An insurance provider faces two distinct market failures arising from asymmetric information:
To combat these, the provider introduces Policy A (requiring a comprehensive medical history report and examination before a policy is issued) and Policy B (introducing a £250 excess/co-payment for every medical claim).
Which of the following correctly pairs the situations with their corresponding market failure and the policy designed to mitigate them?
Situation 1 is adverse selection, addressed by Policy A (screening); Situation 2 is moral hazard, addressed by Policy B (incentive alignment).
Situation 1 is moral hazard, addressed by Policy A (signalling); Situation 2 is adverse selection, addressed by Policy B (incentive alignment).
Situation 1 is adverse selection, addressed by Policy B (incentive alignment); Situation 2 is moral hazard, addressed by Policy A (screening).
Situation 1 is moral hazard, addressed by Policy B (screening); Situation 2 is adverse selection, addressed by Policy A (signalling).