Making good use of the economic theory of health insurance: Catching the wind

1. Michael Thiede Making good use of the economic theory of health insurance:Catching the wind HEPNet & PG Diploma Workshop on Health Insurance in Developing Countries Cape Town, 28 May 2007

2. Let me introduce you to …

3. Wise words IV “...[T]he special economic problems of medical care can be explained as adaptations to the existence of uncertainty in the incidence of disease and in the efficacy of treatment.” K.J. Arrow 1963

4. Wise words V “...It should be noted that the subject is the medical-care industry, not health. The causal factors in health are many, and the provision of medical care is only one. Particularly at low levels of income, other commodities such as nutrition, shelter, clothing, and sanitation may be much more significant.” K.J. Arrow 1963

5. Ignorance is knowing nothing. Risk is where there are uncertain states of the world but these are known and the probabilities of their occurrence. Uncertainty is the same as risk but the probabilities are not known. Uncertainty

6. Each individual acts so as to maximise the expected value of a utility function, e.g. utility attached to income (& medical care as random deduction from this income) Risk-averse individuals (If an individual is given a choice between a probability distribution of income with given mean m, and the certainty of the income m, she would prefer the latter.) Actuarially fair basis of insurance:costs of medical care are random variable with mean m  premium m  welfare gain for the individual but: risk pooling, risk aversion by insurers, administrative costs/loading, third party control over payments Theory of Ideal Insurance

7. If a competitive equilibrium exists at all, and if all commodities relevant to costs or utilities were in fact priced in the market, then the equilibrium is necessarily optimal in the following precise sense: There is no other allocation of resources to services which will make all participants in the market better off. First Optimality Theorem of Welfare Economics

8. If there are no increasing returns in production, and if certain other minor conditions are satisfied, then every optimal state is a competitive equilibrium corresponding to some initial distribution of purchasing power. Second Optimality Theorem of Welfare Economics

9. Wise words VI “... If the … allocation mechanism in the real world satisfies the conditions for a competitive model, then social policy can confine itself to steps taken to alter the distribution of purchasing power.” K.J. Arrow 1963

10. Wise words VII “If ... the actual market differs significantly from the competitive model … the separation of allocative and distributional procedures becomes, in most cases, impossible.” K.J. Arrow 1963

11. Dual loss in the event of illness- Income- Health Issues I

12. Dual moral hazard(exploiting “information asymmetry” to take advantage of the other party to the contract)- ex ante- ex post Issues II

13. Adverse selection(occurs when individuals use their inside information to accept or reject a contract, so that those who accept are not an average sample of the population) Issues III

14. Basis: Rapid increase in medical care costs as result of the spread of health insurance, which has “generated demand for both a higher quality and an increased quantity of medical services”. Objectives:1. Demand response of insuring the poor through public programmes2. Price elasticities, e.g. more generous insurance for less price elastic services3. Health care as merit good: effects of marginal changes in consumption of medical services on health4. Reasons for lower costs in HMOs: cream skimming? lower “depth”? The Rand Health Insurance Experiment (HIE) 1974-1977* *Manning W et al. (1987), Health insurance and the demand for medical care: evidence from a randomised experiment, AER 77:251-277.

15. Design:6 sites14 fee-for service insurance plans + pre-paid group practice2 variables: coinsurance rate (percentage paid out-of-pocket): 0, 25, 50, 95 percent (variations in inpatient and outpatient services) upperlimit to annual out-of-pocket expenses: 5, 10, 15 percent of family income, up to max of $ 1.0005.809 people, 20.190 person years The Rand Health Insurance Experiment (HIE) contd.

16. Use of medical services responds to changes in the amount paid out-of-pocket (no. of contacts stronger affected than intensity of contacts) No significant differences in the use of inpatient services Expenditure correlates as predicted Two conflicting effects of income: positive on outpatient use, negative on inpatient use Children are less “plan responsive” for inpatient care No differential response to health insurance coverage between the healthy and the sickly HMO experiment: less hospital admissions; hardly any significant differences from fee-for-service system (just one HMO!) HIE - Results

17. Degree of coverage (services) Differentiation according to health goods included Differentiation according to type of provider Differentiation according to the extent of compensation –bears on:(a) quantity of the service consumed(b) price of the service(c) product of quantity and price = expenditure Health Insurance Contracts & Incentive Effects

