Comm 323 Risk, Insurance & Financial Plannin.docx

Comm
323
Risk,
Insurance
&
Financial
Planning
Assignment
#2
Case
Studies
1)
Planning
for
the
future
Mary and Peter are 21 and just starting grad school. When they
emerge two years hence as
software engineers, they plan to marry and buy a small house or
condo, and a car.
In the meantime, they are living together and bringing in a
combined $75,000 a year from
scholarships, research grants and work, he is a research
assistant, and she is a teaching assistant.
When they graduate, they expect to earn a starting salary of

$55,000 each.
What distinguishes them from many other 21-year-old students
is that they have $60,000 in the
bank, savings Mary set aside from working during her
undergraduate years. This year and next,
they will each contribute $5,000 to their tax-free savings
accounts. When they start working,
they plan to live on one salary and take full advantage of the
registered retirement savings plan.
They plan a simple wedding costing about $4,000 followed by a
“shoestring” trip to Europe for
$4,000 or $5,000.
Mary wants to put her savings to work for the next few years
“so that I will have enough money
to deal with the expenses of becoming an adult, whatever they
may be and if they decide to have
children” she writes in an e-mail.
We asked a financial planner/advisor what the analysis and
recommendations are for the two
entering grad school.
Mary and Peter plan to draw on their savings in two or three
years – perhaps to tide them over
until they find work, to cover the cost of moving to a new city,
to buy a car or some furniture or
even as a down payment for their home.
First, the investment question; with such a short time horizon,
what should they do with their
funds?
How should they invest in the longer term for retirement once

they are established in their
careers?
Mary and Peter figure they’ll have to pay about $240,000 for a
small house or condo, preferably
in their hometown of Halifax if they can find work there.
Estimate their monthly mortgage
payments with $20,000 down, 5-per-cent interest and a 25-year
amortization pay back period.
If they work for a while before they buy, as they plan, they can
stash away some money in their
RRSPs.
They will have additional costs for insurance, utilities,
maintenance and property taxes, so their
living expenses will be higher. What other financial
considerations do they have with plans for
children?
-------------------
The People: Mary and Peter, both 21
The Problem: How to invest $60,000 in savings and set finances
on course for marriage, careers
and the purchase of a home.
The Plan:
The Payoff: Lifelong financial security and the peace of mind it
brings.
Monthly net income: $4,500

Assets: Bank accounts $15,000; GICs and term deposits
$42,000; TFSA (mutual funds) $5,000.
Total: $62,000.
Monthly Disbursements: Groceries, dining out $600; clothing
$50; medical, drugs, dental $50;
rent $1,100; telecom, TV $110; furniture, appliances $50;
entertainment $50; tuition $1,260; bus
$20; gifts $20; miscellaneous $100. Total: $3,410. Savings
Capacity: $1,090.
Liabilities: None
2)
Planning
for
House
and
Baby
Danielle and Brad haven’t been married a year and already
they’re on sound financial footing.
They each owned a condo in downtown Vancouver, so when
they moved in together, they sold
one and paid off the mortgage on the other. Now they own their
$310,000 apartment outright.
Brad, 37, earns a little more than $60,000, Danielle, who is 34,
earns about $55,000. They both
work in the media.
Like most people their age, they have great plans.

“We want to have a comfortable life, be able to afford to raise
our children properly, save for
their education, move up from our condo to a house in
Vancouver and have enough money to
retire at 60 with a vacation property,” Danielle writes in an e-
mail.
Their short-term plans are to have children and buy a house to
live in that can also generate some
rental income. Danielle also hopes to quit her job and go
freelance (self employed) in the next
two to three years.
We asked a financial planner to look at this young couple’s
situation.
Danielle and Brad are currently saving about $675 a month
outside of their company savings and
pension plans after expenses. What are the challenges in
meeting the financial goals given their
financial resources and plans?
The couple’s search for ways to generate an income stream,
either by renting their condo when
they buy a house or renting out part of the house, would involve
taking on more debt.
Another income source is their company savings and pension
plans. Brad’s employer matches
his stock purchase savings plan contributions by 50 per cent,
making for a “pretty nice return,”
“It’s like buying a GIC [guaranteed investment certificate]
paying 50 per cent interest.”

