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Health Insurance Adverse Selection Moral Hazard. FGS 8,10,11, 12 Cutler 1994. Outline. Uninsured in the US Demand for Insurance What is insurance – risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Problems with demand for insurance

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Health Insurance Adverse Selection Moral Hazard


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    1. Health Insurance Adverse Selection Moral Hazard FGS 8,10,11, 12 Cutler 1994

    2. Outline • Uninsured in the US • Demand for Insurance • What is insurance – risk pooling • What is risk aversion • Demand for insurance • Factors affecting demand for insurance • Problems with demand for insurance • Moral hazard • Adverse selection • Problems with the health insurance market (Cutler) • Health insurance features • Insurance and demand for medical care • Supply of insurance • Fee-for-service • Managed care • Consumer-driven health plans and health savings accounts • US health insurance market a brief history

    3. Uninsured • Uninsured and Underinsured • 47 million people uninsured in 2006 (15 % of population) • An increase of 8.6 million from 2000 • Majority are employed in small firms (<100) • 16 million non-elderly adults (20%) were underinsured • High out-of-pocket health costs to income ratio

    4. Figure 1: 47 million uninsured in 2006;Increase of 8.6 million since 2000 Number of uninsured, in millions Source: U.S. Census Bureau, March Current Population Survey, 2001–2007.

    5. Percentage of uninsured workers Ages 18-64, by Firm Size (1997)

    6. Who are the uninsured? • Mostly adults, not children – half are childless adults. • The number of uninsured children increased from 8 million (10.9 percent) in 2005 to 8.7 million (11.7 percent) in 2006 • Poor and near-poor – 60% have incomes above federal poverty level • Workers and family members – 80% in families with at least 1 worker • Unskilled laborers, service workers • 3 of 5 of the uninsured who work, work in firms with <100 workers

    7. Uninsured: Why are they uninsured • Three primary reasons that workers don’t have insurance: • The employer does not offer a health plan. • Employer offers health plan, but employee is not eligible for the plan because of part-time status or some other rule. • Employee doesn’t buy plan because plan too expensive or does not perceive need for plan

    8. Uninsured: Why are they uninsured • Uninsured, more likely to: • Change jobs • Work part-time • Work for small firms • Small-firms pay much higher premiums because their risk is perceived to be large. • Why don’t they buy private health insurance • There is no risk pooling with private health insurance and it is expensive • Average annual cost of family policy in the private market (3,330) • Average annual cost an employee pays out of pocket towards group insurance (2,700)

    9. Uninsured: Impact on health outcomes • Empirical research gives mixed results • Empirically difficult to measure • Selection bias: Those who choose not to buy health insurance do so because they are healthier • Endogeneity: does lack of insurance cause poor health, or does poor health decrease the probability of being insured. (can’t determine direction of causality) • Despite inconclusive empirical evidence, the argument that those without insurance experience poor health is powerful. • As the number of uninsured grow, policy makers will have an increasingly difficult time ignoring health consequences of the uninsured.

    10. Do the uninsured receive necessary health care?

    11. Do the uninsured receive necessary health care? • Often No… compared to the insured population, the uninsured... • Have higher rates of preventable and/or untreated illness • Are less likely to receive care that they feel they need • Have more preventable hospitalizations • Have shorter hospital stays for the same conditions • Are hospitalized sicker and have poorer health outcomes (including death)…

    12. Do the uninsured receive necessary health care? • Are not known to be a sicker or higher-cost population. • Pay higher medical fees. (NYT, 4/2/01) • “A New York gynecologist says he gets $25 for a routine exam for a woman insured by group health insurance and charges $175 for the same exam for a woman without insurance.”… “The care of the poor once was supported by the wealthy and the insured, but now the opposite is happening.”

    13. Effect on employers Rising health costs take bite out of small biz – USA Today 10/5/03 “Small-business profits are getting pinched because of price increases for employee health insurance. Among small companies that posted lower earnings in August vs. a year ago, 18% blamed higher insurance costs, says a survey of 544 firms by the National Federation of Independent Business trade group. In a similar survey a year ago, 11% blamed health insurance costs for their earnings dip.”

    14. Outline • Uninsured in the US • Demand for Insurance • What is insurance – risk pooling • What is risk aversion • Demand for insurance • Factors affecting demand for insurance • Problem with demand for insurance • Moral hazard • Adverse selection • Problems with the health insurance market (Cutler) • Health insurance features • Insurance and demand for medical care • Supply of insurance • Fee-for-service • Managed care • Consumer-driven health plans and health savings accounts • US health insurance market a brief history

    15. What is insurance • Meant to insure us against random uncertainty. • Club of 100 members. • On average, each year one member gets sick, it costs $20,000. It is random who gets sick. • This is a lot of money for one person to pay.

