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
Kyle	$120
Casey	$100
Kelly	$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?

Answer 1

Ans a) The above scenario is based on the Acturially Fair Premiums policy of Insurance.

Assumptions :

1) No individual AFP If medical exam does not take place.

2) In scenario A, medical exams are not conducted.

Also, Acturially fair Premiums is defined as

insurance whose premiums paid are equal to the expected value of the compensation received.

Considering the above details along with the scenario mentioned:

The most important things that will determine if Kelly will buy insurance or not are: a) his level of income or wealth b) probability of event c) amount of loss that shall take place d) also Kelly will have to keep in mind the amount he will have to pay in case no one turns up or in a scenario where in the other two are also willing to buy it. Since the cost of insurance is eventually evaluated based on it.

B) Two scenarios have been mentioned above: a) if medical examination is done

b) if it does not done

Depending upon it the price of insurance is determined.

Thus if not all the three are willing to buy the policy he will have to pay more depending upon the average AFP policy.

Also, depending upon the necessity of it in future he shall determine whether to go for medical examination.