“When evaluating the guaranteed investment return from a
defined benefit pension, the rates are
often quite compelling.” Both Brad and Danielle currently have
defined benefits pension plans.
What are financial implications if Danielle decides to work
freelance instead of employed with a
company?
Looking further into the future, Danielle and Brad are on track
to retire in their early 60s –
“assuming they continue to live in their current condo.” If they
buy a house, how will this
potentially change and what will they need to do to retire as
planned?
Client Situation
The People: Danielle, 34, and Brad, 37
The Problem: How to start a family, buy a house in Vancouver
and save for the
children’s education without running into cash flow problems.
The Plan:
The Payoff: Achieving at least most of their goals and
ultimately, financial security.
Monthly net
income:
$7,338.61
Assets: Bank accounts $12,700; Tax-Free Savings Account
$14,101, mutual funds

$33,725; company stock $3,500; condo $310,000: Total
$374,026.
Monthly
disbursements:
Union dues $70.65; savings $675; RRSP $375; employer
savings plan $472;
employer pension plans $395.08; food and eating out $1,150;
clothing $460;
medical, drugs, dental $10; dog $150; storage locker $160; gym
$53; property
taxes, utilities, condo fees $570; house insurance $20;
telephone, cable,
Internet, cellphone $237; painting, repairs and maintenance
$120; furniture
and appliances $500; vacations $500; entertainment, music,
books $150; auto
expenses $550; other transportation $200; life insurance $38.86;
group
insurance, disability, dental $145.75; donations $20.83; gifts
$200. Total:
$7,223.17
Liabilities: None
3)
Managing
Goals
and
Priorities

At 23 and fresh out of university, Katheryn has the world by the
tail. She’s just started her first
full-time job, in Edmonton, and already she has $5,000 in
mutual funds, $4,000 in a tax-free
savings account and $10,000 to invest.
Before starting her new job, she had been working at two part-
time jobs and saving money.
Like most young people, Katheryn has grand ambitions. First,
she wants to buy a car, travel, and
build an investment portfolio. Over three years, she aims to
save three years’ worth of living
expenses plus tuition so she can get her MBA.
That’s just the beginning.
In four years, she wants to buy a house, which she will rent out
while she is studying, and live in
later. Over four to eight years, she hopes to accumulate a large,
diversified investment portfolio.
Then she plans to buy a second property for rental.
Katheryn figures she’ll be earning $80,000 a year to start when
she gets her MBA.
Can she do it all?
We ask a senior financial adviser to take a look at Katheryn’s
situation.
Because Katheryn clearly is eager to become a successful
investor, she might want to start by
taking an investment course and reading up on personal finance
or taking the Canadian Securities

Course, offered by the Canadian Securities Institute.
“It’s great to see a young person caring about their finances.
Often, this line of thinking doesn’t
occur until age 35 when a baby is on the way. My overall tip to
a young person out of school is
to get knowledgeable about financial planning and investing.”
Katheryn’s desire to start saving now for her many goals is
“noble,” “but I am concerned that she
is biting off more than she can chew.”
What and how should she invest her funds in given her goals,
priorities and timelines?
Client situation
The Person: Katheryn, 23
The Problem: How to save for grad school, buy a car, travel,
buy a house and build an investment portfolio all in the next
few years.
The Plan:
The Payoff: Successfully achieving the most important goals,
one by one.
Monthly net
income: About $4,200.
Assets: Bank accounts $13,150; TFSA $4,000; mutual funds
$5,000. Total $22,150.
Monthly

