Screening

Screening Definition

The definition of screening refers to the actions of an uninformed party to push the informed party to reveal private information. Often there are inefficiencies in markets that are caused by asymmetric information. Screening helps the market become more efficient by making information available to everyone involved in a transaction.

Screening Examples

There are many screening examples. Let's consider an auto insurance company as a screening example.

The screening process then enables the company to differentiate between drivers and offer insurance packages accordingly. Screening allows the company to increase its profit and reduce costs.

If the driver is risky, in the event of an accident, they may already have paid the insurance company enough to cover the expense. However, if it wasn't for screening, and the insurance company had no idea of the risk associated with the driver, it would have resulted in a much higher cost for the company.

Screening Techniques

Screening techniques depend on the type of industries in which they are being used. The screening techniques used in the labor market, for example, differ from those of insurance companies. Some of the most common screening techniques include historical records, health records, aptitude tests, college background, and grade point average.

Figure 1 shows the five main important types of screening techniques.

• Historical record. When assessing a client's degree of risk and the likelihood that they may engage in dangerous conduct in the future, insurers consider both the client's current behavior and the client's history of activity. For instance, if a customer has a record of being involved in a number of automobile accidents in the past, there is a high probability that the client may be in an accident in the future.
• Health record. Health records are used as a screening technique by health insurance providers. When considering whether or not to provide health insurance coverage to a customer, the insurer will be interested in learning about the customer's current health status and the types of diseases the customer suffers from.
• Aptitude tests. Aptitude tests are one of the most common techniques employers use to screen potential candidates. Employers often resort to aptitude tests as one of the most effective screening tools to choose qualified applicants from a larger group of people looking for work.
• College background. When college graduates apply for jobs with little experience, companies will use their college background as a screening technique. The college background will help companies determine whether candidates have acquired the skills required for the job throughout their education.
• Grade point average (GPA). The grade point average is a common screening technique used not only by employers but also by colleges. Students who have had varying levels of success during their time in school are likely to have lower averages than students who have been among the school's top scorers and who have maintained a high level of academic achievement. This reveals information about the student's likelihood to maintain high performance in the company or the college they apply to.

Screening vs. Signaling

The main difference between screening vs. signaling is that signaling occurs when an informed party reveals private information. On the other hand, screening occurs when an uninformed party induces the informed party to reveal information.

Signaling is very similar to screening, with the key difference being that the agent with all of the information decides to act first to single themselves out as a good agent. That is to say, when signaling occurs, the information is revealed without the need to have another party induce the informed party to disclose information.

Similar to screening, signaling reduces asymmetric information. That's because the party is revealing the information; therefore, none of the parties have more information than the other. This enables a much more efficient allocation of resources.

Advantages of Screening

One of the main advantages of screening is that it reduces asymmetric information in the markets, leading to efficient resource allocation.

There are several fields in which some participants in a transaction will always have more information than others involved in the same transaction.

There are two main situations that occur as a result of asymmetric information, which are moral hazard and adverse selection as seen in Figure 2 below. Screening helps prevent both of these situations.

It occurs when both parties have inaccurate or partial knowledge about the other person.

Clients with a history of engaging in such activity may be denied a loan or offered an alternative loan with a higher interest rate better suited to their elevated level of risk if the loan provider recognizes such customers and screens them throughout the registration process.

By screening, the insurance provider could prevent such a situation from happening.