Principles of Microeconomics Scarcity and Social Provisioning Chapter 22 Information, Risk, and Insurance

CHAPTER 22 . INFORMATION , RISK , AND INSURANCE INTRODUCTION TO INFORMATION , RISK , AND INSURANCE Figure . President Obama Health Care Reform . The Patient Protection and Affordable Care Act has become a controversial which relates strongly to the topic of this chapter . Credit modification of work by Daniel Creative Commons ) WHAT THE BIG DEAL WITH ?

In August 2009 , many members of the US . Congress used their summer recess to return to their home districts and hold town meetings to discuss President Obama proposed changes to the US . healthcare system . This was officially known as the Patient Protection and Affordable Care Act ( or as the Affordable Care Act ( but was more popularly known as . The bill opponents claims ranged from the charge that the changes were and would add 750 billion to the deficit , to extreme claims about the inclusion of things like the implantation of microchips and death panels that decide which patients receive care and which do not . Why did people react so strongly ?

After all , the intent of the law is to make healthcare insurance more affordable , to allow more people to get insurance , and to reduce the costs of healthcare . For each year from 2000 to 2011 , these costs grew at least double the rate of . In 2014 , healthcare spending accounted for around 24 of all federal government

PRINCIPLES or ECONOMICS 623 ing . In the United States , we spend more for our healthcare than any other nation . Yet in 2015 , over 32 lion people in the United States , about , were without insurance . Even today , however , several years after the Act was signed into law and after it was mostly upheld by the Supreme Court , a 2015 Kaiser Foundation poll found that 43 of likely voters viewed it unfavorably . Why is this ?

The debate over the and healthcare reform could take an entire textbook , but what this chapter will do is introduce the basics of insurance and the problems insurance companies face . It is these problems , and how insurance companies respond to them that , in part , explain the . OB ( Introduction to Information , Risk , and Insurance In this chapter , you will learn about The Problem of Imperfect Information and Asymmetric Information Insurance and Imperfect Information Every purchase is based on a belief about the satisfaction that the good or service will provide . In turn , these beliefs are based on the information that the buyer has available . For many products , the available to the buyer or the seller is imperfect or unclear , which can either make buyers regret past purchases or avoid making future ones . This chapter discusses how imperfect and asymmetric information affect markets . The first module of the chapter discusses how asymmetric information affects markets for goods , labor , and financial capital . When buyers have less information about the quality of the good ( for example , a gemstone ) than sellers do , sellers may be tempted to mislead buyers . If a buyer can not have at least some in the quality of what is being purchased , then he will be reluctant or unwilling to purchase the products . Thus , mechanisms are needed to bridge this information gap , so buyers and sellers can engage in a transaction . The second module of the chapter discusses insurance markets , which also face similar problems of imperfect information . For example , a car insurance company would prefer to sell insurance only to those who are unlikely to have auto it is hard for the firm to identify those perfectly safe drivers . Conversely , buyers of car insurance would like to persuade the auto insurance company that they are safe drivers and should pay only a low price for insurance . If insurance markets can not find ways to grapple with these problems of imperfect information , then even people who have low or average risks of making claims may not be able to purchase insurance . The chapter on financial markets ( markets for stocks and bonds ) will show that the problems of imperfect information can be especially poignant . Imperfect information can not be eliminated , but it can often be managed .

THE PROBLEM OF IMPERFECT INFORMATION AND ASYMMETRIC INFORMATION LEARNING By the end of this section , you will be able to Analyze the impact of both imperfect information and asymmetric information Evaluate the role of advertisements in creating imperfect information Identify Ways to reduce the risk of imperfect information Explain how imperfect information can affect price , quantity , and quality a purchase that many people make at important times in their lives buying expensive jewelry . In May 1994 , Doree Lynn bought an expensive ring from a jeweler in Washington , which included an emerald that cost . Several years later , the emerald fractured . Lynn took it to another jeweler who found that cracks in the emerald had been filled with an epoxy resin . Lynn sued the original jeweler in 1997 for selling her a treated emerald without telling her , and won . The case publicized a number of facts about precious stones . Most emeralds have internal flaws , and so they are soaked in clear oil or an epoxy resin to hide the flaws and make the color more deep and clear . Clear oil can leak out over time , and epoxy resin can discolor with age or heat . However , using clear oil or epoxy to fill emeralds is completely legal , as long as it is disclosed . After Doree Lynn lawsuit , the news show Dateline bought emeralds at four prominent stores in New York City in 1997 . All the sales clerks at these stores , unaware that they were being recorded on a hidden camera , said the stones were untreated . When the emeralds were tested at a oratory , however , it was discovered they had all been treated with oil or epoxy . Emeralds are not the only gemstones that are treated . Diamonds , topaz , and tourmaline are also often irradiated to enhance colors . The general rule is that all treatments to gemstones should be revealed , but often disclosure is not made . As such , many buyers face a situation of asymmetric information , where the both parties involved in an economic transaction have an unequal amount of information ( one party knows much more than the other ) Many economic transactions are made in a situation of imperfect information , where either the buyer , the seller , or both , are less than 100 certain about the qualities of what is being bought and sold . Also , the transaction may be characterized by asymmetric information , in which one party has more information than the other regarding the economic transaction . Let begin with some examples of how imperfect information complicates transactions in goods , labor , and financial capital . The presence of imperfect information can easily cause a decline in prices or quantities of

PRINCIPLES or ECONOMICS 625 sold . However , buyers and sellers also have incentives to create mechanisms that will allow them to make mutually beneficial transactions even in the face of imperfect information . If you are unclear about the difference between asymmetric information and imperfect information , read the following Clear It Up feature . WHAT IS THE DIFFERENCE BETWEEN IMPERFECT AND ASYMMETRIC INFORMATION ?

