Question

Life insurance companies require applicants to submit to a physical examination as proof of insurability prior to issuing standard life insurance policies. In contrast, credit card companies offer their customers a type of insurance called “credit life insurance” which pays off the credit card balance if the cardholder dies. Would you expect insurance premiums to be higher (per dollar of death benefits) on standard life or credit life policies? Explain.

Short answer

The credit life policy premiums must be higher.

Step-by-step solution

Define Asymmetric Information

Asymmetric information signifies the condition where a consumer or the buyer has limited or no information regarding a commodity where the other party has the full information regarding it. Such thing can create a situation where the latter can take the advantage and sell a defective product to the former without their knowledge about it.

Explanation 

It would be expected that credit line life insurance premiums to be higher (per dollar of death benefits) because credit companies must deal with hidden characteristics about their clients' physical and mental health. It creates an adverse selection situation in which the process of selecting people for this line of credit results in a pool of people with undesirable characteristics.

Unlike life insurance firms, the credit line life insurance firms need potential consumers to undergo a series of physical tests before they can be insured. These companies want to minimize asymmetric information and adverse selection in order to decrease risk. As a result, by lowering risk with more knowledge, premiums will be cheaper because the odds of a person dying in the short term will be significantly reduced.

Therefore, credit life policies must be higher.