1. Suppose the average annual malpractice cost is $40,000 for reckless doctors and $2,000 for careful doctors. If half of an insurance company s insured doctors are reckless, the company will earn zero economic profit if the price of insurance is $ ________. If careful doctors are not willing to pay any more than $5,000 for insurance, the price required for zero economic profit is $________.
2. Arrows up or down: In an insurance market, the presence of high-cost consumers’ ________the average cost of providing insurance. The resulting ________in the number of low-cost consumers________ the average cost of providing insurance and ________price.
3. Genetic Testing and Insurance Prices. Suppose the likelihood that a person will get disease X is determined in large part (but not exclusively) by his or her genes. Initially, it is impossible to determine who carries the gene for the disease, and many people spend $500 on special health insurance to cover the costs of treatment for the disease. Suppose scientists uncover the gene responsible for the disease and develop a simple test for the gene.
a. Suppose the government passes a law that prevents insurance companies from getting the results of a customer s genetic test for X. Will the new price of X insurance be greater than or less than $500?
b. Suppose insurance companies have access to the results of genetic tests and they require all customers to get the test. How will the insurance company change its price of X insurance?
4. Rising Insurance Rates. Consider an insurance company that provides group medical coverage for university employees. The company discovered that some of its younger employees had switched to other insurance companies. The company responded to the loss of customers by increasing its price. This is puzzling because you might think the insurance company would drop its price to prevent other employees from switching to other companies.
a. What is the rationale for increasing the price?
b. If you change one word in the second sentence, it would be logical for the insurance company to decrease rather than increase its price. What is the word, and why is it decisive?
5. State Auto Insurance Pool. Consider a state in which automobile drivers are divided equally into two types of drivers: careful and reckless. The average annual auto insurance claim is $400 for a careful driver and $1,200 for a reckless driver. Suppose the state adopts an insurance system in which all drivers are placed in a common pool and allocated to insurance companies randomly. An insurance company cannot refuse coverage to any driver it is assigned, but a driver who is unhappy with the insurance company has the option of being randomly reassigned to another insurance company. By law, each insurance company must charge the same price to all its customers. Predict the price of auto insurance under the two alternative policy scenarios:
a. Under Policy M, auto insurance is mandatory.
b. Under Policy V, auto insurance is voluntary.