Chapter 13: Healthcare

When the US discussed improvements to its healthcare system (2010), Canada was often mentioned

Most Canadians consider our Medicare one of the best health systems in the world…But worry this may not persist

There currently are huge struggles for increased healthcare funding and overall healthcare reformHealthcare has risen from 6% of GDP in 1960 to 10%

of GDP in 2008

Chapter 13: HealthcareWhat’s Special About Healthcare?National Medicare In CanadaCanada vs. The WorldChallenges and Future Directions

What’s Special About Healthcare?Healthcare is different from a typical good (ipod),

and is publicly provided for 5 reasons:

1)Healthcare is Insurance

2)Poor Information

3)Paternalism

4)Income Redistribution

5)Externalities

1) Healthcare Is Insurance

Healthcare costs are:

1)Very unpredictable

2)Very large

And therefore most people want health insurance to cover them in the case of this unexpected costs.

-In the US, this insurance is private, in Canada, it is public

Healthcare=Insurance

1) Insurance

Health insurance involves a variety of issues:

a)Expected Values

b)Premiums (actuarially fair premiums)

c)Why Insurance?

d)Risk Premiums and Loading Fees

e)Risk Pooling

This argues for government involvement due to:

f) Adverse Selection

And causes issues through:

g) Moral Hazard

1) Insurance

Insurance is best understood through examples:

Assume you spend $2000 over 5 years on electronics. You buy a laptop has a 20% chance of breaking down, with a repair cost of $500.

There are 2 cases:

1)Laptop doesn’t break down – you have $2000 left to spend.

2)Laptop does break down – you have $1500 left to spend

1a) Expected Value

Expected value is the amount of money a person can expect “on average”

E($)=∑(outcome) (probability of outcome)

In the case of our laptop,

E($)=$2,000(0.8)+$1500(0.2)

E($)=$1600+$300=$1900

Without insurance, we expect $1900 on average.

1b) Premiums and Payouts

Typically, in insurance,

1)Every year (term), you pay a PREMIUM for the insurance

2)IF you make a claim, there is a payout

An ACTUARIALLY FAIR premium charges just enough to cover expected compensation:

AFP=(loss)x(probability of loss)

1b) Actuarially Fair Premium

For the laptop,

AFP = ($500)(0.2)=$100

Since insurance would cover the cost of the repair, WITH INSURANCE,

E($)=($2,000-$100)(0.8)+($2000-$100)(0.2)

E($)=$1900

But why buy insurance if the E($)’s are equal?

1c) Why Insurance?

Due to Diminishing Marginal Utility, people prefer certain incomes:

E(Uinsurance)=U($1900)

E(Uno insurance)=U($2000)(0.8)+U(1500)0.2

52.4315002.020008.0)(

59.431900)(

noinsure

insure

UE

UE

IUIf

1c) Why Insurance?

The utility lost from the $500 repair in the bad years far outweighs the utility gained from the extra $100 in the good years.

People prefer RISK SMOOTHING – reducing income in high income years to protect themselves from income drops

12

Income

U

Due to DIMINISHING MARGINAL UTILITY,

utility from insurance (UI), is greater than utility without

insurance (UO), even though the expected incomes are

equal.

1.5K

U

P

1.9K 2K

UIUO

1c) Why Isn’t Insurance Actuarially Fair?

Assuming no administration fees (which is a weak assumption),

The shape of the utility curve measures RISK ADVERSION – a preference for paying more than the actuarially fair premium in order to guarantee compensation if an adverse event occurs.

RISK PREMIUM – the amount above the actuarially fair premium that a risk-adverse person is willing to pay to guarantee compensation if the adverse event occurs

14

Income

U

U(Expected)=U(Equivalent)

Max Risk Premium=

Expected-Equivalent

Bad

U

P

ExpectedGood

UIUO

Equivalent

1d) Loading Fees

Loading Fee = Actual Premium – Actuarially Fair Premium

-Average loading ratio for private US insurance companies is 1.2 (Phelps 2003)

-(typical laptop service plan is $200 for 3 years, working out to a Loading Fee of 4.0 – 10% failure rate in year 2 and 3 for $500 laptop)

-keep in mind this includes administration costs

1e) Risk Pooling

An insurance company can’t insure just one person

-If the claim happens, the company can’t pay for it

-An insurance company has to insure MANY similar people

-that way the percentage of claims is close to the probability

-Insurance works by POOLING risk across individuals

1f) Adverse Selection

Health insurance can break down due to ASYMMETRIC INFORMATION – when one party have information not available to another party

Assume there are 3 laptop purchasers:Bill has a laptop failure rate of 10% (he’s a

computer technician)Charles has a laptop failure rate of 20% (he’s

average)Denis has a laptop failure rate of 30% (he clicks on

all the “you won” pop-ups)

