ECONOMICS

In 1992 in New Jersey, auto insurance premiums were extremely high and drivers facing very high premiums decided not to buy any insurance at all. The governor of New Jersey decided to remedy the situation by offering a state-sponsored auto insurance policy that would be available to all drivers.

Insurance premiums were calculated based on average driver risk in the state during the previous three years.

Q1. What factors might have caused New Jersey's auto insurance fund to experience a large deficit?

A. Moral hazard

B. Adverse selection

C. Both moral hazard and adverse selection

Q2. Explain how these factors would lead to an insurance fund deficit.