Identify whether each of the following is a potential proble

Identify whether each of the following is a potential problem of moral hazard or adverse selection: (explain why)

a) Someone whose parents lived to 100 is anxious to buy a life annuity.

b) People who are eligible for Social Security retire earlier than they would otherwise.

Solution

Solution :

a) Someone whose parents lived to 100 is anxious to buy a life annuity is an example of adverse selection .

This is a situation where an individual\'s demand for insurance is positively correlated with the individual\'s risk of loss. An individual whose parents have lived to 100 is anxious to buy life annuity because the individual is aware the parents will not live much longer and making a few annuity payments can fetch the individual a lump sum in few years .

b) People who are eligible for Social Security retire earlier than they would otherwise is an example of moral hazard because social security encourages individuals to retire early and leave the labor force. This moral hazard has not only reduced the revenue supporting the program , but it has also allowed people to collect benefits for a longer retirement period .