Requires the insurer to closely monitor behaviour of

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-requires the insurer to closely monitor behaviour of the insured which is costly and sometimes impossible Major methods of reducing moral hazard: (1) experience rating - makes the premium charged contingent on the claims in prior periods (2) limiting coverage - uses deductibles and other provisions that require insured to bear part of the loss Both of the above provide incentives for insured to take precautions after policies are issued by placing some risk on the insured. Moral hazard implies that there is a tradeoff between risk shifting and incentives. c) Adverse Selection - situations where consumers have different expected losses but the insurer is unable to distinguish between the two types of consumers and charge them different premiums - if same price is offered to all consumers, higher risk individuals will buy more insurance and lower risk individuals will buy less insurance
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Deductible –eliminates coverage for relatively small losses - also reduces the costs of processing small claims that occur relatively frequently Ex. If James has a $250 deductible per occurrence, he will pay up to $250 of the loss each time his windshield is damaged; if the loss is less than $250, then he will pay the entire loss. If the loss is $1,000, James will pay $250 and the insurer will pay $750. A Coinsurance provision requires an insured to pay a specified proportion of the loss (ex. 20%). It provides less than full coverage while reducing moral hazard. Since the insured pays part of any loss with a coinsurance provision, the insured has a greater incentive to reduce losses. Insurance policies often limit the amount of coverage by placing an upper limit, known as a policy limit , on the amount that the insurer will pay for any loss. Ex. The insurer will pay up to $20k.
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