Lecture 13: Social Insurancelfbrooks/leahweb/teaching/pppa6085/... · 2015-11-28 · If bad things...
Transcript of Lecture 13: Social Insurancelfbrooks/leahweb/teaching/pppa6085/... · 2015-11-28 · If bad things...
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Lecture 13: Social Insurance
November 24, 2015
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Overview
Course Administration
Ripped From Headlines
Why Should We Care?
What is Insurance?
Why Social Insurance?
Additional Reasons for Government Intervention
How Much Consumption to Smooth?
Moral Hazard Problem of Insurance
In Sum
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Course Administration
1. Problem Set 12 is posted
2. Still openings for office hours tomorrow
3. Will post all grades to date to Blackboard by final class;please feel free to check
4. For next class Skim GLS 15.1, 15.2 and we will cover 15.3 and15.4
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Elasticity Memo Reminders
Things that do not count in the five pages
• Tables and pictures
• References
Also
• Put tables and charts at the back, reference by number inpaper
• I will send out a link later in the week for submitting yourpaper electronically
• Bring a hard copy to class
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Problem Set 9: Public Goods
Better Examples
• Public good: Traffic lights
• Impure public good:Drinking water
More Difficult Examples
• American History Museum
• Public transit
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Problem Set 9: Public Goods
Better Examples
• Public good: Traffic lights
• Impure public good:Drinking water
More Difficult Examples
• American History Museum
• Public transit
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Problem Set 9: Public Goods
Better Examples
• Public good: Traffic lights
• Impure public good:Drinking water
More Difficult Examples
• American History Museum
• Public transit
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Ripped from the Headlines
Next Week
Afternoon
Finder Presenter
Sharon Alvarez Enoch Obeng
Evening
Finder Presenter
Tosin Ajayi Cassandra Kubes
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Why Should We Care About Social Insurance?
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance as a Government Responsibility
• Until the 1900s, governments spent primarily on war
• Taxes were predominantly trade and excise
• In the past century, governments began to spend on socialwelfare programs
• Before, this was a matter of private provision
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance as a Government Responsibility
• Until the 1900s, governments spent primarily on war
• Taxes were predominantly trade and excise
• In the past century, governments began to spend on socialwelfare programs
• Before, this was a matter of private provision
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
This is US, But Same is True for Much of the World
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What is Social Insurance and Why Do IndividualsValue It?
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What is Insurance?
A product where
• You worry about a future state of the world
• You pay premiums before the future state of the world occurs
• Then things happen
• If bad things happen, you get benefits
• If good things happen, you get nothing
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What is Insurance?
A product where
• You worry about a future state of the world
• You pay premiums before the future state of the world occurs
• Then things happen
• If bad things happen, you get benefits
• If good things happen, you get nothing
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What Types of Insurance Do You Buy?
• Health insurance
• Life insurance
• Auto insurance
• Renters insurance
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What Types of Insurance Do You Buy?
• Health insurance
• Life insurance
• Auto insurance
• Renters insurance
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Why Do People Value Insurance?How do you see diminishing MU in the picture?
Q, health care
Q,everything
else
• If you have diminishingmarginal utility, you preferto smooth your consumption
• Compare• 1 car today and 1 car
tomorrow• 2 cars today or tomorrow,
and 0 cars on the otherday
We say that consumers value consumption smoothing.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Why Do People Value Insurance?How do you see diminishing MU in the picture?
Q, health care
Q,everything
else
• If you have diminishingmarginal utility, you preferto smooth your consumption
• Compare• 1 car today and 1 car
tomorrow• 2 cars today or tomorrow,
and 0 cars on the otherday
We say that consumers value consumption smoothing.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Why Do People Value Insurance?How do you see diminishing MU in the picture?
Q, health care
Q,everything
else
• If you have diminishingmarginal utility, you preferto smooth your consumption
• Compare• 1 car today and 1 car
tomorrow• 2 cars today or tomorrow,
and 0 cars on the otherday
We say that consumers value consumption smoothing.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How To Describe Utility in All States of the World
• Suppose it is either sunny or snowing
• If sunny• It is sunny p% of the time, 0 ≤ p ≤ 1• Your utility is a
• If snowing• It snows (1− p)% of the time• Your utility is b
• How can we write your utility in one equation?