disbursements:
Food and eating out $250; clothing $100; medical, drugs, dental
$50;
miscellaneous $300; rent $750; telephone, cable, Internet $60;
replacement of
furniture, appliances $50; vacations $200; entertainment, music,
books $20;
transportation $60; donations $20; gifts $20. Total: $1,880.
Monthly saving
capacity: $2,320.
Liabilities: None
4)
Life
After
University
Carmen and John admit that while they're “book-smart” – they
have six degrees between them –
they lack even a basic understanding of money and investing.
Carmen, 28, is a librarian. “I just graduated in April and for the
first time have a real job making
enough money to cover the bills,” she writes in an e-mail. John,
31, is working on his PhD in
archaeology, living on government grants and university
scholarships.
“We would both really appreciate some advice on how to start
saving and investing money now

that we both pull in a salary and our student loans are almost
paid off,” Carmen writes. Their
goals include buying a house, starting a family and landing a
professorship for John after he
graduates next year. “We aren't sure where to start.” We asked
an adviser at a financial planning
and investment counsel firm.
Carmen and John should be proud of their accomplishments.
“Many people in their situation,
with such a long pursuit of post-secondary education, would
still be burdened with huge student
loans, car loans, credit card balances for many years.”
Carmen estimates their savings capacity at $2,100 a month,
about a third of their net income.
The main obstacle to planning at this point is the couple's
uncertain future. When John graduates,
he will look for a teaching job, which could take him anywhere.
Carmen and John have been investing some of their savings in
stock mutual funds. Is this
appropriate given purpose and timelines?
If they move, Carmen will have to give up her job. Indeed, they
may have to move more than
once if John has to take short-term teaching jobs before he lands
a permanent post.
Their target house price is up to $300,000 some time in the next
two or three years. How should
they plan for this home purchase with 10 percent down
payment? Assuming 5% interest rate and
25-year amortization, what is their approximate monthly

mortgage payment? How much are
monthly payments with 20% down?
Carmen and John face a number of challenges. When they move,
Carmen will have to give up
her secure government job with its pension and benefits. It may
take time for her to find another
job in a new city and she may have to settle for less income.
How will this affect their plan for
home purchase?
Starting a family, another of their near-term goals, will add to
the challenges – “and of course the
rewards” – because Carmen will likely take time off for
maternity leave.
Carmen wonders if they are saving enough for retirement.
Client Situation
The People: Carmen, 28, and John, 31
The Problem:
How to allocate their money given that Carmen has graduated
and has her
first job, John may have to move to find work, and they have
long-term plans
to buy a home and raise a family.
The Plan:

The Payoff: Peace of mind and financial stability in face of an
uncertain but bright future.
Monthly after-
tax income:
$6,300
Assets: $11,020; tax-free savings account $10,015; mutual
funds $22,500. Total: $43,535
Monthly
disbursements:
Food and eating out $500; clothing $200; haircuts, cosmetics
$25;
miscellaneous $485; rent $1,348; tenants' insurance $22;
utilities, phone,
cable, Internet $125; vacations and other travel $975;
entertainment $300;
books and magazines $20; public transit $30; donations $20;
gifts $50; pet
care $100 Total: $4,200. Savings Capacity: $2,100
Liabilities: None
5)
Time
to
Rethink
Retirement
strategy

Harry and Sally are in the enviable position of working for
themselves as employees of their own
corporation.
They’ve been successful, amassing $1.8-million in investments.
Their Vancouver home is valued
at $500,000.
Even so, their goals differ little from those of other working
people. They want to retire early –
in their case in two or three years – work part-time, fix up their
house a bit and arrange things so
they can live comfortably from their investments for the rest of
their lives. He’s 59, she’s 53.
They have no children, so they hope to leave a financial legacy
to their favourite charities.
They invest through a discount stockbroker in individual stocks
and keep a cash reserve of 10 per
cent to 25 per cent of their portfolio. They’ve done well,
chalking up a return of 8.5 per cent a
year over the past dozen or so years.
“Therefore, I hope to compound 8 per cent, including inflation,
in retirement,” Harry writes in an
e-mail. They figure they’ll need about $100,000 a year after tax
when they retire because they
expect to spend about the same amount of money then as they
do now. “We would appreciate
feedback about our budget and plan.”
Harry fancies himself a good stock-picker, the couple’s
portfolio is risky and poorly diversified

