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(共37张PPT)
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12.1 What Is Insurance and Why Do Individuals Value It
12.2 Why Have Social Insurance Asymmetric Information and Adverse Selection
12.3 Other Reasons for Government Intervention in Insurance Markets
12.4 Social Insurance versus Self-Insurance: How Much Consumption Smoothing
12.5 The Problem with Insurance: Moral Hazard
12.6 Putting It All Together: Optimal Social Insurance
12.7 Conclusion
Social Insurance: The New Function of Government
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Social Insurance: The New Function of Government
Preamble to the United States Constitution:
Establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity.
For most of the country’s history, emphasis on “common defense.”
Since 1950 or so, shift toward “the general welfare.”
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Government Spending by Function,1953 and 2014
1953 2014
Defense 69.4% 17.2%
Disability and Unemployment 5.0 14.7
Social Security 3.6 24.3
Health 0.4 26.4
Other 21.6 17.5
Government today devotes a much larger portion of its budget to social insurance than it did 50 years ago.
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Social Insurance: The New Function of Government
Government spending now focuses on social insurance programs.
Social insurance programs: Government interventions in the provision of insurance against adverse events.
For most programs, eligibility is not means-tested.
Means-tested: Refers to programs in which eligibility depends on the level of one’s current income or assets.
12.1
Insurance is a promise to make some payment in case of a particular event, in exchange for a payment, called a premium.
Insurance premiums: Money that is paid to an insurer so that an individual will be insured against adverse events.
Insurance products in the United States include health insurance, auto insurance, life insurance, and casualty and property insurance.
Annual private premiums for these products totals more than $1.6 trillion.
What Is Insurance
12.1
Insurance is valuable because it helps individuals’ insurance consumption across states of the world.
Consumption smoothing: The translation of consumption from periods when consumption is high, and thus has low marginal utility, to periods when consumption is low, and thus has high marginal utility.
States of the world: The set of outcomes that are possible in an uncertain future.
Why Do Individuals Value Insurance
12.1
Diminishing marginal utility means that the fourth slice of pizza is less important than the first.
Always having two slices is better than sometimes having four and sometimes having zero.
Always a moderate amount of consumption for sure is better than a 50–50 chance of having a lot or nothing.
Individuals will demand full insurance in order to fully smooth their consumption across states of the world.
Why Do Individuals Value Insurance
Diminishing Marginal Utility
12.1
We formalize these ideas in the expected utility model.
Expected utility model: The weighted sum of utilities across states of the world, where the weights are the probabilities of each state occurring.
Suppose an adverse event occurs with probability . Expected utility is
Formalizing This Intuition: Expected Utility Model
12.1
1% chance that Sam gets hit by a car, resulting in $30,000 in medical expenses.
Insurance costs b for each dollar of coverage.
If Sam buys $m of coverage, his premium is $mb.
To analyze Sam’s choice, assume , and premiums are actuarially fair.
Actuarially fair premium: An insurance premium that is set equal to the insurer’s expected payout.
The Expected Utility Model: Health insurance
12.1
Full Insurance Is Optimal
Purchase Hit C Expected Utility
No insurance Yes 30,000
No 0 0 Full insurance ($300) Yes 38,700
No 38,700 Partial insurance ($150) Yes 38,850
No 14,850
12.1
Full Insurance Is Optimal
No Insurance Full insurance Partial Insurance
Premium 0 300 150
C if not hit 30,000 38,700 38,850
C if hit 0 38,700 14,850
U if not hit 173.2 172.34 172.77
U if hit 0 172.34 121.86
Expected utility 0.99 × 173.2 + 0.01 × 0 = 171.5 0.99 × 172.34 + 0.01 × 172.34 = 172.34 0.99 × 172.77
+ 0.01 × 121.86
= 172.26
Risk aversion: The extent to which individuals are willing to bear risk.
Risk-averse people may still want to buy some insurance even if it is not actuarially fair.
People may differ in their risk aversion, and if insurance premiums are extremely unfair, then only the most risk averse will want it.
12.1
The Role of Risk Aversion
Why should the government provide insurance
Information asymmetry can lead to a key market failure called adverse selection.