18. Equity • Equity (fairness/justice) in financing: Those with different ability to pay should make appropriately dissimilar payments • (  progressivity of contributions financing incidence) • Equity in delivery of health services: Those with different needs should get dissimilar benefits ( benefit incidence [usually takes into account only SES]) • Financing, benefit and overall incidence • Vertical equity, horizontal equity • Process equity

19. Some more health insurance terms • Risk-pooling • Risk factors - Age - Gender - Births and deaths - Ethnicity - Family size - CDL • Income and X-subsidies • Benefits • Voluntary or compulsory membership

20. Providers Risk Pooling Entity Private Insurance General Taxation Social Insurance Public private for profit, private not for profit, community, some mandatory, group, individual primary, secondary Tax Collector Social Insurance Revenue Collector Premiums Taxes Individualsand Employers Source: WHO Types of insurance based on source of funds

21. Private health insurance and voluntary health insurance Private health insurance is a National Health Accounts category. Definition based on ‘source of financing’ Most insurance in this category is voluntary but this is not criterion for inclusion Definitions I

22. Key dimensions of health insurance Enrolment Voluntary Mandatory

23. Privately funded (Private Insurance) Publicly funded through taxation (Public insurance) Spectrum of Insurance Arrangements(WHO) Source: Sekhri & Savedoff (2005)

24. Moves away from ideology Moves towards integration of health financing strategies rather than compartmentalization Focuses on design of insurance coverage to provide financial protection, promote equity, efficiency… So what’s new?

25. Financing Fairness Capacity Building/ Institutional Strengthening Majority of population covered through publicly funded schemes (e.g. general taxation, social insurance) Increasing public share of health financing through targeted coverage for vulnerable populations Limited Public Funding (for vulnerable) Private insurance for secondary coverage Private Insurance pools cover other segments of the population Out-of-pocket payments predominate Potential Model Towards Universal Coverage(WHO) Public Spending HIGH LOW Private Spending

26. Social Health Insurance Compulsory / mandated, regular income-related contributions (employers and employees) Covers those who contribute [versus National Health Insurance (universal)] Social solidarity / cross-subsidisation:- high to low income (income-related cross-subsidies)- young and healthy to elderly and ill (risk-related cross-subsidies) Standardised minimum benefit package Definitions II

27. Community(-Based) Health Insurance (Fund) Criteria? Voluntary (except e.g. Ghana NHIS) Targeted at those outside formal sector (rural areas, some in peri-urban areas) Strong community involvement May be linked to a specific facility Definitions III

28. Coverage: formal sector – gradually extend Benefit package: - Hospital cover a priority, comprehensive where affordable- Primary care gatekeepers Tends to be less progressive than general tax revenue (can be regressive) Administration costs Bargaining with providers International Experience SHI

29. Administrative expenditure increases with benefits (solution: benefits in kind [?]) There may be too little incentive to invest in prevention, when sick funds do not make any efforts at observing preventive effort. The price elasticity of demand for health care services, although not very high, is different from zero, giving rise to “ex post moral hazard”. … Theoretical Shortcomings of Comprehensive SHI/NHI

30. Protection against “free rider” problem “Adverse selection” (occurs when individuals use their inside information to accept or reject a contract, so that those who accept are not an average sample of the population; therefore:) Introduction of compulsory insurance may result in a Pareto improvement. Cream-skimming Mandatory vs. voluntary membership

31. high Insurance and health care delivery by the same organisation Hospitals owned by insurer, remaining services through contracting Ambulatory care provided by the insurer, remaining through contracting Some health plans managed by the insurer, other plans devoid of vertical restraints Selective/exclusive contracting of insurer with service providers Contracting between insurer and providers at association level Any provider can deliver any service to the insurer’s customers low Vertical restraints and integration

32. Determinants of system choice • Historical context of choice • Cultural preferences (mutuality vs. solidarity) • Capacity • Feasibility • Socio-economic environment

33. Caveats • Dynamic planning context • No high income country uses private coverage as the primary method for insuring populations who are poor or at high risk (not even the US which has the largest private insurance market in the world) • Government stewardship of health insurance markets is critical to their effective functioning (policies, incentives and regulations)