health economics- lecture ch11

8/3/2019 Health Economics- Lecture Ch11

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The Organization of

Health Insurance Markets

Dr. Katherine Sauer

Metropolitan State College of Denver

Health Economics



Outline:

I. Loading Costs

II. Employer-Provided Health Insurance and Demand

III. Employer-Provided Health Insurance and Labor Supply

IV. The Uninsured



I. Loading Costs

Consumers can improve their well-being by sacrificing

a (relatively) small but certain premium to insure

against the probability of a considerably larger loss.

It is important to examine how the policies will be

offered to specific groups.

(why some groups will find it difficult to get

insurance at all)



Insurance firms incur costs of doing business that are

added to the claims payouts.

These loading costs are largely related to the numbersand types of customers and claims processed.

- must be passed on to consumers in order for

insurers to cover their costs



How much are people willing to pay for insurance?

When the probability of being well is 100%, then there are

no gains from insurance.

When the probability of being sick is 100%, then there are

no gains from insurance.

- might as well set money aside



Wealth

Total Utility of

Wealth

10,000 20,000

140

200 TU

EU

The horizontal

distance between thecertainty utility curve

and the expected

utility curve is the

marginal gain frominsurance.

The marginal gains

increase, thendecrease.

no gain from

purchasing insurance

no gain from


max gain from




Wealth

Total Utility of

Wealth

10,000 20,000

140

200 TU

EU

Some events can

substantially reduce

wealth.

- heart attack

Some events won¶t

substantially reduce

wealth.

- hang nail

The expected utility line

will reflect that.

EU



When comparing types of losses at any given

probability, the larger the expected loss, the larger the

gain from insurance.hangnail vs heart attack

insurer¶s marginal cost

Wealth

Consumers¶ Expected Marginal Gain $,

Insurer¶s Marginal Cost $

Marginal Gain for Heart

Attack Insurance

Marginal Gain for

Hangnail Insurance

When the marginal gains to the consumer exceed the

insurer¶s marginal cost, insurance coverage will exist.



This analysis provides one avenue for addressing the

problem of the uninsured.

It is apparent that the per-person costs of processing

information and claims of those individuals who are

outside larger organizations (either companies or unions)may be higher.

This would result in an increase in the insurance firms¶

marginal costs relative to the consumer¶s marginal benefits and would reduce or eliminate the range of

services that may be offered.



II. Employer-Provided Health Insurance and Demand

The largest segment of the American population

acquires health insurance through the workplace.

A. Labor Market

Assume a lower money wage rate leads to firms hiringmore workers.

Employers will hire workers as long as the incremental

(marginal) revenue from the goods those workers produce exceeds the per hour wage.



Suppose that workers negotiate a health insurance benefit

worth $1 per hour to them, and costing exactly $1 for the

employer to provide.

The employer, who was previously willing to pay a wage

of $20, will now be willing to pay $20 less the $1 cost.

The workers are no worse off at a wage of $19 with the

health insurance than at $20 without the health insurance

because the insurance is worth the $1 that it cost in

reduced wages.

The employer earns no less profit for providing the health

benefit.



Initially:

market clears at wage W1

with L1 employees

With Insurance Benefit:

Labor Demand is reduced by $z.

Labor Supply increases by

$z.

Market clears at wage W2

with L1 employees

wage

#workers

SL

DL

L1

W1

Z

DL2

Z

SL2

W2



B. Spousal Coverage

Suppose a town has two employers, firm A and firm B.A employs only married men.

Half of their spouses work at B.

Half of their spouses do not work.

B employs married women and singles.

Half are the spouses of firm A employees.

Half are single.

The wage in each firm is $80,000.



Firm A offers to buy family coverage worth $8000.

Firm B offers to pay $4000 per person, as long as those

who want insurance pay $20 a month. ($240 year)

All workers at each firm (respectively) will receive the

same take-home pay regardless of whether they elect to

receive coverage.



In firm A, who will buy insurance?

Men with non-working spouse:

coverage through firm A is the only option$8,000 insurance for both

$72,000 yearly take home pay

Men with working spouse:coverage through either firm A or B

A: ³free´ coverage, $72,000 take-home pay

spouse take-home pay $72,000 or $76,000

B: $72,000 take-home pay, coverage costs

$240 x 2 = $440, spouse take-home pay $72,000

or $76,000



In Firm A, all of the men will opt for the insurance

coverage through their firm.



In Firm B, who will buy insurance?

Women with working spouses:

Will have gotten coverage through their spouse¶s

firm.

Singles:

Must opt for insurance through firm B.

Pay $240 for coverage.

Since half of the workers opt for coverage, the

monetary salary will be reduced by (.50)(4,000).

Take-home pay is $78,000 minus $240.



So who really pays for insurance?