For a market to reach equilibrium sellers and buyers must have full information about the product price and quality . If there is limited information , then buyers and sellers may not be able to transact or will possibly make poor decisions . Imperfect information refers to the situation where buyers or sellers do not have all of the necessary information to make an informed decision about the price or quality of a product . The term imperfect information simply means that not all the information necessary to make an informed decision is known to the buyers sellers . Asymmetric tion is the condition where one party , either the buyer or the seller , has more information about the quality or price of the product than the other party . In either case ( imperfect or asymmetric information ) buyers or sellers need remedies to make more informed decisions . LEMONS AND OTHER EXAMPLES OF IMPERFECT INFORMATION Consider Marvin , who is trying to decide whether to buy a used car . Let assume that Marvin is truly clueless about what happens inside a car engine . He is willing to do some background research , like reading Consumer Reports or checking websites that offer information about makes and models of used cars and what they should cost . He might pay a mechanic to inspect the car . Even after devoting some money and time collecting information , however , Marvin still can not be absolutely sure that he is buying a used car . He knows that he might buy the car , drive it home , and use it for a few weeks before discovering that car is a lemon , which is slang for a defective product ( especially a car ) Imagine that Marvin shops for a used car and finds two that look very similar in terms of mileage , exterior appearances , and age . One car costs , while the other car costs . Which car should Marvin buy ?

If Marvin was choosing in a world of perfect information , the answer would be simple he should buy the cheaper car . But Marvin is operating in a world of imperfect information , where the sellers likely know more about the cars problems than he does , and have an incentive to hide the information . After all , the more problems that are disclosed , the lower the cars selling price . What should Marvin do ?

First , he needs to understand that even with imperfect information , prices still information . Typically , used cars are more expensive on some dealer lots because the dealers have a trustworthy reputation to uphold . Those dealers try to fix problems that may not be obvious to their customers , in order to create good word of mouth about their vehicles long term reliability . The short term benefits of selling their customers a lemon could cause a quick collapse in the dealers reputation and a loss of long term profits . On other lots that are less , one can find cheaper used cars , but the buyer takes on more risk when a dealer reputation has little at stake . The cheapest cars of all often appear on Craigslist , where the individual seller has no reputation to defend . In sum , cheaper prices do carry more risk , so Marvin should balance his appetite for risk versus the potential headaches of many more unanticipated trips to the repair shop . Similar problems with imperfect information arise in labor and financial capital markets . Consider

626 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Greta , who is applying for a job . Her potential employer , like the used car buyer , is concerned about ending up with a lemon this case a poor quality employee . The employer will collect information about Greta academic and work history . In the end , however , a degree of uncertainty will inevitably remain regarding Greta abilities , which are hard to demonstrate without actually observing her on the job . How can a potential employer screen for certain attributes , such as motivation , timeliness , ability to get along with others , and so on ?

Employers often look to trade schools and colleges to screen candidates . Employers may not even interview a candidate unless he has a degree and , times , a degree from a particular school . Employers may also View awards , a high grade point average , and other accolades as a signal of hard work , perseverance , and ability . Employers may also seek for insights into key attributes such as energy level , work ethic , and so on . HOW IMPERFECT INFORMATION CAN AFFECT EQUILIBRIUM PRICE AND QUANTITY The presence of imperfect information can discourage both buyers and sellers from participating in the market . Buyers may become reluctant to participate because they can not determine the quality of a product . Sellers of or goods may be reluctant to participate , because it is difficult to demonstrate the quality of their goods to since buyers can not determine which goods have higher quality , they are likely to be unwilling to pay a higher price for such goods . A market with few buyers and few sellers is sometimes referred to as a thin market . By contrast , a market with many buyers and sellers is called a thick market . When imperfect information is severe and buyers and sellers are discouraged from participating , markets may become extremely thin as a relatively small number of buyer and sellers attempt to communicate enough information that they can agree on a price . WHEN PRICE MIXES WITH IMPERFECT INFORMATION ABOUT QUALITY A buyer confronted with imperfect information will often believe that the price being charged reveals something about the quality of the product . For example , a buyer may assume that a gemstone or a used car that costs more must be of higher quality , even though the buyer is not an expert on stones . Think of the expensive restaurant where the food must be good because it is so expensive or the shop where the clothes must be stylish because they cost so much , or the gallery where the art must be great , because it costs so much . If you are hiring a lawyer , you might assume that a lawyer who charges 400 per hour must be better than a lawyer who charges 150 per hour . In these cases , price can act as a signal of quality . When buyers use the market price to draw inferences about the quality of products , then markets may have trouble reaching an equilibrium price and quantity . Imagine a situation where a used car dealer has a lot full of used cars that do not seem to be selling , and so the dealer decides to cut the prices of the cars to sell a greater quantity . In a market with imperfect information , many buyers may assume that the lower price implies cars . As a result , the lower price may not attract more customers . Conversely , a dealer who raises prices may find that customers assume that the higher price means that cars are of higher quality as a result of raising prices , the dealer might sell more cars . Whether or not consumers always behave rationally , as an economist would see it , is the subject of the following Clear It Up feature . The idea that higher prices might cause a greater quantity demanded and that lower prices might cause a lower quantity demanded runs exactly counter to the basic model of demand and supply

PRINCIPLES or ECONOMICS 627 ( as outlined in the Demand and Supply chapter ) These contrary effects , however , will reach natural limits . At some point , if the price is high enough , the quantity demanded will decline . Conversely , when the price declines far enough , buyers will increasingly find value even if the quality is lower . In addition , information eventually becomes more widely known . An overpriced restaurant that charges more than the quality of its food is worth to many buyers will not last forever . IS CONSUMER BEHAVIOR RATIONAL ?

There is a lot of human behavior out there that mainstream economists have tended to call irrational since it is at odds with economists utility maximizing models . The typical response is for economists to brush these aside and call them anomalies or unexplained quirks . If only you knew more economics , you would not be so irrational , is what many mainstream economists seem to be saying . A group known as behavioral economists has challenged this notion , because so much of this quirky behavior is extremely common among us . For example , a conventional economist would say that if you lost a 10 bill today , and also got an extra 10 in your paycheck , you should feel perfectly neutral . After all , 10 10 . You are the same financially as you were before . However , behavioral economists have done research that shows many people will feel some negative , frustration , and so those two things happen . We tend to focus more on the loss than the gain . This is known as loss aversion , Where a loss pains us times more than a gain helps us , according to the economists Daniel and Amos in a famous 1979 paper . This has implications for investing , as people tend to overplay the stock market by reacting more to losses than to gains . Behavioral economics also tries to explain why people make seemingly irrational decisions in the presence of different , or how the decision is framed . A popular example is outlined here Imagine you have the opportunity to buy an alarm clock for 20 in Store A . Across the street , you learn , is the exact same clock at Store for 10 . You might say it is worth your five minute save 10 . Now , take a different example You are in Store A buying a 300 phone . Five minutes away , at Store , the same phone is 290 . You again save 10 by taking a five minute Walk . Do you do it ?