1f) Adverse SelectionRecall that actuarially fair insurance just

charges enough to over expected repairsExpected repairs ($500xP(failure)):

Bill: $50Charles $100Denis $150

If you charge:$50 – Charles and Denis cause a loss$100 – Bill doesn’t want insurance and Denis

causes a loss$150 – Charles and Bill don’t want insurance

1f) Adverse Selection

If health insurance were a private option, those most likely to be sick would purchase it, and healthy people won’tThis leads to more expensive claimsThis leads to higher premiumsThis leads to more people not buying insurance

The end result would be UNDERPROVISION of healthcare

1f) Adverse Selection Saviors

3 Issues can keep Adverse Selection from killing a private insurance market:

i) Risk Aversion

ii)Group Insurance

iii)Risk Categories/Risk Profiling

1fi) Risk Aversion

Because people are risk averse, they are willing to pay a RISK PREMIUM above the actuarially fair premium.This may keep more people in the market

1fi) Group InsuranceLarger companies can offer group insurance

plans that automatically cover everyone (high and low risk) This doesn’t help small firms or the self-employed

1fiii) Risk CategoriesAdverse selection occurs due to asymmetric

info – inability to know a person’s riskHOWEVER, a company can charge premiums

based on OBSERVABLE characteristics statistically linked to UNOBSERVABLE riskie: Male 20-year olds pay more for auto insurance

because they are STATISTICALLY more likely to have an accident than Female 20-year Olds

1fiii) Risk Profiling?The Supreme Court of Canada ruled this does

not violate the Canadian Charter of Rights and Freedoms because there is statistical evidence that 20-year-old males do have higher loss probabilities

Some ask how long until we are charged based on:EthnicityReligionSexual Orientation (marital status already applies)

If there is statistical evidence?

1f) Public Insurance and Adverse Selection

Public Health Insurance is MANDATORY, and therefore Adverse selection is avoided since the low risk individuals can’t drop out

PRO’s:Mid and High-risk individuals are covered at a

reasonable rate ($100 in our example)

Con’s:Low risk individuals would rather not be

covered at a high rate (for them)

1f) Public Insurance and Adverse Selection

Public Health Insurance is argued for based on:

i) Equity – everyone is equally treated, or the poor tend to have lower average health than the rich

ii)Utilitarianism – the gain to the low-risk individuals tends to be greater than the loss to the high-risk individuals

1g) Moral Hazard

If people have health insurance, their actions may change in two ways:1) They live unhealthy lifestyles, knowing they are

covered (unhealthy eating, unhealthy living, extreme sports, etc)

2) They over consume healthcare since it’s free (“Last night on House the woman had Ebola, so I figured I should get tested.”)

This effect can be shown through supply and demand:

27

D=MB

S=MC (constant)P0

Q

P

With insurance, x% is covered, and a patient pays (1-x)P0 and consumes Q1 (where new S=D). This causes healthcare

expenditures of Area A +B (expenditures increase).

(1-x

)P0

Without insurance, a patient pays P0 and

consumes Q0 (where S=D).

This causes healthcare expenditures of area A.

A BQ0 Q1

28

D=MB

S=MC (constant)P0

Q

P

While some argue against downward sloping demand (no, I don’t want that life-saving operation), enough medical

procedures are optional to empirically give a downward slope.

(1-x

)P0

This overcomsumption causes deadweight

loss where MC>MB:

DWL

Q0 Q1

1g) Government and Moral Hazard

Government health insurance DOES NOT eliminate Moral HazardThe DWL still exists

Canadian governments have fought Moral Hazard through Medicare budget caps and medical service rationingThis leads to controversies over waiting times

What’s Special About Healthcare?

Healthcare is different from a typical good (ipod), and is publicly provided for 4 additional reasons:

2)Poor Information

3)Paternalism

4)Income Redistribution

5)Externalities

2) Poor Information

Often, consumers are fairly well informed about the goods they buy (you know how an apple tastes, you can test drive a car, etc)

When you are sick, you may not be well informed about the treatment you buy

In addition, the expert in the field is also the person selling you the product (the doctor)Imagine if you trusted a car dealer about the “right”

car for you

3) PaternalismSome may not purchase health insurance:

a) They don’t know how it works

b) They don’t think they need it (“I am INVINCIBLE!”)

c) They forget about it

Mandatory medical insurance (such as public healthcare) makes sure everyone is covered.

“people who are forced to pay for medical care out of pocket don’t have the ability to make good decisions about what care to purchase” (Krugman 2006)

4) Income Redistribution

Canadians generally agree that everyone should have equal access to medical services, regardless of ability to pay. (Even the US supplies free EMERGENCY medical services, regardless of ability to pay.)

