Suppose your company is considering three health insurance policies. The first p

Question

Suppose your company is considering three health insurance policies. The first policy requires no tests and covers all preexisting illnesses. The second policy requires that all covered employees test negative for the HIV virus. The third policy does not cover HIV- or AIDS-related illnesses. All insurance policies are priced at their actuarially “fair” value. All individuals are slightly risk avers. An individual with the HIV virus requires, on average, $100,00 worth of medical care each year. An individual without the virus requires, on average, $500 worth of medical care each year.

a. Suppose that the incidence of HIV in the population is 0.0005. Calculate the annual premium of the first policy. (hint: Adverse selection)

If you don’t; have insurance that covers HIV-related illnesses, the probability of getting of getting HIV is 2%. Calculate the premium of the second policy. Show your calculations. (Hint: Moral hazard)

Explanation / Answer

a) 0.0005(10000)+ 0.9995(500) = 504.75 b) 0.02(10000) + 0.98(500) = 690

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