Surprisingly , it is likely that you would not . Mainstream economists would say 10 is 10 and that it would be irrational to make a five minute walk for 10 in one case and not the other . However , behavioral economists have pointed out that most of us evaluate outcomes relative to a reference the cost of the think of gains and losses as percentages rather than using actual savings . Which View is right ?

Both have their advantages , but behavioral economists have at least shed a light on trying to describe and explain systematic behavior which previously has been dismissed as irrational . If most of us are engaged in some behavior , perhaps there are deeper underlying reasons for this behavior in the first place . MECHANISMS TO REDUCE THE RISK OF IMPERFECT INFORMATION If you were selling a good like emeralds or used cars where imperfect information is likely to be a problem , how could you reassure possible buyers ?

If you were buying a good where imperfect is a problem , what would it take to reassure you ?

Buyers and sellers in the goods market rely on reputation as well as guarantees , and service contracts to assure product quality in the labor market , occupational licenses and certifications are used to assure competency , while in financial capital market and collateral are used as insurance against unforeseen , detrimental events . In the goods market , the seller of a good might offer a guarantee , an agreement that functions as a promise of quality . This strategy may be especially important for a company that sells goods through catalogs or over the web , whose customers can not see the actual products , because it encourages people to buy something even if they are not certain they want to keep it .

623 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER . Bean started using in 191 , when the founder stitched waterproof shoe rubbers together with leather shoe tops , and sold them as hunting shoes . He guaranteed satisfaction . However , the stitching came apart and , out of the first batch of 100 pairs that were sold , 90 pairs were returned . Bean took out a bank loan , repaired all of the shoes , and replaced them . The . Bean reputation for customer satisfaction began to spread . Many firms today offer for a few weeks or months , but . Bean offers a complete guarantee . Anything you have bought from . Bean can always be returned , no matter how many years later or what condition the product is in , for a full guarantee . Bean has very few stores . Instead , most of its sales are made by mail , telephone , or , now , through their website . For this kind of firm , imperfect information may be an especially difficult problem , because customers can not see and touch what they are buying . A combination of a and a reputation for quality can help for a firm to . Visit this Website to read about the origin of Eddie Bauer 100 customer satisfaction guarantee . I Sellers may offer a warranty , which is a promise to fix or replace the good , at least for a certain period of time . The seller may also offer a buyer a chance to buy a service contract , where the buyer pays an extra amount and the seller agrees to fix anything that goes wrong for a set time period . Service contracts are often used with large purchases such as cars , appliances and even houses . Guarantees , warranties , and service contracts are examples of explicit reassurance that sellers vide . In many cases , firms also offer unstated guarantees . For example , some movie theaters might refund the cost of a ticket to a customer who walks out complaining about the show . Likewise , while restaurants do not generally advertise a guarantee or exchange policies , many rants allow customers to exchange one dish for another or reduce the price of the bill if the customer is not satisfied . The rationale for these policies is that firms want repeat customers , who in turn will recommend the business to others as such , establishing a good reputation is of paramount importance . When ers know that a firm is concerned about its reputation , they are less likely to worry about receiving a product . For example , a grocery store with a good reputation can often charge a higher price than a temporary stand at a local farmers market , where the buyer may never see the seller again . Sellers of labor provide information through resumes , recommendations , school transcripts , and examples of their work . Occupational licenses are also used to establish quality in the labor market . Occupational licenses , which are typically issued by government agencies , show that a worker has

PRINCIPLES or ECONOMICS 629 completed a certain type of education or passed a certain test . Some of the professionals who must hold a license are doctors , teachers , nurses , engineers , accountants , and lawyers . In addition , most states require a license to work as a barber , an embalmer , a dietitian , a massage therapist , a hearing aid dealer , a counselor , an insurance agent , and a real estate broker . Some other jobs require a license in only one state . Minnesota requires a state license to be a field archeologist . North Dakota has a state license for bait retailers . In Louisiana , a state license is needed to be a stress analyst and California requires a state license to be a furniture upholsterer . According to a 2013 study from the University of Chicago , about 29 of workers have jobs that require occupational licenses . Occupational licenses have their downside as well , as they represent a barrier to entry to certain industries . This makes it more difficult for new entrants to compete with , which can lead to higher prices and less consumer choice . In industries that require licenses , the government has decided that the additional information provided by licenses outweighs the negative effect on . ARE ADVERTISERS ALLOWED TO BENEFIT FROM IMPERFECT INFORMATION ?

Many advertisements seem full of imperfect least by what they imply . Driving a certain car , drinking a particular soda , or wearing a certain shoe are all unlikely to bring fashionable friends and fun automatically , if at all . The government rules on advertising , enforced by the Federal Trade Commission ( allow advertising to contain a certain amount of exaggeration about the general delight of using a product . They , however , also demand that if a claim is as a fact , it must be true . Legally , deceptive advertising dates back to the when created a television advertisement that seemed to show Rapid Shave shaving cream being spread on sandpaper and then the sand was shaved off the sandpaper . What the television advertisement actually showed was sand sprinkled on then scraped aside by the razor . In the 19605 , in magazine advertisements for Campbell vegetable soup , the company was having problems getting an appetizing picture of the soup , because the vegetables kept sinking . So they filled a bowl with marbles and poured the soup over the top , so that the bowl appeared to be crammed with vegetables . In the late , the Volvo Company filmed a television advertisement that showed a monster truck driving over cars , crunching their except for the Volvo , which did not crush . However , the found in 1991 that the roof of the Volvo used in the filming had been reinforced with an extra steel framework , while the roof supports on the other car brands had been cut . The Wonder Bread Company ran television advertisements featuring Professor Wonder , who said that because Wonder Bread contained extra calcium , it would help children minds work better and improve their memory . The objected , and in 2002 the company agreed to stop running the advertisements . As can be seen in each of these cases , factual claims about the product performance are often checked , at least to some extent , by the Federal Trade Commission . Language and images that are exaggerated or ambiguous , but not actually false , are allowed in advertising . Untrue facts are not allowed . In any case , an old Latin saying applies when watching Caveat is , let the buyer beware . On the buyers side of the labor market , a standard precaution against hiring a lemon of an employee is to specify that the first few months of employment are officially a trial or probationary period , and that the worker can be let go for any reason or no reason after that time . Sometimes workers also receive lower pay during this trial period . In the financial capital market , before a bank makes a loan , it requires a prospective borrower fill