Information asymmetry: The difference in information that is available to sellers and to purchasers in a market.
Adverse selection: The fact that the insured individuals knows more about their risk level than does the insurer might cause those most likely to have the adverse outcome to select insurance, leading insurers to lose money if they offer insurance.
12.2
Why Have Social Insurance Asymmetric Information and Adverse Selection
12.2
Adverse Selection Example
Two kinds of people:
Careless people have a 5% chance of being in a car accident (half the population).
Careful people have a 0.5% chance (half the population).
If the insurance companies knows each person’s type, it can charge them separate prices.
If the insurance company doesn’t know their type, it could try charging a price that is fair on average, or try charging separate prices.
12.2
Insurer Breaks Even with Full Information Pricing
What happens if the insurance company could charge each type their actuarially fair price
Charge careless people $1,500.
Charge careful people $150.
Earn $150,000 per 100 careless people, pay out $150,000.
Earn $15,000 per 100 careful people, pay out $15,000.
12.2
Asymmetric Information Pricing: Separate
What if the insurance tries to charge different prices but cannot tell who is careless
Careless people pretend to be careful, pay $150.
Careful people pay $150.
Earn $15,000 per 100 careless people, pay out $150,000. Lose $135,000.
Earn $15,000 per 100 careful people, pay out $15,000.
12.2
Asymmetric Information Pricing: Separate
What if the insurance company tries to charge average price
Average price: $825.
Insurance is a great deal for careless people, so they buy it, pay $825.
Careful people decline it.
Earn $82,500 per 100 careless people, pay out $150,000. Lose $67,500.
Earn nothing from careful people.
12.2
The Problem of Adverse Selection
Adverse selection: The fact that insured individuals know more about their risk level than does the insurer might cause those most likely to have the adverse outcome to select insurance, leading insurers to lose money if they offer insurance.
Selling to both requires that low-risk people subsidize high-risk people.
Low-risk people may not want to do this.
Sometimes, only high-risk people end up with insurance.
12.2
If low-risk people have a high enough risk premium, they will subsidize high-risk people in a pooling equilibrium.
Risk premium: The amount that risk-averse individuals will pay for insurance above and beyond the actuarially fair price.
Pooling equilibrium: A market equilibrium in which all types of people buy full insurance even though it is not fairly priced to all individuals.
Separating equilibrium: A market equilibrium in which different types of people buy different kinds of insurance products designed to reveal their true types.
Does Asymmetric Information Necessarily Lead to
Market Failure
12.2
In 1995, Harvard stopped subsidizing its most generous plans, which were experience-rated.
Experience rating: Charging a price for insurance that is a function of realized outcomes.
Before 1995, there was a pooling equilibrium.
Healthy employees chose the cheap, generous plan.
After 1995, there was a separating equilibrium.
Healthy employees dropped the now expensive generous plan.
APPLICATION: Adverse Selection and Health Insurance “Death Spirals”
12.2
APPLICATION: Adverse Selection and Health Insurance “Death Spirals”
Because the less-healthy employees used much more medical care, the experience-rated premiums of the more generous plans increased substantially.
By 1998, the most generous plan had gotten so expensive that it was no longer offered.
Adverse selection had led to a “death spiral” for this plan.
It kept getting more expensive, and healthy people kept leaving, driving its price ever higher.
12.2
Adverse selection leads to market failure since healthy people may not be able to buy insurance.
The government can address adverse selection, and improve market efficiency, in a number of ways…
…but they involve redistribution from the healthy to the sick, which may be quite unpopular.
How Does the Government Address Adverse Selection
12.3
Externalities: Vaccines have positive spillovers; car crashes negative ones.
Administrative costs: Government-run Medicare has much lower administrative costs than private insurance.
Redistribution: Governments may want to redistribute from healthy to sick.
Paternalism: Governments may feel that people would choose to buy too little insurance for themselves.
Other Reasons for Government Intervention in
Insurance Markets
12.3
The Samaritan’s Dilemma is another rationale for intervention.
Compassionate governments want to bail out hard-hit citizens.
But, knowing this, citizens may not buy insurance, making bailouts expensive.
This is especially important for floods.
Congress established National Flood Insurance Program (NFIP) in 1968 to address this.
