Screening
What is Screening?
Screening is when a less-informed party designs choices to get an informed party to reveal hidden information.
Insurers offer different deductible–premium menus so high- and low-risk customers self-select; lenders use credit checks. Screening is the mirror image of signaling and helps reduce adverse selection.
Screening: a worked example
An insurer knows that careful drivers file a claim with probability 0.10 and risky drivers with probability 0.40, but cannot tell them apart. Each accident costs $5,000. The insurer posts two policies and lets customers choose. Policy A charges a $700 premium with a $4,500 deductible. Policy B charges a $2,300 premium with no deductible. A careful driver's expected cost under A is $700 plus 0.10 times $4,500, or $1,150, well under B's $2,300, so she picks A. A risky driver's expected cost under A is $700 plus 0.40 times $4,500, or $2,500, above B's $2,300, so he picks B. The menu has sorted the two types without the insurer observing anyone's driving. Check the insurer's side: from a careful driver it collects $700 and expects to pay 0.10 times $500, or $50, for a margin of $650.
The mistake students make with screening
Students treat a separating menu as a fix that costs nothing. Look at what the careful driver actually walks away holding: a policy with a $4,500 deductible, which leaves her carrying most of the risk she came to insure against. The insurer cannot hand her cheap full coverage, because the risky driver would take that contract too. Screening buys information by forcing the good type to accept a worse contract than she would get if her type were visible. The separation is real, and so is the loss.
Screening questions
What is the difference between screening and signaling?
Screening is done by the party that lacks information, and signaling by the party that has it. An insurer offering a menu of deductibles is screening, because the insurer builds the choice set and reads the customer's pick. A job applicant paying for a certification is signaling, because the applicant holds the private information about ability and spends money to make it credible. Both shrink the information gap, but only the screener starts out uninformed.
How does a deductible screen out high-risk customers?
A deductible costs a customer more the more often that customer expects to claim, so the two types value it differently. Someone who expects one claim every ten years barely feels a large deductible and will take it in exchange for a low premium. Someone who expects a claim every other year faces a big expected bill from the same deductible and prefers the expensive full-coverage policy. The customer's choice therefore reveals the risk level the insurer could not see.
Is a job interview screening or signaling?
A job interview is screening, since the employer is the uninformed party designing the questions to draw out what the applicant knows about her own ability. The same hiring process contains signaling on the other side: the degree, portfolio, or certification the applicant brings was costly to obtain and is meant to prove type. One hiring decision can hold both at once, which is why the test is always who acts, not what the setting is called.
Related terms
Common comparisons
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