Adverse selection
... don’t buy the insurance, the insurance companies have to increase their premium rates to break even or make profits. As the premium rate increases, more and more customers whose risk below average level will choose not to buy insurance. Then insurance companies need to increase premium rate further to break even or make profit. What’s going on? More low-risk customers will not buy insurance. The insurance companies need to initiate a new round of premium rate increase to break even or make profit. This vicious cycle will drive even more low-risk customers out of the insurance market, causing premium rate to increase higher and force even more low-risk customers leave the insurance market. However, adverse selection isn’t a unique phenomenon in insurance industry. It exists widely in realistic even when there is no information asymmetry. As managers, we should be fully aware of adverse selection when we make decision in wages and sacks, or unexpected bad result would come about. Here I think I have a good example. A CEO of a losing money bank tried to change its current trend. The first step of his action was to lower employees’ salary since labor cost was a large share of the cost of the bank. In this way he hoped to reduce deficit for the bank. However, he found employees’ moral and performance reduced and talented employees quit their jobs (He didn’t realize that here existed an adverse selection). Situation got worse than before. The second step of his action was to dismiss employees. However, the bank could not control of the process in case of life-long labor contract....