Type II Diabetes is a costly and potentially debilitating disease. The total costs incurred over a lifetime by a person with Type 2 diabetes were recently estimated to be $85,000 - from treating the disease directly, and complications like nerve damage, amputations, and stroke.

Consider a simplified model of the market for health insurance, where diabetes is the only future health risk people face. Assume that there are 1,000 people classified as "normal weight" and 1,000 people classified as "overweight." Normal weight people face a 20% chance of developing Type II diabetes in their lifetime, and overweight people a 30% chance.

Assume an individual can expect to earn $2,000,000 over the course of their lifetime. Additionally, assume individuals spend all their money on consumption, andu(c)=sqrt(c) . Ignore any intertemporal considerations of interest rates, inflation or discount factors, i.e.r=0 .

In order to increase fairness and equity, lawmakers enacted a requirement that insurers utilize "community rating": they must charge everyone the same price.

Consider the impact of this policy change.

-If all individuals purchase insurance, at what price would the insurer break even?

-Given this, what price will insurers actually set?

-What will be the consumer and producer surplus in this market?