Question

) Market imperfections can raise the cost of insurance above the actuarially fair price. Explain three frictions that may arise between the firm and its insurer.

(b) Suppose you are the manager of an insurance company. Describe three ways in which you can reduce the above-mentioned frictions.

Answer 1

A.

1. Inflation of medical claims

Health insurance is used to pay for medical claims. Doctors and other providers submit claims to your insurer every time they perform a service for you, whether it’s a check-up, MRI or surgery. As the cost of performing those services gets more expensive, insurance has to get more expensive to cover it.

The prices of goods always rise as the economy grows, and health care is no exception. In fact, health care costs generally rise much faster than inflation. Specifically, health insurance costs in 2015 rose nearly 5 percent, according to the Bureau of Labor Statistics, while the economy as a whole grew just 2.4 percent.

2. Consumers are still learning

So why are health care costs rising so fast? That’s a tough question to answer succinctly. One reason is that patients are still learning how to act like consumers. Some people do not use healthcare responsibly or cost-effectively, and this raises prices for the whole system. These are people who go to the emergency room for non-emergencies, or people who do not receive preventive care in a timely manner.

The uninsured rate has an impact on this, too. Many people who do not have insurance cannot afford to manage their conditions, like asthma or diabetes. They might not visit the doctor for check-ups or be able to afford to buy their insulin. Then they wind up in the ER in a diabetic coma, which costs a lot more to treat. These are just individual examples, but they happen every day, and it adds up.

3. Natural disasters can raise rates
After Hurricane Harvey hit Houston, Texas, about half a million auto insurance claims were filed, according to the New York Times. The Texas Department of Insurance estimated that car insurance companies faced $2.7 billion in losses. Car insurance costs went up, with Texas indicating hikes of about 8%.

From California wildfires to East Coast hurricane activity, premiums can see spikes after natural disasters. Where there's widespread damage, there will also be an increase in insurance claims. More insurance claims mean greater costs for the insurance companies, and that money has to be made back somehow. Generally, that's in the form of rate increases for drivers.

B. Inflation

This can only be compromised through a serious discussion with medical associations. You should have tie up with these hospitals to reduce the amount charged on different medical tests etc.