Insurance for Heart Attacks

Insurance for Heart Attacks and Hangnails

In comparing types of losses, for any probability of illness, the larger the expected loss, the larger the
gain from the insurance. We see this in Figure 11-1A by comparing the distances between the expected utility line and the utility curve for a small loss (line segment EA) and for a large loss (line segment BA). Segment EA shows a small distance; segment BA, a larger one. Hence, if Sara has equal probabilities of a hangnail (small loss) and a heart attack (large loss), the expected gain to her from insurance for heart attack coverage will exceed the gain for hangnail coverage. Consider now the insurers’ decisions in providing insurance. If the event is almost certain, the insurers’ costs of administering the policy may exceed the benefits to the consumers. In Figure 11-1B from B to C, it will not pay to insure claims because for the firms to earn profits they must charge marginal costs, which here exceed the expected consumers’ marginal benefits. Between points C and D expected marginal benefits exceed marginal costs. To the right of point D, again the marginal costs exceed the expected marginal benefits, and no insurance will be provided. As the diagram is drawn, no firm could afford to offer hangnail coverage.