to higher overall prices since businesses insure themselves agains5t high-risk customers, a missing market since low-risk customers may find it too expensive, and companies invest a lot of time identifying groups of consumers with higher risk.
In the health insurance industry, adverse selection occurs when sicker people buy health insurance while the heathier people do not. Additionally, it happens when those who present a higher risk to the insurer purchase more health insurance plans while the healthier ones buy less insurance. Consequently, this means that the insurer risk losing money through claims that it had not predicted. This leads to higher premiums, making the coverage expensive. If adverse selection is left unchecked, health insurance firms would become unprofitable (Prescott and Townsend, 1984).

Moral hazard occurs when one party gets into a risky contract with the knowledge that they are protected against the risk and the other party will incur the cost. Here both parties have incomplete information concerning each other. The situation happens when the borrower knows that someone else will cover for their mistakes, which gives them more incentive to act in a riskier manner.
Insurance is a way of transferring risk to another person, and it functions best when moral hazard is not a work. The health insurance industry is affected severely by this phenomenon. It happens when sicker people fail to disclose information since they know the health insurance company is mandated to pay their claims. Consequently, they may choose riskier lifestyles since they are covered (Zanjani, 2015).
References
Keane, M., & Stavrunova, O. (2016). Adverse selection, moral hazard and the demand for Medigap insurance. Journal of Econometrics, 190(1), 62-78.
Prescott, E. C., & Townsend, R. M. (1984). Pareto optima and competitive equilibria with adverse selection and moral hazard. Econometrica: Journal of the Econometric Society, 21-45.
Zanjani, G. (2015). Moral Hazard in Health Insurance. Kenneth J. Arrow Lecture Series.