for the population as a whole, average healthcare spending us $1,190 per year. t
ID: 2763317 • Letter: F
Question
for the population as a whole, average healthcare spending us $1,190 per year. those with a family history of cancer (5 percent of the population) spend $20,000 on average, and those with no family history (95 percent of the population) spend $200. An insurer is offering first-dollar coverage for $1,200.
a. You are not risk averse and do not have a family history of cancer. Do you buy coverage?
b. You are not risk averse and have a family history of cancer. Do you buy coverage?
c. If you were risk averse, how would your answers to the two previous questions change?
d. What could an insurer do to prevent this sort of adverse selection?
e. What would be wrong with having everyone undergo a physical exam to qualify for coverage?
Explanation / Answer
A person who is not risk averse , usually doesnt buy coverage whether he had any family history of cancer or not. They prefer to take chance of escaping from cancer due to their risk taking attitude.
If a person is risk averse, still he would not prefer to take the high cost cover because his family doesnt have any cancer history. However, if he has a family history, he would prefer to take this cover as the cost of spend is very high at $20000.
From insurer's perspective, he should ensure that there are no pre existing diseases for which the cover is being proposed. Giving a first dollar coverage means all the expenses incurred would be met by insurance company without any deductions. The above model indicates that only few risk averse people who falls under family history of cancer would be covered. Hence, he should reduce the premium in such a way it is affordable by majority section of the population. He can avoid first dollar coverage to off set the reduction in premium cost.
Such physical exam requirement can be insisted on very old people as they would be having some preexisting diseases. Making such a requirment for all the population would attract only few takers and it consumes unnecessary time of the prospective insured. Now a days, most of the health policies are being given online to ease the process from customer perspective. Hence, such physical exam option has to be selectively chosen.
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