In a small island population, half the people are healthy and half are sick. The annual expected medical claims of the healthy and sick are $200 and $4,000, respectively. Assume that the health insurance company does not know whether people are healthy or sick before they buy insurance. If the health insurance company charges an annual premium of $2,100 (the average expected claim), only the _____ will buy insurance, driving future premiums _____.
A) sick; up
B) healthy; down
C) sick; down
D) healthy; up

Question

Quizplus · Accepted Answer

If the health insurance company charges an annual premium that is equal to the average expected claim, only the sick population will see the value in purchasing insurance as their expected claims are much higher than the premium. This means that only the sick will buy insurance, and the health insurance company will have to pay out more claims, driving future premiums up to cover those costs.

In a Small Island Population, Half the People Are Healthy