Review of the Last Lecture
• began our discussion of health insurance and its impact on the
healthcare market
• Defined proportional insurance, indemnity insurance, insurance
rate, co-insurance rate, annual deductible, per loss deductible
• purpose of deductibles: reduce administrative costs, control moral
hazard
• then began our discussion of proportional insurance => rotates the
demand curve clockwise => equilibrium P and Q rise
317_L11, Jan 30 , 2008,
J. Schaafsma
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Effect of Insurance on P and Q,
and Welfare Loss
• Insurance coverage drives up P and Q and total expenditure on HC
(see diagram)
• Creates a welfare loss: the cost of the additional HC consumed as a
result of insurance exceeds the value placed on the additional benefits
(see diagram)
• Also creates additional producer surplus: a payment to factors of
production in excess of what is needed to have them produce HC (see
diagram) in this case.
• The producer surplus is a transfer from the insured to the providers.
• have ignored the wealth effect of buying insurance, premium reduces
income => demand curves for all goods shift left.///
317_L11, Jan 30 , 2008,
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J. Schaafsma
The Slope of the Demand and
Supply Curves and the Effect of
Proportional Insurance on P & Q
• the size of the welfare loss depends on the slopes of the
demand and supply curves
• the steeper the demand curve the less the increase in P & Q
from proportional insurance
• if the supply curve is vertical insurance only increases P
• if the supply curve is horizontal insurance only increases Q
317_L11, Jan 30 , 2008,
J. Schaafsma
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A User Fee and the Welfare Loss
• suppose there is 100% insurance coverage ~> P to the consumer = 0
• get the maximum welfare loss (see diagram)
• user fee ~> an amount paid by the patient per unit of HC consumed
• even a modest user fee can reduce the welfare loss substantially (see
diagram) Reason ~> user fee reduces consumption of HC units with
the largest per unit welfare loss, i.e. it eliminates the most wasteful
spending.///
317_L11, Jan 30 , 2008,
J. Schaafsma
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Proportional Insurance and Shifts
in Supply
•As noted earlier: proportional insurance rotates the demand curve
clockwise and increases its slope
• shifts in supply thus have larger P effects and smaller Q effects
(explain the economics with a diagram) the steeper the demand curve
• Implication: with proportional insurance rising costs on the supply
side are easier to pass forward through a higher market P (show). ///
317_L11, Jan 30 , 2008,
J. Schaafsma
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Indemnity Insurance and Demand
• Indemnity insurance reimburses for a loss at a pre-specified unit rate,
e.g., $50 for a GP visit, $20 for a flu shot
• if the actual unit price is greater, the consumer pays the difference
• if the actual unit price is less, the consumer keeps the difference
• assume DC without the indemnity is Q = a - bPe Pe= effective price
• with indemnity Pe = P-I ~> DC is Q = (a+bI) - bP P = product price
•indemnity insurance shifts the DC  by the amount of the indemnity, or
to the right by bI (see diagram)
• equilibrium P & Q , extent depends on slopes of the S & D curves
(show)
• Indemnity insurance also creates a welfare loss and additional producer
surplus (show).///
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J. Schaafsma
•
The Economic Effect of an Annual
Deductible
three cases:
1. Annual deductible large relative to expected expenditure, believe
deductible will never be exceeded ~> consumption decision based
on the full price
2. Annual deductible small relative to expected expenditure, believe
deductible will be exceeded ~> already from Jan 1 consumption
decision based on P(1-ir).
3. Problem area ~> initially believe deductible won’t be exceeded ~>
consumption based on the full price. However, as deductible used
up ~> may come to believe it will be exceeded after all ~> switch to
consumption based on P(1-ir).
•
Why a problem? ~> don’t know if (when), this switch will be made.
317_L11, Jan 30 , 2008,
J. Schaafsma
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Maximum Payment Limits
• some insurance policies have insurance limits ~> maximum payout
• maximum payout could be per person by type of treatment e.g.
orthodontic work
• could be a maximum lifetime payout, e.g. extended health benefits
covered to a maximum of $1,000,000 over the insured’s lifetime.
• Problem: lose catastrophic coverage, i.e., very large losses may not be
covered, however, these are the very losses you want to insure for.
• max payment limits ~> place an upper limit on the insurance
company’s losses.///
317_L11, Jan 30 , 2008,
J. Schaafsma
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Stop Loss
• a stop loss is the opposite of a maximum insurance limit => a stop
loss places an upper limit on the loss a consumer can incur
• e.g., B.C. Pharmacare limits total personal liability for approved
prescription drug costs
•For example, suppose a family’s income tested deductibles are as
follows: if expenditures on pharmaceutical drugs are:
$0 – 1000 the family pays 100% pharmacare pays
0%
$1001 – 2000 the family pays 30%
pharmacare pays 70%
$2001+
pharmacare pays 100%
the family pays 0%
Stop loss here is $1300 per annum (max amount paid by family).///
317_L11, Jan 30 , 2008,
J. Schaafsma
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Price Elasticity of Demand for HC
• Key issue: how responsive is Qd to P? ~> P elasticity of demand?
% change in Qd in response to a % change in P (show on diagram)
• Expect: demand is P inelastic since HC is a necessity
• P elasticity of demand for HC has been extensively analyzed for:
aggregate HC expenditures, and by component (see table 8.2, Text,
p. 177)
• General agreement: P matters to the consumer
• Also, elasticity estimates are generally less than 1 (demand is price
inelastic) but vary substantially across studies, and some estimates
show elastic demand. Not clear why.///
317_L11, Jan 30 , 2008,
J. Schaafsma
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