Life insurance companies require applicants to submit to a physical examination as proof of insurability prior to issuing standard life insurance policies. In contrast, credit card companies offer their customers a type of insurance called “credit life insurance” that pays off the credit card balance if the cardholder dies. Would you expect insurance premiums to be higher (per dollar of death benefits) on standard life or credit life policies? Explain.

Life insurance companies require applicants to submit to a physical examination as proof of insurability prior to issuing standard life insurance policies. In contrast, credit card companies offer their customers a type of insurance called “credit life insurance” that pays off the credit card balance if the cardholder dies. Would you expect insurance premiums to be higher (per dollar of death benefits) on standard life or credit life policies? Explain.

Managerial Economics: A Problem Solving Approach

5th Edition

ISBN:9781337106665

Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Chapter19: The Problem Of Adverse Selection

Section: Chapter Questions

Problem 9MC

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Similar questions

In the mid-1990s, the state of New Jersey revised its rules for the individual insurance market and began requiring that insurers charge the same premiums for the same coverage to all applicants. Assuming that insurers had previously used medical underwriting, which of the following is a predictable consequence of adverse selection? 1) Insurance becomes less attractive to the healthiest individuals, so fewer of them buy it 2) Insurers’ average costs of providing coverage increase because of a changing risk pool 3) The average age of those buying in the individual market goes up 4) All of the above
In the field of financial management, it has been observed that there is a trade-off between the rate of return that one earns on investments and the amount of risk that one must bear to earn that return. a) Draw a set of indifference curves between risk and return for a person that is risk-averse (a person that does not like risk).
The problem of adverse selection in insurance markets means that it is generally a bad deal for companies to offer insurance at the same price for all potential customers. Why then do we observe some insurance companies (such as those selling “trip insurance” that refunds money to people who purchase trips that they are unable to take) do exactly this?
The difference between the actuarily fair price for insurance and the price a risk-averse individual is willing to pay to fully insure is called a-insurance benefit b-risk aversion c-the risk premium d-risk profit
Consider two individuals whose utility function over wealth I is ?(?) = √?. Both people face a 10 percent chance of getting sick, and foreach the total cost of illness equals $50,000. Suppose person A has a total net worth of $100,000, and person B has a total net worth of $1,000,000. Both people have the option to buy an actuarially fair insurance contract that would fully insure them against the cost of the illness. a. Using expected utility calculations, show that person A would certainly buy full, actuarially fair insurance. b. Suppose an insurance company wants to maximize profits and wants to charge each customer the maximum price they are willing to pay. How much should the insurance company charge each client so that both buy the contract? c. What is surprising about your result in part b? What does this tell you about how insurance companies may be pricing health insurance contracts in the real world?
Loss aversion refers to the idea that people ________. generally tend to avoid risky activities are more prone to making losses than gains in day-to-day transactions psychologically weight a loss more heavily than they psychologically weight a gain are unwilling to undertake expenditures that reduce the probability of future losses
Julia is a 28- year-old nonsmoking , non-drinking female of normal weight Because of adverse selection in health insurance , (A) She will be charged less for her premiums than people who are higher risks ) B)She is less likely to buy health insurance than the average person, because policy premiums are based on expected medical expenditures of people who are less healthy than she is ( C) When she get health insurance , she will be less likely to take care of herself. ) D)She must get health insurance early in life, and is likely to lose health insurance if she smokes , drinks to excess, or gains weight. E) She is more likely than the average person to buy health insurance , because she is more likely to be offered it.
BPO Services is in the business of digitizing information from forms that are filled out by hand. In 2006, a big client gave BPO a distribution of the forms that it digitized in house last year, and BPO estimated how much it would cost to digitize each form. Form Type Mix of Forms Form Cost A 0.5 $3.00 B 0.5 $1.00 The expected cost of digitizing a form is . Suppose the client and BPO agree to a deal, whereby the client pays BPO to digitize forms. The price of each form processed is equal to the expected cost of the form that you calculated in the previous part of the problem. Suppose that after the agreement, the client sends only forms of type A. The expected digitization cost per form of the forms sent by the client is . This leads to an expected loss of per form for BPO. (Hint: Do not round your answers. Enter the loss as a positive number.)
Priyanka has an income of £90,000 and is a von Neumann-Morgenstern expected utility maximiser with von Neumann-Morgenstern utility index u(x) = square root x . There is a 1 % probability that there is flooding damage at her house. The repair of the damage would cost £80,000 which would reduce the income to £10,000. a) Would Priyanka be willing to spend £500 to purchase an insurance policy that would fully insure her against this loss? Explain
Indicate whether the statement is true or false, and justify your answer.Having generous insurance makes you fat because you do not pay the full health costs of eating poorly and not exercising.
Which of the following statements is FALSE regarding the concept of "adverse selection"? Multiple Choice Adverse selection describes a situation where an individual's demand for insurance is positively correlated with the individual's risk of loss. Adverse selection occurs when someone increases their exposure to risk when insured. This can happen, for example, when a person takes more risks because someone else bears the cost of those risks. The relationship between smoking status and mortality provides a good illustration for adverse selection, especially in the case in which a life insurance company did not vary its premiums according to smoking status of its customers. To counter the effects of adverse selection, insurers may offer premiums that are proportional to a customer's risk.
Scenario 2 Tess and Lex earn $40,000 per year and all earnings are spent on consumption (c). Tess and Lex both have the utility function (sqrt c) . Both could experience an adverse event that results in earnings of $0 per year. Tess has a 1% chance of experiencing an adverse event and Lex has a 12% chance of experiencing an adverse event. Tess and Lex are both aware of their risk of an adverse event. Refer to Scenario 2 Suppose that insurance companies do not know specific probabilities of adverse events for Tess or Lex, but do know the average probability of an adverse event. If they assumed that both Tess and Lex purchase full insurance, what is the actuarially fair premium charged? Round to two decimal places