You have been hired by an insurance company to help them launch a new product which would pay for long-term care in a nursing home for people at an average cost of $150,000/year. Among 90% of the population, there is a 1% chance of going into a nursing home in the next year but for 10% of the population, people with chronic conditions or over age 80, there is a 10% chance of going into a home. Assume that people live two years, the current year and the next, and you buy the policy this year and either use it or not next year.

a) If you were able to sell this to the entire population, what is the fair market value of this policy? (That is to say, what is the expected value of the policy to the average person?) What is the fair market price if you marketed the policy exclusively to people with chronic conditions and those over age 80.

b) Who would you expect would buy your policy if you offered it at the fair market price for the whole population? Will you be able to make profits offering it at this price to anyone who wants the policy?

c) What alternative strategies could you offer the company to make profits selling long-term insurance market? Think about moral hazard and adverse selection and how these affect your markets. Would you expect markets with moral hazard and adverse selection to provide the optimal amount of long-term care insurance at an efficient price?