Assume that 50 percent of the population consisting of 2,000 low-risk people and 1,000 high-risk people choose a comprehensive health insurance plan having a break even premium of $800.The remaining 50 percent, also consisting of 2,000 low-risk people and 1,000 high-risk people, choose a Health Maintenance Organization plan having a break even premium of $400.If high-risk people submit claims worth $2,000 under the comprehensive plan and $1,000 under the HMO plan, which of the following situations will occur?
A)High-risk people will shift to the comprehensive plan resulting in an increase in its premium rate.
B)High-risk people will shift to the HMO plan resulting into a fall in its premium rate.
C)Low-risk people will shift to the comprehensive plan resulting in a substantial decrease in its premium rate.
D)Low-risk people in both groups will stick to their respective plans and minimize their losses.

Question

Quizplus · Accepted Answer

Since high-risk people submit claims worth $2,000 under the comprehensive plan and $1,000 under the HMO plan, they will prefer the comprehensive plan. This will lead to adverse selection and a higher risk pool for the comprehensive plan, increasing its premium rate. Thus, high-risk people will shift to the comprehensive plan resulting in an increase in its premium rate.

Assume That 50 Percent of the Population Consisting of 2,000