The purpose of this simulation is to create a competitive market and to observe the market as it achieves equilibrium. In this experiment, you will experience real market forces. The same human traits and behaviors that govern real markets exist in the simulation. What are artificial are your surroundings. The market forces are real. 1

The Players and the Goals In this experiment, there are CONSUMERS and INSURERS. INSURERS sell INSURANCE. CONSUMERS buy FOOD and INSURANCE. 2

Consumers Each consumer has $20 to spend. A unit of food costs $1. 3 $20 The more food the consumer eats, the happier the consumer becomes.

Consumers: The Catch Each consumer faces some risk of badness. 4 vs. If badness befalls the consumer, the consumer loses all of the purchased food.

Consumers: The Insurance But, consumers can purchase insurance contracts from the insurance companies. 5 Each contract pays the consumer $1 if badness befalls that consumer. The consumer automatically buys food with the $1.

Consumers: Example Suppose a consumer can purchase insurance contracts at a price of $0.50 each (the price of food is always $1 each). 6 $20 Suppose that the consumer spends $5 on insurance contracts. The remaining $15 is automatically spent on food. 10 insurance contracts 15 food (Consumers may buy fractions of a unit of food.) $15$5

Consumers: Example If badness does not befall the consumer, the consumer eats 15 units of food and is very happy. 7 Very Happy !!

Consumers: Example If badness does befall the consumer, the 15 units of food disappear, each insurance contract pays $1. The consumer automatically buys food and the consumer is somewhat happy. 8 Somewhat Happy

Consumers Each consumer’s goal: Maximize happiness More insurance means  More food when badness befalls.  Less food when badness does not befall.  Too little insurance is bad. Too much insurance is also bad. 9

Insurers Each insurer can write as many insurance contracts as liked and charge any price. 10

Insurers If badness does not befall the consumer, the insurer walks away with the money the consumer paid for the contracts. 11 $$$ $$$

Insurers If badness does befall the consumer, the insurer pays the consumer $1 for each contract the insurer sold the consumer. 12

Insurers: Example Suppose an insurer sells Consumer A six contracts for $0.60 each, and sells Consumer B five contracts for $0.30 each. 13 The insurer collects $3.60 from Consumer A and $1.50 from Consumer B. $3.60 $1.50 $5.10 Revenue =

Insurers: Example Suppose badness befalls Consumer B but not Consumer A. 14 The insurer owes Consumer B $1 for each contract Consumer B purchased. $5.00 $5.10 Revenue = $5.00 Cost = $0.10 Profit =

Insurers: Example Suppose badness befalls Consumer A but not Consumer B. 15 The insurer owes Consumer A $1 for each contract Consumer A purchased. $6.00 $5.10 Revenue = $6.00 Cost = $0.90 Loss = (Insurers do not need cash reserves to cover policies.)

Insurers Each insurer’s goal: Maximize expected profit Insurers can ask whatever prices they like for contracts  Too low a price is bad. Too high a price is also bad. 16

17 Type 1 10% Badness There are five types of consumer. Each faces a different probability of badness. Type 2 20% Type 3 30% Type 4 40% Type 5 50%

The Objects 18 = insurance contract(s) = sales register

Contracts $4.80 Customer 6 purchases 12 contracts from insurer for $0.40 each. The total cost is the number of contracts multiplied by the agreed price per contract.

Register $ $3.60$1.20 The register is for your own use in tracking your expected costs. Feel free to cross out and re-enter information when your suspected risk for a consumer changes $4.80 $6.00-$1.20 Only give your agent one contract form at a time. Otherwise, you’ll likely miss recording sales.

The Mechanics 21 Agent InsurersConsumers Head Office $0.50 Prices are per contract. You may buy multiple contracts.

The Mechanics 22 Agent InsurersConsumers Head Office

The Mechanics 23 Agent InsurersConsumers Head Office Consumers: Keep track of how much you have spent. You need to save cash to buy food and you only have $20. Head Office: Keep track of your expected profits. Judge risk based on offer prices.

Risk Types 24

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Ready to begin… 26

27 Agent Head Office Head Office: Keep track of your expected profits. Consumers:Buy some insurance. All remaining money goes to food. Insurers:Sell insurance to maximize expected profit. Consumers: Keep track of your spending. You only have $20!

Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s) 28

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Mandated Insurance Concerned that some consumers do not have enough insurance coverage, the law stipulates that an insurer may not sell fewer than 50 contracts to a buyer unless the buyer has already purchased at least 50 contracts (from any insurer) this round. 31

Risk Types 32

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Ready to begin… 34

35 Agent Head Office Head Office: Keep track of your expected profits. Consumers:Buy some insurance. All remaining money goes to food. Insurers:Sell insurance to maximize profit. You may not sell a buyer fewer than 50 contracts. Consumers: Keep track of your spending. You only have $20!