    16. What is insurance • Instead, they insure each other and each pay $200 a year. • They pay this to avoid the risk of uncertainty that they will have to pay 20,000. • Money put in bank to get interest, and pay out when someone gets sick. • Aim of insurance is to reduce the variability in one’s income by pooling risks with a large number of people.

    17. What is insurance • Outlays for health may be variable for one person, they are fairly predictable for the group. • Health insurance would not be necessary if everyone had average needs. But we do not it is variable. • Insurance makes it possible to obtain health care without going Bankrupt (new cancer drug $100,000 a year).

    18. What is insurance Desirable characteristics for insurance: • The number of insured should be large, and they should be independently exposed to potential risk • Losses covered should be definite in time, place, and amount • The chance of loss should be measurable • The loss should be accidental from view point of person who is insured

    19. Concentration of personal health expenditures, in US in 2002 Source: Getzen T. “Health Economics: Fundamentals and Flow of Funds”,

    20. Terminology Loading Fee: general costs associated with the insurance company doing business, such as sales, advertising, or profit. Premium: When people buy insurance policies, they typically pay a given premium for a given amount of coverage should the event occur. Should cover average medical care expenses

    21. Demand for health insurance • Results of uncertainly • Illness and medical expenditures are unpredictable • Hospitalizations, serious injury, and rehabilitation and other advanced modern treatments can be very expensive • Can save for possible medical expenditures • Most households are averse to risk • Insurance companies pool risk • Don’t take on risk, spread risk among many consumers • What is risk aversion?

    22. Risk aversion Consider the gambling game: • Zan and Forest flip a coin. • If it comes up heads, Zan wins a dollar and Forest nothing. • If it comes up tails, Forest wills a dollar and Zan nothing. • How much should they each be willing to pay to play this game? • Expected Return for Zan: P(head)*$2 + P(tails)*0=$1 • Willing to pay $1 cents

    23. Risk aversion • Would you be willing to play this game for $5 get $10 if win, for $10,000 get $20,000 if win? • The fact that you are less willing to play at larger amounts shows you are risk averse

    24. Risk aversion • A simple test to see if you are “risk adverse.” • Which would you select? • Your pay check, OR • Double your pay check for correctly picking one coin flip. • Equal expected values; most of us are risk adverse and select the “certain” option. • Risk aversion: - the degree to which a certain income is preferred to a risky alternative with the same expected income.

    25. Risk aversion Expected Value: E [income if heads]=Prb(H)*$2+Prb(T)*0=1 Actuarially fair gamble: is one in which the amount you pay for the gamble is equal to the expected value of the gamble. • You paid a $1 to play, and the expected value of the game was $1.

    26. Risk aversion • If price of gamble (amount pay to play game) is equal to the expected return, then the gamble is actuarially fair. • In health, if expected benefit payment is equal to premiums, the insurance policy is actuarially fair. • Now suppose the gamble was instead for $5,000, would you want to play the game? • If not you are defined as being risk averse, because you do not want to take the actuarially fair gamble.

    27. Risk aversion Reflected by the diminishing marginal utility of income/wealth. A > B. Utility lost when lose a dollar is larger than utility gained by winning a dollar Utility B A 1 2 3 Income

    28. Risk aversion • Presence of aversion makes consumers willing to pay to spread risk with others. • Insurance companies specialize in pricing risks, not in taking risks. • Lesson from the theory of insurance: the losses that are insured are: large, infrequent, random, and not associated with a large moral hazard.

    29. Demand for insurance See notes from black board Factors affecting demand for health insurance: • Probability of illness • Loading fee • Magnitude of loss relative to income (cost of illness) • Degree of risk aversion • Price: Higher price reduces likelihood that an individual will insure against a given event

    30. Demand for insurance • Probability of Illness -- evidence • Increases with age • Affected by availability of public health insurance programs (Medicare) • Differs by gender • Result of women responsible for child birth • Affected by availability of public health insurance program targeting pregnant women • Differs by type of care needed • Chronic vs. acute vs. preventive • Elasticity of demand will differ

