Screening

Screening is the mirror image of signaling: the uninformed party designs a menu of contracts to induce the informed party to self-select and reveal their type. The key difference: in signaling, the informed party moves first; in screening, the uninformed party moves first by offering different options that appeal differently to different types.

Real-world screening examples are everywhere: (1) Insurance deductibles: insurers offer high-deductible/low-premium vs. low-deductible/high-premium plans. Low-risk people choose high deductibles (they rarely claim); high-risk people choose low deductibles. (2) Airline pricing: business class vs. economy with Saturday-night stay requirements. Business travelers reveal themselves by paying more for flexibility. (3) Credit markets: banks require collateral, credit scores, and co-signers to screen borrowers. (4) Coupons: price-sensitive consumers clip coupons; less sensitive consumers pay full price (self-selecting by price sensitivity).

The widget below uses an insurance market with two driver types — high-risk (20% chance of an accident each year) and low-risk (5% chance). The loss is fixed at 10,000 dollars if an accident happens. The insurer offers a menu of two plans:

• Plan A — full coverage, premium varies (this is what we’ll change).
• Plan B — 5,000-dollar deductible, premium 500 dollars.

Each driver picks the plan with the lower expected annual cost. Plan A’s expected cost is just its premium (full coverage means no out-of-pocket). Plan B’s expected cost is its 500-dollar premium plus the chance of an accident times the 5,000-dollar deductible — so 1,500 dollars for high-risk drivers and 750 dollars for low-risk drivers.

We’ll step through three values for Plan A’s premium and watch each driver’s choice. The shorter (cheaper) bar wins in each panel.