36 Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s)

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Mandatory Insurance Concerned that some consumers do not have any insurance, the law requires that all consumers buy not less than 50 contracts this round. 39

Risk Types 40

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Ready to begin… 42

43 Agent Head Office Head Office: Keep track of your expected profits. Consumers:Buy some insurance. All remaining money goes to food. You must buy at least 50 contracts. Insurers:Sell insurance to maximize profit. Consumers: Keep track of your spending. You only have $20!

44 Accounting Phase Consumers report: Contracts purchased, cost, and from which insurer(s)

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Results… 47

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Forces lower risk people to consume quantities of goods that they may not want to consume. Transfers wealth from low risk to high risk people. A better solution is simply to tax the low risk people, give the money to the high risk people and let them buy what they want. 56 What is the effect of insurance mandates? (but what if they don’t buy insurance?)

But, we have to do something! Look at what has been happening to the cost of health care over time! 57

58 Source: Bureau of Labor Statistics ( Price of medical care has increased 349% since 1980 versus 135% for other consumer prices.

59 Source: Bureau of Labor Statistics ( Hospital services+ 576% Drugs and supplies+ 402% Physician services+ 282% Other consumer prices+ 135%

60 Source: Bureau of Labor Statistics (

61 Source: Bureau of Labor Statistics and Bureau of Economic Analysis ( Price Indices (1954=400) From 1954 to 2009, the cost of the Federal government (on a per person basis) rose 2800%. Over the same period, the cost of medical care rose only 2000%.

But, the cost of health care is only half of the picture. What has been happening to the quality of health care? 62

How do we measure the quality of health care? 1.What is “quality?” 63 2.How do we account for health care that has become routine but didn’t exist in the past (e.g., pre-natal care)? 3.How do we weigh qualities across different types of care (e.g., glasses vs. heart transplant)?

How does one measure the quality of health care? An easy and composite measure of the effectiveness of health care is the mortality rate. 64 Some health care may have little or no impact on the mortality rate (e.g., orthodonture). But, it is not unreasonable to assume that the qualities of other types of health care grow at similar rates.

65 Source: Statistical Abstract of the United States, 2008, Table 77. From 1960 to 2006, infant mortality fell 70%.

66 Source: Statistical Abstract of the United States, 2008, Table 110. Deaths by Influenza and Pneumonia (per 100,000 population) From 1960 to 2004, deaths due to influenza and pneumonia fell 60%.

67 Source: Statistical Abstract of the United States, 2008, Table 77. From 1960 to 2006, the mortality rate fell by 15%.

68 Source: Derived from Statistical Abstract of the United States, and the Bureau of Economic Analysis. What does increased cost of health care buy us? 400,000 lives saved annually

But, what about the uninsured? They aren’t sharing in this increased quality of health care. 69

70 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. The percentage of the population that is uninsured has remained stable over time.

71 Source: Bureau of Labor Statistics, Census Bureau (15% of the population) How many Americans are uninsured?

72 Source: Bureau of Labor Statistics, Census Bureau (12% of the population) How many Americans are uninsured?

73 Source: Bureau of Labor Statistics, Census Bureau (4% of the population) How many Americans are uninsured? If we count one-third of this group, the uninsured are between 6% and 8% of the population depending on whether or not we count this group.

74 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. The percentage of uninsured adults is highest among in the years of peak health.

75 Source: Income, Poverty, and Health Insurance Coverage in the U.S.: 2006, US Census Bureau. The growth in the uninsured is commensurate with the hypothesis that, as the price of health care rises, the more healthy willingly choose not to be insured.

A free choice to purchase is a vote, but with three important differences. Political vote:One size fits all. Free market vote:Multiple sizes for multiple recipients. Political vote:Speed of change is driven by the election cycle. Free market vote:Speed of change is driven by the accounting cycle. Political vote:Signal is distorted because the vote is for a “bundle” of issues embodied by one candidate. Free market vote:Signal is clear because the vote is for a specific issue. 76 Voting for the “right” amount of insurance

77 Can one place a value on a human life? (and, if yes, is it wrong to do so?) Yes, it is possible. No, it is not wrong to do so.  Almost everyone does it almost every day.

Example Installing and requiring children to use seatbelts on school buses will reduce the number of child travel deaths. But, it will cost (on average) $2.5 million for every child’s life we save.  Should we install seatbelts on school buses? The naïve response is: “Yes! You can’t put a value on a child’s life.” The correct response is: “What do we give up by spending money on seatbelts?”

Spend $2.5 million on:# Lives Saved Annually Seatbelts on school buses1 Airbags in cars3 Heart transplants13 Malaria prevention975 Midwife training in third world310,000 HIV tests for sex workers715,000