Under which pricing system do insurers have an incentive to engage in preferred risk selection?"
Health insurance providers use the rating system to calculate the charge for their insurance. Rating systems such as community rating and experience rating use difference statistical method to estimate the amount a given individual or a group will pay for the healthcare insurance. Using the rating system, health insurance providers have been able to determine the amount an individual or a group will pay for their insurance.
Experience rating is defined as the practice of setting a rate for an individual or a group based on the benefits paid on behalf of that group, and experience rating adjusts future premium based on benefit utilization and experience. In insurance, experience rating is based on the traditional insurance concept, which base the premium of a group individual on the probability of the loss among the group. On the other hand, it is a strategy of fixing the premium based on the financial gain or loss. The insurance companies use the experience rating for the health insurance and it has been used in life insurance for many years. Thus, experience rating is a desired to keep medicine and health insurance on private basis. (Follmann, 1962).
On the other hand, community rating is a strategy of setting premium, which spread the risks evenly across the community. Within the community rate system, everyone pays the same coverage regardless of age or health status. A 20-year-old person would pay the same premium rate with 60-year-old individual.
However, there are differences between experience rating and community rating. Experience rating is used to estimate the amount a group or an individual will pay on medical care. The rating is based on how much a person has already paid and on what risks a person is having. An insurer uses experience rating to predict the medical costs of a group based on the cost of healthcare coverage at a given period. On the other hand, under community rating, an insurer establishes premiums based on the medical statistics of a community. Typically, health insurance provider establishes the same premium in a community without regard to age, health status, gender and occupation. This system determines the equal premium within a community based on the demographic profile and health of the community. Under community rating, healthy people pay more than people who are less healthy. (Feldstein, 2011).
The difference between experience rating and community rating is that experience rating increases company profits and provides saving for those who are healthier and raise expenses for those who are less healthy. However, the premium of experience rating could be too high for sick people to pay, and it only allows insurance provider to insure only people who are healthy and not for those who are likely to have larger medical spending .Contrarily, community rating spreads out the health cost in the community and allows people who are less healthy to afford medical costs. In an experience rating, an insurer calculates future medical costs based on the insurer past experience and community rating uses the overall community experience to calculate future medical costs.
Preferred risk selection is the ability to control costs and escape from competitive pressure. Typically, community rating does not solve much of the health plan. (Enthoven, 1980) and community rating suffers disproportional heavy claims due to its preferred risk selection by other insurer operating in the market.
"What is adverse selection? How does its existence affect the market for health insurance? What are some ways insurance companies protect themselves from adverse selection?"
"Adverse selection is originally defined in insurance theory which describes a situation where the information asymmetry between policyholders and insurers leads the market to a situation that the policyholders claim losses that are higher than the average rate of loss of population used by the insurers to set their premiums." (Mahdavi, 2008 P. 2).
Adverse selection is also defined as the situation where policyholders claim loss higher than the average rate loss of the population. On the other hand, the adverse selection is a situation where people in a high risks lifestyle or in a dangerous job get life insurance. Adverse selection also reveals a situation where sellers have more information than buyers do about the quality of insurance. Due to the high risks that insurers are exposed to the practice of adverse selection, the insurance providers raise premiums or reduce exposure to large claim by limiting the coverage. In some situation, some customers may possess more information about the riskiness than the insurer, which assist them to make large claim from insurers. With the loopholes identified within the adverse selection, some customers take advantages of the loopholes to efficiently use the information against the insurers.
On the other hand, Siegelman, (2004) identified adverse selection as the process where an insured utilizes the information about his riskiness to buy insurance. For example, if Mr. A knows that he would die tomorrow where his insurance provider does not, the insured will use life insurance to assist his family to make large claim on insurer. The fundamental findings of adverse selection theory is that the insured who are able to buy better coverage tend to have poorer health, have more accident and otherwise pose more risks for insurers. Based on the risk that insurance providers face with the concept of adverse selection, there are several strategies that insurer use to protect themselves:
First, the insurers facing the adverse selection set the premium higher to be able to afford the claim that might have occurred from the market. Siegelman, (2004) argues that the best method that insurance provider could use to protect themselves against adverse selection is to have a complete understanding of the technical language of the insurance contract. Moreover, an insurance company might use the credit score to determine the creditworthiness of an individual and the likelihood of an automobile accident of an insured.
3). "What is moral hazard and how does it affect demand for health insurance? What approaches do insurance companies use to control its existence?"
Moral hazard is a post-insurance contract information asymmetry where the action of one part affects the payoff of other party. In the insurance context, an insured unverifiable action reduces the probability of loss. Concept of moral hazard in the insurance market is also a situation where a party protected by insurance policy will behave differently than if not protected. For example, an individual covered by the auto-theft insurance will be less vigilant about where he parks his automobile with believe that his insurance will pay another car if his car is stolen. More importantly, organizations that believe that they will receive financial bailout may take more risk in pursuing profit. An insured who is covered by a car accident may decide to drive recklessly. Typically, the insurance policy that covers people from the misfortune often change people behavior making them to make less effort to avoid risks. This type of change in behavior is called a moral hazard. Moral hazard creates problem for private insurance company.
To control the existence of moral hazard, the insurance company does not cover the loss by 100%. The insurance companies keep the auto or building insured less than their true worth. In the United States, it is against the law to intentionally create misfortune against insurance policy that you are insured against. Thus, insurance company safeguards against great loss and if the losses are too great, there will be no insurance coverage for the misfortune. It is important to realize that the insurance company often face the problem of information asymmetry because people with big risks are the people buying some selected insurance product which is often an adverse selection because these people may hide substantial information about their past. To safeguard this misfortune against insurance companies, the automobile insurance company may refuse insurance policy for an individual having the habit of driving recklessly or people with terminal illness.
4) "Discuss each of the factors affecting the demand for health insurance. Indicate the effect each has on demand. Additionally, how will a change in price affect the demand for health insurance?"
Provision of healthcare consists of product and service as well as personal health intervention and treatment that promote the well-being of an individual. Many factors affect the demand for health insurance, and one of the factors is level of probability of illness in a given economy and the probability of illness may increase with age. There will be an increase in the number of people demanding for the health insurance with the increase in the number of people reaching the old age. It is essential to realize that people tend to be susceptible to sickness as the ages increases.
Difference in gender also affects demand for health insurance. For example, if the number of female people is higher than male number people within a country, there will be increase in the number of health insurance…