Skip to content

IAI Actuarial Core Principles · Business Economics · Government intervention in a market

In the health insurance market, buyers know more about their own health risks than insurers do. If insurers charge a single average premium, what is the most likely outcome that may justify regulation such as mandatory community-rated cover?

Adverse selection is the likely outcome. Because buyers hold private information and the premium is an average, healthy people drop out, the pool becomes riskier and premiums rise, a market failure that can justify mandatory cover or regulation.

  1. AAdverse selection, with healthier people leaving and the average risk pool worseningCorrect
  2. BMoral hazard arising before the policy is bought
  3. CA price ceiling creating excess demand for insurance
  4. DPerfect risk pooling at the average premium for all
  5. A positive externality leading to overconsumption of insurance

Explanation

With asymmetric information and a uniform premium, low-risk individuals find cover poor value and exit. The remaining pool is riskier, pushing premiums up and possibly collapsing the market. Compulsory participation or regulation addresses this. Moral hazard concerns behaviour after insurance is bought, so B is wrong.

Did you get it right without looking?

One question tells you little. A timed set on Government intervention in a market shows your real accuracy, how long you take and where you lose marks.

Practise Government intervention in a marketFree diagnostic mock

More Government intervention in a market questions