Question

“The idea of insurance is to share the risks of bad outcomes. You don't know whether your house is going to burn down next year, and neither does the insurance company. But the company knows the odds, and with enough customers the odds turn into a certainty that some percentage will suffer a fire.” Two important features of the Patient Protection and Affordable Care Act state exchanges and employer group policies are: “guaranteed issue” and “community rating”. The first means that insurance companies are required to sell insurance to anyone who wants it, and the second means that they have to charge everyone the same price (with a few specific exceptions, like designated higher rates based on age) . Answer eaccch of the following(not multiple choice):
a. Why do people buy insurance?
b. How does the problem of “adverse selection” affect the ability of insurance to provide the benefit of risk sharing?
c. How does “moral hazard” affect insurance?
d. If the group or state health insurance exchange included healthy and unhealthy individuals, when would the healthy individuals have an incentive to leave the group?
e. Suppose health insurance company policies did not require guaranteed issue, what would be the result? f. Suppose community rating was not required what would be the result?

Answer 1

a. people buy insurance to guard against the occurrence of an unwanted event for which the insurance is sought. The utility of the insurance payment is less than the utility that will be gained by the insurance coverage in the case the event occurs.

b. This problem impacts the ability of insurance to provide the benefit of risk sharing as adverse selection is the process due to which the quality and the costs of goods in the market undergo alteration as one party has more information than the other party involved. The party with the lesser information cannot get it at a reasonable price.

c. Moral hazard affect insurance because the insure knows more about his circumstances than the insurer. Moreover at times the insure may not reveal all the information to the insurer. There is a lack of equal information between the two parties. This situation leads to the insure taking unnecessary risks as the costs are not borne by him/her.

d. If the group or state health insurance exchange included healthy and unhealthy individuals, the healthy individuals have an incentive to leave the group when the insurance coverage did not cover the disutility of the insurance payment.

e. Suppose health insurance company policies did not require guaranteed issue the result would be an increase in the risk borne by the insurance company. There would be a lot of information that would be withheld by the insurees leading to an increase in asymmetric information. Ultimately the insurance payment by the company would display a rising trend. Same would be the case with

f. Suppose community rating was not required the result would be that there would be variation in the rate of insurance and information imbalance.