I. Insurance transfers the cost of some uncertain event, such as a factory burning down, from the owner to the insurance company. Considering only the issue of moral hazard, under what circumstances is this change an improvement? In other words, when is moral hazard a feature rather than a bug?
II. New genetic tests make it possible to predict, at low cost and with considerable accuracy, whether someone will get cancer, die young of a heart attack, etc. Consider three alternative scenarios. In each case, ignore complications associated with the fear of death--the possibility that people would not want to know their future, even though the knowledge would be useful, for fear the knowledge that they were likely to die young would make them unhappy. In each case, assume that the outcome of the test is not public information, even if the fact of the test is.
1. Insurance companies are forbidden to condition their rates on an individual's willingness to be tested or on the results of such tests; whether an individual has been tested is not public information.
2. Insurance companies are permitted, if they wish, to condition rates on test results and to require a test as a condition of insurance; whether an individual has been tested is not public information.
3. Insurance companies are permitted to condition rates on test results, and to require a test as a condition of insurance; whether an individual has been tested is public information; anyone who wants to, including the insurance companies, can find out.
What will happen in each case?
Will people choose to be tested?
Will people buy more or less life and health insurance than before the testing was invented?
Is any scenario an economic improvement (in terms of efficiency as we have defined it) over a world without testing? Over other scenarios?