among asset classes.
“They have 84 per cent in equities with the balance in cash.”
Nearly 40 per cent of the stocks are
in small-capitalization companies, many of them penny stocks.
Roughly 40 per cent of the
portfolio is in the industrial sector, which comprises only 8 per
cent of the S&P/TSX composite
index.
Part of the problem is that Harry believes they need to earn an
average annual return of 8 per
cent to meet their spending goals. In truth, they can likely get
by with a return of 5 per cent
because they will spend less when they are retired than they do
now. What should they do?
As well, an 8-per-cent return is very difficult to achieve year in
and year out.
“It is very easy to plug a higher return into a financial plan; it is
considerably more difficult to
achieve it.”
What options are available to the couple in seeking professional
investment advisors?
Finally, $480,000 of their capital is held in their jointly owned
corporation, which will become a
holding company when they retire.
They “should speak to an insurance agent about the possibility
of using corporate-owned
insurance to reduce the tax bite that will be triggered as this
money comes out of the company
and is spent by the surviving spouse.”

Client situation
The People: Harry, 59, Sally, 53
The Problem: How to retire in two or three years with enough
money from their savings to
live comfortably for the rest of their lives and leave a financial
legacy to
charity.
The Plan: Because they rely almost solely on their investments,
they should shift their
portfolio from high risk to one that focuses on preserving their
capital and cut
their spending if necessary.
The Payoff: Financial security and a legacy.
Monthly net
income:
$7,200.
Assets: Home $500,000; non-registered stock portfolio
$730,000; registered
investment portfolio $850,000; cash in investment accounts
$240,000. Total
$2.32-million.
Monthly
disbursements:
Food and eating out $1,000; clothing $200; medical, drugs,

dental $400; pets
$150; personal allowance $350; miscellaneous $400; property
taxes $320;
house insurance $70; heating, hydro, water $325; telephone,
cable, Internet,
cellphone $350; painting, repair and maintenance $200;
replacement of
furniture, appliances $150; vacations $1,800; entertainment,
music, books
$450; auto expenses $400; subway, bus $85; donations $300;
gifts $250. Total
$7,200.
Liabilities: None.
Case StudiesCase Studies
TRACKING THE U.S. ECONOMY
Case Study 6.1: GDP and The State of the USA
GDP estimates have been refi ned for decades and are arguably
the most complex data aggregation effort in the
world. But they have their limits, as discussed already, and they
have their critics. One criticism is that GDP leaves
out much of what’s going on in the nation—with health care, the
environment, the family, energy use, and so on.

One challenge to GDP as the primary indicator of national
progress is coming from a nonprofi t group that has
developed a Web site to bring together hundreds of indicators.
The idea is to help Americans assess the progress of
the United States by using quality data selected by experts.
First, a little background. In 2003, a team at the U.S.
Government Accountability Offi ce, the investigative arm of
Congress, was looking for
alternatives to GDP to assess national progress. The team
became an independent nonprofi t agency in 2007 and took the
name “The State
of the USA.” With startup funding from the Gates, Hewlett,
MacArthur, and Rockefeller foundations, the group set out to
identify data that
would amount to a report card on how the country is doing in
specifi c areas—such as health care, education, the
environment, safety, energy,
transportation, the economy, the family, and so forth. The goal
is to help citizens and leaders assess what progress has been
made and where
we need to improve.
The effort got a big boost from a small provision in the massive
2010 health care bill that requires Congress to help fi nance and
oversee
a “key national indicator system.” State of the USA will become
that system, overseen by the National Academy of Sciences, a

