Reference no: EM133079174
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. (already done)
|
|
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Expected Monthly Cost
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Maximum WTP for Insurance
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Total Expected Monthly Cost
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Type of Person
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Number of People
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($)
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($)
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($)
|
|
Very Healthy
|
450
|
100
|
110
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$45,000
|
|
Healthy
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250
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550
|
633
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$137,500
|
|
Unhealthy
|
100
|
650
|
910
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$65,000
|
|
Very Unhealthy
|
505,000
|
|
7,500
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$250,000
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Total
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|
|
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$497,500
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Questions that needs to be answered:
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.
Discussion questions
9. How could the model you just examined be extended to more than four types of health insurance consumers?
10. What if the insurance company does incur administrative costs? How would this affect the expected costs of running the insurance policy, the premiums charged, and the consumer surplus of those who buy insurance? (Provide realistic estimates of administrative costs and your reasons).
11. How would the results of this model change if the insurance companies were not required to provide full insurance to everyone and could offer multiple policies (including one with either a co-pay or deductible?