Chapter 13: Healthcare

1. Chapter 13: Healthcare • When the US discussed improvements to its healthcare system (2010), Canada was often mentioned • Most Canadians consider our Medicare one of the best health systems in the world… • But worry this may not persist • There currently are huge struggles for increased healthcare funding and overall healthcare reform • Healthcare has risen from 6% of GDP in 1960 to 10% of GDP in 2008

2. Chapter 13: Healthcare • What’s Special About Healthcare? • National Medicare In Canada • Canada vs. The World • Challenges and Future Directions

3. What’s Special About Healthcare? Healthcare is different from a typical good (ipod), and is publicly provided for 5 reasons: • Healthcare is Insurance • Poor Information • Paternalism • Income Redistribution • Externalities

4. 1) Healthcare Is Insurance Healthcare costs are: • Very unpredictable • Very large And therefore most people want health insurance to cover them in the case of this unexpected costs. -In the US, this insurance is private, in Canada, it is public Healthcare=Insurance

5. 1) Insurance Health insurance involves a variety of issues: • Expected Values • Premiums (actuarially fair premiums) • Why Insurance? • Risk Premiums and Loading Fees • Risk Pooling This argues for government involvement due to: f) Adverse Selection And causes issues through: g) Moral Hazard

6. 1) Insurance Insurance is best understood through examples: Assume you spend $2000 over 5 years on electronics. You buy a laptop has a 20% chance of breaking down, with a repair cost of $500. There are 2 cases: • Laptop doesn’t break down – you have $2000 left to spend. • Laptop does break down – you have $1500 left to spend

7. 1a) Expected Value Expected value is the amount of money a person can expect “on average” E($)=∑(outcome) (probability of outcome) In the case of our laptop, E($)=$2,000(0.8)+$1500(0.2) E($)=$1600+$300=$1900 Without insurance, we expect $1900 on average.

8. 1b) Premiums and Payouts Typically, in insurance, • Every year (term), you pay a PREMIUM for the insurance • IF you make a claim, there is a payout An ACTUARIALLY FAIR premium charges just enough to cover expected compensation: AFP=(loss)x(probability of loss)

9. 1b) Actuarially Fair Premium For the laptop, AFP = ($500)(0.2)=$100 Since insurance would cover the cost of the repair, WITH INSURANCE, E($)=($2,000-$100)(0.8)+($2000-$100)(0.2) E($)=$1900 But why buy insurance if the E($)’s are equal?

10. 1c) Why Insurance? Due to Diminishing Marginal Utility, people prefer certain incomes: E(Uinsurance)=U($1900) E(Uno insurance)=U($2000)(0.8)+U(1500)0.2

11. 1c) Why Insurance? The utility lost from the $500 repair in the bad years far outweighs the utility gained from the extra $100 in the good years. People prefer RISK SMOOTHING – reducing income in high income years to protect themselves from income drops

12. Why Insurance? U Due to DIMINISHING MARGINAL UTILITY, utility from insurance (UI), is greater than utility without insurance (UO), even though the expected incomes are equal. U UI UO P Income 1.5K 1.9K 2K

13. 1c) Why Isn’t Insurance Actuarially Fair? Assuming no administration fees (which is a weak assumption), The shape of the utility curve measures RISK ADVERSION – a preference for paying more than the actuarially fair premium in order to guarantee compensation if an adverse event occurs. RISK PREMIUM – the amount above the actuarially fair premium that a risk-adverse person is willing to pay to guarantee compensation if the adverse event occurs

14. Risk Premium U U(Expected)=U(Equivalent) Max Risk Premium = Expected-Equivalent U UI UO P Income Bad Good Expected Equivalent

15. 1d) Loading Fees Loading Fee = Actual Premium – Actuarially Fair Premium -Average loading ratio for private US insurance companies is 1.2 (Phelps 2003) -(typical laptop service plan is $200 for 3 years, working out to a Loading Fee of 4.0 – 10% failure rate in year 2 and 3 for $500 laptop) -keep in mind this includes administration costs

16. 1e) Risk Pooling An insurance company can’t insure just one person -If the claim happens, the company can’t pay for it -An insurance company has to insure MANY similar people -that way the percentage of claims is close to the probability -Insurance works by POOLING risk across individuals

17. 1f) Adverse Selection • Health insurance can break down due to ASYMMETRIC INFORMATION – when one party have information not available to another party • Assume there are 3 laptop purchasers: • Bill has a laptop failure rate of 10% (he’s a computer technician) • Charles has a laptop failure rate of 20% (he’s average) • Denis has a laptop failure rate of 30% (he clicks on all the “you won” pop-ups)

