Chapter 9: Health Care Market. Why is the health care debate so contentious?. 1. For many, access to health care can be a life or death decision. In any event, it is critical to the well being of people. Emotions run high.
1. For many, access to health care can be a life or death decision. In any event, it is critical to the well being of people. Emotions run high.
2. There is uncertainty with regard to an individual’s health. A small accident or illness can have catastrophic financial consequences.
3. The US spends approximately _________________. This has increased over time from roughly __________ Whereas spending on other “critical” categories such as housing, clothing, and food have decreased as a percentage of GDP. See graph on next page.
Emily is considering two options: Option 1: no insurance and Option 2: full insurance. Assume that Emily has a 90% chance of staying healthy and a 10% chance of getting sick.
When healthy, Emily earns an income of $50,000 and has no health care expenses. If she gets sick health expenditures cost $30,000 leaving her with $20,000 income.
Determine the actuarially fair insurance premium:
Calculate the expected value of her payoff in each scenario.
Given the ability to set premiums it seems that private markets for insurance should work without the need for government intervention. However, there is also a problem of asymmetric information in the market for health care. Emily may know her probability of getting sick based on family history, her personal medical history, stress, environmental factors, etc. However, the insurance company will not have access to similar information.
For low risk clients (1 in 10 chance of getting sick) their expected loss in income is:
For high risk clients (1 in 5 chance of getting sick) their expected loss in income is
If the firm continued to charge the $3,000 premium to all clients then they would certainly lose money.
Firm loses $15,000.
If the firm knew which clients were at high risk and which were low risk they could theoretically charge different prices. But they don’t have this information.
Suppose the firm knowing its expected payout is $45,000 and wants to spread the risk by making the average premium $4,500 for each of the ten people in an effort to cover costs. Would the firm survive?