A fair policy covering the compete loss
A fair policy covering only half of any loss
incurred
Calculate the cost of the second type of
policy and show that the individual will
generally regard it as inferior to the first.
c. Suppose individuals who purchase cost-sharing policies of the second type take better care
of their health, thereby reducing the loss suffered when ill to only $7,000. In this situation,
what will be the cost of a cost-sharing policy?
Show that some individuals may now prefer
this type of policy. (This is an example of the
moral hazard problem in insurance theory.)
d. Illustrate your findings from the previous parts
in a two-state diagram with C1 (consumption
in the no-disease state) on the horizontal axis
and C2 (consumption in the disease state) on
the vertical axis.