    31. Uninsured by age, 2005 Source: ASPE tabulations of the 2005 Current Population Survey

    32. Uninsured by income Source: ASPE tabulations of the 2005 Current Population Survey

    33. Percentage of Population Without Health Insurance, by Gender, Jan-June 2003 MALE FEMALE

    34. Outline • Uninsured in the US • Demand for insurance • What is insurance – risk pooling • What is risk aversion • Demand for insurance • Factors affecting demand for insurance • Problems with demand for insurance • Moral hazard • Adverse selection • Problems with the health insurance market (Cutler) • Health insurance features • Insurance and demand for medical care • Supply of insurance • Fee-for-service • Managed care • Consumer-driven health plans and health savings accounts • US health insurance market a brief history

    35. Problems in demand for insurance Two main problems with demand for insurance • Moral hazard: The disincentives created by insurance for individuals to take measures that would reduce the amount of care demanded. OR, additional quantity of health care demanded, resulting from a decrease in the net price of health care attributable to insurance

    36. Problems in demand for insurance • Adverse selection: A situation often resulting from asymmetric information in which individuals are able to purchase insurance at rates that are below actuarially fair rates plus loading costs - alternatively: occurs when high-risk consumers, who know more about their own health status than insurers do, subcribe to an insured group composed of lower-risk individuals to secure low premiums.

    37. Moral hazard • What are the effects of the new price system (with insurance) on demand for insurance. • Buying insurance lowers the price per unit of health care service at time it is bought. • Person with health insurance is more likely to go to the doctor for a small problem than someone without health insurance • Likely to affect good with higher elasticity of demand such as preventive care.

    38. Moral hazard Moral Hazard: refers to the increased usage of services when the pooling of risks lead to decreased marginal costs for services. (i.e. the price is reduced). • It is also used to refer to how one changes behavior when they are insured. • We may take more risks, which could have health care implications when insured rather than not insured. • Learning snow boarding (lot of people break their arms). May not learn if don’t have health insurance.

    39. Moral hazard • Five sources of Moral Hazard • Quantity demanded of medical care greater than amount consumer would purchase if he/she paid full cost • Individual less likely to engage in preventive behavior and/or more likely to engage in unhealthy behavior • Individual demands higher quality/more costly types of care than he/she would in the absence of insurance • Individual’s incentives to monitor health care providers lower than in absence of insurance • Individual’s incentive to search for lower prices lower in than in the absence of insurance

    40. Moral hazard Price Price without insurance Po Dead weight Lost (DWL) Price with insurance P1 Qo Q1 Quantity “Moral Hazard” increase in consumption due to insurance

    41. Moral hazard Price Price without insurance Po Dead weight Lost (DWL) Price with insurance P1 Qo Q1 Quantity “Moral Hazard” increase in consumption due to insurance

    42. Moral hazard • Moral Hazard: • decreases when the price becomes more elastic. (i.e. for those goods you want no matter the price. Price D2 D1 Price without insurance Po DWL Price with insurance P1 Qo Q2 Q1 Quantity

    43. Moral hazard • For services that are not very price sensitive, insurance will not cause them to purchase more services. • E.g. purchase of insulin for diabetics. • For those that are price sensitive (cosmetic surgery – not from accidents), insurance may encourage one to buy more.

    44. Question: If you designed a health care plan… • Hospital Care • Surgical & in-hosp medical • Outpatient doctor • Dental exams/cleaning • Mental health • Over the counter drugs • Flu shots

    45. Patterns of Insurance Coverage The losses that are insured are: large, infrequent, random, and not associated with a large moral hazard.

    46. Typical solutions to the moral hazard • Increase cost sharing • Could do this through co-payments or deductibles • Reduce the quantity demanded by increasing price consumer faces • Increases preventive behavior/reduces unhealthy behavior since consumer faces part of “costs” from these behaviors • Increases the likelihood of consumer choosing less expensive types of medical care

    47. Typical solutions to the moral hazard • Raises the likelihood that consumer better monitors provider behavior • Increases likelihood that consumer “shops around” for less expensive sources of care • Offer less generous insurance for specific services with more elastic demand (e.g., mental health coverage, preventive care)

    48. Problems with solutions • Assumes you will decrease unnecessary care • People don’t know which care is unnecessary so may decrease necessary and unnecessary care • Some health services which are elastic have long-term health gains which may not be realized by consumer • Externalities argument • Preventive care and chronic disease management will lead to better health in the future and can lead to lower health costs in the future • These models don’t take the long-term effects of not receiving care into consideration. • Increasing price may decrease demand in the short-run but increase it in the long-run

    49. Other solution to moral hazard • Instead of rationing on price, ration on need • Don’t use price mechanism to say how much care you should or should not get • Managed Care or many universal care countries • Utilization review • Gatekeepers • Provider guidelines • Provider networks