630 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER out forms regarding the sources of income in addition , the bank conducts a credit check on the past borrowing . Another approach is to require a cosigner on a loan that is , another person or firm who legally pledges to repay some or all of the money if the original borrower does not do so . Yet another approach is to require collateral , often property or equipment that the bank would have a right to seize and sell if the loan is not repaid . Buyers of goods and services can not possibly become experts in evaluating the quality of gemstones , used cars , lawyers , and everything else they buy . Employers and lenders can not be perfectly scient about whether possible workers will turn out well or potential borrowers will repay loans on time . But the mechanisms mentioned above can reduce the risks associated with imperfect tion so that the buyer and seller are willing to proceed . KEY CONCEPTS AND SUMMARY Many economic transactions are made in a situation of imperfect information , where either the buyer , the seller , or both are less than 100 certain about the qualities of what is being bought and sold . When information about the quality of products is highly imperfect , it may be difficult for a market to exist . A lemon is the name given to a product that turns out , after the purchase , to have low quality . When the seller has more accurate information about the quality of the product than the buyer , the buyer will be hesitant to buy , out of fear of purchasing a Markets have many ways to deal with imperfect information . In goods markets , buyers facing information about products may depend upon guarantees , warranties , service tracts , and reputation . In labor markets , employers facing imperfect information about potential employees may turn to resumes , recommendations , occupational licenses for certain jobs , and employment for trial periods . In capital markets , lenders facing imperfect information about ers may require detailed loan applications and credit checks , and collateral . SELF CHECK QUESTIONS . For each of the following purchases , say Whether you would expect the degree of imperfect information to be relatively high or relatively low a . Buying apples at a roadside stand . Buying dinner at the neighborhood restaurant around the corner Buying a used laptop computer at a garage sale Ordering over the Internet for your friend in a different city . Why is there asymmetric information in the labor market ?

What signals can an employer look for that might indicate the traits they are seeking in a new employee ?

PRINCIPLES OF ECONOMICS 631 REVIEW QUESTIONS . Why might it be difficult for a buyer and seller to agree on a price when imperfect information exists ?

What do economists ( and dealers ) mean by a lemon ?

What are some of the ways a seller of goods might reassure a possible buyer who is faced with imperfect information ?

What are some of the ways a seller of labor ( that is , someone looking for a job ) might reassure a possible employer who is faced with imperfect information ?

What are some of the ways that someone looking for a loan might reassure a bank that is faced with imperfect information about whether the loan will be repaid ?

CRITICAL THINKING QUESTIONS . You are on the board of directors of a private high school , which is hiring new science teachers . As you think about hiring someone for a job , what are some mechanisms you might use to overcome the problem of imperfect information ?

offers a place for people to buy and sell emeralds , but information about emeralds can be quite imperfect . The website then enacts a rule that all sellers in the market must pay for two independent examinations of their emerald , which are available to the customer for inspection . a . How would you expect this improved information to affect demand for emeralds on this website ?

How would you expect this improved information to affect the quantity of emeralds sold on the website ?

PROBLEMS Using Critical Thinking Question , sketch the effects in parts ( a ) and ( on a single supply and demand diagram . What prediction would you make about how the improved information alters the equilibrium quantity and price ?

REFERENCES Center on Budget and Policy Priorities . 2015 . Policy Basics Where Do Our Federal Tax Dollars Go ?

Accessed April , Consumer Reports . Consumer . Federal Trade Commission . About the Federal Trade Last modified October 17 , Post . 2015 . Poll Shows Uptick In Favorable Accessed April , 632 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER , Daniel , and Amos . Prospect Theory An Analysis of Decision under . 47 , no . 1979 ) Reports , asymmetric information a situation where the seller or the buyer has more information than the other regarding the quality of the item being sold collateral something property or a lender would have a right to seize and sell if the loan is not repaid cosigner another person or firm who legally pledges to repay some or all of the money on a loan if the original borrower does not do so imperfect information a situation where either the buyer or the seller , or both , are uncertain about the qualities of what is being bought and sold guarantee a promise that the buyers money will be refunded under certain conditions occupational license licenses issued by government agencies , which indicate that a worker has completed a certain type of education or passed a certain test service contract the buyer pays an extra amount and the seller agrees to fix anything specified in the contract that goes wrong for a set time period Warranty a promise to fix or replace the good for a certain period of time SOLUTIONS Answers to Questions Imperfect information is relatively low after all , you can see the apples . Imperfect information is relatively low . The neighborhood restaurant probably has a certain local reputation . Imperfect information is relatively high . How can you tell whether the computer is really in good working order ?

Why are they selling it ?

Imperfect information is relatively high . What do those really look like ?

Asymmetric information often exists in the labor market because employers can not observe many key employee attributes until after the person is hired . Employees , however , know whether they are energetic or . Employers , therefore , often seek schools to candidates . Employers may not even interview a candidate unless he has a degree and often a degree from a particular school . Employers may also view awards , a high grade point average , and other accolades as a signal of hard work , perseverance , and ability . Finally , employers seek references for insights into key attributes such as energy level , work ethic , and so on .

INSURANCE AND IMPERFECT INFORMATION LEARNING By the end of this section , you will be able to Explain how insurance works Identify and evaluate various forms of government and social insurance Discuss the problems caused by moral hazard and adverse selection Analyze the impact of government regulation of insurance is a method that households and firms use to prevent any single event from having a significant detrimental financial effect . Generally , households or firms with insurance make lar payments , called premiums . The insurance company prices these premiums based on the probability of certain events occurring among a pool of people . Members of the group who then fer a specified bad experience receive payments from this pool of money . Many people have several kinds of insurance health insurance that pays when they receive medical care car insurance that pays if they are the driver in an automobile accident house or renter that pays if possessions are stolen or damaged by fire and life insurance , which pays for the ily if the principal dies . Table lists a set of insurance markets . Type of Insurance Who Pays for It ?

