Adverse selection and moral hazard (Antiselektion and moralisches Risiko)
Adverse selection and moral hazard are different information problems in insurance. Adverse selection occurs before contracting when people with higher hidden risk are more likely to seek generous cover. Moral hazard occurs after coverage when insurance changes prevention, use, or claiming behaviour. Both can raise pool costs, but they require different evidence and responses.
Why it matters
Insurance works by pooling uncertain losses. If price cannot reflect relevant risk, the mix of people entering the pool may change. If coverage reduces the financial consequence of a loss, behaviour after joining may change. Calling both effects “fraud” is wrong: either can arise without deception.
Worked pool example
Suppose 1,000 people each face a 5% probability of a €10,000 covered loss. Expected claims are 1,000 × 5% × €10,000 = €500,000, or €500 per person before administration and capital costs.
Now separate the mechanisms:
| Change | Timing | Mechanism |
|---|---|---|
| Higher-risk people enroll disproportionately | Before coverage | Adverse selection changes the pool's risk mix |
| Covered people use more services because their marginal price falls | After coverage | Moral hazard changes behaviour or utilization |
| A claimant invents a loss | After coverage | Fraud, a distinct intentional act |
If the pool's average loss probability rises from 5% to 8%, expected claims rise to €800 per member before costs. That arithmetic does not reveal whether selection, behaviour, claim inflation, or an external shock caused the increase; claims data and study design must do that.
How insurers respond
Underwriting, waiting periods, broad participation, and risk adjustment mainly address selection. Deductibles, co-payments, prevention requirements, claim review, and limits can address post-contract incentives. Each response has trade-offs: stronger screening can exclude people who need cover, while more cost-sharing can deter necessary as well as unnecessary use.
Check yourself
Higher-risk people disproportionately enroll before coverage begins. Which mechanism is this?
After obtaining coverage, people use more services because their marginal price falls. Which mechanism is this?
In a pool of 1,000 people, each has an 8% expected chance of a €10,000 claim. Expected claims per member in euros?
Why is neither adverse selection nor moral hazard automatically fraud?
Sources
- European Union — Directive (EU) 2016/97 on insurance distribution and product oversight, https://eur-lex.europa.eu/eli/dir/2016/97/2024-01-09/eng (consolidated 2024)
- Arrow, Kenneth J. — Uncertainty and the Welfare Economics of Medical Care, American Economic Review, https://www.jstor.org/stable/1812044 (1963)
- Akerlof, George A. — The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, Quarterly Journal of Economics, https://doi.org/10.2307/1879431 (1970)