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IAI Actuarial Core Principles · Business Economics · Relationship between the government and the individual firm

Health insurers often face adverse selection in individual policies. Which action by the government best addresses this market failure?

Compulsory or mandated insurance cover addresses adverse selection by pooling high and low risks, which stops low-risk people leaving and premiums spiralling. A price ceiling below claim costs or deregulation would not correct the information problem.

  1. ABanning all insurers from using any information
  2. BMaking cover compulsory for the whole population or a defined groupCorrect
  3. CImposing a price ceiling below the cost of claims
  4. DRemoving all regulation of premiums
  5. Taxing the premiums of low-risk customers only

Explanation

Adverse selection arises when high-risk people are more likely to buy cover, pushing up premiums and driving out low-risk people. Compulsory or mandated cover pools the risks and keeps low-risk people in. A price ceiling below claims cost would make supply unviable.

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