Question

Kyle, Casey and Kelly are the sole three workers at Becker and Joe electronics. They can each buy their insurance through the employer's firm if they want to, but each will have their wages reduced by the full premium if they choose to participate in the plan. Their personal actuarially fair premiums (AFPs) are listed below, along with the average AFPs depending on how many of them choose to participate in the insurance plan. Assume there is no moral hazard. The insurance company observes the number of employees that buy the policy and knows the relationship between the number of buyers and the average AFP. However, the insurer cannot observe each worker’s individual AFP unless it performs a medical exam on each worker. If the insurer does not perform the medical exams, assume it charges each worker a premium equal to the average AFP given the total number of workers who buy insurance. If the insurer does perform the medical exams, assume it charges each employee a premium equal to their individual AFP.

	AFP
Manny	$120
Moe	$100
Jack	$50
Average AFP If all 3 buy	$90
Average AFP If 2 buy	$110
Average AFP If only 1 buys	$120

a) Suppose medical exams are not conducted. What factors will determine whether or not Kelly will buy insurance (assume Kelly knows that if he purchases the policy, Kyle and Casey will also purchase the policy)?

b) What determines whether or not Casey would like the insurance company to conduct the medical exams?

Use calculations to support your answer

Answer 1