Chapter 6: Health Insurance Chapter 6 Health Insurance Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Chapter 6: Health Insurance Introduction Principles of health insurance Features of the health sector The role of government 6 - 2

Chapter 6: Health Insurance Principles of Health Insurance The Genesis of Health Insurance Government does not play a role in health insurance Do you buy health insurance from a private company? Risk aversion How much should a private company charge as a premium? Actuarially fair premium = (% risk)(high medical cost) + (% risk)(low medical cost) Expected value 6 - 3

Chapter 6: Health Insurance Price Equals Expected Medical Cost Chance of a $61,000 Medical Bill Chance of a $1,000 Medical Bill Expected Medical Bill High Cost Person9%91%$6,400 Low Cost Person1%99%$1,600 Table 6.1: Expected Medical Bills P i = (EMC) i The price charged to a person will vary with the person’s expected medical costs, not the person’s income

Chapter 6: Health Insurance Moral Hazard and Price Responsiveness Adverse Selection and Asymmetric Information Moral hazard: the use of medical care because they know the insurer will pay part of their bill. Price responsiveness Price elasticity Adverse selection: instead of a random sample selecting to enroll, a biased sample with higher medical costs is likely to enroll. Asymmetry of information 6 - 5

Chapter 6: Health Insurance Catastrophic Insurance Table 6.2: Catastrophic Insurance v. Complete Insurance Insurance coverage Premium Out-of-Pocket Burden 5% chance 95% chance Total Burden 5% chance 95% chance None$0$61,000$1,000$61,000$1,000 Complete$4,800$0 $4,800 Catastrophic$3,400$5,200$1,000$8,600$4,400 The patient has a deductible and then the insurance pays the remainder of the bill How do individuals choose health insurance? 6 - 6

Chapter 6: Health Insurance X% Insurance Insurance pays a specific percentage (X%) and the patient pays the remainder (100% - X%). Cost-sharing rate or coinsurance rate Figure Medical Care P S $400 $300 $100 $50 $200 D J O D’ F D” G 6 - 7

Chapter 6: Health Insurance The Impact of Insurance on Efficiency and Redistribution Figure Medical Care P S H MB MSB $400 $300 $100 $50 $200 J F Inefficiency if there is no externality $150 FJH is the efficiency loss from not cutting medical care from J to H The size of FJH depends on how steep the MB curve is 6 - 8

Chapter 6: Health Insurance The Impact of Insurance on Efficiency and Redistribution Optimal redistribution from the healthy to the sick Citizens’ preferences on redistribution of resources from the healthy to the sick are complex Efficiency if there is a positive externality A corrective subsidy may increase efficiency The socially optimal quantity of health care is greater than the quantity consumed privately 6 - 9

Chapter 6: Health Insurance Limitation of Price and Supply by the Insurer Figure Medical Care P S D D’ D” $400 $300 $100 $50 $200 J G G = 100% insurance Q and P of medical care O O = no insurance F F = 75% insurance If max P = $100, and demand is D”, there will be a shortage of 20. If max P = $100, and demand is D’, there will be a shortage of

Chapter 6: Health Insurance Features of Health Insurance Markets Regulation by insurers The insurer has an incentive to limit expenditures Patients, doctors, and the principal-agent problem A fee-for-service (FFS) and health maintenance organizations (HMO) cause opposite risks for the patient The patient relies on the doctor for medical advice Employer-provided health insurance Tax advantages and attractiveness to employees Most people obtain health insurance through work Allowable charges and refusal to pay

Chapter 6: Health Insurance Who Bears the Burden of Employer- Provided Health Insurance? Figure Labor Cash Salary S D $50,000 Initial equilibrium when there is no health insurance offered D’ D decreases to D’ $42,000 $8,000 Now, $8,000 of health insurance is offered S’ S decreases to S’

Chapter 6: Health Insurance Table 6.3: Cash Salary and Health Insurance for an Employee Option Employee’s Compensation Cash Insurance Employee’s Purchase of Insurance Employee’s Burden from Insurance #1$50,000$0$8,000 #2$42,000$8,000$0$8,000 Who Bears the Burden of Employer- Provided Health Insurance? Short run versus long run burden Employees bear most of the burden of cost Rising Medical Expenditures

Chapter 6: Health Insurance The Role of Government The unemployed What about health insurance for… Low wage workers Retirees Medicaid and SCHIP are programs to help the poor Medicaid and the State Children’s Health Insurance Program Poor people cannot afford medical care without help

Chapter 6: Health Insurance Alternative Public Policies for Working Families Table 6.4: Proposed Tax Credit by Household Income for a Family of Four Household IncomeTax Credit $0$8,000 $50,000$6,000 $100,000$4,000 $150,000$2,000 Responsible Health Insurance (RHI) Consumer-driven health care and health savings accounts The free market can work if each consumer bears more of the burden of his own medical care

Chapter 6: Health Insurance Government reinsurance Government commits to private insurers for X% of any huge medical bill An employer mandate or an employer play-or-pay option Play-or-pay Employer mandate Government insurance Single-payer plan Alternative Public Policies for Working Families

Chapter 6: Health Insurance Medicare for Retirees Government insurance for retirees How Medicare works Medicare regulation of hospital and doctor fees Medicare prescription drug coverage Income-related patient cost-sharing Rationing

Chapter 6: Health Insurance Health Insurance in Other Countries: An International Perspective Most high-income countries finance most medical care through taxed rater than private insurance premiums. Great Britain and the National Health Service (NHS) Canada and the single-payer system Taiwan and cost sharing

Chapter 6: Health Insurance Principles of health insurance Features of the health sector The role of government Summary

Chapter 6: Health Insurance Preview of Chapter 7: Tax Incidence and Inefficiency Incidence: Who bears the burden People, not firms, ultimately bear all tax burdens A tax on capital income Inefficiency A tax on wage income The efficiency loss from a tax on a good The efficiency loss from a tax on wage income The efficiency loss from a tax on capital income