• E (U) = pa + (1− p)b
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How To Describe Utility in All States of the World
• Suppose it is either sunny or snowing
• If sunny• It is sunny p% of the time, 0 ≤ p ≤ 1• Your utility is a
• If snowing• It snows (1− p)% of the time• Your utility is b
• How can we write your utility in one equation?
• E (U) = pa + (1− p)b
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
The Mechanics of Insurance
• Chance of bad state of the world is 0 < p < 1
• You pay premiums of 0 < m < 1 for each dollar of insuredvalue
• The insurance pays benefit b in the bad state of the world
• If nothing bad happens, you lose your payment:
−mb• this occurs with probability (1− p)
• If the bad thing happens, you pay mb and get b: b −mb• this occurs with probability p
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
The Mechanics of Insurance
• Chance of bad state of the world is 0 < p < 1
• You pay premiums of 0 < m < 1 for each dollar of insuredvalue
• The insurance pays benefit b in the bad state of the world
• If nothing bad happens, you lose your payment: −mb• this occurs with probability
(1− p)
• If the bad thing happens, you pay mb and get b: b −mb• this occurs with probability p
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
The Mechanics of Insurance
• Chance of bad state of the world is 0 < p < 1
• You pay premiums of 0 < m < 1 for each dollar of insuredvalue
• The insurance pays benefit b in the bad state of the world
• If nothing bad happens, you lose your payment: −mb• this occurs with probability (1− p)
• If the bad thing happens, you pay mb and get b: b −mb• this occurs with probability p
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
The Mechanics of Insurance
• Chance of bad state of the world is 0 < p < 1
• You pay premiums of 0 < m < 1 for each dollar of insuredvalue
• The insurance pays benefit b in the bad state of the world
• If nothing bad happens, you lose your payment: −mb• this occurs with probability (1− p)
• If the bad thing happens, you
pay mb and get b: b −mb• this occurs with probability p
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
The Mechanics of Insurance
• Chance of bad state of the world is 0 < p < 1
• You pay premiums of 0 < m < 1 for each dollar of insuredvalue
• The insurance pays benefit b in the bad state of the world
• If nothing bad happens, you lose your payment: −mb• this occurs with probability (1− p)
• If the bad thing happens, you pay mb and get b: b −mb• this occurs with probability
p
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
The Mechanics of Insurance
• Chance of bad state of the world is 0 < p < 1
• You pay premiums of 0 < m < 1 for each dollar of insuredvalue
• The insurance pays benefit b in the bad state of the world
• If nothing bad happens, you lose your payment: −mb• this occurs with probability (1− p)
• If the bad thing happens, you pay mb and get b: b −mb• this occurs with probability p
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Actuarially Fair Premium
• Premium (m) equal to insurer’s expected payout
• Assume no administrative costs and no profits
• Suppose there is a 0 < p < 1 chance that the insurer has topay a benefit b
• Then the insurer’s expected cost is
= pb
• Actuarially fair premiums, mb, are equal to pb
• For example• Suppose a 1% chance of an accident, or p = 0.01• Suppose the payout is $30,000• Expected cost is 30, 000(0.01) = 300• Insurer can break even by collecting $300 from 100 people, and
paying $30,000 once
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Actuarially Fair Premium
• Premium (m) equal to insurer’s expected payout
• Assume no administrative costs and no profits
• Suppose there is a 0 < p < 1 chance that the insurer has topay a benefit b
• Then the insurer’s expected cost is = pb
• Actuarially fair premiums, mb, are equal to pb
• For example• Suppose a 1% chance of an accident, or p = 0.01• Suppose the payout is $30,000• Expected cost is 30, 000(0.01) = 300• Insurer can break even by collecting $300 from 100 people, and
paying $30,000 once
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Actuarially Fair Premium
• Premium (m) equal to insurer’s expected payout
• Assume no administrative costs and no profits
• Suppose there is a 0 < p < 1 chance that the insurer has topay a benefit b
• Then the insurer’s expected cost is = pb
• Actuarially fair premiums, mb, are equal to pb
• For example• Suppose a 1% chance of an accident, or p = 0.01• Suppose the payout is $30,000• Expected cost is 30, 000(0.01) = 300• Insurer can break even by collecting $300 from 100 people, and
paying $30,000 once
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Example to Show Value of Insurance
• You might get hit by a car• With probability p = 0.99 you don’t get hit• With probability p = 0.01 you get hit
• Usually you work and earn $30,000
• If you get hit, you can’t work and earn $0
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Value of InsuranceWhat is Expected Utility?
