This chapter discusses three areas in which asymmetric information has substantial “real world” applications.

HEALTH CARE AND HEALTH CARE INSURANCE

There are many instances in which problems of adverse selection or moral hazard are resolved (or ameliorated) without government intervention. However, one sector in which these problems have been particularly profound, and have consequently prompted government intervention, is the provision of health care and health insurance. In Canada, as in many European countries, universal health care insurance and many forms of health care are provided by the government. In the United States, there is a smaller but nevertheless significant degree of government involvement. Let's look at the problems and their solutions.

Adverse Selection

An insurance company is offering actuarially fair insurance if, in an average year, the premiums paid by the policy-holders are just equal to the payments made to the policy-holders. Risk-averse people would always accept actuarially fair insurance, and for the remainder of this section, we shall imagine that everyone is risk-averse.

Suppose that a group of companies offered health care insurance which would be actuarially fair if it were accepted by all of the residents of a region. Would everyone living in the region actually accept the insurance? Would the companies have an incentive to alter the terms on which they offer insurance?