Public Healthcare redistributes income from the rich (who pay more taxes) to the poor (who may not be able to afford healthcare)Also, lower incomes may have a greater need for

healthcare, resulting in a greater redistribution

4) Income Redistribution

Unfortunately:The poor are less likely to have a family

doctor or receive specialist medical care in Canada (Curtis and MacMinn, 2008)

16% of the US population is without either private or public health insurance (2008 stats)Typically low income, irregular employed, and self-

employed workers lacked healthcare

5) Externalities

Health services typically carry positive externalities (if people around you are vaccinated and healthy, you are less likely to be sick)

Since goods with positive externalities are underconsumed in private markets, public healthcare would increase consumption to ideal levels

National Medicare In CanadaMedicare – Canada’s national health insurance

programPays the full cost of all medically necessary

hospital and physician servicesMedical care providers directly bill the

government for servicesFees for service are determined by seach

provinceEssentially Canada has 13 health insurance plans,

one for each province and territoryEach plan follows the Canada Health Act

Theory - Canada Health ActThe Canada Health Act (1984) lays out 5

conditions for federal grants for healthcare:

1)Universality: All residents are entitled to health insurance coverage

2)Accessibility: No financial or other barriers for medically necessary hospital and physician services (provincially defined). Reasonable compensation for hospitals and physicians, extra billing prohibited.

Canada Health Act3) Comprehensiveness: All medically necessary

services (provincially defined) must be insured.

4) Portability: Coverage is maintained when a resident moves within Canada or travels outside the country (covered at provincial rates).

5) Public Administration: Health insurance administered on a non-profit basis by a public authority

Canada Health Act & Private Insurance

The Canada Health Act prohibits private health insurance for all medically necessary treatments.

Private insurance is permitted for services not covered by Medicare.

Private health care DELIVERY is not illegal (doctors are private practitioners who opt in or opt out of public insurance, and must follow provincial fee-for-service schedules)

2010 Per Capita Health Expenditures

While all provinces support the Act, per-capita expenditures vary widely (due to demographics, remuneration differences, etc)

Government fines for violating the act have been small

Public support, not fines, enforce the Act (Boothe and Johnston 1993)

History of Canadian Healthcare

1940 – hospital and medical care were privately funded, with religious or voluntary organizations running some hospitals considering ability to pay

1947 – Saskatchewan introduced hospital insurance

By 1961 – All provinces had hospital insurance, with the federal government covering 50% of costs on average (physician payments were still private)

History of Canadian Healthcare

1962 – Saskatchewan started provincial Medicare

1971 – All provinces had Medicare, federal government covering about 50%

1977 – Federal government funded healthcare and post-secondary education through Established Program Financing (EPF), offering equal per-capital grants to provinces (increasing with GDP growth)

1982-1995 – government limited growth in EPF grants (frozen in 1990)

History of Canadian Healthcare

1984 – Canadian Health Act Passed, laying out 5 conditions for EPF transfers

1996 – EPF grants replaced with Canadian Health and Social Transfer (CHST), covering health, education, and post-secondary education (Health Act still applied)

2004 – CHST broken into Canada Social Transfer (CST - welfare and post-secondary education) and Canada Health Transfer (CHT)

History of Canadian Healthcare

2004 10-Year Plan to Strengthen Health Care signed by provincial and federal governments. Federal government legislates 6% CHT growth until 2013-2014

2011-12 – $27 Billion in CHT grants (expected)

Health Expenditure TrendsChart shows per-capita healthcare expenditure in 2002 dollars.

1990’s had federal spending constraint, resulting in decreasing per-capita expenditure

Health Expenditure Trends

Jumps : 1966-1971 (Medicare), 1979-1983, 1988-1992 (9.8%)

Drops in 1992 to 1996 (restraints and cuts), public backlash

Spending increase 1996-2008 (response to backlash)

2008 Spending at 10.4% of GDP

Health Expenditure Trends

Hospitals receive less funding due to more community and home health services

Drug costs have increased due to rising drug prices, advances in using drugs as treatments, and aging population

Canada vs. The World

A “snapshot” of country statistics can give us an idea of Canada’s healthcare compared to the world:

1)Demand for healthcare can be examined through senior population (who have higher healthcare demand)

2)Number of physicians can give us and idea of health care supply

3)Life expectancy and infant mortality can give us an idea of healthcare output

Canada vs. The World

4) Healthcare expenditures can give us an idea of how much we spend on healthcare, and can then be compared to healthcare results

Note that Canada spends less on healthcare than the US, but has better life expectancy and lower infant mortality

Sweden spends less and does better, howeverNote also that factors other than healthcare

(income support, weather, suicide, etc) also affect these healthcare statistics:

Go Canada, Go!

