©2016 by McGraw-Hill Education Limited. HEALTH CARE Chapter 9 ©2016 by McGraw-Hill Education Limited.

Learning Objectives Describe the function of health insurance. Calculate the actuarially fair insurance premium. Using a diagram, illustrate the conditions under which an individual would purchase insurance. Describe the role of insurance firms in pooling risks. Explain how adverse selection can lead to a market failure in the market for health insurance.

Learning Objectives (cont) Outline how government intervention can address the adverse selection problem. Demonstrate how the problem of moral hazard can lead to inefficient levels of health services. Outline how information, externality, and equity concerns can give rise to problems in privatized health care markets. Discuss the current challenges facing Canada’s health care system and the difficulties encountered when attempting to measure its performance.

What is Special About Health Care? LO1 What is Special About Health Care? The role of insurance Social insurance – government programs that protect people against a variety of adverse events Health insurance – buyers pay money (insurance premium) to providers of insurance, who agree to disburse some money to the insured person should an adverse health event occur Other things being the same, the greater the insurance premium, the more compensation the buyer receives in the case of an illness

Expected Value The amount of money an individual can expect to receive “on average” when she faces uncertain outcomes 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)

LO2 Why Buy Insurance? Table 9.1 The actuarially fair insurance premium charges just enough to cover the expected compensation for the expenses ($3,000 in the example) In general, option 2 is preferred as it provides the same expected income but with more certainty Diminishing marginal utility

Why People Buy Insurance LO3 Why People Buy Insurance Option 2 Full insurance B Utility UB U D UD UC C Expected Utility Risk Smoothing A Option 1 No insurance UA 20,000 47,000 50,000 Income Figure 9.1

Do People Buy Insurance if Premiums are not Actuarially Fair? A. Less risk averse B. More risk averse Utility B Utility B E E’ C C A A Income 20,000 46,500 47,000 50,000 20,000 40,000 47,000 50,000 Figure 9.2

Do People Buy Insurance if Premiums are not Actuarially Fair? Risk Aversion The demand for insurance depends on the curvature of the utility function Risk premium – the amount an individual is willing to pay above the actuarially fair premium Loading fee – the difference between an insurance premium charged by a company and the actuarially fair premium Current average loading ratio for private insurance companies = 1.20

The Role of Risk Pooling LO4 The Role of Risk Pooling Insurance in a small population Insurance in a large population Law of large numbers

Asymmetric Information in the Health Insurance Market Situation in which one party engaged in an economic transaction has better information than the other party Adverse selection Buyer has more information about the probability of loss than the seller Moral Hazard The insured individual has more information about actions that affect the probability of incurring loss

How Adverse Selection Can Cause Failure in the Insurance Market LO5 How Adverse Selection Can Cause Failure in the Insurance Market Table 9.2

Adverse Selection Empirical evidence: A death spiral at Harvard? LO6 Adverse Selection Empirical evidence: A death spiral at Harvard? Does adverse selection justify government intervention? Private market responses to adverse selection Group coverage Categorize risk - observable characteristics Social insurance programs are compulsory Not subject to the adverse selection process that arises when individuals can use their private information regarding their loss probability to choose their insurance coverage

Low-Risk Individuals Prefer Zero Coverage to Social Insurance B Utility E UC F C UF A PMAX 20,000 45,500 46,500 47,000 50,000 Income Figure 9.3

Moral Hazard and Market Failure If people know they have insurance, they may take less care to avoid risks People have an incentive to over-consume because insurance pays for some or all of the cost

Market for Medical Services LO7 Market for Medical Services Coinsurance rate Expenditures in the absence of insurance Price per unit Deadweight Loss a b Sm P0 Additional expenditures induced by insurance Axes and labels 1st click – Dm 2nd click – Sm, 3rd click - brown rectangle 4th click - .2P0 5th click - gray rectangle 6th click – deadweight loss triangle 7th click – “Flat-of-the-curve medicine” h .2P0 Dm M0 M1 Medical services per year Figure 9.4

Additional Considerations LO8 Additional Considerations Does moral hazard justify government intervention? All third party payment systems generate moral hazard Other Problems in the Health Care Market Poor information Paternalism Income redistribution Externalities

National Medicare in Canada Medicare refers to Canada’s national health insurance program The Canada Health Act Universality Accessibility Comprehensiveness Portability Public administration The history of Canadian health care financing Constitutionally, the provision of health care is the responsibility of the provinces Canada Social Transfer (CST) and Canada Health Transfer (CHT)

Per Capita Health Expenditure by Provincial Governments in 2014* Figure 9.5

Trends in Health Expenditures Provincial and Territorial Government per Capita Health Expenditures, 1975 to 2014 (constant 2002 dollars) Figure 9.6

Trends in Health Expenditures Total Health Expenditures as a Percent of GDP Figure 9.7

Trends in Health Expenditures Percent Shares of Health Care Expenditures by Category Table 9.3

Comparing Health Systems Around the World Selected Health Statistics for OECD Countries, 2011 Table 9.4

Challenges and Future Directions LO9 Challenges and Future Directions Is the Canadian health system in decline? Challenges Cost pressures facing the Canadian health system Increasing wait times What will the Canadian health care system look like in the future? Changing incentives Defining medically necessary services A national pharmacare program Privatization User charges

Wait Times Compared for Selected Countries, 2013 (in percent) Table 9.5

Percent of Patients Receiving Care Within Benchmark Wait Time Table 9.6

Chapter 9 Summary For a risk-averse person, an insurance plan that charges an actuarially fair premium increases expected utility because it allows risk smoothing. The more risk averse an individual is, the more he or she is willing to pay for an insurance policy. By pooling individuals into one insurance program, an insurance company can lower risk from a societal point of view. Health care services may be different from other commodities and services for a number of reasons, including adverse selection, moral hazard, and society’s desire to act paternalistically, to redistribute income, or to internalize externalities.

Chapter 9 Summary (cont) Government can address adverse selection by providing universal health insurance coverage. Government provision of health insurance faces the same moral hazard problem as private insurance, because it too reduces the price of medical services faced by patients. Health care insurance is a provincial government responsibility; The federal government contributes transfers to support health care services. The Canada Health Act lays out five conditions that must be met for provincial health insurance schemes to qualify for federal transfers.

Chapter 9 Summary (cont) Compared with health systems in selected OECD countries, Canada’s health system produces average or above-average outcomes at above-average cost. As we look to the future of the Canadian health care system, we note that the health of Canadians is generally improving over time. Significant future public cost pressures will come as a result of the aging population; technical advances in health sciences, which will expand the range of health problems that can be treated; and the increasing reliance on public funding for drugs. Current debates about future directions for the Canadian health care system centre on changing incentives faced by physicians and other health care providers, defining a list of medically necessary services, the value of a national pharmacare program, and the role of the private sector in health care financing.