APPLICATION: Flood Insurance and the Samaritan’s Dilemma
12.3
NFIP has paid out $51.1 billion since 1969 and has lead to improved building standards.
But nearly half of the victims of Hurricane Katrina in 2005 did not have flood insurance, and the claims of people with insurance bankrupted the system.
NFIP failed in part because people avoid buying flood insurance if they are assured the government is going to continue to help individuals in disaster areas.
Acts were passed in 2012 and 2014 to more accurately price flood insurance and control the rate adjustments for flood insurance premiums in vulnerable areas.
APPLICATION: Flood Insurance and the Samaritan’s Dilemma
12.4
Even if private insurance markets do not function well, people may still be able to insure with self-insurance.
Self-insurance: The private means of smoothing consumption over adverse events, such as through one’s own savings, the labor supply of family members, or borrowing from friends.
Social Insurance versus Self-Insurance: How Much Consumption Smoothing
Example: Unemployment Insurance
12.4
People can insure against unemployment in many ways:
They can draw on their own savings.
They can borrow, either in collateralized forms (such as borrowing against the equity they have in their homes) or in uncollateralized forms (such as on their credit card).
Other family members can increase their labor earnings.
They can receive transfers from their extended family, friends, or local organizations.
Unemployment insurance provides benefits through the replacement rate.
UI replacement rate: The ratio of unemployment insurance benefits to pre-unemployment earnings.
A higher replacement rate corresponds to more generous insurance.
But private insurance reduces the consumption-smoothing value of this insurance.
12.4
Example: Unemployment Insurance
12.4
Example: Unemployment Insurance
12.4
The importance of social insurance for consumption smoothing will depend on two factors:
Predictability of the event: It is easier for people to self-insure against a predictable event, such as increasing their savings. More predictable risks reduce the benefits of providing social insurance.
Cost of the event: It is more difficult to self-insure against high-cost events, such as becoming injured and unable to work. Costly risks increase the benefits of providing social insurance.
Lessons for Consumption-Smoothing Role of Social Insurance
12.5
The cost of insurance is moral hazard.
Moral hazard: Adverse actions taken by individuals or producers in response to insurance against adverse outcomes.
“Nothing emboldens sin so much as mercy.”
The existence of moral hazard means that it may not be optimal for the government to provide the full insurance that is demanded by risk-averse consumers.
The Problem with Insurance: Moral Hazard
12.5
Prison guard Ricci DeGaetano
Supposedly injured by an inmate. Collected $82,500 in claims over three years while operating a karate school.
Detective Rocky Sherwood
Injured in traffic accidents. While claiming workers’ compensation, coached little league team to California World Series victory.
Waitress Christina Gamble
Too injured to “stand” and “change positions.” Received $360/week in insurance payments while working as a stripper.
APPLICATION: The Problems with Assessing Workers’ Compensation Injuries
12.5
What determines moral hazard
How easy it is to observe whether the adverse event has happened.
How easy it is to change behavior in order to establish the adverse event.
The Problem with Insurance: Moral Hazard
12.5
In examining the effects of social insurance, four types of moral hazard play a particularly important role.
Reduced precaution against entering the adverse state.
Increased odds of entering the adverse state.
Increased expenditures when in the adverse state.
Supplier responses to insurance against the adverse state.
The Problem with Insurance: Moral Hazard
12.5
Moral hazard is costly for two reasons.
The adverse behavior encouraged by insurance lowers social efficiency because it reduces the provisions of socially efficient labor supply.
When social insurance encourages adverse events, which raise the cost of the social insurance program, it increases taxes and lowers social efficiency further.
The Consequences of Moral Hazard
12.6
Optimal social insurance systems should partially, but not completely, insure individuals against adverse events.
The benefit of social insurance is the amount of consumption smoothing provided by social insurance programs.
The cost of social insurance is the moral hazard caused by insuring against adverse events.
Putting It All Together: Optimal Social Insurance
12.7
Asymmetric information in insurance markets has two important implications:
It can cause adverse selection.
It can cause moral hazard.
The ironic feature of asymmetric information is therefore that it simultaneously motivates and undercuts the rationale for government intervention through social insurance.
Conclusion

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