Lecture 5 - Information

Question 1

Who will choose large deductible (share paid by the insuree before the insurance pays)?

Answer 1

• Less risk-averse individuals (risk-averse individuals want to insure everything)
• better-off individuals (paying for small costs is okay)
• low-risk individuals

Question 2

Results of adverse selection in insurance market

Answer 2

• no pooling eq (cream-skimming is possible)
• no full insurance for both types
• separating eq can exist with full insurance for high-risk people but not for low-risk (as in EI)

Question 3

Benefits of private insurance over public insurance

Answer 3

• Sharper incentives for productive efficiency and innovation
• variety of offering is easier

Question 4

Contracting out of public insurance

Answer 4

Not sustainable as there would be self-selection, eg. for unemployment insurance, low-risk people stand to gain more from contracting out, which would leave the state with only bad risks to insurance

Question 5

Ways to control moral hazard (in insurance)

Answer 5

• deductibles and co-insurance
• better info and monitoring (eg. monitoring devices in cars)
• rationing on the basis of assessment of need (not allowing everything)

Question 6

Public vs. private sector in handling MH

Answer 6

• private sector can’t sustain huge losses indefinitely
• may be economies of scale in gathering info, probably favouring the state
• arbitrary rationing of entitlements may be more acceptable if made by the state instead of a profit-motivated private insurer

Question 7

Controlling MH in P-A relationships

Answer 7

The idea is to align interests of P and A:

• bonuses for senior managers based on profits or other targets
• sales commissions
• shares to employees
• > formally: incentive compatible contract

Question 8

Why are some of the mechanisms used in the private sector to reduce MH in P-A relationships less effective in the public sector?

Answer 8

Because some dimensions of output cannot be easily measured, unlike profits in the private sector

Question 9

Measuring government output

Answer 9

Some measures may distort behaviour:

• surgeon refusing to take on difficult cases that risk worsening his average performance
• school performance incentives may encourage selection of students, exclusion of difficult ones, focus on exam prep rather than broader aspects of education, etc.
• > professional ethos may be more effective at maintaining quality than incentive pay

Question 10

Some strategies used to improve public sector performance

Answer 10

• monitoring by public sector audit agencies
• budget based on performance
• incentives and bonuses for individual staff
• decentralisation -> yardstick competition
• contracting-out (to private sector)
• consumer pressure by making info on performance public
• privatisation