InsuranceDecision
State of theWorld
Consmp. U = C 1/2 E (U)
No insuranceNot hit by a car,
p = 0.99$30,000 173.2
(0.99)173.2+
(0.01)0
Hit by a car,
p = 0.01$0 0
= 171.5
Full insurancefor $300
Not hit $29,700 172.34
(0.99)172.3+
(0.01)172.3
Hit $29,700 172.34
= 172.34
Partialinsurance,$150
Not hit $29,850 172.77
(0.99)172.3+
(0.01)121.68
Hit $14,850 121.86
= 172.26
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Value of InsuranceAgain, What is Expected Utility?
InsuranceDecision
State of theWorld
Consmp. U = C 1/2 E (U)
No insuranceNot hit by a car,
p = 0.99$30,000 173.2
(0.99)173.2+
(0.01)0
Hit by a car,
p = 0.01$0 0 = 171.5
Full insurancefor $300
Not hit $29,700 172.34
(0.99)172.3+
(0.01)172.3
Hit $29,700 172.34
= 172.34
Partialinsurance,$150
Not hit $29,850 172.77
(0.99)172.3+
(0.01)121.68
Hit $14,850 121.86
= 172.26
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Value of InsuranceAgain, What is Expected Utility?
InsuranceDecision
State of theWorld
Consmp. U = C 1/2 E (U)
No insuranceNot hit by a car,
p = 0.99$30,000 173.2
(0.99)173.2+
(0.01)0
Hit by a car,
p = 0.01$0 0 = 171.5
Full insurancefor $300
Not hit $29,700 172.34(0.99)172.3+
(0.01)172.3
Hit $29,700 172.34 = 172.34
Partialinsurance,$150
Not hit $29,850 172.77
(0.99)172.3+
(0.01)121.68
Hit $14,850 121.86
= 172.26
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Value of InsuranceWith Actuarially Fair Premiums, People Always Want Insurance
InsuranceDecision
State of theWorld
Consmp. U = C 1/2 E (U)
No insuranceNot hit by a car,
p = 0.99$30,000 173.2
(0.99)173.2+
(0.01)0
Hit by a car,
p = 0.01$0 0 = 171.5
Full insurancefor $300
Not hit $29,700 172.34(0.99)172.3+
(0.01)172.3
Hit $29,700 172.34 = 172.34
Partialinsurance,$150
Not hit $29,850 172.77(0.99)172.3+
(0.01)121.68
Hit $14,850 121.86 = 172.26
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What About Risk Aversion?
• We just learned that even if you don’t worry about the future,you want insurance to smooth consumption
• If you are nervous about the future – “risk averse” – you wantinsurance even more
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Risk Averse is This Class?
A Choose between
1. $0.90 for sure2. 50% likelihood of $1.20, 50% likelihood of $0.80
B Choose between
1. $67 for sure2. 20% likelihood of $20, and 80% likelihood of $80
• Note that the gamble has greater expected value than thesure thing
A E (U) = 0.5(1.20) + 0.5(.80) = 0.6 + 0.4 = 1B E (U) = 0.2(20) + 0.8(80) = 4 + 64 = 68
• If you prefer the sure thing, you are risk averse
Being risk averse makes you like insurance.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Risk Averse is This Class?
