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8/6/2019 Economics 186 7 Health Insurance Rev
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3/21/20
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: theory
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
Demand for health insurance: theory
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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Demand for health insurance: theory
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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Demand for health insurance: theory
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)
Demand for health insurance: theory
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
Demand for health insurance: theory
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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Demand for health insurance: theory
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.
Demand for health insurance: theory
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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Demand for health insurance: theory
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.
Demand for health insurance: theory
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
Demand for health insurance: theory
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
Demand for health insurance: theory
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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Demand for health insurance: theory
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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Demand for health insurance: theory
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
Demand for health insurance: theory
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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Demand for health insurance: theory
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
Demand for health insurance: theory
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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Demand for health insurance: theory
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
Demand for health insurance: theory
Factors that affect the price of 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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Demand for health insurance: theory
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.
Demand for health insurance: theory
Factors that affect the price of insurance
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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Demand for health insurance: theory
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
Demand for health insurance: theory
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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Demand for health insurance: theory
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.