MARIE
MARIE
Question 1
Using examples, compare and contrast adverse selection and moral hazard, focusing on how lack of
complete information(asymmetry) affects each concept within the context of insurance. (10 marks)
Solution
Selection occurs when individuals with a greater risk are more likely to buy insurance than those with a
lower risk e.g. People with health issues are more likely to get health insurance than healthy people.
On the other hand, moral hazard occurs when individuals take on more risk because they have insurance
coverage e.g. drivers with insurance are more likely to drive recklessly than those with no insurance.
Comparison
• In insurance markets, information asymmetry is the root cause of both moral hazard and adverse
selection. A lack of complete risk profile data by insurers could result in moral hazard and adverse
selection.
• Insurers handle both problems by modifying premiums or providing various plans depending on risk
assessment to draw a balanced risk population.
• In both cases, there is increased uncertainty and potential losses due to incomplete information or
changes in behavior.
• Both adverse selection and moral hazard can lead to higher rates for insurers and policyholders.
Contrast
• Adverse selection occurs before the purchase of insurance, where individuals with higher risks self-
select into the insurance pool, while moral hazard occurs after the purchase, where insured individuals
may change their behavior.
• Adverse selection results from differences in risk profiles among insured individuals, while moral
hazard results from changes in behavior due to reduced personal financial consequences
• Adverse selection influences the insurance pool's composition, resulting in unbalanced risk
distributions and higher rates; moral hazard influences the frequency and extent of losses, increasing
insurance expenses associated with filing claims.
• Moral hazard results from behavioral changes brought on by a reduction in personal financial risk after
acquiring insurance, whereas adverse selection is the result of disparities in risk information at the time
of acquisition.
Question 2
Using examples, what is the role of the risk management department in an organization? What are the
main functions and responsibilities of a risk manager? Discuss the key elements like policy statements
and risk management manuals. (10 marks)
• Applying strategies externally with insurers, risk finance experts, and department heads as well as
externally with loss control companies.
• Assessment of the nature, frequency, severity, and potential impact of risks on an organization.
• Organizing and arranging suitable risk financing and management strategies to effectively reduce the
impact of losses on the company,
1. Crisis Management: Developing plans and protocols to respond effectively to crises or emergencies
2. Data Analysis: Examining data related to risks, incidents, and controls to identify patterns, trends, and
areas for improvement.
3. Risk identification: Identifying potential risks by assessing internal and external factors.
4. Reporting: preparing and delivering reports regularly to the appropriate parties. Risk Mitigation:
Formulating and implementing strategies to reduce or eliminate the impact of identified risks.
5. Risk evaluation. Using quantitative analysis, and qualitative analysis to assess identified risks.
8. Risk Mitigation: Formulating and implementing strategies to reduce or eliminate the impact of
identified risks.
Discuss the key elements like policy statements and risk management manuals.
Policy statements help the organization determine the overall direction and the activity controls related
to risk management.
Advantages
• It lays out the overarching goals of an organization's risk management function. • It outlines the
responsibilities, authorities, and tasks of the risk management department. • It ensures the continuation
of the program and makes transitions easier when things change.
Risk management manuals outline steps for controlling loss exposures inside the organization and
encompass all enterprise activities.
Advantages