The problem of asymmetric information is a major issue in the market for health
ID: 1161743 • Letter: T
Question
The problem of asymmetric information is a major issue in the market for health insurance. Insurance companies must be able to predict the amounts they will have to pay out to policyholders in order to set premium levels that are neither too low to cover costs or too high to be acceptable to customers -- but the insurance companies don't have the same level of knowledge about customers' state of health that the customers have themselves. Describe the two key consequences, to the health insurance industry, of this fact that the companies know less about individuals' health than the individuals who buy the policies do.Explanation / Answer
Assymetric information is the situation where one party has insufficient infomation regarding the other party , which leads to market failure . Assymetric information generates two very critical outcomes : a) adverse selection , b) moral hazard .
a) Adverse Selection : Here the possesion of lesser information by the insurance company about the state of health of an individual than the individual himself during a contract , is termed as adverse selection . This problem of adverse selection can be corrected to some extent through : signalling and screening . The company can demand a full medical check up of the individual before selling a policy .
b) Moral Hazard : This refers to the situation where assymetry occurs after an aggrement is obtained . There is a tendency among insured indivuduals to lead a reckless life and not take good care of their health . People think that there will be extra costs in taking health care and precautions . So when they are fully insured they will not incur such costs , because their insurance will cover the loss when they fall sick . To prevent such moral hazard problem , the company can demand co- payment as a provision in the policy . So the customer has to pay a certain percentage of the bill .
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