CHAPTER 9

The Health Care Market

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

9-2

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

9-3

Social Insurance

• Social insurance - government programs that provide insurance to protect against adverse events

• Examples– Medicaid– Medicare– Social Security– Unemployment Compensation

9-4

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)

9-5

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

9-6

Why Buy Insurance?

Insurance Options

Income Probability of Staying Healthy

Probability of Getting

Sick

Lost Income if She Gets

Sick

(A) (B) (C)

Income if She Stays

HealthyIncome if She Gets

Sick

Expected Value

Option 1: No Insurance

$50,000 9 in 10 1 in 10 $30,000 $50,000 $20,000 $47,000

Option 2: Full Insurance ($3,000

premium to cover $30,000 in

losses

$50,000 9 in 10 1 in 10 $30,000 $47,000 $47,000 $47,000

Actuarially Fair Insurance Policy

9-7

Why People Buy Insurance

Income

Util

ity

20,000 47,000 50,000

UA

UC

UD

UBD

C

B

A

• Expected Utility

• Risk Smoothing

9-8

Do People Buy Insurance with Loading Fees?

• Risk Aversion

• Risk Premium

• Loading Fee

9-9

The Role of Risk Pooling

• Insurance in a small population

• Insurance in a large population

• Law of large numbers

9-10

Adverse Selection in the Health Insurance Market

• Asymmetric information

9-11

Asymmetric Information and Adverse Selection

  

(A) (B) (C) (D) (E) (F)

Expected Benefit Expected Benefit Expected Benefit

  Probability of Lost Income Expected Minus Premium Minus Premium 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

9-12

Does Adverse Selection Justify Government Intervention?

• Experience rating

• Experience rating and equity

• Community rating

9-13

Insurance and Moral Hazard

• Moral hazard

• Deductible

• Co-payment

• Co-insurance

9-14

Moral Hazard

Medical services per year

Pric

e pe

r un

it

Dm

Sm

M1M00

P0

.2P0

a b

h

deadweight loss

Flat-of-the-curve medicine

9-15

Additional Considerations

• The Elasticity of Demand for Medical Services

• Does Moral Hazard Justify Government Intervention?– Third Party Payment

9-16

Other Market Failures in the Health Care Market

• Information Problems

• Externalities

9-17

Do We Want Efficient Provision of Health Care?

• Paternalism

• The Problem of the Uninsured– Who are the uninsured?– Does health insurance improve health?

9-18

High Health Care Costs

Source: Organization for Economic Cooperation and Development [2008a].

9-19

Causes of Health Care Cost Inflation

• The Graying of America

• Income Growth

• Improvements in Quality

• Commodity Egalitarianism