Suppose a Large Firm Allows Its Employees to Choose Whether

question 147

Multiple Choice

Suppose a large firm allows its employees to choose whether to participate in its health insurance plan.The firm is trying to decide between two plans: Plan I has a low monthly premium but a high deductible, and Plan II has a high monthly premium but a low deductible.Under which plan is adverse selection likely to be a bigger problem?

• A)Plan I because it is likely to draw participants who expect high medical costs. This group expects to consume much health care services and therefore prefer low deductibles.
• B)Plan II because it is likely to draw participants who expect high medical costs. Healthy individuals who do not expect to consume much health care services will not be willing to pay the high premiums.
• C)Plan I because it is likely to draw the relatively healthy employees who do not expect to spend much on health care. Because the monthly premiums are low, the insurance company has to bear a bigger financial burden in the event of serious illnesses.
• D)Plan II because it is likely to draw employees who tend to over-consume health care services because of the low deductible. Insurance companies are likely to end up paying out more claims than the premiums they collect.

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Definitions:

Effective Interest Method

A way of amortizing the bond premium or discount over the life of the bond in a manner that reflects a constant rate of interest.

Bond Premium

The amount by which the market price of a bond exceeds its principal amount or face value, typically as a result of changes in interest rates.

Interest Expense

The expenses an entity faces for borrowing funds, encompassing payments for loans, bonds, or credit lines.

Effective Rate

Refers to the real rate of interest earned or paid on an investment, loan, or other financial product, adjusted for the effect of compounding over a given period.