Chapter 6: Health Insurance
Chapter 6
McGraw-Hill/Irwin
Health Insurance
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 6: Health Insurance
Introduction
Principles of health insurance
Features of the health sector
The role of government
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Chapter 6: Health Insurance
Principles of Health Insurance
The Genesis of Health Insurance
• Government does not play a role in health insurance
• Do you buy health insurance from a private company?
• Risk aversion
• How much should a private company charge as a
premium?
• Expected value
= (% risk)(high medical cost) + (% risk)(low medical cost)
• Actuarially fair premium
6-3
Chapter 6: Health Insurance
Price Equals Expected Medical Cost
Table 6.1: Expected Medical Bills
Chance of a
$61,000
Medical Bill
Chance of a
$1,000
Medical Bill
Expected
Medical Bill
High Cost Person
9%
91%
$6,400
Low Cost Person
1%
99%
$1,600
Pi = (EMC)i
• The price charged to a person will vary with the person’s
expected medical costs, not the person’s income.
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Chapter 6: Health Insurance
Moral Hazard and Price Responsiveness
• Moral hazard: the use of medical care because
they know the insurer will pay part of their bill.
• Price responsiveness
• Price elasticity
Adverse Selection and Asymmetric Information
• Adverse selection: instead of a random sample
selecting to enroll, a biased sample with higher
medical costs is likely to enroll.
• Asymmetry of information
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Chapter 6: Health Insurance
Catastrophic Insurance
• The patient has a deductible and then the
insurance pays the remainder of the bill
• How do individuals choose health insurance?
Table 6.2: Catastrophic Insurance v. Complete Insurance
Insurance
coverage
Premium
None
Out-of-Pocket Burden
Total Burden
5% chance
95% chance
5% chance
95% chance
$0
$61,000
$1,000
$61,000
$1,000
Complete
$4,800
$0
$0
Catastrophic
$3,400
$5,200
$1,000
$4,800
$8,600
$4,400
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Chapter 6: Health Insurance
X% Insurance
Figure 6.1
P D’
D”
$400
S
$300
G
• Insurance pays a
specific percentage
(X%) and the patient
pays the remainder
(100% - X%).
F
$200
• Cost-sharing rate
or coinsurance rate
D
$100
O
$50
J
100
110
120 Medical Care
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Chapter 6: Health Insurance
The Impact of Insurance on
Efficiency and Redistribution
Figure 6.2
P
$400
Inefficiency if there
is no externality
MSB
$300
S
MB
F
$200
H
$150
$100
$50
J
110
• FJH is the efficiency
loss from not cutting
medical care from J to H
• The size of FJH
depends on how steep
the MB curve is
Medical Care
6-8
Chapter 6: Health Insurance
The Impact of Insurance on
Efficiency and Redistribution
Efficiency if there is a positive externality
• The socially optimal quantity of health care is
greater than the quantity consumed privately
• A corrective subsidy may increase efficiency
Optimal redistribution from the healthy to the sick
• Citizens’ preferences on redistribution of
resources from the healthy to the sick are complex
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Chapter 6: Health Insurance
Limitation of Price and Supply by the Insurer
Figure 6.3
P D’
D”
$400
$300
G
F
$200
D
$100
$50
J
110
• If max P = $100, and
demand is D”, there will
be a shortage of 20.
• If max P = $100, and
demand is D’, there will
be a shortage of 15.
O
100
Q and P of medical care
• O = no insurance
• F = 75% insurance
• G = 100% insurance
S
115
120 Medical Care
6 - 10
Chapter 6: Health Insurance
Features of Health Insurance Markets
Patients, doctors, and the principal-agent problem
• The patient relies on the doctor for medical advice
• A fee-for-service (FFS) and health maintenance
organizations (HMO) cause opposite risks for the patient
Regulation by insurers
• The insurer has an incentive to limit expenditures
• Allowable charges and refusal to pay
Employer-provided health insurance
• Most people obtain health insurance through work
• Tax advantages and attractiveness to employees
6 - 11
Chapter 6: Health Insurance
Who Bears the Burden of EmployerProvided Health Insurance?
Figure 6.4
• Initial equilibrium when there
is no health insurance offered
Cash Salary
S
$50,000
S’
$8,000
• Now, $8,000 of health
insurance is offered
• D decreases to D’
$42,000
• S decreases to S’
D
D’
110
Labor
6 - 12
Chapter 6: Health Insurance
Who Bears the Burden of EmployerProvided Health Insurance?
• Employees bear most of the burden of cost
• Short run versus long run burden
Table 6.3: Cash Salary and Health Insurance for an Employee
Employee’s Compensation
Cash
Insurance
Employee’s
Purchase of
Insurance
#1
$50,000
$0
$8,000
$8,000
#2
$42,000
$8,000
$0
$8,000
Option
Employee’s
Burden from
Insurance
Rising Medical Expenditures
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Chapter 6: Health Insurance
The Role of Government
Retirees
What about health insurance for…
The unemployed
Low wage workers
Medicaid and the State Children’s Health
Insurance Program
• Poor people cannot afford medical care without help
• Medicaid and SCHIP are programs to help the poor
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Chapter 6: Health Insurance
Alternative Public Policies for Working Families
Consumer-driven health care and health savings accounts
• The free market can work if each consumer bears more
of the burden of his own medical care
Responsible Health Insurance (RHI)
Table 6.4: Proposed Tax Credit by Household Income for a Family of Four
Household Income
Tax Credit
$0
$8,000
$50,000
$6,000
$100,000
$4,000
$150,000
$2,000
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Chapter 6: Health Insurance
Alternative Public Policies for Working Families
An employer mandate or an employer
play-or-pay option
• Employer mandate
• Play-or-pay
Government reinsurance
• Government commits to private insurers
for X% of any huge medical bill
Government insurance
• Single-payer plan
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Chapter 6: Health Insurance
Medicare for Retirees
• How Medicare works
• Government insurance for retirees
• Medicare regulation of hospital and doctor fees
• Medicare prescription drug coverage
• Income-related patient cost-sharing
• Rationing
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Chapter 6: Health Insurance
Health Insurance in Other Countries:
An International Perspective
Most high-income countries finance most medical care
through taxed rater than private insurance premiums.
• Great Britain and the National Health Service (NHS)
• Canada and the single-payer system
• Taiwan and cost sharing
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Chapter 6: Health Insurance
Summary
Principles of health insurance
Features of the health sector
The role of government
6 - 19
Chapter 6: Health Insurance
Preview of Chapter 7:
Tax Incidence and Inefficiency
Incidence: Who bears the burden
People, not firms, ultimately bear all tax burdens
A tax on wage income
A tax on capital income
Inefficiency
The efficiency loss from a tax on a good
The efficiency loss from a tax on wage income
The efficiency loss from a tax on capital income
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