29.11.2023 Asymmetric Information & Social Insurance#

4 Questions for public economics

  • When intervenve?

  • How intervene?

  • What is the effect?

  • Why do governments choose to intervene the way they do

Asymmetric Information#

Akerlof: Market for Lemons

  • Buyer does not know the „real“ value of the car

  • Seller does know, mistrust

=> asymmetric information => market failure => government intervention

Car Insurance Market#

  • high risk people = 5% chance of accident in year

  • low risk people = 0.5% chance of accident

  • cost of car accident = 30.000$

actuarially fair premiums:

  • low risk: \(0.005 \times 30.000 = 150\)

  • high risk: \(0.05 \times 30.000 = 1500\)

Insurance Company wiht 100 people of each group

  • low risk calculation:

    • income: \(150*1000 = 15.000\)

    • damage payments: \(30.000 \times 0.05 \times 100 = 15.000\)

    • income = payment = 0 profit

  • high risk similar

But: asymmetric information!

  • insurance company cant tell the difference

  • averagy insurance premium in the middle

    • low risk people wont pay

    • high risk people will profit and drive company bankrupt

separating equilibrium

insurers offers two contracts

  • full coverage of 30k at 1500$ premium

  • partial coverage up to 10k at 50$ premium

but still market failure (financial risk persists)

Adverse Selection#

Adverse Selection: market situation where buyers and sellers have different information => unequal distribution of benefits to both parties

Example: Harvard Death Spiral

2 plans of Helath insurance

  • full benefits with premium

  • lower benefits with no premium

in crisis, higher prices for 1., healthy people change

Social Insurance#

German System

  1. Health Insurance (1883)

  2. Accident Insurance (1884)

  3. Pension Insurance (1889)

  4. Unemployment Insurance (1927)

  5. Long-term Care Insurance (1995)

Characteristics

  • solidarity

  • mandatory

  • Benefit is tied to certain event (unemployment, sickness, needs care)

Reasons for government intervention#

  • Asymmetric Information

  • Externailities (e.g vacciation in health)

  • Administrative Costs

  • Redistribution

  • Paternalism

  • Samaritans Dilemma

Problems: Crowd Out of Self Insurance

  • e.g Consumption Smoothing before unemployment

  • due to saving, borrwing, family etc

  • only very partial crowd out

Moral Hazard#

Moral Hazard: Adverse actions taben by individuals or producers in resppnse to insurance against adverse outcomes

  • ex ante: changes in behavior that affect insured risk (smoking => lung cancer)

  • ex post: after risk has materialized (cancer => want every possible treatment)

Problems of Moral Hazard

  • increase cost

  • higher taxes => deadweight loss