Asymmetric Info

Question 1

Perfect Info

Answer 1

both purchasers and providers know who is high/low-risk
– each group is charged a price equal to the group’s probability of adverse event
– prices are actuarially fair for each group, everyone will buy full insurance
– no market failure

Question 2

asymmetric info

Answer 2

a situation where purchasers and sellers differ in what they know
– a common phenomenon in insurance

Question 3

Completely asymmetric info

Answer 3

extreme but can happen

Question 4

Approach 1: Asking people their risk types

Answer 4

• ask people if they are low-/high-risk
• causes free-riding
• pricing structure is unsustainable

Question 5

expected profit from the high-risk type

Answer 5

Premium from the high-risk type minus exp. payout to the high-risk type

Question 6

Pooled price approach

Answer 6

the price that is actuarially fair for the population as a whole

Question 7

Adverse Selection High-Risk Pooled Price

Answer 7

– less than their actuarially fair price: ρ < pH
→ The pooled price is a good deal. Buy full coverage

Question 8

Adverse Selection Low-Risk Type Pooled Price

Answer 8

The pooled price is greater than their actuarially fair price: ρ > pL
→ The pooled price is a bad deal. Buy no or partial coverage

Question 9

Adverse Selection

Answer 9

The phenomenon that the people who most want to buy insur. at the pooled price are those with a high risk of suffering the adverse event

Question 10

Does Raising Prices Combat Adverse Selection?

Answer 10

Raising the price won’t necessarily solve adverse selection
– Instead, it can sometimes make the problem worse:
– If the price is higher, more low-risk individuals will drop out
⇒ The risk pool will be more strongly tilted toward the high-risk type
⇒ Avg. payouts will be even higher, and the insurer may again lose money

Question 11

Unraveling EQ:

Answer 11

– adverse selection causes the market to collapse
– low-risk individuals drop out and do not buy insurance
– high-risk individuals buy full coverage at their actuarially fair price, pH

Question 12

Conditions for Unraveling EQ

Answer 12

W/ two risk types, there are three conditions for the market to unravel:
1. sL small relative to sH
2. pH much larger than pL
3. Low-risk individuals are not very risk-averse

Question 13

Pooling EQ conditions

Answer 13

1. sL big relative to sH
2. pH not much larger than pL
3. Low-risk individuals are strongly risk-averse

Question 13

Pooling EQ

Answer 13

– Adverse selection is not severe enough to distort the insurance market
– Everyone buys full insurance coverage at the pooled price
– all low-risk want to buy full coverage at the pooled price (No adverse selection)

Question 14

Separating EQ

Answer 14

two distinct insurance options: (a) Full coverage at a high price & (b) Partial coverage at a low price
– Induce low-/high-risk to reveal their types via self-selection
– High-risk have strong demand for insurance; prefer (a)
– Low-risk have weak demand for insurance; prefer (b)

Question 15

What do High-Risk individuals prefer

Answer 15

pooling eq

Question 16

what do low-risk individuals prefer

Answer 16

prefer perfect info or prefer separating to unraveling

Question 17

What can the gov do?

Answer 17

Mandate that everyone buy insurance or directly provide the insurance and fund it using tax revenue
– Creating the pooling equilibrium improves wellbeing for high-risk

Question 18

Whether makes them better/worse off depends on:

Answer 18

1. Their degree of risk aversion
2. The nature of the eq. that would exist absent the policy

Question 19

Actuarially Fair Premium

Answer 19

equals the insurer’s expected payout. It is the probability of the adverse event times the amount of the insurance benefit

Question 20

Distributional Concerns of Private Insurance

Answer 20

– In the free market, high-risk have to pay a lot for private insurance
– If gov. provide the insurance, we can subsidize high-risk people

Question 21

Externalities of Private Insurance

Answer 21

If someone lacks health ins. may not get treated for an infectious disease

Question 21

Administrative Costs of Private Insurance

Answer 21

– Gov. sometimes has lower waste: 2% of claims paid for Medicare v. 12.4% for private insurance
– Private insurers spend on advertising; sometimes engage in predatory practices
– But gov.-provided insurance can have bureaucratic issues

Question 22

Internalities of Private Insurance

Answer 22

people are bad at accounting for risk
⇒ may not buy enough insurance on their own

Question 23

Samaritan’s Dilemma of Private Insurance

Answer 23

– Society often redistributes to people who suffer adverse events
– Can avoid footing the bill if force people to buy insurance

Question 24

Insurance

Answer 24

Allows people to smooth consumption
→ Give up a little in the good state to maintain consumption in the bad state

Question 25

Social Insurance

Answer 25

Deals with asymmetric info. ⇒ can ↑ access to insurance
Potentially deals with the other issues with private insurance:
– distributional concerns, externalities, admin. costs, internalities, Samaritan’s dilemma, etc.

Question 26

cost of insurance

Answer 26

moral hazard

Question 27

Forms of Moral Hazard

Answer 27

1. Fewer precautions against an adverse event ex. Car insurance ⇒ drive less carefully
2. Less effort on getting out of the adverse event ex. Unemploym. insurance ⇒ stay unemployed for longer
3. Higher expenditures when suffering the adverse event ex. Health insurance ⇒ use too much healthcare

Question 28

moral hazard

Answer 28

insurance can induce people to engage in harmful behaviors
— It reduces the incentives to avoid or remedy adverse events

Question 29

imperfect monitoring

Answer 29

Insurers often can’t observe the behavior of beneficiaries
– why moral hazards exist