economics 186 7 health insurance rev

8/6/2019 Economics 186 7 Health Insurance Rev

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7Health Insurance

A.D. Kraft

Economics 186: Health Economics

Outline Health insurance terminology

Economic theory of demand for health insurance

Adverse selection

Moral hazard


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Terminology

Deductibles Deductible refers to a flat amount that is paid for by

consumers before their insurance picks up all or part of

the remainder of the price of the service.

May be set in number of ways:

o May apply to each unit of the service or may be

cumulative

o May be on an individual or family basis

o May be related to family income

Terminology Deductibles

Advantages

o May lower transaction costs for small claims,

thereby increasing demand for insurance for

larger claims

o Incentive for people to shop around for insurers

Disadvantages

o Deterrent to care

o May be greater burden on low income families


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Terminology

Deductibles Will either tend to result in greater use of services

(similar to a zero price) when a low deductible is

used, or if the deductible is high, will make insurance

coverage irrelevant

The effectiveness of the deductible depends on the

size of the deductible, the expected medical

expenditures of the family and family income

Terminology Co-insurance

When the third-party payer reimburses the patientfor a certain fraction of the price of the service, thearrangement is termed co-insurance.

Co-insurance levels can vary by service covered andby family income.

Reduces the price of the service while still providing

the individual with an incentive to seek out lesscostly providers. Effectiveness of co-insurance depends on how

responsive utilization is to lower prices, i.e., theprice elasticity of demand.


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Terminology

Stop loss levels once a patients out-of-pocket expenses reaches a

certain amount, then the patient is no longer

responsible for additional out-of-pocket payments.

Protects the consumer

Limits and maximums

How much insurance companies are willing to

reimburse after which responsibility for care shifts to

the patient

Protects the insurer from losses

Terminology Limits and maximums

Shifts the cost of very large expenditures, orcatastrophic expenses to the patient

Since this expenditure meets criteria for insurancerisksi.e., large unexpected losses to a smallpercentage of the population, excluding this partmay not be wise

To lower the insurance premium, alternativeapproach would be to use a small deductible for themany families that have small expenditures - less of afinancial hardship than a catastrophic expense

befalling a small percentage of the population.


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Terminology

Other forms of coverage Insurance contracts may include any or all of the

above in various combinations of deductibles, co-

insurance and limits.

Other aspects of coverage

o Pre-existing condition

o Salary insurance

o Disability benefits

Terminology Indemnity vs. service benefit

Service benefitprice to the patient for a stay in thehospital is reimbursed in full to the hospital.

o Patients have less incentive to shop around for theless costly provider

Indemnity benefitreimburses the patient apredetermined amount for the patients medical costs.

o The patient has an incentive to minimize the costof the illness since they have to advance the money

and only a portion is reimbursed.


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Terminology

PhilHealth More of a first peso coverage, with limits and

maximums

Different ceilings for services, i.e. room and board,

diagnostics, drugs, professional fees

Case-based payments for some.

PHIC benefits

UNIFIED MEDICARE BENEFITS

For all Members and Dependents under the National Health Insurance Program

BENEFITSHOSPITAL CATEGORY

PRIMARY SECONDARY TERTIARY

ROOM AND BOARD

200 300 400Not exceeding 45 days for eachmember & another 45 days to beshared by his dependents

DRUGS & MEDICINES

1,500

2,5000

1,700

4,0008,000

3,000

9,00016,000

Per single period of confinement

a. Ordinary

b. Intensivec. Catastrophic

X-RAY, LAB, ETC.

3507000

8502,0004,000

1,7004,00014,000

Per single period of confinement

a. Ordinaryb. Intensivec. Catastrophic


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PHIC benefitsUNIFIED MEDICARE BENEFITS

For all Members and Dependents under the National Health Insurance Program

PROFESSIONAL FEES

P 150/day for General PractitionerP 250/day for Specialist

Per single period ofconfinement shall notexceed:

a. OrdinaryGeneral PractitionerSpecialist

6001,000

6001,000

6001,000

b. IntensiveGeneral PractitionerSpecialist

900

1,500

900

1,500

900

1,500

b. CatastrophicGeneral PractitionerSpecialist

9001,500

9001,500

9002,500

OTHERS

3850

0

6701,140

2,160

1,0601,350

3,490

Operating Room

a. RVU of 30 and belowb. RVU of 31 to 80

c. RVU of 81 and aboveSurgeon Maximum of 16,000

Anesthesiologist Maximum of 5,000

Compensable Outpatient Services:

Ambulatory surgeries and procedures including dialysis,radiotherapy and chemotherapy

TB DOTS

Demand for health insurance: theory

Demand for health insurancerepresents the amount ofinsurance coverage that a person is willing to buy at differentprices (premiums) for health insurance

Negatively sloping demand for insurance - As premiums decrease (i.e.,the loading charge decreases) additional insurance coverage will bepurchased.