group of pre-
eminent scholars established by Abraham Lincoln in 1863 to
“investigate, examine, experiment, and report upon any subject
of science or art”
whenever called upon to do so by any department of the
government (half the 20 economists in the National Academy
are Nobel laureates).
Along with the federal authorization came federal funding
totaling $70 million between 2010 and 2018.
The objective is not so much to replace GDP as the primary
measure of economic performance, but to broaden the
conversation and the
debate by including many more data series. Instead of just
having one gauge on the dashboard, GDP, there would be many
gauges. The State
of the USA Web site went live in 2010, and is accessible for
free. Eventually, The State of the USA plans to offer about 300
indicators. Rather
than develop original data, the site compiles and displays data
gathered by others. Despite the number of data series, the group
says the site
will be selective, not encyclopedic. For example, in health care
alone the government collects about 1,000 different measures.
The State of
the USA offers what they claim are the 20 most crucial health
care measures. The group says its objective is not to interpret
the data but to

disseminate it in a strictly nonpartisan manner.
The idea is to offer data in a form that can be easily shared to
promote as wide a distribution as possible. Data will be
available on the
national level, state level, and as far down the jurisdictional
chain as possible. For example, one of the 20 health care
measures reports smok-
ing rates by state (West Virginia is the highest and Utah is the
lowest). The State of the USA will also offer a variety of
interactive features to
encourage exploration, such as motion charts with audio
tutorials focusing on health costs and outcomes for the
developed world. Check out
the site and see what you think.
SOURCES: Jon Gertner, “The Rise and Fall of the G.D.P.” New
York Times, 10 May 2010; and The State of the USA site at
http://www.stateoftheusa.org/.
QUESTION
1. Is The State of the USA designed to replace GDP as the
primary measure of economic performance?
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Case Study 6.2: Price Check on Aisle 2
The U.S. economy is one of the most dynamic in the world,
marked by rapid technological change. The Bureau of Labor
Statistics (BLS), the
government agency that calculates the CPI each month, employs
dozens of economists to analyze the impact of any quality
changes to prod-
ucts in the CPI market basket. Each month 400 data collectors
visit stores to record about 85,000 prices for 211 item
categories in the CPI
basket. About a week before the CPI is released, the BLS offi ce
is locked down with bright red “restricted area” signs on all the
doors. A total of
90 people, including product specialists and the other
economists working on the CPI, compute the basic indexes in
each category. Results are
released at 8:30 A.M., Eastern Time, about two weeks after the
end of the month in question. This release is a big deal.
Most price adjustments are straightforward. For example, if a
candy bar shrinks 10 percent but still sells for the same price,
the CPI shows
this as a 10 percent price increase. But sometimes a product
changed in a more complicated way. Economists at BLS
specialize in particular
products, such as televisions, automobiles, kitchen appliances,
and so on. One of their greatest challenges is to identify
substitutes for products

that are no longer available on the market. For example, data
collectors fi nd the model of TV they priced the previous month
is missing about
one-fi fth of the time. When a particular product is missing, a
four-page checklist of features such as screen size and the type
of remote control
guides the data collector to the nearest comparable model. That
price is reported and the product specialist in Washington must
then decide
whether it’s an acceptable substitute.
For example, the TV specialist decided that the newer version
of the 27-inch model had some important improvements,
including a fl at
screen. A complex computer model estimated that the
improvements alone would be valued by consumers as worth
$135 more. After factoring
improvements into the price of the $330 set, the analyst
determined that the price of the TV had actually declined 29
percent [= 135/(330 +
135)]. In another example, the price of a 57-inch TV dropped
from $2,239 to $1,910, for an apparent decline of 15 percent.
But on closer
inspection, the analyst found that the new model lacked an
HDTV tuner that had been included in the model it replaced.
This tuner would be
valued by consumers at $514. So, instead of declining 15
percent, the price of the 57-inch TV actually rose 11 percent [=

