Question

Why is health insurance necessary?
Explain how adverse selection and moral hazard are different, and give an example of each.
Why do employers provide health insurance coverage to their employees?
There is a 1 percent chance that you will have healthcare bills of $100,000; a 19 percent chance that you will have healthcare bills of $10,000; a 60 percent chance that you will have healthcare bills of $500; and a 20 percent chance that you will have healthcare bills of $0.
Instead of complete insurance, you have a policy with a $5,000 deductible. What will your expected out-of-pocket spending be? What will your expected insurance benefits be? Assuming that the premium equals 116 percent of expected insurance benefits, do you prefer the policy with a $5,000 deductible or complete coverage? Explain.

Answer 1

Moral Hazard: purposely driving recklessly because you know insurance will pick up the tab for damages, or eat unhealthy food and get fat and have heat problem but knowing insurance will pay for treatment.

Adv Selection: If the insurance has an attractive rate for families or for singles with children, only groups that are those particular demographics will sign up. Or if the insurance company have a rider for say 100% covered cancer treatment, and groups that somehow knows they all have cancer or have a big chance, buy that rider. Adv selection is when groups that have these "negative" traits apply for quotes from companies that offer attractive rates for those "traits". The result is the insurance comp get too many bad groups.

out of pocket expenses
0.01* 5000 + .19* 5000+ .60* 500+ .20* 0.= 1300
insurance proceeds
0.01* 95000 + .19* 5000+ .60* 0+ .20* 0.= 1900
premium for 5000 deductible
1900*1.16= 2204
premium for total coverage
0.01* 100000 + .19* 10000+ .60* 500+ .20* 0.= 3200
3200*1.16= 3712
difference:
3712-2204= 1508
premium minus expected out of pocket = 208
you expect to save 208 dollars with the $5000 deductible