Diminishing marginal benefit of insurance coverage - the marginalbenefit of increasing the comprehensiveness of insurance declines themore comprehensive the coverage.


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Demand for health insurance

Appropriate amount of insurance -When the marginal

benefit of the additional coverage equals the marginal cost

of buying that additional coverage

Implications of the definition: At positive administrative

prices for insurance, the consumer would demand less than

100 percent coverage


Economic theory of insurance

Assumption: In the presence of uncertainty, i.e., the

uncertainty of illness and consequently, a loss of wealth to pay

for it, the individual seeks to maximize expected utility. Two

alternative courses of action

Buy insurance - incur a small loss in the form of theinsurance premium

Self-insure - facing a small probability of a large loss in the

event of illness or the large possibility that a medical loss

will not occur.


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Economic theory of insurance

Compare the two alternatives in order to determine

which choice provides a higher utility

For an individual to buy insurance, she must believe that

the marginal utility of wealth is decreasing, additional

wealth has lower marginal utility.

Utility and wealth

W1 W2 W3

U1

U2

U3


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Assume the following Loss in the event of illness = $ 8,000

W3 - Initial wealth, assumed to be $ 10,000

W1 -Wealth after the loss = W3 - 8,000

Pure premium = covers the actuarial value of the expectedloss. If the probability of the individual requiring medicalservices costing 8,000 is .025, then the pure premium of theinsurance would be .025 x 8,000 = 200

Pure premium is a function of both the size of the expected

loss and the probability of occurrence for a large group ofpeople (law of large numbers)

W2wealth level if a person were to buy insurance priced at200, (200 is a definite loss)


Use expected utility to compare choices. The expected utility

is the weighted sum of the utilities of each outcome, with the

weights being the probabilities of each outcome.

If U1=20, U2=99 and U3=100

Therefore the expected utility of choice b is:

o

The expected utility of choice a is: U=99 (given)

Since the utility level of choice a is higher than the utility

level of choice b, then the person will purchase insurance.

98)100)(975.0()20(025.))(1()( 31 UPUP


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Expected utility

W1 W2 W3

U1

U2

U3

A

B


Expected utility of choice b is shown by the straight line

connecting the two utility levels. The straight line

represents expected utility levels for different probabilities

of illness occurrence.

The lower the probability that the event will occur, thecloser is the expected utility to the point farthest to the

right on the expected utility curve.


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Because the individuals actual utility curve (decreasing

marginal utility wrt wealth) is always above the

expected utility line (constant marginal utility wrt

wealth), the individual will always buy health insurance

if it is sold at its actuarially fair value (pure premium).

A risk-averse person will prefer to take a certain loss

(the premium) rather than accept the uncertainty of

loss, even though the expected value of the loss is equal.


Insurance is never sold at its pure premium because of

administrative, claims processing and marketing costs.

Additional costs are referred to as loading charges, in effect,

the price of insurance

To determine whether an individual will buy insurancewhen there are additional costs, we calculate the

maximum amount above the pure premium that consumer

would be willing to pay for insurance


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W3-W2 represents the the pure premium for an

8,000 loss that has a 2.5 % chance of occurring.

Person buying the insurance will be willing to pay an

amount above the pure premium that makes the

actual utility after the payment of premium =

expected utility level.


Point A is the expected utility without insurance. If

one draws a straight line from this point to where it

crosses the actual utility curve, then at this point B, a

persons actual utility level and expected utility are

the same.

Distance from A to B on the wealth axis determines

the amount above the pure premium that a person

would be willing to pay for insurance.


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WTP additional premium

W1 W2 W3

U1

U2

U3

A

B

E

F

W4


At large probabilities and at very small probabilities, a

person is willing to pay less over the pure premium than

at other more intermediate probabilities.

o High probability of loss, i.e., points closer to W1-With

an expected utility level at point E, the pure premium

would be W3-W4 which is a large amount, since theprobability of loss occurring is high. The amount above

the pure premium is the distance EF.

o Near certain events (e.g. annual medical or dental check-

ups, probability = 1) it would be cheaper to self-insure.


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Large and small losses

W1 W5 W3

U1

U2

U3 AB

C


Magnitude of the expected loss also affects the pure

premium the person is willing to pay for insurance

WTP amount above pure premium is larger for big

loss than for small one.

o The area between the actual utility curve and theexpected utility line is much greater for the

large loss than for the small one.


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Price-quantity relationship of demand for health insurance Vertical axis - price of insurance = the amount above the

pure premium

Horizontal axis- the probability that the event will occur.

Curved line is just the distance between the actual utility

curve and the expected utility line.

