Suppose that young drivers are more likely to have an automobile accident than adult drivers. As a result, insurance companies charge higher insurance premiums for young drivers. Suppose one insurance company decided to charge young drivers and adult drivers the same premium based on the average risk of an accident among both groups. Using your knowledge of the problems associated with asymmetric information, explain whether you think this insurance company will be profitable.

Question:

This insurance company is (unlikely/likely) to be profitable because of the problem of (adverse selection/moral hazard).

The insurance premium based on the average risk of an accident among both young and adult drivers will be (lower/higher) than the premium for adult drivers alone and (higher/lower) than the premium for young drivers alone.

Therefore, (young drivers/adult drivers) will not choose to be insured by this company but (adult drivers/young drivers) will.

The premium charged based on the average risk of young and adult drivers would not be sufficient to cover the claims of an (adult-only driver pool, young-only driver pool) and so the company (would not/would) be profitable.