A Choose between
1. $0.90 for sure2. 50% likelihood of $1.20, 50% likelihood of $0.80
B Choose between
1. $67 for sure2. 20% likelihood of $20, and 80% likelihood of $80
• Note that the gamble has greater expected value than thesure thing
A E (U) = 0.5(1.20) + 0.5(.80) = 0.6 + 0.4 = 1B E (U) = 0.2(20) + 0.8(80) = 4 + 64 = 68
• If you prefer the sure thing, you are risk averse
Being risk averse makes you like insurance.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Risk Averse is This Class?
A Choose between
1. $0.90 for sure2. 50% likelihood of $1.20, 50% likelihood of $0.80
B Choose between
1. $67 for sure2. 20% likelihood of $20, and 80% likelihood of $80
• Note that the gamble has greater expected value than thesure thing
A E (U) = 0.5(1.20) + 0.5(.80) = 0.6 + 0.4 = 1B E (U) = 0.2(20) + 0.8(80) = 4 + 64 = 68
• If you prefer the sure thing, you are risk averse
Being risk averse makes you like insurance.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Risk Averse is This Class?
A Choose between
1. $0.90 for sure2. 50% likelihood of $1.20, 50% likelihood of $0.80
B Choose between
1. $67 for sure2. 20% likelihood of $20, and 80% likelihood of $80
• Note that the gamble has greater expected value than thesure thing
A E (U) = 0.5(1.20) + 0.5(.80) = 0.6 + 0.4 = 1
B E (U) = 0.2(20) + 0.8(80) = 4 + 64 = 68
• If you prefer the sure thing, you are risk averse
Being risk averse makes you like insurance.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Risk Averse is This Class?
A Choose between
1. $0.90 for sure2. 50% likelihood of $1.20, 50% likelihood of $0.80
B Choose between
1. $67 for sure2. 20% likelihood of $20, and 80% likelihood of $80
• Note that the gamble has greater expected value than thesure thing
A E (U) = 0.5(1.20) + 0.5(.80) = 0.6 + 0.4 = 1B E (U) = 0.2(20) + 0.8(80) = 4 + 64 = 68
• If you prefer the sure thing, you are risk averse
Being risk averse makes you like insurance.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Risk Averse is This Class?
A Choose between
1. $0.90 for sure2. 50% likelihood of $1.20, 50% likelihood of $0.80
B Choose between
1. $67 for sure2. 20% likelihood of $20, and 80% likelihood of $80
• Note that the gamble has greater expected value than thesure thing
A E (U) = 0.5(1.20) + 0.5(.80) = 0.6 + 0.4 = 1B E (U) = 0.2(20) + 0.8(80) = 4 + 64 = 68
• If you prefer the sure thing, you are risk averse
Being risk averse makes you like insurance.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Risk Averse is This Class?
A Choose between
1. $0.90 for sure2. 50% likelihood of $1.20, 50% likelihood of $0.80
B Choose between
1. $67 for sure2. 20% likelihood of $20, and 80% likelihood of $80
• Note that the gamble has greater expected value than thesure thing
A E (U) = 0.5(1.20) + 0.5(.80) = 0.6 + 0.4 = 1B E (U) = 0.2(20) + 0.8(80) = 4 + 64 = 68
• If you prefer the sure thing, you are risk averse
Being risk averse makes you like insurance.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Why Have Social Insurance? AsymmetricInformation and Adverse Selection
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Why Social Insurance Rather than Private Insurance?
• We just learned that people want insurance. Why can’t theybuy it privately?
• Asymmetric information causes problems of adverse selection
• Adverse selection may lead to market failure and suggests arole for government intervention.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Asymmetric Information
• When sellers and buyers not do have the same information
• Examples?
• Nobel-prize winning example in economics: “Market forLemons”
• Suppose the quality of used cars is quite variable• Sellers know the quality of their cars• Buyers can’t figure out the quality of the seller’s car• =⇒ market for used cars is too small, and prices are too low• Or, there is a market failure
Asymmetric information can cause market failure.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Asymmetric Information
• When sellers and buyers not do have the same information
• Examples?