Price of insurance is represented by line AA. This line

increases as the probability of the events occurring

increases

Price of insurance and quantitydemanded

Probability of event occurring

Price of insurance above pure premium

B

P1 P2

A

A

B


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Price-quantity relationship of demand for health insurance

the person is willing to pay for insurance and will buy

insurance for events that fall between P1 and P2.

The price of insurance is greater than the amount that a

person is willing to pay for events that either have a

very small probability of occurring or a very high

probability of occurring.

If the price of insurance were to rise to BB, we would

expect the individual to self-insure


Summarizing, the following factors would affect thedemand for health insurance

How risk-averse the individualRisk averse peoplehave more demand for insurance.

The probability of the event occurringThedemand for health insurance is lower when the

probability of the event occurring are either verylow or very high.

Magnitude of the lossthe larger the magnitude ofthe loss, the greater will be the amount above thepure premium that the individual is willing to paythe insurer.


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Factors, contd Price of insurancethe higher the price, the lower the

demand

Income of the individual the size of the persons

income and wealth will affect the amount above the

pure premium that she is willing to pay for health

insurance. At both low and high incomes, the marginal

utility of income is either relatively high or low, so that

persons might prefer to self-insure


Factors that affect the price of insurance

Whether a person is part of a group, group prices are

lower

Reduced prices are because of:

o Reductions in administrative costs

o Less likelihood of adverse selection Reductions in administrative costs

o Administrative and claims processing costs are

handled by the group

o Lower marketing costs on the part of the insurer


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Factors that affect the price of insurance Whether a person is part of a group, group prices are

lower

Less likelihood of adverse selection, i.e., lower risk

of event occurring

o Individuals seeking to purchase health insurance

may be the ones expecting to use such coverage

in the future.

o Higher prices charged to individuals leads to a

smaller demand for health insurance



Technology

Technology has made it possible to treat certain

diseases that were previously untreatable, however

these technologies are costly.

Once a treatment becomes available, there is

increased probability that an individual may requiresuch treatment, increasing the demand for health

insurance


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Factors that affect the price of insurance Technology

At the same time the price of insurance increases, thereby

lowering the quantity demanded.

Demand for insurance is increased when the latest

technology is covered, but the premium increases because

the loss is greater.



Technology

Reimbursement methods used by insurer to pay for

the new technologies

o retrospective cost based-payments to hospitals and

no out-of-pocket payments by patients

o eliminated provider efficiency incentives whileproviding an incentive to patient and physician to

perform the service as long as there were positive

marginal benefits, even if benefit were less than

resource costs.


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Factors that affect the price of insurance Technology

While technology has increased the demand for

insurance, insurance has encouraged the growth of

technology.

The emphasis on cost reduction would therefore

change investments in technologies, e.g.,

substitution of outpatient for inpatient care


Welfare implications

Welfare losses will occur if consumers pay a price for a good

that is higher than its marginal benefitsituation if all

consumers are required to have complete coverage against all

of their medical expenses.

There are two situations in which the price of insurance will

exceed the amount of the pure premium

o The first is for medical losses that have a very high or

very low probability of occurring

o The second is when there are small medical losses.


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Welfare implications

Mandatory insurance coverage that covers all

medical losses, no matter how small or routine and

expected, will make some consumers worse off than

if they had a choice and could self-insure in those

situations.

Adverse Selection and Moral Hazard

Existence of either adverse selection and moral hazard

results in less insurance coverage


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Adverse Selection

An individual is more knowledgeable about his or healthstatus than an insurance company

Insurance companys concern that this difference in

information will lead to high-risk groups purchasing

insurance based on a lower groups premium is considered as

adverse selection

Adverse Selection

Consequences If insurer is unable to identify between low and high

risks, premium will reflect average risk of the twogroups

High risk group will purchase insurance, low risk groupwill not

Result in a biased sample of those who purchase health

insurance at a premium that is based on the low risksample Insurance companies lose money Insurance company would raise its premium to reflect

proportionately higher risk individuals but this wouldresult in lower risk individuals dropping out.


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Adverse Selection

Illustration: Assume

the same utility function and degree of risk aversion

Low risk individuals have a .2 chance of getting sick,

while those who have high risk = 0.8

Equal number of persons in each group.

Pure premium for low-risk= 1,600=8,000*.2 and

resulting wealth position is 8,400

Pure premium for high risk =6,400=8,000*.8 and

resulting in wealth position 3,600

Adverse selection

W8400

U1

U2

U3A

E

D

F

3600

C

G

6000

H


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Adverse Selection

AB shows the expected utility of an 8,000 loss.

If insurer cannot identify between high and low risk, the

pure premium would be based on the average risk of the

two populations, i.e., 4,000=8,000*.5

High risk individuals will still purchase insurance

because their utility level H is higher than F.

