(1) Pricing health insurance

In the 1950s, Health Insurance in New Hamsterdam was provided by a monopoly. There were three types of customers: Healthy, Sick-P, and Sick-R. The costs of serving each kind of customer were different. Healthy customers were (on average) cheap to do, costing only $5 per year, while (on average) Sick customers (whether R or P) were expensive to serve, costing $40 a year. The number of customers of each type and the respective willingness-to-pay of each class is described in the table below.

Number of customers Willingness to pay

Healthy 300 $15

Sick-P 300 $45

Sick-R 300 $60

(New Hamsterdam was unique among the US States because employers didnt provide health insurance; people purchased it directly on the open market from the monopolist insurer.) State regulation mandated that all customers pay the same price for insurance (but people could elect to remain uninsured). As a result, only one policy was offered, called comprehensive coverage. Further, due to regulation, the company was unable to turn down any customer who was willing to pay the price of coverage. The fee for coverage was a single price paid once per year. A coverage policy lasted only one year.

(a) How much revenue did the insurer make if they charged $15 per year? (Assume that if a consumer is indifferent between buying and not, she believes.)

(b) What are the insurers costs at $15? What about profits?

(c) What do you think the actual price of insurance ended up being in the New Hamsterdam market if the monopolist could choose any price it wanted? Justify your answer.

(d) This market suffers from unrealized gains from trade. Briefly identify these unrealized gains from trade.

(e) The State Legislature considered allowing another insurance company to enter the market. Regulation still mandated that any insurer must charge all its customers the same price for insurance. Each insurance company would decide its own cost, and customers could purchase from either insurance company (or neither). If both insurance companies charged the same price, they would evenly split the market of customers who were willing to buy insurance. What do you think the fees charged by each insurance company would be? Justify your answer.