• Nobel-prize winning example in economics: “Market forLemons”
• Suppose the quality of used cars is quite variable• Sellers know the quality of their cars• Buyers can’t figure out the quality of the seller’s car• =⇒ market for used cars is too small, and prices are too low
• Or, there is a market failure
Asymmetric information can cause market failure.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Asymmetric Information
• When sellers and buyers not do have the same information
• Examples?
• Nobel-prize winning example in economics: “Market forLemons”
• Suppose the quality of used cars is quite variable• Sellers know the quality of their cars• Buyers can’t figure out the quality of the seller’s car• =⇒ market for used cars is too small, and prices are too low• Or, there is a market failure
Asymmetric information can cause market failure.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Asymmetric Information
• When sellers and buyers not do have the same information
• Examples?
• Nobel-prize winning example in economics: “Market forLemons”
• Suppose the quality of used cars is quite variable• Sellers know the quality of their cars• Buyers can’t figure out the quality of the seller’s car• =⇒ market for used cars is too small, and prices are too low• Or, there is a market failure
Asymmetric information can cause market failure.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
An Example of How Asymmetric Information CausesMarkets to Fail
• Each person earns $30,000 per year and loses this income if hehas an accident
• There are two types of guys: careful and careless• Careful people have accidents with p = 0.005• Careless people have accidents with p = 0.05
• 100 of each type
• Each person always knows if he is careless or careful
• We’ll assess three cases
1. Insurer knows consumers’ types2. Insurer does not know consumers’ types, offers actuarially fair
premiums3. Insurer does not know consumers’ types, offers the average
premium
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
An Example of How Asymmetric Information CausesMarkets to Fail
• Each person earns $30,000 per year and loses this income if hehas an accident
• There are two types of guys: careful and careless• Careful people have accidents with p = 0.005• Careless people have accidents with p = 0.05
• 100 of each type
• Each person always knows if he is careless or careful
• We’ll assess three cases
1. Insurer knows consumers’ types2. Insurer does not know consumers’ types, offers actuarially fair
premiums3. Insurer does not know consumers’ types, offers the average
premium
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailWhat are Total Premiums?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailHow Much Does the Insurer Pay Out?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailProfits?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailAs Good as It Gets
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailWith Partial Information and Separate Pricing: Premiums?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailWith Partial Information and Separate Pricing: Benefits?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailWith Partial Information and Separate Pricing: Profits?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailNot a Long Run Solution
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Sep. 1500 150
(0)1500
+(200)150
= 30, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
−135, 000
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailWith Partial Information and Average Pricing: Premiums?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Av. 825 825
(100)825
+(0)825
= 82, 500
(0.05)(100)(30000)
+(0.005)(0)(30000)
= 150, 000
−67, 500
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailWith Partial Information and Average Pricing: Benefits?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Av. 825 825
(100)825
+(0)825
= 82, 500
(0.05)(100)(30000)
+(0.005)(0)(30000)
= 150, 000
−67, 500
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailWith Partial Information and Average Pricing: Profits?
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Av. 825 825
(100)825
+(0)825
= 82, 500
(0.05)(100)(30000)
+(0.005)(0)(30000)
= 150, 000
−67, 500
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to FailAgain, Not a Long Run Solution
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Av. 825 825
(100)825
+(0)825
= 82, 500
(0.05)(100)(30000)
+(0.005)(0)(30000)
= 150, 000
−67, 500
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
How Asymmetric Information Causes Markets to Fail
Info P’ingC’lessprem.
C’fulprem.
TotalPrem.
Ben. PaidNetπ
Full Sep. 1,500 150
(100)1500
+(100)150
= 165, 000
(0.05)(100)(30000)
+(0.005)(100)(30000)
= 165, 000
0
Asym.Av. 825 825
(100)825
+(0)825
= 82, 500
(0.05)(100)(30000)
+(0.005)(0)(30000)
= 150, 000
−67, 500
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Adverse Selection
• You may know more about your personal risk than the insurer
• Therefore you choose insurance with your personal risk inmind
• =⇒ insurance market unravels
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Dental “Insurance” and Adverse Selection
• How does dental insurance work?