18. 1f) Adverse Selection • Recall that actuarially fair insurance just charges enough to over expected repairs • Expected repairs ($500xP(failure)): • Bill: $50 • Charles $100 • Denis $150 • If you charge: • $50 – Charles and Denis cause a loss • $100 – Bill doesn’t want insurance and Denis causes a loss • $150 – Charles and Bill don’t want insurance

19. 1f) Adverse Selection • If health insurance were a private option, those most likely to be sick would purchase it, and healthy people won’t • This leads to more expensive claims • This leads to higher premiums • This leads to more people not buying insurance • The end result would be UNDERPROVISION of healthcare

20. 1f) Adverse Selection Saviors • 3 Issues can keep Adverse Selection from killing a private insurance market: • Risk Aversion • Group Insurance • Risk Categories/Risk Profiling

21. 1fi) Risk Aversion • Because people are risk averse, they are willing to pay a RISK PREMIUM above the actuarially fair premium. • This may keep more people in the market 1fi) Group Insurance • Larger companies can offer group insurance plans that automatically cover everyone (high and low risk) • This doesn’t help small firms or the self-employed

22. 1fiii) Risk Categories • Adverse selection occurs due to asymmetric info – inability to know a person’s risk • HOWEVER, a company can charge premiums based on OBSERVABLE characteristics statistically linked to UNOBSERVABLE risk • ie: Male 20-year olds pay more for auto insurance because they are STATISTICALLY more likely to have an accident than Female 20-year Olds

23. 1fiii) Risk Profiling? • The Supreme Court of Canada ruled this does not violate the Canadian Charter of Rights and Freedoms because there is statistical evidence that 20-year-old males do have higher loss probabilities • Some ask how long until we are charged based on: • Ethnicity • Religion • Sexual Orientation (marital status already applies) • If there is statistical evidence?

24. 1f) Public Insurance and Adverse Selection • Public Health Insurance is MANDATORY, and therefore Adverse selection is avoided since the low risk individuals can’t drop out PRO’s: • Mid and High-risk individuals are covered at a reasonable rate ($100 in our example) Con’s: • Low risk individuals would rather not be covered at a high rate (for them)

25. 1f) Public Insurance and Adverse Selection • Public Health Insurance is argued for based on: • Equity – everyone is equally treated, or the poor tend to have lower average health than the rich • Utilitarianism – the gain to the low-risk individuals tends to be greater than the loss to the high-risk individuals

26. 1g) Moral Hazard • If people have health insurance, their actions may change in two ways: • They live unhealthy lifestyles, knowing they are covered (unhealthy eating, unhealthy living, extreme sports, etc) • They over consume healthcare since it’s free (“Last night on House the woman had Ebola, so I figured I should get tested.”) This effect can be shown through supply and demand:

27. Moral Hazard P Without insurance, a patient pays P0 and consumes Q0 (where S=D). This causes healthcare expenditures of area A. S=MC (constant) P0 A B (1-x)P0 Q Q0 Q1 D=MB With insurance, x% is covered, and a patient pays (1-x)P0 and consumes Q1 (where new S=D). This causes healthcare expenditures of Area A +B (expenditures increase).

28. Moral Hazard P This overcomsumption causes deadweight loss where MC>MB: S=MC (constant) P0 DWL (1-x)P0 Q Q0 Q1 D=MB While some argue against downward sloping demand (no, I don’t want that life-saving operation), enough medical procedures are optional to empirically give a downward slope.

29. 1g) Government and Moral Hazard • Government health insurance DOES NOT eliminate Moral Hazard • The DWL still exists • Canadian governments have fought Moral Hazard through Medicare budget caps and medical service rationing • This leads to controversies over waiting times

30. What’s Special About Healthcare? Healthcare is different from a typical good (ipod), and is publicly provided for 4 additional reasons: • Poor Information • Paternalism • Income Redistribution • Externalities

31. 2) Poor Information • Often, consumers are fairly well informed about the goods they buy (you know how an apple tastes, you can test drive a car, etc) • When you are sick, you may not be well informed about the treatment you buy • In addition, the expert in the field is also the person selling you the product (the doctor) • Imagine if you trusted a car dealer about the “right” car for you

32. 3) Paternalism • Some may not purchase health insurance: • They don’t know how it works • They don’t think they need it (“I am INVINCIBLE!”) • They forget about it Mandatory medical insurance (such as public healthcare) makes sure everyone is covered. “people who are forced to pay for medical care out of pocket don’t have the ability to make good decisions about what care to purchase” (Krugman 2006)

33. 4) Income Redistribution • Canadians generally agree that everyone should have equal access to medical services, regardless of ability to pay. (Even the US supplies free EMERGENCY medical services, regardless of ability to pay.) • Public Healthcare redistributes income from the rich (who pay more taxes) to the poor (who may not be able to afford healthcare) • Also, lower incomes may have a greater need for healthcare, resulting in a greater redistribution

