Many health and casualty insurance policies require policyholders to pay a certain amount (called a deductible) for claims before the insurer itself will begin to pay.
a. Explain how the existence of a deductible reduces the problems of moral hazard.
b. Often, insurers will let policyholders choose a low deductible, or will offer them a larger deductible in exchange for a substantial reduction in the premium. Explain how this two-tiered system helps insurers deal with the problem of adverse selection.