It Pays Out When . Health insurance Employers and individuals Medical expenses are incurred Life insurance Employers and individuals Policyholder dies Automobile insurance Individuals Car is damaged , stolen , or causes damage to others Homeowners and renters Dwelling is damaged or burglarized Liability insurance Firms and individuals An injury occurs for which you are partly responsible Malpractice insurance Doctors , lawyers , and other A poor quality of service is provided that causes professionals harm to others Table . Some Insurance Markets All insurance involves imperfect information in both an obvious way and in a deeper way . At an ous level , future events can not be predicted with certainty . For example , it can not be known with certainty who will have a car accident , become ill , die , or have his home robbed in the next year . Imperfect information also applies to estimating the risk that something will happen to any

634 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER . It is difficult for an insurance company to estimate the risk that , say , a particular male driver from New York City will have an accident , because even within that group , some drivers will drive more safely than others . Thus , adverse events occur out of a combination of peoples and choices that make the risks higher or lower and then the good or bad luck of what actually happens . HOW INSURANCE WORKS A simplified example of automobile insurance might work this way . Suppose that a group of 100 vers can be divided into three groups . In a given year , 60 of those people have only a few door dings or chipped paint , which costs 100 each . Another 30 of the drivers have accidents that cost an average of in damages , and 10 of the drivers have large accidents that cost in damages . For the moment , let imagine that at the beginning of any year , there is no way of ing the drivers who are , or . The total damage incurred by car dents in this group of 100 drivers will be , that is ( 60 100 ) 30 ) 10 ) 600 186 , 000 If each of the 100 drivers pays a premium of each year , the insurance company will collect the that is needed to cover the costs of the accidents that occur . Since insurance companies have such a large number of clients , they are able to negotiate with providers of health care and other services for lower rates than the individual would be able to get , thus increasing the benefit to consumers of becoming insured and saving the insurance company itself money when it pays out claims . Insurance companies receive income , as shown in Figure , from insurance premiums and investment income . Investment income is derived from investing the funds that insurance companies received in the past but did not pay out as insurance claims in prior years . The insurance company receives a rate of return from investing these funds or reserves . The investments are typically made in fairly safe , liquid ( easy to convert into cash ) investments , as the insurance companies needs to be able to readily access these funds when a major disaster strikes . Money In Money Out Payments to customers Premiums from customers Insurance Expenses company Investment Income Profits or losses Figure . An Insurance Company What Comes In , What Goes Out . Money flows into an insurance company through premiums and investments and out through the payment of claims and operating expenses .

PRINCIPLES or ECONOMICS 635 GOVERNMENT AND SOCIAL INSURANCE Federal and state governments run a number of insurance programs . Some of the programs look much like private insurance , in the sense that the members of a group makes steady payments into a fund , and those in the group who suffer an adverse experience receive payments . Other programs protect against risk , but without an explicit fund being set up . Following are some examples . Unemployment insurance Employers in every state pay a small amount for unemployment insurance , which goes into a fund that is used to pay benefits to workers for a period of time , usually six months , after they lose their jobs . Pension insurance Employers that offer pensions to their retired employees are required by law to pay a small fraction of what they are setting aside for pensions to the Pension Benefit Guarantee Corporation , which is used to pay at least some pension benefits to workers if a company goes bankrupt and can not pay the pensions it has promised . Deposit insurance Banks are required by law to pay a small fraction of their deposits to the Federal Deposit Insurance Corporation , which goes into a fund that is used to pay depositors the value of their bank deposits up to ( the amount was raised from to in 2008 ) if the bank should go bankrupt . Workman compensation insurance Employers are required by law to pay a small percentage of the salaries that they pay into funds , typically run at the state level , that are used to pay benefits to workers who suffer an injury on the job . Retirement insurance All workers pay a percentage of their income into Social Security and into Medicare , which then provides income and health care benefits to the elderly . Social Security and Medicare are not literally insurance in the sense that those currently contributing to the fund are not eligible for benefits . They function like insurance , however , in the sense that regular payments are made into the programs today in exchange for benefits to be received in the case of a later becoming old or becoming sick when old . Such programs are sometimes called social The major additional costs to insurance companies , other than the payment of claims , are the costs of running a business the administrative costs of hiring workers , administering accounts , and insurance claims . For most insurance companies , the insurance premiums coming in and the claims payments going out are much larger than the amounts earned by investing money or the administrative costs . Thus , while factors like investment income earned on reserves , administrative costs , and groups with different risks complicate the overall picture , a fundamental law of insurance must hold true The average person payments into insurance over time must cover ) the average person claims , the costs of running the company , and ) leave room for the firms profits . This law can be boiled down to the idea that average premiums and average insurance payouts must be approximately equal . RISK GROUPS AND ACTUARIAL FAIRNESS Not all of those who purchase insurance face the same risks . Some people may be more likely , because of genetics or personal habits , to fall sick with certain diseases . Some people may live in an area where car theft or home robbery is more likely than others . Some drivers are safer than others . A risk group can be defined as a group that shares roughly the same risks of an adverse event occurring .

636 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Insurance companies often classify people into risk groups , and charge lower premiums to those with lower risks . If people are not separated into risk groups , then those with must pay for those with high risks . In the simple example of how car insurance works , given earlier , 60 drivers had very low damage of 100 each , 30 drivers had accidents that cost each , and 10 of the drivers had large accidents that cost . If all 100 of these drivers pay the same , then those with low damages are in effect paying for those with high damages . If it is possible to classify drivers according to risk group , then each group can be charged according to its expected losses . For example , the insurance company might charge the 60 drivers who seem safest of all 100 apiece , which is the average value of the damages they cause . Then the intermediate group could pay apiece and the group each . When the level of insurance premiums that someone pays is equal to the amount that an average person in that risk group would collect in insurance payments , the level of insurance is said to be actuarially Classifying people into risk groups can be controversial . For example , if someone had a major mobile accident last year , should that person be classified as a driver who is likely to have similar accidents in the future , or as a driver who was just extremely unlucky ?

