CH 12 Quiz

Asymmetric information important implications in insurance markets

1.) can cause adverse selection (makes it hard for insurance markets to provide actuarially fair insurance) 2.) can cause moral hazard

Moral hazard 2 types

1.) probabilities of adverse events increases because: -reduce caution-change the probability of adverse event. Build on a flood plain, for example 2.) overconsumption of health care -by people because insurance makes the price of care very low. More doctor visits, medicine, etc. -by providers: providers deliver/offer more services because you have insurance. Medical testing, MRI's, etc.

Suppose there are two regions of a state, one where car theft is high and the other where car theft is very low Assume that all drivers in the state are very risk averse when it comes to insurance against theft and that the insurance firms offer one premium rate to all drivers in that state. What kind of equilibrium will result?

This is an example of pooling equilibrium (all receive community-rated prices).

eligibility for benefits

does not depend on a person's income-not means tested

community rating

everyone in the insurance pool pays about the same insurance premium regardless of record, age, etc. -known as "community rating" and equilibrium characterized as "pooling equilibrium"

Other motivations for social insurance

externalities, administrative inefficiencies in the private insurance market, the desire for redistribution and paternalism

paternalism (definition)

for social security government insuring against people's lack of savings for retirement

government insurance vs private insurance companies

government has lower administrative costs because they have no need to earn profits

moral hazard (consumers alter their behavior because they have insurance)

government may intervene due to having health insurance can influence consumers' choices about health care consumption. Definition: an offsetting cost to the benefits of social insurance. By insuring individuals against adverse events, we may increase the incidence of these events among the insured *happens naturally when people are insured against adverse events* altering the probability of unfavored event

administrative costs

government-run Medicare has much lower administrative costs than private insurance

paternalism

governments may feel that people would choose to buy too little insurance for themselves or save too little for retirement. underestimate their risks or overestimate their risks

redistribution

governments may want to redistribute from healthy to sick or philosophy of pay when you are young and get benefits later in life

when is private insurance provision preferred?

in a market economy

experience rating

individuals' risks are priced into their policies (auto insurance) -equilibrium characterized as "separating equilibrium" -people placed into different risk pools -ex. automobile insurance premium prices based on accident record, violations, age, sex, type of car, etc

social insurance programs

insurance against adverse events. Health, inadequate retirement saving. Consumption smoothing is major concept in insurance. mandatory, contribution-based systems that tie the payout of benefits to the occurrence of a measurable event

Ironic feature of asymmetric information

it simultaneously motivates and undercuts the rationale for government intervention through social insurance

consumption smoothing

maintains consumption even if an expensive adverse event occurs

what eliminates the death spiral?

mandating that everyone purchase insurance and pay average premiums

amount of benefits received

means tested

what is the largest and fastest growing function of the government?

provision of social insurance against adverse events such as retirement, unemployment, injury, or illness

means-tested

refers to programs in which eligibility depends on the level of one's current income or assets

social insurance eligibility

related to work or having worked

merit good

social insurance generally in place to help lower-income groups gain access to insurance, income, healthcare

the consumption-smoothing benefits of social insurance are determined by...

the ability of individuals to use other forms of self-insurance to smooth their consumption

Fair insurance

the company pays out exactly the amount it collects in premiums (to cover extra expenses, insurance companies will have to charge insurance premiums larger than actuarially fair insurance)

major concepts in social insurance evaluation

the extent to which social insurance crowds-out private insurance or saving (known as self insurance) extent to which they discourage work or encourage retirement

what is the major motivation for government-provided social insurance?

the failure in private insurance markets caused by adverse selection. (remember adverse selection causes insurance markets to fail because imperfect information leads insurers to be unable to offer full insurance to different types of consumers

The more risk averse people are..

the more they are willing to pay for insurance. purchasing unfair insurance means people value consumption smoothing more than size of the expected loss

why is full insurance unlikely to be optimal?

the optimal social insurance benefit level trades off moral hazard costs against consumption-smoothing benefits

administrative inefficiencies

they can lead to market failure since not all people will be fully insured, as is optimal

If low-risk people have high risk aversion...

they will pay high risk premiums (amount willing to pay above fair insurance amount) and will buy insurance at more unfavorable rates

how to calculate expected value

(change of no problem)*(price of house)+(chance of fire)*($0)=$198,000

Excepted utility

-adverse event or accident occurs with probability -linear equation (probabilities sum to one) -line connects the expected utility of two uncertain events -falls on the line, where it falls depends on the probabilities

Insurers risks

-adverse selection for insurers -moral hazard for individuals and providers

Utility function

-has concave shape -the more concave the function is, the faster marginal utility diminishes

Adverse selection

-insurers need a normal distribution of risk to price insurance and keep it affordable suppose insurance is not mandatory: adverse selection: people with higher probabilities of losses are more likely to buy insurance -insurance draw clients on the riskier portion of the normal distribution of people

Health insurance

-patients who have health insurance pay little for visits to physicians and other providers moral hazard: name for tendency to over consume because the prices are low to patients who have third party payments doctors' visits -lack of transparency between patients' cost of care and effectiveness of care -asymmetric info among providers, insurance companies, and consumers

Why sell insurance?

-to make a profit -but to make profits, insurance company has to charge more in premiums than it pays out to cover losses

adverse selection

The fact that insured individuals know more about their risk level than does the insurer might cause those most likely to have the adverse outcome to select insurance, leading insurers to lose money if they offer insurance. Only those who feel the insurance is a good deal will buy it, which will be those in the high-expense group

pooling equilibrium

a market equilibrium in which all people buy insurance at a community-rated price (average price) *low-risk people subsidize high-risk people in a pooled equilibrium

separating equilibrium

a market equilibrium in which people in different risk pools purchase different insurance products

amount tested

amount of benefits received depends on income and generally means tested favors lower-income individuals

What drivers will be better off and what drivers will be worse off when insurance firms offer one insurance premium for all drivers instead of two different premiums in regions based on theft risk?

careful drivers would find this unfair because they are faced with the decision to buy insurance at the given cost or to not buy insurance at all (which usually ends up happening). They're paying all this money for such a small probability of getting hit. iMeanwhile, the careless consumers would view it as a good deal

How to make a pooled equilibrium charge workable?

company needs mandatory coverage to avoid adverse selection