Question

Health insurance companies offer polices that strike a balance among three objectives: consumption smoothing for insurance purchasers, reduce incentives for overuse of medical services (moral hazard restraint), and guard against adverse selection. Explain consumption smoothing, moral hazard and adverse selection.

Answer 1

Consumption smoothening refers to maintain a certain level of standard of living (consumption) throughout the lifetime irrespective of the income an individual earn during any time. An individual could be earning low income during initial years and higher income during later years. It is possible, that due to low income, people couldn't able to afford health care but health insurance make health care available to everyone. So in this way health insurance helps in smoothening of the consumption

Moral hazard is a problem in which an individual behaves with carelessness when he is insured as compare to when he doesn't have any insurance. In the case of health insurance, an individual with insurance would be a bit carefree regarding catching the illness and take less precaution against them when insurance companies are covering the fees of visiting the doctor. But the companies often offers such health insurance policies which made consumers pay some part of the doctor's bill. Even if it is a small amount, it matters. It encourages people to take preventive measures.

Problem of adverse selection occurs when there exist assymetric information. In the case of health insurance, insurance companies don't know which person is more likely to get sick or which one is more prone to have an accident. The insurance company would be at risk if it attracts only those people who are more prone to get infected with dangerous diseases and require costly treatments. These health insurance companies deal with this issue by providing insurance to tha huge amount of people, so that it covers healthy people as well. One way to do this is to provide insurance through an employer as no one will reject free insurance.