Question

In automobile collision insurance and health insurance, the policy usually has a provision calling for a deductible according to which the portion of any insured loss up to some fixed limit is payed for by the insured person; only the excess is paid by the insurance company. In addition, health insurance policies often provide for co-payments by the insured so that even after the deductible is met, the insured pays some fraction or fixed amount of the medical costs until some maximum "stop loss" amount is satisfied. (a) What economic function do deductible and copayment provisions serve? (b) Why do we see deductibles but not copayments used in auto collision insurance? 3.

Answer 1

Solution

Deductibles and Co-payments are usually implemented by the various insurance companies for different purposes:

1.Reduction in premiums : Due to co-payments and / or deductibles,the amount of payout reduce resulting in comparitively lower premiums to be paid by the insured.

2.Morale Hazard : In lay-man terms,the term "Moral Hazard" is phenomena where the insured will be negligent / less careful as he/she is already covered by an insurance policy.

So,if deductibles and /or co-payments are introduced,this type of behaviour (moral hazard) of an insured can be mitigated.

By definition,Insurance is a process in which the risk of the insured is transferred to another party / company (insurer) in return for a payment (on regular intervals of time) by the insured to the insurer.

Insurance is just covering one-self against the potential loss occurring in unforseen situations but it is not an investment.

3.Measure of financial stability of the insurer : The insurance companies can make use of these deductibles and co-payments to ensure the measure of financial stability on their part

They act as a cushion between any given minimal loss and true loss that allows the insurer / insurance company to administer it's policy.

(b) There are deductibles used in auto collision insurance but not co-payments:

Deductibles are part of any kind of insurance policy be it health -insurance,medical insurance,auto insurance,etc.,

These deductibles are the costs that need to be paid to the insurance companies even before they start covering the insured with their policy.These are like some kind of administrative / operational charges required for the policy to come into effect.

Co-payments are fixed amounts that are needed to payed by the insured.The remaining loss will be covered by the insurer according to the plan coverage opted by the insured.

In Auto Collision,there will not be co-payments because this concept of co-payments is introduced to mitigate the moral hazard behavior of the insured and to bring out ethical behavior in the insured.In case of a Auto insurance,there will not be any situation where an insured will risk his life in order to get the insured amount.According to human psychology,any human treats his/her life with at-most importance than money and will not risk his/her life voluntarily for the sake of money.

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