Chapter 1. Chapter 18

Step 1

Work It Out
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You must read each slide, and complete any questions on the slide, in sequence.

Question

In a private insurance market, there are two different kinds of people: some who are more likely to require expensive medical treatment and some who are less likely to require medical treatment and who, if they do, require less expensive treatment. One health insurance policy is offered, tailored to the average person’s health care needs: the premium is equal to the average person’s medical expenses (plus the insurer’s expenses and normal profit).

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The insurance policy is unlikely to be feasible because those people who are less likely to require expensive treatment generally know that they are less likely to need health insurance. And since the insurance premium is based on the average person’s medical expenses, those who are less likely to require treatment will find this policy too expensive. So many of these individuals will not purchase this one-size-fits-all policy. However, the policy is generally a good deal for those who know they are likely to require a lot of—and very expensive—medical treatment,and those individuals will want to buy the policy. So the insurer will be left with an adverse selection of mostly high-risk individuals and, in order to avoid losing money on selling the policy, will have to increase the premium. These are the first steps in what is known as the adverse selection death spiral.
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Step 2

Question

In an effort to avoid the adverse selection death spiral, a private health insurer offers two health insurance policies: one that is intended for those who are more likely to require expensive treatment (and therefore charges a higher premium) and one that is intended for those who are less likely to require treatment (and therefore charges a lower premium).

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Even offering two different insurance policies will likely not work, because the insurer generally knows less well than the individual whether any given individual has a high or low risk of requiring treatment. As a result, everyone would want to buy the cheaper (lower-premium) policy. If the insurer is unable to tell whether some high-risk individuals are purchasing the insurance policy not intended forthem, it will lose money on this policy and will have to increase the premium. This, again, is the first step in the adverse selection death spiral.
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Step 3

Question

In an effort to avoid the adverse selection death spiral, a private health insurer offers two health insurance policies: one that is intended for those who are more likely to require expensive treatment (and therefore charges a higher premium) and one that is intended for those who are less likely to require treatment (and therefore charges a lower premium).

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As you learned in the chapter, the British National Health Service is a government agency that extends health care to everyone in Britain (this includes you as an American if you are in Britain on vacation!). And it pays for the cost out of general taxation. That is, no one has the option to opt out of paying for this government-provided health insurance policy.
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