34. 4) Income Redistribution • Unfortunately: • The poor are less likely to have a family doctor or receive specialist medical care in Canada (Curtis and MacMinn, 2008) • 16% of the US population is without either private or public health insurance (2008 stats) • Typically low income, irregular employed, and self-employed workers lacked healthcare

35. 5) Externalities • Health services typically carry positive externalities (if people around you are vaccinated and healthy, you are less likely to be sick) • Since goods with positive externalities are underconsumed in private markets, public healthcare would increase consumption to ideal levels

36. National Medicare In Canada Medicare – Canada’s national health insurance program • Pays the full cost of all medically necessary hospital and physician services • Medical care providers directly bill the government for services • Fees for service are determined by seach province • Essentially Canada has 13 health insurance plans, one for each province and territory • Each plan follows the Canada Health Act

37. Theory - Canada Health Act The Canada Health Act (1984) lays out 5 conditions for federal grants for healthcare: • Universality: All residents are entitled to health insurance coverage • Accessibility: No financial or other barriers for medically necessary hospital and physician services (provincially defined). Reasonable compensation for hospitals and physicians, extra billing prohibited.

38. Canada Health Act 3) Comprehensiveness: All medically necessary services (provincially defined) must be insured. 4) Portability: Coverage is maintained when a resident moves within Canada or travels outside the country (covered at provincial rates). 5) Public Administration: Health insurance administered on a non-profit basis by a public authority

39. Canada Health Act & Private Insurance The Canada Health Act prohibits private health insurance for all medically necessary treatments. Private insurance is permitted for services not covered by Medicare. Private health care DELIVERY is not illegal (doctors are private practitioners who opt in or opt out of public insurance, and must follow provincial fee-for-service schedules)

40. 2010 Per Capita Health Expenditures While all provinces support the Act, per-capita expenditures vary widely (due to demographics, remuneration differences, etc) Government fines for violating the act have been small Public support, not fines, enforce the Act (Boothe and Johnston 1993)

41. History of Canadian Healthcare 1940 – hospital and medical care were privately funded, with religious or voluntary organizations running some hospitals considering ability to pay 1947 – Saskatchewan introduced hospital insurance By 1961 – All provinces had hospital insurance, with the federal government covering 50% of costs on average (physician payments were still private)

42. History of Canadian Healthcare 1962 – Saskatchewan started provincial Medicare 1971 – All provinces had Medicare, federal government covering about 50% 1977 – Federal government funded healthcare and post-secondary education through Established Program Financing (EPF), offering equal per-capital grants to provinces (increasing with GDP growth) 1982-1995 – government limited growth in EPF grants (frozen in 1990)

43. History of Canadian Healthcare 1984 – Canadian Health Act Passed, laying out 5 conditions for EPF transfers 1996 – EPF grants replaced with Canadian Health and Social Transfer (CHST), covering health, education, and post-secondary education (Health Act still applied) 2004 – CHST broken into Canada Social Transfer (CST - welfare and post-secondary education) and Canada Health Transfer (CHT)

44. History of Canadian Healthcare 2004 10-Year Plan to Strengthen Health Care signed by provincial and federal governments. Federal government legislates 6% CHT growth until 2013-2014 2011-12 – $27 Billion in CHT grants (expected)

45. Health Expenditure Trends Chart shows per-capita healthcare expenditure in 2002 dollars. 1990’s had federal spending constraint, resulting in decreasing per-capita expenditure

46. Health Expenditure Trends Jumps : 1966-1971 (Medicare), 1979-1983, 1988-1992 (9.8%) Drops in 1992 to 1996 (restraints and cuts), public backlash Spending increase 1996-2008 (response to backlash) 2008 Spending at 10.4% of GDP

47. Health Expenditure Trends Hospitals receive less funding due to more community and home health services Drug costs have increased due to rising drug prices, advances in using drugs as treatments, and aging population

48. Canada vs. The World A “snapshot” of country statistics can give us an idea of Canada’s healthcare compared to the world: • Demand for healthcare can be examined through senior population (who have higher healthcare demand) • Number of physicians can give us and idea of health care supply • Life expectancy and infant mortality can give us an idea of healthcare output

49. Canada vs. The World 4) Healthcare expenditures can give us an idea of how much we spend on healthcare, and can then be compared to healthcare results • Note that Canada spends less on healthcare than the US, but has better life expectancy and lower infant mortality • Sweden spends less and does better, however • Note also that factors other than healthcare (income support, weather, suicide, etc) also affect these healthcare statistics:

50. Go Canada, Go!