Health Sciences 3840B Lecture Notes - Lecture 9: Risk Aversion, Life Insurance, Pareto Efficiency
30 May 2018
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You can’t tell between people who have higher and lower risk status
Insurance prices driven higher and higher, people that have lower risk status find that they can’t get insurance, because an insurance company can’t really tell that
they are low risk status in the finer details
Premium price for insurance but the willingness to pay will be less, people with lower risk won’t want to buy insurance because it’s not worth it
Selecting: insurance or not
Adverse: people of higher risk classes with higher expected costs
An insurance company wants to divide people up into risk classes
If you’re charged the average in a group but you actually have lower expected costs you won’t want insurance
If you have higher expected costs this is good for you
Those who expect to benefit more will want to sign up for insurance -> more expensive for the insurance company
Also depends on WTP
Insurance costs more than expected benefit but still within WTP sometimes
ARS leads to the average risk status of those who have insurance is higher than the average in the actual risk class
Insurer realizes they’re charging not enough – they’re having to pay out too much, the higher risk people got the insurance
The premium has to increase again! They’ll adjust to charge for the expected costs of people who actually have insurance
You will only take insurance if the willingness to pay is greater than the price
Example of risk selection: only the high risk person bought the insurance
For there to be a market, there has to be somewhere that you can go to purchase something, it has to be sold somewhere
Price might be high but market still there
ARS means there might not be any market for low risk individuals
Different than it being a good that’s too expensive. In this case there just isn’t insurance for people with low expected costs
Missing market or incomplete market –typically signals market failure
Only market failure if it leads to inefficiency in the market (if the good being available would be a Pareto improvement)
Also need someone willing to sell for it to be a missing market ?
Person 1 with expected cost of 10, willing to pay 11.
Could pool a bunch of people who have 10$ expected costs, there would be sellers willing to be in that market
When the sellers enter the market, because they can’t distinguish who’s who they can’t provide to these people although they would if they had that information
Because there’s someone willing to pay more than the loss, theoretically there is someone out there willing to sell it because they can make a profit
Can’t make that transaction because insurance company can’t know your expected costs
The market can’t even though everyone is willing
If a market doesn’t exist it doesn’t mean that there’s market failure!
Could imaging some improvement to a laptop that you want to be able to purchase –doesn’t exist because there’s no innovation for it. There’s a market that’s missing
but we don’t say that’s market failure because there has to be sellers that are willing to sell it –it’s market failure when you have buyers willing to buy and sellers
willing to sell but something prevents that from happening
We can also say the insurance market is not sustainable
Any market that is there would be Pareto inefficient
It’s a problem that people with low risk can’t get health insurance
Policies that try to solve this on the next slide
If you had 100 people with expected costs of 9-11 dollars, and put them into a risk class. The $9 people might not drop out because the class is so small. As the risk
class gets narrower people wont’ drop out to such an extent. How well can you observe expected costs? Hard because a lot of stuff is unobservable. Also raises equity
concerns –individuals with higher expected costs and lower income and less ability to pay, putting some people into a higher risk class and saying that they have to
pay more?
You don’t have low risk people dropping out because you have employer provided plan.
Happens when the insurer has more info than the individual
Having data across lots of people so they can make statistical information
Can target people who have lower risk and charge them higher price
Only works if the insurer has info that the buy does NOT have, otherwise buyer will know and won’t take the offered price
2. Attract people who are more health conscious selecting themselves into the insurance
Another source of market failure
Resources going into something that isn’t socially useful – not increasing social welfare, just redistributing income from individuals to the insurer
What is the impact of that redistribution on social welfare?
When you have higher wealth there is less benefit to gaining more wealth
So it decreases social welfare
Lec 9 Risk Selection and Private Insurance Markets
May 6, 2018
3:54 PM
Health Economics Page 1
Document Summary
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