The driver is likely to claim to be , and thus someone who should be in a risk group with those who pay low insurance premiums in the future . The insurance company is likely to believe that , on average , having a major accident is a signal of being a driver , and thus try to charge this driver higher insurance premiums . The next two sections discuss the two major problems of imperfect information in insurance moral hazard and adverse selection . Both problems arise from attempts to categorize those purchasing insurance into risk groups . THE MORAL HAZARD PROBLEM Moral hazard refers to the case when people engage in riskier behavior with insurance than they would if they did not have insurance . For example , if you have health insurance that covers the cost of visiting the doctor , you may be less likely to take precautions against catching an illness that might require a doctors visit . If you have car insurance , you will worry less about driving or parking your car in ways that make it more likely to get dented . In another example , a business without insurance might install absolute security and fire sprinkler systems to guard against theft and fire . If it is insured , that same business might only install a minimum level of security and fire sprinkler . Moral hazard can not be eliminated , but insurance companies have some ways of reducing its effect . Investigations to prevent insurance fraud are one way of reducing the extreme cases of moral hazard . Insurance companies can also monitor certain kinds of behavior to return to the example from above , they might offer a business a lower rate on property insurance if the business installs a and fire sprinkler system and has those systems inspected once a year . Another method to reduce moral hazard is to require the injured party to pay a share of the costs . For example , insurance policies often have , which is an amount that the insurance must pay out of their own pocket before the insurance coverage starts paying . For ple , auto insurance might pay for all losses greater than 500 . Health insurance policies often have a , in which the policyholder must pay a small amount for example , a person might have to pay 20 for each doctor visit , and the insurance company would cover the rest . Another method of is coinsurance , which means that the insurance company covers a certain percentage of

PRINCIPLES or ECONOMICS 637 the cost . For example , insurance might pay for 80 of the costs of repairing a home after a fire , but the homeowner would pay the other 20 . All of these forms of discourage moral hazard , because people know that they will have to pay something out of their own pocket when they make an insurance claim . The effect can be . One prominent study found that when people face moderate and for their health insurance , they consume about less in medical care than people who have insurance and do not pay anything out of pocket , presumably because and reduce the level of moral hazard . However , those who consumed less health care did not seem to have any difference in health status . A final way of reducing moral hazard , which is especially applicable to health care , is to focus on the incentives of providers of health care , rather than consumers . Traditionally , most health care in the United States has been provided on a basis , which means that medical care providers are paid for the services they provide and are paid more if they provide additional services . However , in the last decade or so , the structure of healthcare provision has shifted to an emphasis on health maintenance organizations ( A health maintenance organization ( provides care that receives a fixed amount per person enrolled in the of how many services are provided . In this case , a patient with insurance has an incentive to demand more care , but the care provider , which is receiving only a fixed payment , has an incentive to reduce the moral hazard problem by limiting the quantity of care long as it will not lead to worse health and higher costs later . Today , many doctors are paid with some combination of managed care and that is , a amount per patient , but with additional payments for the treatment of certain health conditions . Imperfect information is the cause of the moral hazard problem . If an insurance company had perfect information on risk , it could simply raise its premiums every time an insured party engages in riskier behavior . However , an insurance company can not monitor all the risks that people take all the time and so , even with various checks and , moral hazard will remain a problem . Visit this Website to read about the relationship between health care and behavioral economics . Eu . THE ADVERSE SELECTION PROBLEM Adverse selection refers to the problem in which the buyers of insurance have more information about whether they are or than the insurance company does . This creates an metric information problem for the insurance company because buyers who are tend to want to buy more insurance , without letting the insurance company know about their higher risk . For

633 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER example , someone purchasing health insurance or life insurance probably knows more about their family health history than an insurer can reasonably find out even with a costly investigation one purchasing car insurance may know that they are a driver who has not yet had a major it is hard for the insurance company to collect information about how people actually drive . To understand how adverse selection can strangle an insurance market , recall the situation of 100 vers who are buying automobile insurance , where 60 drivers had very low damages of 100 each , 30 drivers had accidents that cost each , and 10 of the drivers had large accidents that cost . That would equal in total payouts by the insurance company . Imagine that , while the insurance company knows the overall size of the losses , it can not identify the , and drivers . However , the drivers themselves know their risk groups . Since there is asymmetric information between the insurance company and the drivers , the insurance would likely set the price of insurance at per year , to cover the average loss ( not including the cost of overhead and profit ) The result is that those with low risks of only 100 will likely decide not to buy insurance after all , it makes no sense for them to pay per year when they are likely only to experience losses of 100 . Those with medium risks of a accident will not buy either . So the insurance company ends up only selling insurance for to drivers who will average in claims apiece . So the insurance company ends up losing a lot of money . If the insurance company tries to raise its premiums to cover the losses of those with high risks , then those with low or medium risks will be even more discouraged from buying insurance . Rather than face such a situation of adverse selection , the insurance company may decide not to sell insurance in this market at all . If an insurance market is to exist , then one of two things must happen . First , the insurance company might find some way of separating insurance buyers into risk groups with some degree of accuracy and charging them accordingly , which in practice often means that the insurance company tries not to sell insurance to those who may pose high risks . Or second , those with low risks must be required to buy insurance , even if they have to pay more than the actuarially fair amount for their risk group . The notion that people can be required to purchase insurance raises the issue of government laws and regulations that the insurance industry . HEALTH CARE IN AN INTERNATIONAL CONTEXT The United States is the only country in the world where most health insurance is paid for and provided by private firms . Greater government involvement in the provision of health is one possible way of addressing moral hazard and adverse selection problems . The moral hazard problem with health insurance is that when people have insurance , they will demand higher quantities of health care . In the United States , private healthcare insurance tends to encourage an demand for healthcare services , which healthcare providers are happy to fulfill . Table shows that on a basis , healthcare spending towers above other tries . It should be noted that while healthcare expenditures in the United States are far higher than healthcare expenditures in other countries , the health outcomes in the United States , as measured by life expectancy and lower rates of childhood mortality , tend to be lower . Health outcomes , however , may not be significantly affected by healthcare expenditures . Many studies have shown that a try health is more closely related to diet , exercise , and genetic factors than to healthcare expenditure . This fact further emphasizes that the United States is spending very large amounts on medical care with little obvious health gain .

