Suppose a large employer contrads with an insurer to provide health insurance coverage or workers compensation coverage for its employees. The employer (the insured) really setf-insures, and the insurer is a third party administrator. Any benefits paid by the insurer to the employees is reimbursed by the employer Theemployer may buy excess coverage, such as coveragefor annual health benefits exceoding $10 milion The insurer and the employer can negotiate the premium for the policy at very low transaction costs. Wo examine the implications of the Coase theorem for daims settiement costs. We provide the scenario in this homework assignment. You explain who should be liablefor daimsettlementexpenses to minimize totalcost The premium is the present value of losses, benefits, and expenses, so minimizing total cost minimizes the premium Claim settlement costs are of two types: Claims department overhead: setting up daim fles, estimating medical costs and disability, making out checks to injured parties or medical practitioners, and so forth. Investigation and dofense costsfor fraudulentclaims or cases where the employer is not liable. For health insurance, these are claims where the physician or hospital overbills (or bills for services not provided) or theemployee is not sick (but malingers to obta intime offfrom work). Forworkers'compensation, these are cases where the disabity does not stem from a work-related accident. The insurance policy states who pays these costs. Either the insurer pays them and is reimbursed by the employer, just as for benefits and loss costs, or the insurer pays them and charges for them in the policy premium Ulimately, the employer pays all costs, not the insurer. Pricing actuaries dont care whether the cost is covered by a charge in the premium or a reimbursement from the insured. The legal incidence of these costs depends on the policy. The policy may say that the insurer pays the cost and charges for them in the premium or the insurer pays the cost and receives a reimbursement from the insured. Transaction costs are zero. Both the insurer's management and the employer want to minimize overall costs Suppose the insurer bills its claims department overhead costs to the employer after incurring them. Do the claims adjustors have an incentive to handie claims efficienty? Would the claims department prefer to adjust claims leisurely and bil the insured for the time spent or adjust claims efficienly to hold down costs? If the insurer's management wishes to minimize total claims handing costs so that it can attract more business, would it wish to have the daims department overhead included as a charge in the premium or collected as a reimbursement from the employer? Which would the employer prefer to minimize its total costs of coverage Suppose the insurer pays investigation and defense costs from its own pocket (does not collect a reimbursement from the insured) and includes a charge of $100,000 in the policy premium. A daim is reported with an estimated cost of $50,000 which seems suspect The insurer can (i spend $10,000 investigating the claim, with a 50% chance that the claim will be found fraudulent, or (ii) pay the claim for $50,000andcollect the full reimbursement from the insured. Which would the insurer's claim department prefer ih the short run? To minimize total costs and atract business, which would the insurer's management prefer? To minimize its long-run cost of coverage, which would the insured prefer