• Why doesn’t it insure anything?• Cabral (2013) shows that people opt into insurance and then
get treatment when insurance starts• Most dental care can wait (though perhaps painfully)• This is adverse selection in dental insurance• And why we don’t have actual dental insurance, just pre-paid
plans called “insurance”
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Dental “Insurance” and Adverse Selection
• How does dental insurance work?
• Why doesn’t it insure anything?• Cabral (2013) shows that people opt into insurance and then
get treatment when insurance starts• Most dental care can wait (though perhaps painfully)• This is adverse selection in dental insurance• And why we don’t have actual dental insurance, just pre-paid
plans called “insurance”
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Does Asymmetric Information Necessarily Lead to MarketFailure?
• If people are very risk averse, they want to buy insurance evenif it is actuarially unfair
• Then both the sick and the healthy buy the same insurance• Pooling equilibrium• No market failure
• Suppose the insurance market offers different products atdifferent prices
• Expensive, better insurance should appeal to sick guys• Cheaper, worse insurance should appeal to healthy guys• Separating equilibrium• But is a market failure if healthy guys want more coverage at
lower, actuarially fair price
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Does Asymmetric Information Necessarily Lead to MarketFailure?
• If people are very risk averse, they want to buy insurance evenif it is actuarially unfair
• Then both the sick and the healthy buy the same insurance• Pooling equilibrium• No market failure
• Suppose the insurance market offers different products atdifferent prices
• Expensive, better insurance should appeal to sick guys
• Cheaper, worse insurance should appeal to healthy guys• Separating equilibrium• But is a market failure if healthy guys want more coverage at
lower, actuarially fair price
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Does Asymmetric Information Necessarily Lead to MarketFailure?
• If people are very risk averse, they want to buy insurance evenif it is actuarially unfair
• Then both the sick and the healthy buy the same insurance• Pooling equilibrium• No market failure
• Suppose the insurance market offers different products atdifferent prices
• Expensive, better insurance should appeal to sick guys• Cheaper, worse insurance should appeal to healthy guys• Separating equilibrium• But is a market failure if healthy guys want more coverage at
lower, actuarially fair price
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Fixing Problems of Adverse Selection
• Force people to buy insurance
• This allows healthy to subsidize sick
• Obviously quite unpopular
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Additional Reasons for Government Intervention inInsurance Markets
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Other Reasons for Government Intervention in InsuranceMarkets
• Externalities
• Administrative costs
• Redistribution
• Paternalism
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance vs. Self-Insurance: How MuchConsumption Smoothing?
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance vs. Self-Insurance
• We’ve learned that market insurance may not be available
• So what can a person do instead?
self-insurance• Rainy day fund• Borrow from relatives• Get a home equity loan• Run up your credit card
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance vs. Self-Insurance
• We’ve learned that market insurance may not be available
• So what can a person do instead? self-insurance• Rainy day fund• Borrow from relatives• Get a home equity loan• Run up your credit card
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Relationship Between Self-Insurance and Social Insurance
• The more generous the social insurance, what happens toself-insurance?
• Self-insurance declines with more generous social insurance
• We can say that social insurance “crowds out” self-insurance
• Examples?• Lowered savings if you lose your job, given unemployment
insurance• Lowered savings for old-age health claims, given Medicare
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Relationship Between Self-Insurance and Social Insurance
• The more generous the social insurance, what happens toself-insurance?
• Self-insurance declines with more generous social insurance
• We can say that social insurance “crowds out” self-insurance
• Examples?
• Lowered savings if you lose your job, given unemploymentinsurance
• Lowered savings for old-age health claims, given Medicare
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Relationship Between Self-Insurance and Social Insurance
• The more generous the social insurance, what happens toself-insurance?
• Self-insurance declines with more generous social insurance
• We can say that social insurance “crowds out” self-insurance
• Examples?• Lowered savings if you lose your job, given unemployment
insurance• Lowered savings for old-age health claims, given Medicare
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance Most Valuable When
• Event is unpredictable
• Cost of event is high
Self-insurance is good for predictable, low cost events (examples?).
