Although it is a firm prediction of Akerlof’s market for lemons, the adverse selection death spiral has never been observed in the real world, true or false?

Directions:

Type written answers in 12-point font or better. Submit to the drop box on blackboard. Homework is due Tuesday, March 12, by midnight.

True, False, Uncertain (18 pts)

State whether each of the following statements is true, false or uncertain.  Explain and support your answer.  There is not necessarily one right answer to these questions.  All the credit is in the explanation (but you must state T, F, or U).  (Refer to textbook, chapters 7, 8, 10, 11)

Although it is a firm prediction of Akerlof’s market for lemons, the adverse selection death spiral has never been observed in the real world.

Governments can solve the problem of adverse selection by setting a price ceiling for insurance.

In countries with national health insurance, moral hazard can be a huge problem, but adverse selection is not a problem at all.

The fact that insured households in Ghana are less likely to sleep under mosquito netting than uninsured households is an example of ex post moral hazard.

Under partial insurance, income in the sick state with insurance is greater than income in the healthy state.

Most people prefer a certain payout (e.g. a check for $250) to a lottery with the same expected value (e.g. 50% chance of winning $500, 50% chance of winning $0).

Definitions (18 pts)

Provide complete but concise definitions for the following terms, as they have been used in class.

Indemnity insurance

Expected value

Full insurance (BHT, Chapter 7)

Co-insurance

Co-payment

Moral hazard

Indemnity insurance (10 pts)

Health insurance is normally perceived to be a good that is most valuable to sick people, since health expenditures are highest for the sick. However, if an individual has a very high probability of being sick (PS is close to 1), they are unlikely to be willing and able to pay for indemnity insurance at an actuarially fair premium. Why not?

On the other hand, if the government mandates that health insurers charge the same premium to everyone, regardless of PS, individuals who have a very high probability of being sick (PS is close to 1) will be most likely to purchase insurance. Why?

Adverse selection (9 pts)

Consider Table 10.1, which has data on insurance status and medical expenditures for different types of professors at Adverse Selection University (ASU). In 2014, every employee of ASU was offered a full insurance contract at no premium. In 2015, ASU charged any employee who wanted to keep health insurance a $4,000 premium. As a result, all history professors dropped their coverage in 2015. Assume that the underlying health of ASU professors did not change much from year to year.

Table 10.1: Information from the human resources department at ASU.

Is there evidence of moral hazard in this market?  How do you know?

Is there evidence of adverse selection in this market?  How do you know?

What premium will the insurer likely charge in 2016 ($4000, $5000, $6000)? Who will buy insurance?

Cost-sharing (9 pts)

Suppose a consumer visits her doctor four times in a year and the medical bill for each visit is $250. Calculate the consumer’s out-of-pocket costs under each of the following insurance plans:

Plan A: $50 co-pay, with 30% co-insurance

Plan B: $200 deductible with 25% co-insurance

Plan C: $100 deductible, $10 co-pay, 40% co-insurance

Risk and insurance (12 pts)

Refer to the individual whose utility curves are shown below.  The individual faces a 1/3 risk of serious illness that would cost $60,000 (their entire annual income).

What is this individual’s expected income?

What is their expected loss?

What is the maximum premium this individual is willing to pay for health insurance to cover their expected loss?

Is this amount more or less than their expected loss?  Explain why the individual is willing to pay this amount.

Risk and insurance (12 pts)

Consider the individual whose actual utility (AU) and expected utility (EU) curves are shown below.  Suppose the individual faces a 50% risk of accident that will leave him with $60,000 in medical bills.

What is this individual’s income if they do not have an accident? What is their income if they do have an accident?

What is their expected income?  What is their expected loss?

What is the maximum amount this individual is willing to pay for insurance that will cover their entire loss in the event of an accident?

Why does the expected utility curve not intersect the origin in this case?

Econometrics (12 pts)

One provision of the Affordable Care Act allowed parents to keep their dependent children on the parents’ health insurance plan until age 26. Prior to the ACA, dependent children aged out of their parents’ plan at age 19 (or age 22 if they were full-time students). Abramowitz (2016) hypothesizes that young adults had less incentive to marry after the ACA, because marriage is a means to obtain health insurance when you lose your parents’ coverage. She tested her hypothesis with data from the American Community Survey for the years 2008-2013.

Table 2 shows regression results for models in which the dependent variable equals 1 if married, 0 if not. Independent variables in the model identify years after the ACA was enacted in 2010, and years after the dependent child provision was implemented in 2011. Each column of the table represents a different sample of young adults, ages 23-30.  Standard errors in parentheses. Refer to the table to answer the questions below.

How did enactment of the ACA affect marriage rates for the full sample of young adults? How did implementation affect marriage rates? Explain your answers.

Was the effect of the ACA greater for young adults who were in school or out of school? Explain how you know.

Do the results for being in school vs. out of school make sense, given the description of insurance rules pre- and post-ACA (above)?  Explain.

Was the effect of the ACA greater for young men or young women? Explain how you know.