Low-risk individuals will not buy insurance because

their utility level with insurance H, would be lower than

G, which is the maximum amount above the purepremium that they would be willing to pay.

Adverse Selection

Attempts to redress the information imbalance.

Excluding preexisting conditions

Require individual to have tests

Require minimum period before services are covered

Low-risk individuals may signal by their willingness to

accept insurance policies that contain high deductibles

and co-insurance.


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Adverse Selection

Preferred risk selection - Cream skimming

Occurs when insurers receive the same premium for everyone

within a group but the risks within the group vary. The insurer

then tries to select the low-risk individuals while receiving a

premium that is based on the average risk

Insurer would be able to increase their profits if they could

receive the average premium and attract just the low-risk

members of the group

Adverse Selection Concluding remarks

Mandatory coverage or universal coverage insurance would

limit adverse selection

To limit preferred risk selection, each group should have a

risk-adjusted premium so that insurers would not have an

incentive to select low-risk groups.

Accurate, risk-adjusted premiums would change the natureof insurance competition from risk selection to risk

management


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Moral Hazard

The presence of some elasticity in the individuals demandcurve indicates that the quantities of medical care wouldrespond to prices.

Moral hazard - Since insurance lowers the price of medicalcare, they will consume more care than of they had to paythe entire price themselves Too much medical care will be consumed. Insurance coverage that reduces the price of care zero results in

an inefficient use of resources since individual will continue toconsume care until the marginal benefits are equal to marginal

costs (=0) This will be at a point where the true marginal costs (the costs

of producing those units) are greater than the marginal benefit.

Moral Hazard

Some individuals may be unwilling to purchase insurance

policy that provides such extensive coverage.

Greater utilization resulting from having insurance will

result in increases in the premium

Instead of paying the higher premium, they would prefer

to self-insure or purchase less comprehensive policy


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Moral Hazard

D1

P(s)

D2

Q1 Q2

P1

Moral Hazard

Illustration: 0.5 probability of getting sick, price of care= 10 per unit Individual with D1:

o Will consume Q1 (=100 units)o Pure premium = 500=.5*0 +.5*1,000

Individual with D2:o Will consume Q2 (=200 units)o Pure premium = 1,000=.5*0+.5*2000

Difference in premium may be enough for some individuals toprefer self-insurance

Requiring the individual to purchase comprehensive insurancethat is the same as the rest of the population will make himworse off.


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Moral Hazard

Approaches to limit utilization Not so successful - Utilization reviews (internal hospital

utilization review committees)o none of the participants had an incentive to use the

utilization review committee- they were reimbursed by theinsurer anyway.

More successful - Introduce incentives on the part of thephysician or patiento Managed care systemsphysicians are likely to have an

incentive if the organizations expenditures are less thantheir premium income.

o Another incentive approachuse deductibles and co-insurance. These allow the patients to bear some of the risksthemselves.

Co-insurance

D1

P(s)

D2

Q1 Q2

P1

P2

Q3


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Moral Hazard

Co-insurance

o Pure premium for insurance = utilization level Q2multiplied by price P1 (multiplied by probability 0.5)

o Cost of self insurance would be P1 multiplied by Q1

o Cost an insurance policy with a co-insurance featurethat lowered the price to the patient from P1 to P2would cost (P1-P2) multiplied by utilization level Q3.

o The pure premium for this policy would be in betweenthe two other alternatives, might make insurance moreattractive to some people.

Moral Hazard

Deductibles

o Using deductibles results either in the consumptionof the same amount of care as in the case of noinsurance, or in consumption of the same amount ofcare as in the situation of complete insurancecoverage

o Without insurance, individual represented by demandcurve D1 would consume Q1 units in the event ofillness. With complete coverage the same individualwill consume Q2.


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Moral Hazard

Deductibles

o With a deductible, the individual would have to use andpay for Q3 units of medical care(P1 times Q3) beforethe insurance would pay the medical costs. Theadditional care would be zero and he would consumeQ2 units of care.

o If the individual does not consume up to the deductible,it would be as if she has no insurance, i.e., use Q1 unitsof care.

o Whether or not the individual will pay the deductibleand then consume up to Q2 units of care depends onwhether the excess amount that must be paid for thedeductible (area A) is less than the consumers surplusrepresented by area B.

Deductibles

D1

P(s)

D2

Q1 Q2

P1

Q3

B

A


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Moral Hazard

Existence of moral hazard has two effects:

Price of health insurance is increased because utilizationis increased when the consumer does not have to payanything out of pocket.

There is decrease in the demand for health insurancewhen the insurance premium is increased, because ofthe previous increase in utilization.

Thus, even if all individuals were risk averse, insurance

coverage for 100 percent of all their medical expensesshould not be required for all persons.

economics 186 7 health insurance rev

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