Challenges and Future DecisionsHealth Care Costs have been increasing:$135 billion was spent by government in 2010$56.7 billion was spent privately in 2010Inflation adjusted expenditures have more than

tripled between 1975 and 2010

How long until these increasing expenses cut into education, welfare, policing, protecting the environment, and infrastructure? (Courchene 2002)

Challenges and Future DecisionsHealth Care Cuts have been made:Acute care beds in hospitals have declined

from 4.6 to 2.7 per 1000 pop. from 1980 to 2007

Average acute-care hospital stay has decreased from 10 days in 1980 to 7.5 days in 2007

Are people right? Is healthcare in decline?

Are we doooooooomed?1) Canada’s self health ratings haven’t changed

in 10 years

2) Life expectancy has increased

3) Lower population proportion report health problems limited daily activities

4) Work-related injuries are down

5) Low-birthrate baby rate is stable since 1980’s

6) Death rates have declined

Noooooooo doooooooom

Challenges and Future DecisionsHealthcare isn’t in decline, but cost pressures are

incoming:

1)Aging population

2)Obesity adds over $4 billion to annual health care costs (Public Heath Agency of Canada 2009)

3)Improving technology (decreasing some costs, making other costs available – ie MRI)

4)New (expensive) drug treatments, especially for seniors

Challenges and Future DecisionsThe data behind Canadian waiting times is bleak:

Challenges and Future Decisions3 reports covered Increased waiting times:

1)Mazankowski Report (Alberta, 2001)

2)Kirby Report (Senate, 2002)

3)Romanow Report (Canada, 2002)

More than 100 recommendations include revolve around the issues of:

1)Cost reductions

2)Quality improvements

3)Better management

4)Better accountability

Theory - Future Issues5 big issues lie in the future of healthcare:

1)Changing incentives

2)Defining medically necessary services

3)A national pharmacare program

4)Privatization

5)User charges

1) Changing IncentivesCurrently, a FEE-FOR-SERVICE method is used

to pay physiciansThis encourages physicians to quickly deal with

patientsThis discourages physicians from referring to

nurses and other health providers

Kirby recommended a capitation program, where patients enrol in a group practice, who get annual payment for number of patients, adjusted for factors such as age and gender.

2) Defining medically necessary services

“Medically necessary services” vary from province to province

This results in significant variations in per-capita spending

Some provinces are thinking of coming up with a common listBut doesn’t “medically necessary” vary from patient

to patient?

3) National Pharmacare Program

Kirby and Romanow suggest that drugs be covered under a public health system

Critics argue that such a plan would be too expensive and private insurance is available

In 2010, 46.5% of prescribed drug expenditures was financed by the public sector, 36% by private insurers, and 17.6% by individuals

4) Privatization

A 2005 Supreme Court of Canada decision (Chaoulli v. Quebec) ruled that if medicare waiting times are long, restricting private medical insurance coverage violates citizens’ rights to life and security of person.

Other provinces have similar laws restricting private medical insurance

On one hand, private medical services may reduce costs and waiting times

On the other (amputated) hand, this may lead to the eventual death of Medicare

4) Privatization

The Romanow Report advised targeted funding for reducing wait times for diagnostic services and improving wait list management.

Provinces, in the 2004 10-Year Plan to Strengthen Health Care committed to reduce wait times for 5 key areas (cancer, heart, diagnostic imaging, joint replacement and sight restoration) by March 31st, 2007.

-The federal government committed $5.5 Billion over 10 years

-Progress and data reports have been slow

4) Privatization

Although data is difficult to find, the following data shows variation among provinces:

5) User Charges

Mazankowski recommends user charges to discourage health care overuse

Kirby counters most care is beyond patient control - charges discriminate against the sick

User fees can take the form of:a) Deductibles

b) Nominal service fees (ie: $5)

c) Co-insurance (patients pay a %)

Canada is the only industrialized country that prohibits user charges for public insured health services (Senate 2002)

Chapter 13 ConclusionHealthcare is public due to: insurance

issues, poor information, paternalism, income redistribution and positive externalieis

Canada has average or above-average outcomes at above-average costBut we beat the US

Provinces supply healthcare with federal contributions

Canada Health Act (1984) outlines 5 healthcare requirements for federal contributions

Chapter 13 Conclusion

Canadian health is improving, but experts agree that changes may be needed in the future due to increasing costs

Costs will increase due to population aging, obesity, technical advances, and drug advances

Current debates are: incentives, “medically necessary services”, national pharmacare, private sector roll, and user charges