Introduction to Insurance

Flashcards covering the economic principles of insurance, including constitutional foundations, expected utility, adverse selection, and moral hazard.

Article I, Section 8, Clause 1

The clause of the U.S. Constitution granting Congress the Power to lay and collect Taxes, Duties, Imposts and Excises to pay Debts and provide for the common Defense and general Welfare.

Bailey v. Drexel Furniture Co. (1922)

A Supreme Court case that viewed the general Welfare clause as a limitation on power, ruling that Congress could not single out companies employing child labor for taxation.

South Dakota v. Dole (1987)

The Supreme Court case that codified the modern understanding of Congress’s expansive powers to promote the general welfare.

Concave Utility

A utility function where U'(c) > 0 and U''(c) < 0, meaning there are diminishing marginal returns to utility over consumption.

Expected Utility ($E[U]$)

The sum of utilities associated with each possible outcome $i$ weighted by the likelihood $q_i$ of that future occurring, formulated as E[U] = ext{\large$\sum_{i}$} q_i U(c_i).

Actuarial Fairness

A condition in competitive insurance markets where insurance companies make no economic profits, meaning the premium $p$ equals the expected benefit payout ($p - q_b b = 0$).

Adverse Selection

A process where, given set premiums, low-risk individuals decline to purchase insurance while high-risk individuals remain, leading to increased average costs and potential market collapse.

Harvard Death Spiral

A 1995 event where removing subsidies for a deluxe health plan caused healthy employees to leave, forcing the premium up for remaining sick participants until the plan folded.

Moral Hazard

Actions taken by individuals that affect outcomes after entering an agreement because they do not bear the full consequences, such as reduced precautions against adverse events.

Economies of Scale in Insurance

The efficiency gained by large insurers; for example, Medicare administrative costs are less than $2\%$ of claims, while private insurance averages about $12\%$.

Medicaid

An insurance program that is jointly funded by federal and state governments but administered at the state level.

Unemployment Insurance

An insurance program mostly administered at the state level with some federal funding and guidance.

Consumption Smoothing

The practice of using insurance to translate consumption from a high-earning state to a low-earning state so that consumption remains the same in both futures.

Negative Externalities of Uninsurance

Costs imposed on society when individuals lack insurance, such as the spread of untreated infectious diseases.

Mandate

A requirement for individuals to carry insurance, used to prevent adverse selection death spirals by requiring the healthy to subsidize the sick.