Which of the following is a contract-based control used by insurers to mitigate adverse selection?

• A. Welfare programs
• B. Warranties
• C. Deductibles
• D. Premium credits

Answer: (C)

Adverse selection happens when higher-risk individuals value and buy insurance more than lower-risk ones, pulling the insurer’s pool toward riskier people. A contract-based control like a deductible changes the economics of buying and using coverage, which helps screen applicants by risk level. With a deductible, the insured must cover a portion of each claim before the insurer pays, so the cost of claiming is borne partly by the buyer. This makes insurance less attractive to those who expect frequent or costly claims (typically higher-risk individuals), reducing the incentive for high-risk people to enroll or to overuse benefits. In contrast, welfare programs and warranties aren’t private contract features used to manage selection in the same way, and premium credits are incentives rather than a direct contract design that screens risk through out-of-pocket costs.