Two Consumers Go to the Insurance Company to Purchase Life

question 185

Essay

Two consumers go to the insurance company to purchase life insurance. James is a smoker and a police officer who races motorcycles in his spare time. Kathy is a nonsmoker and a librarian who likes to make quilts in her spare time. The insurance company knows that both consumers are 40 years old, but the company has no information about occupations or hobbies. How does the private information in this situation set up an adverse-selection problem? How could the insurance company lessen this problem?

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Definitions:

Bad Debts Expense

An estimated expense that represents accounts receivable that a company does not expect to collect.

Normal Balance

Normal balance refers to the side of the accounting equation on which increases to an account are recorded, which is debits for asset and expense accounts, and credits for liability, equity, and revenue accounts.

Allowance for Doubtful Accounts

An account that offsets assets, designed to predict the amount of a company’s accounts receivable that is likely to be uncollectible.

Normal Balance

The side (debit or credit) of an account that is positive or increasing in nature, depending on the type of account.