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance Most Valuable When
• Event is unpredictable
• Cost of event is high
Self-insurance is good for predictable, low cost events (examples?).
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Moral Hazard Problems Caused by Insurance
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
The Problem of Flood InsuranceOr, The Samaritan’s Dilemma
• Disaster hits, perhaps a flood
• Government responds regardless of insured status
• Person in flood plain thinks “why should I buy insurance?”
• Appears to be sufficient information for flood insurance market
• This is a “moral hazard” problem
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Moral Hazard
• Moral hazard problem ≡ adverse actions taken by individualsor producers in response to insurance against adverseoutcomes
• For example, because you have health insurance, you are lesscareful of your fingers when chopping onions
• Other examples?
• Many examples of workers’ compensation (insurance forworkplace injury) fraud
• Getting more medical tests than you would otherwise becauseyou are insured
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Moral Hazard
• Moral hazard problem ≡ adverse actions taken by individualsor producers in response to insurance against adverseoutcomes
• For example, because you have health insurance, you are lesscareful of your fingers when chopping onions
• Other examples?• Many examples of workers’ compensation (insurance for
workplace injury) fraud• Getting more medical tests than you would otherwise because
you are insured
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What Determines Moral Hazard?
• Asymmetric information• For example, the insurer can’t verify or disprove your claim of
injury
• Ease of changing behavior to establish adverse event• You can get in a car crash to get money for damages, but you
probably don’t want to get in a car crash• But you can pretend that you have a back or neck injury
without causing any harm
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What Determines Moral Hazard?
• Asymmetric information• For example, the insurer can’t verify or disprove your claim of
injury
• Ease of changing behavior to establish adverse event
• You can get in a car crash to get money for damages, but youprobably don’t want to get in a car crash
• But you can pretend that you have a back or neck injurywithout causing any harm
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
What Determines Moral Hazard?
• Asymmetric information• For example, the insurer can’t verify or disprove your claim of
injury
• Ease of changing behavior to establish adverse event• You can get in a car crash to get money for damages, but you
probably don’t want to get in a car crash• But you can pretend that you have a back or neck injury
without causing any harm
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Consequences of Moral Hazard
1. It modifies the production of the good being insured• too little labor is supplied when there is unemployment
insurance or workers’ compensation• too much health care is supplied with health insurance
2. More expenditures on social insurance means more tax raising;this comes at a cost of discouraging labor effort
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance, In Sum
1. People value insurance because they prefer smoothconsumption, all else equal
2. Private market may fail to provide insurance, possibly becauseof adverse selection
3. Social insurance is valuable to the extent that self-insurance isinfeasible
4. Expanding insurance coverage comes at a cost of moralhazard in inducing adverse behavior
Optimal insurance balances consumption smoothing benefits withmoral hazard costs, and should not completely insure individualsagainst adverse events.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance, In Sum
1. People value insurance because they prefer smoothconsumption, all else equal
2. Private market may fail to provide insurance, possibly becauseof adverse selection
3. Social insurance is valuable to the extent that self-insurance isinfeasible
4. Expanding insurance coverage comes at a cost of moralhazard in inducing adverse behavior
Optimal insurance balances consumption smoothing benefits withmoral hazard costs,
and should not completely insure individualsagainst adverse events.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Social Insurance, In Sum
1. People value insurance because they prefer smoothconsumption, all else equal
2. Private market may fail to provide insurance, possibly becauseof adverse selection
3. Social insurance is valuable to the extent that self-insurance isinfeasible
4. Expanding insurance coverage comes at a cost of moralhazard in inducing adverse behavior
Optimal insurance balances consumption smoothing benefits withmoral hazard costs, and should not completely insure individualsagainst adverse events.
Admin RFH Why Do We Care? Insurance? Why Social Insurance? Addt’l Reasons How Much Moral Hazard In Sum
Today: Social Insurance
• What is insurance?
• Why do people want insurance?
• Why might the government provide it?
• How much to insure?
• Moral hazard