1,910/(2,239 – 514)].
The TV analyst is applying the hedonic method, which breaks
down the item under consideration into its characteristics, and
then estimates
the dollar value of each characteristic. This is a way of
capturing the impact of a change in product quality on any price
change. Otherwise,
price changes would not refl ect the fact that consumers are
getting more or less for their money as product features change
over time.
SOURCES: Jon Hilsenrath, “A Deeper Look at the Fed’s Infl
ation Debate,” Wall Street Journal, 5 April 2010; Javier
Hernandez, “Prices of Consumer Goods Hold Steady, Indicating
That Infl ation Is at Bay,” New York Times, 18 March 2010;
and Mary Kokoski, Keith Waehrer, and Patricia Rosaklis,
“Using Hedonic Methods for Quality Adjustment in the CPI,”
U.S.
Bureau of Labor Statistics Working Paper (2000) found at
http://www.bls.gov/cpi/cpiaudio.htm.
QUESTION
1. What is the hedonic method and why is it sometimes used to
track changes in the consumer price index?
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Case StudiesCase Studies
CONSUMER CHOICE AND DEMAND

Case 6.1: Water, Water, Everywhere
Centuries ago, economists puzzled over the price of diamonds
relative to the price of water. Diamonds are mere
bling—certainly not a necessity of life in any sense. Water is
essential to life and has hundreds of valuable uses.
Yet diamonds are expensive, while water is cheap. For example,
the $10,000 spent on a high-quality one-carat
diamond could buy about 10,000 bottles of water or about 2.8
million gallons of municipally supplied water (which
sells for about 35 cents per 100 gallons in New York City).
However measured, diamonds are extremely expensive
relative to water. For the price of a one-carat diamond, you
could buy enough water to last two lifetimes.
How can something as useful as water cost so much less than
something of such limited use as diamonds? In 1776, Adam
Smith dis-
cussed what has come to be called the diamonds-water paradox.
Because water is essential to life, the total utility derived from
water greatly
exceeds the total utility derived from diamonds. Yet the market
value of a good is based not on its total utility but on what
consumers are willing
and able to pay for an additional unit—that is, on its marginal
utility. Because water is so abundant in nature, we consume it to
the point where

the marginal utility of the last gallon purchased is relatively
low. Because diamonds are relatively scarce compared to water,
the marginal utility
of the last diamond purchased is relatively high. Thus, water is
cheap and diamonds expensive. As Ben Franklin said “We will
only know the
worth of water when the well is dry.”
Speaking of water, sales of bottled water are growing faster
than any other beverage category—creating a $15 billion U.S.
industry, an
average of 25 gallons per person in 2010. Bottled water ranks
behind only soft drinks in sales, outselling coffee,milk, and
beer. The United
States offers the world’s largest market for bottled water—
importing water from places such as Italy,France, Sweden,
Wales, even Fiji. “Water
bars” in cities such as Newport, Rhode Island, and San
Francisco feature bottled water as the main attraction. A 9-
ounce bottle of Evian water
costs$1.49. That amounts to $21.19 per gallon, or nearly 10
times
more than gasoline. Youthink that’s pricey? Bling H
2
O is available in
bottles decorated with Swarovski crystals and sells for more
than $50

a bottle—that’s about 100 times more than gasoline.
Why would consumers pay a premium for bottled water when
water from the tap costs virtually nothing? After all, some
bottled water
comes from municipal taps (for example, New York City water
is also
bottled and sold under the brand name Tap’dNY). First, many
people
do not view the two as good substitutes. Some people have
concerns
about the safety of tap water, and they consider bottled water a
healthy alternative (about half those surveyed in a Gallup Poll
said they
won’t drink water straight from the tap). Second, even those
who drink
tap water fi nd bottled water a convenient option away from
home.
And third, some bottled water is now lightly fl avored or fortifi
ed with
vitamins. People who buy bottled water apparently feel the
additional benefi t offsets the additional cost.
Fast-food restaurants now offer bottled water as a healthy
alternative to soft drinks. Soft-drink sales have been declining

