CHAPTER 9 The Health Care Market Mc Graw-Hill Irwin

CHAPTER 9 The Health Care Market Mc. Graw-Hill/Irwin Copyright © 2010 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

U. S. Expenditures of Selected Goods and Services as Share of GDP (1960 -2007) Source: US Bureau of the Census [2009, pp. 95, 425], and National Income and Product Accounts 9 -2

Social Insurance • Social insurance - government programs that provide insurance to protect against adverse events • Examples – Medicaid – Medicare – Social Security – Unemployment Compensation 9 -3

How Health Insurance Works • Insurance premium • Expected Value – Expected value (EV) = probability of outcome 1) * (Payout in outcome 1) + probability of outcome 2)*(Payout in outcome 2) + … + (probability of outcome n)*(Payout in outcome n) 9 -4

Expected Value Computation Draw cards from deck of cards Draw heart and receive $12 Draw spade, diamond or club and lose $4 Probability of drawing heart = 13/52 = ¼ Probability of drawing spade, diamond or club = 39/52 = ¾ EV = (1/4)($12) + (3/4)(-$4) = $0 9 -5

Why Buy Insurance? (A) Insurance Options Income Probability of Staying of Getting Healthy Sick Option 1: No Insurance $50, 000 9 in 10 Option 2: Full Insurance ($3, 000 premium to cover $30, 000 in losses $50, 000 9 in 10 Income if She Stays Healthy (B) (C) 1 in 10 Lost Income if She Gets Sick $30, 000 $50, 000 $20, 000 $47, 000 1 in 10 $30, 000 $47, 000 Income if Expected She Gets Value Sick Actuarially Fair Insurance Policy 9 -6

Utility Why People Buy Insurance B UB UD UC D C • Expected Utility A • Risk Smoothing UA 20, 000 47, 000 50, 000 Income 9 -7

Do People Buy Insurance with Loading Fees? • Risk Aversion • Risk Premium • Loading Fee 9 -8

The Role of Risk Pooling • Insurance in a small population • Insurance in a large population • Law of large numbers 9 -9

Adverse Selection in the Health Insurance Market • Asymmetric information 9 -10

Asymmetric Information and Adverse Selection (A) (B) (C) (E) (F) Expected Benefit (D) Expected Benefit Probability of Lost Income Expected Minus Premium Insurance Buyer Getting Sick if Sick Lost Income (Differential Premiums) (Premium = $3, 000) (Premium = $4, 500) Emily 1 in 5 (High Risk) $30, 000 $6, 000 $0 $3, 000 $1, 500 Jacob 1 in 5 (High Risk) $30, 000 $6, 000 $0 $3, 000 $1, 500 Emma 1 in 5 (High Risk) $30, 000 $6, 000 $0 $3, 000 $1, 500 Michael 1 in 5 (High Risk) $30, 000 $6, 000 $0 $3, 000 $1, 500 Madison 1 in 5 (High Risk) $30, 000 $6, 000 $0 $3, 000 $1, 500 Joshua 1 in 10 (Low Risk) $30, 000 $3, 000 $0 $0 -$1, 500 Olivia 1 in 10 (Low Risk) $30, 000 $3, 000 $0 $0 -$1, 500 Matthew 1 in 10 (Low Risk) $30, 000 $3, 000 $0 $0 -$1, 500 Hannah 1 in 10 (Low Risk) $30, 000 $3, 000 $0 $0 -$1, 500 Ethan 1 in 10 (Low Risk) $30, 000 $3, 000 $0 $0 -$1, 500 Insurer's Net Profits $0 -$15, 000 $0 9 -11

Does Adverse Selection Justify Government Intervention? • Experience rating and equity • Community rating 9 -12

Insurance and Moral Hazard • • Moral hazard Deductible Co-payment Co-insurance 9 -13

Price per unit Moral Hazard Flat-of-the-curve medicine deadweight loss P 0 a b h . 2 P 0 0 Sm Dm M 0 M 1 Medical services per year 9 -14

Additional Considerations • The Elasticity of Demand for Medical Services • Does Moral Hazard Justify Government Intervention? – Third Party Payment 9 -15

Other Market Failures in the Health Care Market • Information Problems • Externalities 9 -16

Do We Want Efficient Provision of Health Care? • Paternalism • The Problem of the Uninsured – Who are the uninsured? – Does health insurance improve health? 9 -17

High Health Care Costs Source: Organization for Economic Cooperation and Development [2008 a]. 9 -18

Causes of Health Care Cost Inflation • • The Graying of America Income Growth Improvements in Quality Commodity Egalitarianism 9 -19