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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

what is microeconomics and macroeconomics
Usman Reply
microeconomic deal with the study of individual firms and household and macroeconomics deal with the economy as a whole.
Ebenezer
definition of Monopoly
malonzy Reply
Wat is the importance of economics
Vicky Reply
it broaden one's mind
malonzy
it help us to make good choices
Yussif
what is an efficient wage and how it causes structural unemployment and how it could be shown graphically?
Amos Reply
economics is a social science and an art discuss
Kerry Reply
further explanation on the definition
Samuel Reply
is demand the same as quantity demanded
Samuel
what is business economics
Nelson Reply
business economics is the way the society uses its limited resources to satisfy their unlimited wants
Sekai
what is business economics
THOMAS Reply
how did Mc connel defined economics
Isaac Reply
what is a economy planning?
Jacob Reply
what is demand
Sunday Reply
demand means desire for a commodity backed by willingness & ability to pay for that commodity
Rajesh
what is supply
Akoheni
supply means suppliers supplying more commodities when price's high or less when price's low to satisfy human want
Prince
the coefficient of price elasticity of supply is the measure of percentage change in the quantity supplied of a good due to a given percentage change in its price.
Khushiba
Please what is Economics of Scales?
Prince
what is cardinal and ordinal utility?
Khushiba
Cardinal utility is the satisfaction derived by the consumers from the consumption of goods and services while ordinal is ranked in terms of preference.
Grace
👍
Khushiba
Please explain what is meant by Economic Integration?
Prince
Please I need help!!!!
Prince
economics scales I don't know but I know laws of returns to scale
Khushiba
hello
TIMAH
hello
Khushiba
can someone help explain to me what is fairly inelastic dd
TIMAH
Economics Economics - The study of how people use their limited resources to try to satisfy unlimited wants
Abdullah
Economic integration has been one of the main economic developments affecting international trade in the last years. Countries have wanted to engage in economic cooperation to use their respective resources more effectively and to provide large markets for member-countries of the resulting integrate
Abdullah
Inelastic Demand When consumers are relatively unresponsive to price changes. A PED coefficient of less than one means that a particular change in the price of a good will be met by a proportionally smaller change in the quantity demanded.
Abdullah
demand refers to goods and services that a consumer is willing and able to buy at given rate over a given period of time
Freeman
Demand  - The entire relationship between the quantity of product that buyers wish to purchase per period time and the price of that product..
Abdullah
what are the factor that affect demand
akbal
what is development planning?
Emmanuel Reply
What is economics?
Shubham Reply
economics is study of scarcity and how humans make decisions.
sade
reason for development planning in West Africa
Emmanuel
what is development planning?
Emmanuel
What is homo Economicus?
nongo Reply
when a person is part 50% rational and the other part of him is 50% focused on money as an incentive
Yahir
what makes the economy to be stable
BELDON Reply
what measures are necessary to the economy which is not doing fine
BELDON
must find out the problems originating from and take remedy for it.
Rigved
Economics as a social science Discuss
Sire

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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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