for more than a
decade as bottled water sales have climbed. But if you can’t fi
ght ’em, join ’em: Pepsi’s Aquafi na is the top-selling bottled
water in America,
and Coke’s Dasani ranks second.
SOURCES: Dana Cimilluca et al., “Coke Near Deal for
Bottler,” Wall Street Journal, 25 February 2010; Jack Healy,
“Five-cent Deposits Set for Bottled Water,” New York Times,
24 October 2009; and Charles Duhigg, “That Tap Water Is Legal
But May Be Unhealthy,” New York Times, 16 December 2009.
The Defi nitive Bottled Water site is http://www.
bottledwaterweb.com/,and the New York City drinking water
department is at
http://www.nyc.gov/html/dep/html/drinking_water/index.shtml.
QUESTIONS
1. What is the diamonds-water paradox, and how is it
explained?
2. Use the same reasoning as in question 1 to explain why
bottled water costs so much more than tap water.
3. If consumers paid an amount for water that refl ected the
value of the total benefi ts they receive from consuming it, then
what would
consumer surplus equal?
6
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Case 6.2: The Marginal Value of Free Medical Care
Certain Americans, such as the elderly and those on welfare,
receive government-subsidized medical care. State and federal
taxpayers spend
more than $750 billion a year providing medical care to 94
million Medicare and Medicaid recipients, or more than $8,000
per benefi ciary.
Medicaid is the large stand fastest growing spending category in
most state budgets. Benefi ciaries pay only a tiny share of
Medicaid costs;
most services are free.
The problem with giving something away is that a benefi ciary
consumes it to the point where the marginal value reaches zero,
although
the marginal cost to taxpayers can be sizable. This is not to say
that people derive no benefi t from these programs. Although
benefi ciaries may
attach little or no value to the fi nal unit consumed, they likely
derive a substantial consumer surplus from all the other units
they consume. For
example, suppose that the fi gure below represents the demand
for health care by Medicaid benefi ciaries. If the price they face
is zero, each
benefi ciary consumes health care to the point where the
demand curve intersects the horizontal axis—that is, where his

or her marginal valu-
ation is zero. Although they attach little or no value to their fi
nal unit of Medicaid-funded health care, their consumer surplus
is the entire area
under the demand curve.
One way to reduce the cost to taxpayers without signifi cantly
harming benefi ciaries is to charge a token amount—say, $1 per
doctor visit.
Benefi ciaries would eliminate visits they value less than $1.
This practice would yield signifi cant savings to taxpayers but
would still leave
benefi ciaries with abundant health care and a substantial
consumer surplus (measured in the fi gure below as the area
under the demand curve
but above the $1 price). In a Medicaid experiment in California,
this $1 charge reduced offi ce visits by 8 percent compared to
the control group.
Medical care, like other goods and services, is also sensitive to
its time cost. For example, a 10 percent increase in the average
travel time to a
free outpatient clinic reduced visits by 10 percent. Similarly,
when the relocation of a free health clinic at one college
increased students’ aver-
age walking time by 10 minutes, visits dropped 40 percent.
Another problem with giving something away is that benefi
ciaries

are less vigilant about getting honest value, and this may
increase
the possibility of waste, fraud, and abuse. According to
President
Obama, “improper payments” for Medicaid and Medicare cost
taxpayers nearly $100 billion in 2009. Medicaid fraud has
replaced
illegal drugs as the top crime in Florida. Crooks were charging
the
government for medical supplies that were not delivered or not
needed (some supposed benefi ciaries were dead). People won’t
tol-
erate padded bills and fake claims if they have to pay their own
bills.
Finally, program benefi ciaries have less incentive to pursue
healthy behaviors themselves in their diet, their exercise, and
the
like. This doesn’t necessarily mean certain groups don’t deserve
heavily subsidized medical care. The point is that when
something
is free, people consume it until their marginal value is zero,
they pay

