In a small island population, half of 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

Since the premium is much closer to the expected claims of the sick ($4,000) than to those of the healthy ($200), primarily sick individuals will find the insurance worth purchasing. This will lead to a pool of insured individuals with higher average claims, driving future premiums up to cover these costs.

In a Small Island Population, Half of the People Are