This is a highly stylized example of an insurance market Suppose there are just two risk types, A and B, and their probabilities of different levels of medical spending are as shown in the table below (similar to Table 7 1 on page 89 of Reinhardt 's book) In this example, we will not be concerned about moral hazard probabilities and medical spending levels are the same whether or not one has insurance Table 1 Probabilities of Different Levels of Medical Spending Size of Medical bill Fraction of TypeA Fraction of Type B Expected to Incur Expected to Incur Bill Such a Bill Such a Bill $0 0 851 0 5295 $5,000 0 12 0 34 $25,000 0 02 0 09 $100,000 0 009 0 0405 Use this additional information for your answer 80 percent of the population is Risk TypeA, 20 percent is Risk Type B Individuals know whether they are TypeA or Type B, and they know the probabilities of different levels of medical spending (this may be the most unrealistic assumption) Insurance is purchased in an individual market In order to cover their costs, insurers need to include a loading factor, L 2, in the premiums they charge Individuals are risk averse up to a point They are willing to pay up to 1 25 times their expected level of medical spending (probability weighted average) for insurance, but they will not buy insurance if the premium is larger than that amount 4 Now suppose that insurers can tell who is TypeA and who is Type B (perhaps because they require a physical exam of anyone applying for coverage) Thus premiums can be different for each type What would you expect premiums to be at equilibrium and who would buy insurance Is anyone better or worse off than they were in Part 3 5 Now suppose that we require insurers to community rate their premiums, that is, charge the same premium to everyone, but also require anyone who does not buy insurance to pay a penalty of $1,500 Now, what will equilibrium look like Will anyone feel better off or worse off than they did in Part 4 Note only need help with 5, 4 is for your reference

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This is a highly stylized example of an insurance market. Suppose there are just two risk types, A and B, and their probabilities of different

This is a highly stylized example of an insurance market. Suppose there are just two risk types, A and B, and their probabilities of different levels of medical spending are as shown in the table below (similar to Table 7.1 on page 89 of Reinhardt\'s book). In this example, we will not be concerned about moral hazard; probabilities and medical spending levels are the same whether or not one has insurance.

Table 1. Probabilities of Different Levels of Medical Spending

Size of Medical bill

Fraction of TypeA Fraction of Type B

Expected to Incur Expected to Incur

Bill Such a Bill Such a Bill

$0 0.851 0.5295

$5,000 0.12 0.34

$25,000 0.02 0.09

$100,000 0.009 0.0405

Use this additional information for your answer:

80 percent of the population is Risk TypeA, 20 percent is Risk Type B
Individuals know whether they are TypeA or Type B, and they know the probabilities of different levels of medical spending (this may be the most unrealistic assumption)
Insurance is purchased in an individual market
In order to cover their costs, insurers need to include a loading factor, L = .2, in the premiums they charge
Individuals are risk-averse up to a point. They are willing to pay up to 1.25 times their "expected" level of medical spending (probability-weighted average) for insurance, but they will not buy insurance if the premium is larger than that amount

4.Now suppose that insurers can tell who is TypeA and who is Type B (perhaps because they require a physical exam of anyone applying for coverage). Thus premiums can be different for each type. What would you expect premiums to be at equilibrium and who would buy insurance? Is anyone better or worse off than they were in Part 3?

5.Now suppose that we require insurers to "community rate" their premiums, that is, charge the same premium to everyone, but also require anyone who does not buy insurance to pay a penalty of $1,500. Now, what will equilibrium look like? Will anyone feel better off or worse off than they did in Part 4? **Note only need help with 5, 4 is for your reference**