Case Study 2 (35 POINTS)

Suppose that within a given city, men ages 41 and 65 fall into one of four health categories: very healthy, healthy, unhealthy, and very unhealthy. As a part of the new Patient Protection and Affordable Care Act (PPACA), the government mandates that insurance companies must charge the same premiums to all people within a given gender, age and geographical region. The insurance company must determine the premium it should charge to all people in this category so that it can cover the total cost of care.

In order to complete your analysis, make the following assumptions:

1. The insurance company does not incur any costs to run or administer the policies, and it does not make any profits
2. The population is large enough so that expected values hold at the aggregate level.
3. Anyone who pays the monthly premium receives complete coverage of all medical expenses (in other words, everyone is offered full insurance).
4. All citizens are risk averse and are therefore willing to pay a premium above the expected value of their costs, up to the amount indicated in the column Maximum Willingness to Pay for Insurance

The following table presents the number of very healthy, healthy, unhealthy, and very unhealthy people, as well as the expected monthly cost of providing care for each category. The table also presents the maximum that an individual is willing to pay within each group, which is higher than the expected cost. This reflects the fact that people are generally risk averse. In the context of health insurance, this means that people prefer to pay some amount for certain each month than to face paying the full cost of somewhat unpredictable care.

Complete the following table by computing the total expected monthly cost of care for each type of citizen, the total number of people in this market, and the total expected monthly cost of insuring all citizens.

		Expected Monthly Cost	Maximum WTP for Insurance	Total Expected Monthly Cost
Type of Person	Number of People	($)	($)	($)
Very Healthy	450	100	110
Healthy	250	550	633
Unhealthy	100	650	910
Very Unhealthy	50	5,000	7,500
Total

1. If the insurance company must offer one plan to all men between the ages of 45 and 65 what will be the monthly premium (rounded to the nearest dollar) per person?
2. What is the Consumer Surplus for this cohort of men? (Show your calculation)

Suppose the government repeals the mandate, and now it allows people to decide whether they want to buy into the policy. Complete the following table, assuming that the premium is the one you calculated in (1) above. If a type of person will not purchase insurance at this premium, enter 0 into the appropriate cell, since the insurance company collects no money from these people.

		Amount Insurance Company Collects (# of People X Premium)
Type of Person	Chooses to buy health insurance? (Yes or No)	($)
Very Healthy
Healthy
Unhealthy
Very Unhealthy

Once consumers are given a choice of whether to buy into the premium:

3. How much will the insurance company collect in total monthly premiums?
4. How much will the insurance company pay out in expected total costs to cover the expenses of all who buy the policy?
5. Based on the groups that still want to buy insurance at the original premium, how much would the insurance company need to collect per person to cover the expected total cost per person?
6. If the insurance company raises the premium to the price in (#5), which of the following groups would still be willing to buy health insurance?
7. Explain what happens without a government mandate to purchase health insurance.
8. What is the problem in #7 known as in health insurance? Explain.