1. Assume that the insurer can NOT distinguish between the two types of consumer
ID: 1205368 • Letter: 1
Question
1. Assume that the insurer can NOT distinguish between the two types of consumers, and can offer only one policy (the same policy to everyone). What will be the breakeven policy premium IF everyone buys the policy? With such a premium, will everyone actually buy the policy? Over long run, what will be the equilibrium policy premium in the market and who will get insurance?
2. Now assume the insurer can offer two different policies, but still can NOT distinguish between the two types of consumers. In this case, will the insurer be able to break even while all consumers buy insurances? Explain.
3. Now assume the insurer can offer two different policies, and can also distinguish between the two types of consumers. In this case, will the insurer be able to break even while all consumers buy insurances? Explain.
4. Going back to the first scenario, assuming that the insurer can NOT distinguish between the two types of consumers, and can offer only one policy (the same policy to everyone). However, a recent technology advancement has lowered the actual cost of the treatment from 50000 to 45000. How does this change the market outcome you found in Question 1? (Hint: follow the exact same analysis you did in the first question.) What if the cost is now further lowered to 30000?
e Share Well 95% Risk of Ilness 1% WTP $600 $500 = 1% × $50,000 Expected Cost $500 1115% 10% $7,500 5,000 $7,500 $5,000 $5,000 = 10% × $50,000Explanation / Answer
1) There are so many instances of insurers not differentiating between high risk and low risk customers, The premium in such case would be risk is shared by all the holders of the policy so they all pay higher premium
2) Insurer launches two different kinds of policies but still unable to distinguish between differnt types of customers he will likely charge different premiums for 2 differnt kinds of policies but still he cant break even as many people wont be willing to pay higher premium when their rate of risk is very low
3) Yes, Different policies are deviced for different types of consumers will give much more easy returns to the insurer, He can charge higher for higher risk groups and lower for lower risk groups, Insurance is nothing but buying risk from the insured, such policies can help insurance companies break even .
4) Technological advancement have lowered treatment cost by almost half, Even then the risk remains higher for people with lower risk, For example a 18 year old women have much lower risk than 80 year old women, Both just cant pay the same premium
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