less attention to getting honest value, and they take less
personal
responsibility for their own health.
Some Medicare benefi ciaries visit one or more medical
specialists most days of the week. Does all this medical
attention improve their
health care? Not according to a long running Dartmouth
Medical School study. Researchers there found no apparent
medical benefi t and even
some harm from such overuse. Even a modest money cost or
time cost would reduce utilization, yet would still leave benefi
ciaries with quality
health care and a substantial consumer surplus. Research
suggests that up to 30 percent of all medical care is
unnecessary.
Federal legislation in 2010 expanded the coverage of Medicaid
and extended insurance coverage to many without it. Research
by Michael
Anderson and others suggests that one result will be a
“substantial increase in care provided to currently uninsured
individuals.” No question,
better health care can improve the quality of life, but overusing
a service because the price is zero also wastes scarce resources.
SOURCES: Michael Anderson, Carlos Dobkin, and Tal Gross,
“The Effects of Health Insurance Coverage on the Use of
Medical Services,” NBER Working Paper 15823 (March 2010);
David Card, Carlos Dobkin, and Nicole Maestras, “The Impact

of Nearly Universal Insurance Coverage on Health Care
Utilization,” American Economic Review, 98 (December2008):
2242–2258; Elliot Fisher et al., “The Implications of Regional
Variation in Medicare Spending,” Annals of Internal Medicine,
18 February 2003; Gina Kolata, “Law May Do Little
to Help Curb Unnecessary Care,” New York Times, 29 March
2010; and Steven Rhoads, “Marginalism,” in The Fortune
Encyclopedia of Economics, edited by D. R. Henderson
(New York: Warner, 1993): 31–33. A transcript of President
Obama’s remarks about ‘improper payments’ is at
http://www.whitehouse.gov/the-press-offi ce/remarks-president-
health-insurance-reform-st-charles-mo. For more on Medicare
and Medicaid, go to http://www.cms.hhs.gov/.
QUESTIONS
1. Medicare recipients pay a monthly premium for coverage,
must meet an annual deductible, and have a co-payment for
doctors’ offi ce
visits. What impact would an increase in the monthly premium
have on their consumer surplus? What would be the impact of a
reduction
in co-payments?
2. President George W. Bush introduced some new coverage for
prescription medications. What is the impact on consumer
surplus of offering
some coverage for prescription medication?
P
ri
c
e

p
e
r
u
n
it
$2
1
0 Quantity per period
D
Market Demand and Consumer Surplus
22212_CS_01-43.indd 1322212_CS_01-43.indd 13 11/11/11
7:57 PM11/11/11 7:57 PM
COURSE TITLE: RISK, INSURANCE AND FINANCIAL
PLANNING
COURSE NUMBER: COMM 323-3
SEMESTER: January 2013
INSTRUCTOR: Patrick Barrette
E-MAIL: [email protected]
Assignment #2 (25% of final grade)
Assignment is Due March 21th, 2013
Students have the option of working with (two) group members

in completing the assignment and handing in one assignment
with all names on the front cover page.
There are 5 cases with direct questions included in the cases, be
sure to answer questions and address any issues, goals or
objectives included in the case and provide recommendations
and present relevant options/alternatives that are applicable to
the case. The case studies are intended to cover concepts
reviewed in Chapters 1 through 10, not all chapters are
applicable to each case.
Each case analysis and recommendations should be a half to full
page in length at most.
A sample case “School & home Plans” has been provided to
give illustration of the issues and recommendation made to the
case.

Comm 323 Risk, Insurance & Financial Plannin.docx

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