Transcript Health Insurance October 19, 2006 Insurance is defined as a means of protecting against risk. Risk is a state in which multiple outcomes are possible.

Health Insurance
October 19, 2006
Insurance is defined as a means of protecting
against risk.
Risk is a state in which multiple outcomes are
possible and the likelihood of each possible
outcome is known or can be estimated.
Key behind insurance: means of
protecting against risk.
The Market for Health Insurance
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It’s impossible to determine whether one particular
individual will suffer from a medical condition, such
as a heart attack or stroke.
When individuals are combined into large enough
groups, or risk pools, the probability that someone in
the group will suffer from a heart attack or stroke
can be estimated.
The estimated probability of an event is based on the
historical frequency of the event occurring in the
past. The larger the group, the greater the accuracy
of the prediction.
Market for Health Insurance (con.)
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Experience rating: Basing health insurance
premiums on the utilization experience of a specific
insured group. Premiums may vary by age, sex, or
other risk factors and are often taken into
consideration prior to use of medical services.
Community rating: Basing health insurance
premiums on the health care utilization of the entire
population of a specific geographic area. Premiums
are the same for all individuals regardless of age,
sex, risk, or prior use of health care services.
Indemnity insurance:
Reimbursement for certain expenditure
 Higher risk persons pay higher premiums
(Key idea here the insurance is based on
the principle that someone suffering an
economic loss receives a payment
approximately equal to the size of the
loss.)
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United States:
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Mostly group insurance
with the same rates within groups
(varying by size of family)
Rates reflect expected rate of use of the
medical system.
Group rates vary depending on past
claims.
Experience rating across groups
Community rating within groups
Social insurance:
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Basis of all government redistribution
programs
Financed by tax revenues
Available to all persons regardless of
ability to pay
Examples in the U.S. are Medicare and
Medicaid
Health Insurance and Market
Failure
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The dominant feature of U.S. medical
market place is the reliance on the third
party payment mechanism.
The tax subsidy to insurance has shaped
the market for medical health insurance.
The subsidy is estimated to be over $100
billion.
Information problems
Economics of Moral Hazard
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When writing contracts and there is a difference
in information between the parties to the
contract. All contracts involve expectations about
future behavior.
One party cannot monitor the other party’s
behavior.
Exploiting the informational problems leads to an
increased probability of use and increased
expenditures given use.
Keep in mind consumers are viewed as weighing
Moral Hazard
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The fact a person has insurance coverage
increases the expected health expenditures.
Having insurance
1. increases the likelihood of purchasing
medical services.
2. induces higher expenditures in the event of
an illness.
Moral Hazard
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These information problems affect the
structure of insurance contracts. The person
with insurance recognizes that the service is
“sale priced.” ($0.10 to $0.20 on the $1)
Adverse Selection
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arises because consumers have more
information about expected medical
expenditures than do insurance
companies
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The ability of prospective insurance
customers to conceal their true risks can
result in some insurance groups having a
disproportionate number of high users.
Example: assume people within a
particular group have the same risk
preferences.
Low risk group, self insured:
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4% chance of a $50,000 loss
What’s the expected value of the loss in
this case?
High risk group, self insured:
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30% chance of a $50,000 loss
What’s the expected value of the loss in
this case?
Suppose we pool these two groups,
each comprising 50% of the
population.
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What is the expected value of the loss in
this case?
Who gains from pooling these two groups?
What incentives will be given to those who
have only a 4% chance of the $50,000 loss?
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It can be shown in the pooled example
that low-risk patients are subsidizing high
risk patients.
Low risk persons choose not to group
insure under this community rating case,
leaving the pooled group including only
the high risk persons.
Response to Moral Hazard
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Coinsurance (typically 10% - 20%)
co-pays (e.g. UD policies $15 for GPs
and $25 for specialists)
Deductibles (typically $100 - $300)
Responses to Adverse Selection
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Look at prior usage (e.g. physical examinations
and/or questionnaires).
Existing conditions may not be covered.
The health portability and accountability act passed in 1996
modified the provision of insurance to those with preexisting
conditions somewhat. An individual who has insurance and
subsequently becomes ill may not be denied continued
coverage under any circumstances. The policy is portable
across plans. Individuals without insurance coverage who are
sick may still be denied coverage.
Conclusion
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Lack of information causes problems in health
care related to moral hazard and adverse
selection.
Keep these concepts in mind when we hear
about the Australia private health insurance
plans. (which are supplements to the state
provided health system)