317_L17, Feb 13, 2008, J. Schaafsma 1 Review of the Last Lecture began our discussion of the case for public health insurance basic reason => market failure in the private health insurance market four sources of market failure in private health insurance market: - decreasing admin costs as # subscribers  - pre-existing conditions - adverse selection - moral hazard have discussed the first source, gave 5 reasons today begin by looking at data on the load factor as a percent of the expected loss then look at the other three sources of market failure

317_L17, Feb 13, 2008, J. Schaafsma 2 How Large are Load Factors? individual policies 60 – 80 % of expected loss medium group policies (11–100 persons) 20 – 30 % of expected loss large group (201 – 1000 persons) policies 8 – 15 % of,,,, very large group policies (> 1000 persons) 5 – 8 % of,,,, source: Phelps, Health Economics, 3 rd edition, p. 343 Provincial health insurance potentially has a very low load factor (Why?)  premium very close to expected loss

317_L17, Feb 13, 2008, J. Schaafsma 3 Second Source of Failure in the Health Insurance Market: Pre- existing Conditions insurance covers risk of ill health for insured period, e.g. one year if one gets ill  covered as long as insurance in force what if one were to lose coverage e.g., was part of a group plan at work and became unemployed? might be able to buy insurance privately but the pre-existing condition would likely not be covered. private plans  cover risk of a loss on an annual basis (pool risk one year at a time)  may result in loss of coverage over time not a problem in a universal public plan  covered for life (pool life time risk)

317_L17, Feb 13, 2008, J. Schaafsma 4 Pre-existing Conditions and Market Failure annual insurance contracts will lead to loss of comprehensive coverage for some no insurance available for risk of losing coverage even if willing to pay a reasonable premium  market failure Public universal insurance gets around this market failure  in for life  no loss of coverage  premium can be set accordingly. really a life time insurance contract with annual payments, i.e., are pooling life time risks rather than pooling risks a year at a time.

317_L17, Feb 13, 2008, J. Schaafsma 5 Third Source of Failure in the Health Insurance Market: Adverse Selection: Part 1 in order to understand the concept of adverse selection in the insurance industry need to understand: community rated premium, ideal insurance, information asymmetry. community rated premium  premium is based on the assumption that those who opt in are representative of the risks in the community. with community rating  same premium for high risk and low risk persons  latter subsidizes the former  ex ante income redistribution, i.e., premium structure redistributes income from low risk to high risk subscribers. ///

317_L17, Feb 13, 2008, J. Schaafsma 6 Adverse Selection in the Insurance Industry: Part 2 ideal insurance  people pooled by expected loss categories  charge different premiums based on expected loss  no ex ante income redistribution from low risk to high risk subscribers. information asymmetry  buyers of insurance know more about their own health and the expected loss than the insurance company. if insurance offered to all at a single community rated premium (based on the average expected loss)  premium will look low to high risk person  opt in premium will look high to low risk person  don’t opt in ///

317_L17, Feb 13, 2008, J. Schaafsma 7 Adverse Selection and Market Failure adverse selection  insurance offered at a community rated premium  high risk, high loss opt in; low risk, low loss don’t opt in  this is selection against the insurer  adverse selection if no information asymmetry  individuals assume, as insurer does, that they are all average risks  no adverse selection with information asymmetry  adverse selection  can cause market failure  as high risk opt in and low risk don’t  premium too low  premium   more low risk drop out of plan  premium  again  and so on  whole market could disappear! no adverse selection with compulsory public insurance (or with any compulsory group insurance). ///

317_L17, Feb 13, 2008, J. Schaafsma 8 Inability to Purchase Health Insurance not always Market Failure have shown that with adverse selection premium can rise until no one wishes to purchase insurance  market failure market failure does not require complete disappearance of the market could simply have some consumers not insured although able and willing to pay a fair premium. the fact that some consumers are not insured is not necessarily evidence of market failure. could simply mean that these consumers have insufficient income to purchase insurance at a fair price  income distribution problem. ///

317_L17, Feb 13, 2008, J. Schaafsma 9 Fourth Source of Health Insurance Market Failure: Moral Hazard Moral Hazard exists if the size of the loss and/or the probability of the loss is larger with insurance coverage than without. can have moral hazard due to patient and/or HC provider behaviour patient  since third party (insurer) pays, uses HC less economically.  may also take less care of self, e.g. with dental insurance may not practice good dental care provider  since patient doesn’t pay for HC may recommend marginally beneficial care (exploit information asymmetry between patient/insurer and provider)  may also charge higher fees than in the absence of insurance ///

317_L17, Feb 13, 2008, J. Schaafsma 10 Public Health Insurance and Moral Hazard on the patient side the moral hazard problem is about the same for public and private insurance. on the HC provider side  public insurance  better able to control HC provider fees  countervailing power to powerful professional organizations private insurers lack market power to control supplier behaviour coordinated by powerful professional organizations that control members through professional licensing. U.S. tries to control moral hazard with cost sharing (makes patient price sensitive and supplier also) ///

317_L17, Feb 13, 2008, J. Schaafsma 11 Public Health Insurance: Single Payer System and Moral Hazard Canadian Public health Insurance  single payer system  countervailing power to professional associations  controls both price and over-servicing  i.e., reduces moral hazard on the supply side  keeps costs down  allows for more comprehensive coverage. ///

317_L17, Feb 13, 2008, J. Schaafsma 12 Why Universal Public Health Insurance? have discussed the case for public health insurance Why universal? i.e. why compulsory? Basically three reasons: 1. No adverse selection 2. Avoid problem of pre-existing conditions 3. Equity: all are covered regardless of ability to pay

317_L17, Feb 13, 2008, J. Schaafsma 13 Why First $ Coverage and No Co-payment? why did the Hall Commission recommend  first $ coverage and no co-payment? wanted to promote use of needed healthcare by all, regardless of income was concerned that cost sharing (user fees and deductibles) would deter use by low income earners recall some support for this concern from the Rand Health Insurance Experiment (Also 1960’s Saskatchewan co-pay Experiment) ///