Lecture 4: Social insurance

Question 1

Optimal Social Insurance Tradeoffs (2 considerations)

Answer 1

1. Benefit of social insurance is the amount of consumption smoothing provided by social insurance programs
2. cost of social insurance is the moral hazard caused by insuring against adverse events

Question 2

Forms of individual moral hazard

Answer 2

1. Reduced Precaution towards adverse state
2. increased odds of staying in adverse state
3. increased expenditures when in the adverse state

Question 3

Adverse Selection

Answer 3

Individual risk probabilities are not known to the insurer (hidden information)

Question 4

Private insurance - market efficiency conditions

Answer 4

1. one individual-specific risk
2. the risk is moderate
3. individual loss probability is fixed and can be objectively determined
4. all market participant are informed about loss probability

Question 5

Social Insurance

Answer 5

Provided by government, is funded by taxation
- health insurance
- retirement + disabliity insurance
- unemployment
- income support

Question 6

Insurance

Answer 6

A scheme that involves the payment of a premium, to get a compensation payment in case of an adverse event

Question 7

Solutions to adverse selections

Answer 7

• pooling contract - price based on average
• separating contract - offer different contracts targeted at each risk type

Question 8

Moral Hazard

Answer 8

Individual risk probability depends on individual’s actions (hidden action)

Question 9

Insurance market failure

Answer 9

Asymmetric information causes conditions (iii) and/or (iv) to fail
* Private insurance markets are then inefficient or the market may
unravel completely

Question 10

Reasons for Social Insurance

Answer 10

1. Health Care as a Right: Access to quality health care (regardless of resources) is perceived as a right that the government should guarantee to
   everyone
2. Redistribution: Private insurers cannot provide insurance against preexisting conditions so those with high risk have to pay more: society may want to compensate high risk people (as being high risk is often not the fault / choice of the person)
3. Externalities: Your lack of insurance can be a cause of illness for me, thereby exerting a negative physical externality (vaccine example)
4. Individual Failures: Individuals may not appropriately insure themselves against
   risks if the government does not force them to do so, because of shortcomings individual decision-making
5. Administrative Costs: Administrative costs for Medicare are less than 2% of claims paid. Administrative costs for private insurance average about 12% of claims paid.