Abstract All available evidence suggests that the great majority of individuals avoid taking unnecessary risks. This is apparent from the fact that most individuals are willing to pay insurance premiums the amount of which exceeds the expected pay-out: the amount of potential damage times the chance that such damage will happen. Although private markets offer protection against a wide array of mishaps, such as fire, death or car accidents, insurance markets are characterized by well-known imperfections. Because insurance companies cannot distinguish between high- and low-risk individuals, they must charge a premium based on average risk. Low-risk individuals will in this case drop out (self-selection) because they can buy cheaper insurance from a company offering lower-priced but more restricted policies only available to low-risk individuals (adverse selection).
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