PRINCIPLES or ECONOMICS 639 In the health insurance market , the main way of solving this adverse selection problem is that health insurance is often sold through groups based on place of employment , or , under The able Care Act , from a state government sponsored health exchange market . From an insurance point of view , selling insurance through an employer mixes together a group of with high risks of future health problems and some with lower thus reduces the firm fear of attracting only those who have high risks . However , many small companies do not provide health insurance to their employees , and many jobs do not include health insurance . Even after all government programs that provide health insurance for the elderly and the poor are taken into account , approximately 32 million Americans were without health insurance in 2015 . While a system can avoid the adverse selection problem entirely by providing at least basic health insurance for all , another option is to mandate that all Americans buy health insurance from some provider by preventing providers from denying individuals based on existing conditions . Indeed , this approach was adopted in the Patient Protection and Affordable Care Act , which is discussed later on in this chapter . Health Care at at Male Chance of Female Chance of Country Spending per . Dying before Age , Dying before Age , Person ( in 2008 ) Yea ( Yea ( per ( in 2012 ) per ( in 2012 ) 2012 ) 2012 ) United States 76 81 Germany 78 83 France 78 85 Canada 79 84 United Kingdom 78 83 Table . A Comparison of Healthcare Spending Across Select Countries . Source 2010 study and World Fact Book ) At its best , the largely private system of health insurance and healthcare delivery provides an extraordinarily high quality of care , along with generating a seemingly endless parade of innovations . But the system also struggles to control its high costs and to provide basic medical care to all . Other countries have lower costs and more equal access , but they often struggle to provide rapid access to health care and to offer the of the most medical care . The challenge is a healthcare system that strikes the right balance between quality , access , and cost . GOVERNMENT REGULATION OF INSURANCE The insurance industry is primarily regulated at the state level indeed , since 1871 there has been a National Association of Insurance Commissioners that brings together these state regulators to exchange information and strategies . The state insurance regulators typically attempt to accomplish two things to keep the price of insurance low and to make sure that everyone has insurance . These goals , however , can with each other and also become easily entangled in politics . If insurance premiums are set at actuarially fair levels , so that people end up paying an amount that accurately reflects their risk group , certain people will end up paying a lot . For example , if health insurance companies were trying to cover people who already have a chronic disease like AIDS , or who were elderly , they would charge these groups very high premiums for health insurance , because their expected health care costs are quite high . Women in the age bracket consume , on

640 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER age , about 65 more in health care spending than men . Young male drivers have more car accidents than young female drivers . Thus , actuarially fair insurance would tend to charge young men much more for car insurance than young women . Because people in groups would find themselves charged so heavily for insurance , they might choose not to buy insurance at all . State insurance regulators have sometimes reacted by passing rules that attempt to set low premiums for insurance . Over time , however , the fundamental law of insurance must hold the average amount received by individuals must equal the average amount paid in premiums . When rules are passed to keep premiums low , insurance companies try to avoid insuring any or even parties . If a state legislature passes strict rules requiring insurance companies to sell to everyone at low prices , the insurance companies always have the option of withdrawing from doing business in that state . For example , the insurance regulators in are for attempting to keep auto insurance premiums low , and more than 20 different insurance companies stopped doing ness in the state in the late and early . Similarly , in 2009 , State Farm announced that it was withdrawing from selling property insurance in Florida . In short , government regulators can not force companies to charge low prices and provide high levels of insurance thus take a sustained period of time . If insurance premiums are going to be set below the actuarially fair level for a certain group , some other group will have to make up the difference . There are two other groups who can make up the difference taxpayers or other buyers of insurance . In some industries , the government has decided free markets will not provide insurance at an affordable price , and so the government pays for it directly . For example , private health insurance is too expensive for many people whose incomes are too low . To combat this , the government , together with the states , runs the Medicaid program , which provides health care to those with low incomes . Private health insurance also does not work well for the elderly , because their average health care costs can be very high . Thus , the government started the Medicare program , which provides health insurance to all those over age 65 . Other programs are aimed at military veterans , as an added benefit , and children in families with relatively low incomes . Another common government intervention in insurance markets is to require that everyone buy tain kinds of insurance . For example , most states legally require car owners to buy auto insurance . Likewise , when a bank loans someone money to buy a home , the person is typically required to have homeowners insurance , which protects against fire and other physical damage ( like ) to the home . A legal requirement that everyone must buy insurance means that insurance companies do not need to worry that those with low risks will avoid buying insurance . Since insurance companies do not need to fear adverse selection , they can set their prices based on an average for the market , and those with lower risks will , to some extent , end up subsidizing those with higher risks . However , even when laws are passed requiring people to purchase insurance , insurance companies can not be to sell insurance to everyone who least not at low cost . Thus , insurance companies will still try to avoid selling insurance to those with high risks whenever possible . The government can not pass laws that make the problems of moral hazard and adverse selection appear , but the government can make political decisions that certain groups should have insurance , even though the private market would not otherwise provide that insurance . Also , the government can impose the costs of that decision on taxpayers or on other buyers of insurance .

PRINCIPLES or ECONOMICS 641 THE PATIENT PROTECTION AND AFFORDABLE CARE ACT In March of 2010 , President Obama signed into law the Patient Protection and Affordable Care Act ( This highly contentious law began to be phased in over time starting in October of 2013 . The goal of the act is to bring the United States closer to universal coverage . Some of the key features of the plan include Individual mandate All individuals , who do not receive health care through their employer or through a government program ( for example , Medicare ) are required to have health insurance or pay a fine . The individual mandate goal was to reduce the adverse selection problem and keep prices down by requiring all the healthiest have health insurance . Without the need to guard against adverse selection ( whereby only the riskiest consumers buy insurance ) by raising prices , health insurance companies could provide more reasonable plans to their customers . Each state is required to have health insurance exchanges whereby insurance companies compete for business . The goal of the exchanges is to improve competition in the market for health insurance . Employer mandate All employers with more than 50 employees must offer health insurance to their employees . The Affordable Care Act ( will be funded through additional taxes to include Increase the Medicare tax by percent and add a percent tax on unearned income for high income taxpayers . Charge an annual fee on health insurance providers . Impose other taxes such as a tax on manufacturers and importers of certain medical devices . Many people and politicians have sought to overturn the bill . Those that oppose the bill believe it an individual right to choose whether to have insurance or not . In 2012 , a number of states challenged the law on the basis that the individual mandate provision is unconstitutional . In June of 2012 , the Supreme Court ruled in a decision that the individual mandate is actually a tax , so it is constitutional as the federal government has the right to tax the populace . WHAT THE BIG DEAL WITH ?

What is it that the Affordable Care Act ( will actually do ?

