As Part of the Most Recent Collective Bargaining Agreement with State

question 86

Essay

As part of the most recent collective bargaining agreement with state employees, a state government must offer dental insurance at "reasonable, nonprofit rates." The state plans to self-insure in place of using a private insurance company. Statistical evidence suggests that the average household currently spends $300 per year for corrective dental work and $80 for routine checkups. Administrative costs are expected to average $20 per family. The collective bargaining agreement dictates that the plan's coverages and rates be fixed for a period of three years. The auditor considers the choice of the plan to be extremely important. Consequently, the auditor has asked you to evaluate the three proposals listed below in terms of their propensity to result in adverse selection and/or moral hazard. Proposal 1 would charge a $400 premium with no deductible. Coverage is extended to preexisting conditions, but to cover the nondeductible clause, routine checkups are not covered. Proposal 2 charges a $200 premium with a $200 deductible. The plan does not cover preexisting conditions, but does cover routine office visits. Proposal 3 charges a $150 premium with a $150 deductible. This plan doesn't cover preexisting conditions or routine checkups. The collective bargaining agreement dictates that participation in the plan must be at the employee's option.

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Definitions:

American Put

An option contract giving the holder the right, but not the obligation, to sell a specified amount of an underlying asset at a predetermined price before or on a specified date.

Real Option

The choice available to managers regarding business investments, such as expanding, deferring, or abandoning a project, based on changing conditions.

Fixed Price

A pricing strategy where the cost of a good, service, or contract does not change, regardless of variations in market conditions or production costs.

Asset

Any resource owned or controlled by a business or an individual that is expected to produce positive economic value.