Single-income families get $8000 in benefits and

³pay´ $8000 in terms of lower wages.

Dual-income families get $8000 in benefits and³pay´ $10,000 in lower wages.

$8,000 lower in firm A

$2,000 lower in firm B

Single workers get $4000 in benefits and ³pay´

$2000 in lower wages and $240 of out-of-pocket.



C. Tax Treatment

One of the most important factors in the increaseddemand for health insurance has been its tax treatment.

John earns $1000 per week.

He is taxed at 28%.Insurance costs $60 per week.

If John pays for the insurance out-of-pocket:

weekly income = 1000(.72) = 720 ± 60 = $660



Suppose John¶s employer purchases the insurance for him.

This fringe benefit is exempt from taxation.

John¶s employer will reduce his monetary wages:

$1000 - $60 = $940

His total compensation package is still $1000.

$940 wages

$60 insurance

His after-tax income is 940(.72) = $677

Compare this with the disposable income he has if he buys

the insurance himself.



As marginal tax rates rise, consumers are better off having

their employer pay for health insurance.

Employers also benefit because they pay less in SocialSecurity and Medicare taxes.

- insurance is treated as an expense to the employer



Because health expenditures have been chosen for

special tax treatment, there exists an allocative problem

within the economy.

Initially: MN is constraint

U0 is utility and I0 is

optimal amount of insurance.

Employer sponsored

insurance lowers the wage but increases the amount of

insurance that can be

consumed. M¶N¶



The new optimal amount of insurance coverage is I1.

The tax treatment of health

insurance benefits to

employees amounts to a

subsidy for employees.-results in the

purchase of more

health insurance than

in the absence of thesubsidy



Two major potential impacts of employer-based health

insurance relate to retirement age and job mobility.



III. Employer-based insurance and labor supply

A. Retirement Age

Gruber and Madrian (2002) show that compared with

those age 35 to 44, those age 55 to 64 are:

-twice as likely to report themselves in fair health-four times as likely to report themselves in poor health

-seven times as likely to have had a heart attack

-five times as likely to have heart disease

-40 percent more likely to have a prescribed medicine(with twice as many medicines if receiving a

prescription)



Gruber and Madrian summarize 16 studies and report

that the availability of retiree health insurance raises the

odds of retirement by between 30 and 80 percent.



B. Worker Mobility

Employer provided health insurance may create joblock which may have several economic effects:

1. Less productive workers may stay at jobs for

insurance reasons only, leading to decreased economicoutput because they would not be replaced by more

productive workers.

2. Even if all workers are equally productive, someworkers may stay in jobs for fear of losing the health

insurance benefits to the exclusion of those who would

otherwise fill the jobs.



3. Those who do change jobs may be denied coverage,face higher premiums, or only obtain insurance subject to

a waiver that excludes coverage of their health condition.

The empirical evidence generally shows that employer

provided health insurance adversely affects job mobility.



IV. The Uninsured

The number of uninsured in the US is always anestimate.

Various surveys have shown that over 45 million

Americans have no health insurance at any moment intime.

In 2006, 3 out of every 8 families with annual incomes

below $20,000 had no health insurance.



27% of those ages 25±34 were uninsured in 2006.

In the 35-to-44 age range 18.9% were uninsured in

2006.

Of the 29.6 million people working in firms with 25 or

fewer employees, about 9.7 million people (33%) were

uninsured.



A. The working uninsured

Barriers to small business provision of health benefits:

- affordability (low profit margins, low wages,

and high premiums)

- insurance redlining or pre-existing condition

clauses (high turnover, seasonal workforce,

commission workforce, lawyers, physicians)

- attitudes (not interested because too complicated)



B. Mandated Coverage Effects

1. firms stop offering insurance

2. firms hire fewer workerswn = net wage

w = monetary wage

i = insurance benefit

wn0 = w0 +i0

DL

net wage rate

wo +io

Number of workersL0



Suppose that insurance benefits are mandated to be i1,

which is larger than io.

DL

net wage rate

If the firm still pays a moneywage of wo, then the net wage

will rise and the firm will hire

fewer workers.

If the firm instead keeps the

net wage constant, then the

money wage will fall.

- households will haveless $ for other goods

(insurance crowds out

spending on other

goods)

wo +io

workersL0

wo +i1

L1



Discussion Questions:

1. Suppose each person¶s health expenditures can be

predicted with certainty by both the insured and the

insurer. What are the implications for insurance

markets? Explain the prevalence of insurance for

highly predictable events, such as routine dental

services.

2. It is often advocated that health insurers be

prevented from denying insurance to those with

preexisting conditions such as cancer or AIDS and that

coverage be provided at ³reasonable´ rates. What

would the impact of such regulations be on insurance

markets?

health economics- lecture ch11

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