To begin with , we should note that it is a massively complex law , with a large number of parts , some of which were implemented immediately , and others that will start every year from 2013 through 2020 . As noted in the chapter , people face healthcare costs in the United States . Those with health insurance demand more health care , pushing up the cost . This is one of the problems the is attempting to fix , in part by regulations designed to control increases in healthcare costs . One example is the regulation that caps the amount healthcare providers can spend on administrative costs . Another is a requirement that healthcare providers switch to medical records ( which will reduce administrative costs . Another component of the is the requirement that states establish health insurance exchanges , or markets , where ple without health insurance , and businesses that do not provide it for their employees , can shop for different insurance

642 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER plans . Setting up these exchanges reduces the imperfections in the market for insurance and , by adding to the supply of insurance plans , may lead to lower prices if the supply increases more than demand . Also , people who are uninsured tend to use emergency rooms for most expensive form of healthcare . Given that there are over 40 million citizens in the United States , this has contributed significantly to rising costs . Capping administrative costs , requiring the use of , and establishing health insurance markets for those currently uninsured , are all components of the that are intended to help control increases in healthcare costs . Over the years , the ranks of the uninsured in the United States have grown as rising prices , designed to offset the problem of distinguishing the from the person , have pushed employers and individuals out of the market . Also , insurance companies have increasingly used conditions to determine if someone is high risk , and thus they either charge prices based on average costs , or they choose not to insure these groups . This has also contributed to the over 32 million uninsured . The addresses this problem by providing that people with preexisting conditions can not be denied health insurance . This presents another selection problem because those with conditions are a group . Taken as a group , the law of insurance says they should pay higher prices for insurance . Since they can not be singled out , prices go up for everyone , and people leave the group . As the group gets sicker and more risky , prices go up again , and still more people leave the group , creating an upward spiral in prices . To offset this selection problem , the includes an employer and individual mandate requirement . All businesses and individuals must purchase health insurance . At the time of this writing , the actual impact of the Patient Protection and Affordable Care Act is still unknown . Due to political opposition and some difficulties with meeting deadlines , several parts of the law have been delayed , and it will be some time before economists are able to collect enough data to determine whether the law has , in fact , increased coverage and lowered costs as was its intent . KEY CONCEPTS AND SUMMARY Insurance is a way of sharing risk . A group of people pay premiums for insurance against some unpleasant event , and those in the group who actually experience the unpleasant event then receive some compensation . The fundamental law of insurance is that what the average person pays in over time must be very similar to what the average person gets out . In an actuarially fair insurance policy , the premiums that a person pays to the insurance company are the same as the average amount of benefits for a person in that risk group . Moral hazard arises in insurance markets because those who are insured against a risk will have less reason to take steps to avoid the costs from that risk . Many insurance policies have , or coinsurance . A deductible is the maximum amount that the policyholder must pay before the insurance company pays the rest of the bill . A is a fee that an insurance must pay before receiving services . Coinsurance requires the policyholder to pay a certain percentage of costs . and coinsurance reduce moral hazard by requiring the insured party to bear some of the costs before collecting insurance benefits . In a health financing system , medical care providers are reimbursed according to the cost of services they provide . An alternative method of organizing health care is through health organizations ( where medical care providers are reimbursed according to the ber of patients they handle , and it is up to the providers to allocate resources between patients who receive more or fewer health care services . Adverse selection arises in insurance markets when buyers know more about the risks they face than does the insurance company . As a result , the

PRINCIPLES OF ECONOMICS 643 insurance company runs the risk that parties will avoid its insurance because it is too costly for them , while parties will embrace it because it looks like a good deal to them . SELF CHECK QUESTIONS Why is it difficult to measure health outcomes ?

REVIEW QUESTIONS What is an insurance premium ?

In an insurance system , would you expect each person to receive in benefits pretty much what they pay in premiums ?

Or is it just that the average benefits paid will equal the average premiums paid ?

What is an actuarially fair insurance policy ?

What is the problem of moral hazard ?

How can moral hazard lead to insurance being more costly than was expected ?

Define , and coinsurance . How can , and coinsurance reduce moral hazard ?

What is the key difference between a healthcare system and a system based on health maintenance organizations ?

How might adverse selection make it difficult for an insurance market to operate ?

What are some of the metrics used to measure health outcomes ?

CRITICAL THINKING QUESTIONS . How do you think the problem of moral hazard might have affected the safety of sports such as football and boxing when safety regulations started requiring that players wear more padding ?

To what sorts of customers would an insurance company offer a policy with a high ?

What about a high premium with a lower ?

PROBLEMS Imagine that men can be divided into two groups those who have a family history of cancer and those who do not . For the purposes of this example , say that 20 of a group of men have a family history of cancer , and these men have one chance in 50 of dying in the next year , while the other 80 of men have one chance in 200 of dying in the next year . The insurance company is selling a policy that will pay to the estate of anyone who dies in the next year . a If the insurance company were selling life insurance separately to each group , what would be the actuarially fair premium for each group ?

644 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER . If an insurance company were offering life insurance to the entire group , but could not find out about family cancer histories , what would be the actuarially fair premium for the group as a whole ?

What will happen to the insurance company if it tries to charge the actuarially fair premium to the group as a Whole rather than to each group separately ?

REFERENCES Central Intelligence Agency . The World . National Association of Insurance Commissioners . National Association of Insurance ers The Center for Insurance Policy and . The Organisation for Economic and Development ( USA Today . 2015 . Uninsured Rates Drop Dramatically under Accessed April , 20 . Thaler , Richard , and . The Concise Encyclopedia of Economics Behavioral Library of Economics and Liberty . Henry Kaiser Family Foundation , The . Health Reform Summary of the Affordable care Last modified April 25 , adverse selection when groups with inherently higher risks than the average person seek out insurance , thus straining the insurance system coinsurance when an insurance policyholder pays a percentage of a loss , and the insurance company pays the remaining cost when an insurance policyholder must pay a small amount for each service , before insurance covers the rest deductible an amount that the insurance must pay out of their own pocket before the insurance coverage pays anything when medical care providers are paid according to the services they provide health maintenance organization ( an organization that provides health care and is paid a fixed amount per person enrolled in the of how many services are provided insurance method of protecting a person from financial loss , whereby policy holders make regular payments to an insurance entity the insurance firm then a group member who suffers significant financial damage from an event covered by the policy moral hazard when people have insurance against a certain event , they are less likely to guard against that event occurring

PRINCIPLES OF ECONOMICS 645 premium payment made to an insurance company risk group a group that shares roughly the same risks of an adverse event occurring SOLUTIONS Answers to Questions It is almost impossible to distinguish whether a health outcome such as life expectancy was the result of personal that might affect health and longevity , such as diet , exercise , certain risky behavior , and consumption of certain items like tobacco , or the result of expenditures on health care ( for example , annual )