What is difference between moral hazard and adverse selection?

Answer 1

Moral hazard is defined as the risk that an individual has the motivation to take bigger risks before the contract is complete. It is the idea that a person will change their behavior by taking more risks. Adverse selection happens when only a certain group selects a product and they offer the worst return for the company.

Answer 2

moral hazard is when people with insurance don't have to pay the full costs of their own care, they will use more services, services that they do not value at their full cost.

Adverse selection is when the plans that provide most generous coverage will attract individuals with the greatest need for care, leading to elevated service use and costs for those insurers independent of their efficiency in service provision.

This seems a very narrow definition. Moral hazard is a phrase that has a broader reference than in insurance. eg: regarding personal insolvency if the law allows individuals to avoid their debts very easily they might be more likely to incur debts in an irresponsible fashion.

In any case, the definition ignores the issue of whether the individual needs the service in question. If they don't the service provider should have the professional integrity to refuse to treat the would-be patient.

Also, surely the whole point of insurance is that you don't have to pay the full cost of your own care at the point of receiving the care. You have effectively already paid for it when you gave your insurance premium to the insurance company.

Answer 3

A moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions. For example, persons with insurance against automobile theft may be less cautious about locking their car, because the negative consequences of vehicle theft are now (partially) the responsibility of the insurance company.

Adverse selection refers to a market process in which "bad" results occur when buyers and sellers have asymmetric information (i.e. access to different information): the "bad" products or services are more likely to be selected. It describes a situation where an individual's demand for insurance is positively correlated with the individual's risk of loss (e.g. higher risks buy more insurance), and the insurer is unable to allow for this correlation in the price of insurance.