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Key concepts and summary

Insurance is a way of sharing risk. A group of people pay premiums for insurance against some unpleasant event, and those in the group who actually experience the unpleasant event then receive some compensation. The fundamental law of insurance is that what the average person pays in over time must be very similar to what the average person gets out. In an actuarially fair insurance policy, the premiums that a person pays to the insurance company are the same as the average amount of benefits for a person in that risk group. Moral hazard arises in insurance markets because those who are insured against a risk will have less reason to take steps to avoid the costs from that risk.

Many insurance policies have deductibles, copayments, or coinsurance. A deductible is the maximum amount that the policyholder must pay out-of-pocket before the insurance company pays the rest of the bill. A copayment is a flat fee that an insurance policy-holder must pay before receiving services. Coinsurance requires the policyholder to pay a certain percentage of costs. Deductibles, copayments, and coinsurance reduce moral hazard by requiring the insured party to bear some of the costs before collecting insurance benefits.

In a fee-for-service health financing system, medical care providers are reimbursed according to the cost of services they provide. An alternative method of organizing health care is through health maintenance organizations (HMOs), where medical care providers are reimbursed according to the number of patients they handle, and it is up to the providers to allocate resources between patients who receive more or fewer health care services. Adverse selection arises in insurance markets when insurance buyers know more about the risks they face than does the insurance company. As a result, the insurance company runs the risk that low-risk parties will avoid its insurance because it is too costly for them, while high-risk parties will embrace it because it looks like a good deal to them.

Problems

Imagine that 50-year-old men can be divided into two groups: those who have a family history of cancer and those who do not. For the purposes of this example, say that 20% of a group of 1,000 men have a family history of cancer, and these men have one chance in 50 of dying in the next year, while the other 80% of men have one chance in 200 of dying in the next year. The insurance company is selling a policy that will pay $100,000 to the estate of anyone who dies in the next year.

  1. If the insurance company were selling life insurance separately to each group, what would be the actuarially fair premium for each group?
  2. If an insurance company were offering life insurance to the entire group, but could not find out about family cancer histories, what would be the actuarially fair premium for the group as a whole?
  3. What will happen to the insurance company if it tries to charge the actuarially fair premium to the group as a whole rather than to each group separately?
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References

Central Intelligence Agency. “The World Factbook.” https://www.cia.gov/library/publications/the-world-factbook/index.html.

National Association of Insurance Commissioners. “National Association of Insurance Commissioners&The Center for Insurance Policy and Research.” http://www.naic.org/.

OECD. “The Organisation for Economic Co-operation and Development (OECD).” http://www.oecd.org/about/.

USA Today. 2015. “Uninsured Rates Drop Dramatically under Obamacare.” Accessed April 1, 2015. http://www.usatoday.com/story/news/nation/2015/03/16/uninsured-rates-drop-sharply-under-obamacare/24852325/.

Thaler, Richard H., and Sendhil Mullainathan. “The Concise Encyclopedia of Economics: Behavioral Economics.” Library of Economics and Liberty . http://www.econlib.org/library/Enc/BehavioralEconomics.html.

Henry J. Kaiser Family Foundation, The. “Health Reform: Summary of the Affordable care Act.” Last modified April 25, 2013. http://kff.org/health-reform/fact-sheet/summary-of-new-health-reform-law/.

Questions & Answers

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Umar Reply
ha
Nathaniel
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Anjali
distinguish between increase in demand curve and extenaion in demamd curve
Farhan Reply
what are the shapes of an indifference curve?
Ovensi Reply
division of labour is simply the breaking of job functions so that each individual is engage to one set or the other for easy delivery
EMMANUEL Reply
What is division of labor
peter Reply
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EMMANUEL
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EMMANUEL
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EMMANUEL
what are the sources of monopoly power?
Winnerman Reply
the first source, are informations
amine
political power and influence in monetary institutions
Shahul
what is imperfect competition ?
SHAH Reply
the situation in which elements of monopoly ( R&D, EOS and stability of prices etc.) allow individual producers or consumers to exercise some control over market prices
Ghulam
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Sowmya Reply
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Shahul
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SHAH
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olaleye Reply
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Ayedun
Micro-economics refers to the branch of economics which deals with smaller unit or element of the economy.
Amadu
or Is the study of individual economic unit in a economy..
Neriel
micro economis is the studay of how Households and firms make decision and they interecr it.
mahad
what is financial intermediaries?
Imran Reply
financial intermediaries are those who are link between borrowers and lenders for.eg bank... Bank is a financial intermediary
Ajit
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Imran
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Ajit
what is the law of dimis
Toyin Reply
what is the feature of public ownership of production factors
Toyin
what is the demand for commodity that posses identical utilities called
Toyin
law of diminishing utility...as the quantity consumed of a commodity increases,the utility derived from each successive unit goes on decreasing... condition___ consumption of other commodities remaining the same.
Malik
sorry it's...Law of diminishing marginal utility
Malik
demand for commodities that posses identical utilities? The commodities having identical utilities are perfect substitutes...and the demand for such type of commodities is called "Competitive Demand".
Malik
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Toyin
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Hatimu
what is the function of the central bank in an economic?
Toyin
the central bank may lend some money to banks if necessary
konglan
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Toyin Reply
Is this a question?
Tala
is the study of how societies allocate and manage their scare resources
Neriel
What is populatiin
Azer Reply
Population is a number of people living in a particular area within a particular time
Rabby
Population is the number of people living in a particular geographical area within a particular time
Rabby
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Dalaya
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South
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South
what is demand schedule
Toyin Reply
is a tabular representation of the quantity demanded of a particular product at a particular price over a given period of time
Loveth
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Hassan
What is Monetary Mass
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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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