What is ‘Managed Care’? A ‘type’ of health insurance –combines both the financing of care (insurance) with the provision of care –variations in MC plans stem from the multiple choices of financing and provision Best understood by comparing to indemnity or ‘FFS’ insurance

Fee-for-Service v. MC Insurance Traditional Insurance in U.S. (1930s) “One ill, one pill, one bill” Historically focussed on financing of medical care, NOT care delivery and management Provider choice NOT restricted Has existed for a long time but growth has been recent (since 1985) Restricts provider choice (hospitals and physicians) ‘Manages Care’ Expanded benefit coverage (e.g. preventive care)

Why Buy Health Insurance? Provides no direct ‘utility’ to consumer –unlike a car, stereo, vacation or restaurant meal Utility of Health Insurance is ‘indirect’ –consumers prefer to spend money on goods/services –medical care provides ‘utility when used’ preventive and wellness care (desired) medical or surgical care (undesired) –insurance pays for medical care

Difference Between Health Insurance and Other Types of Insurance

Why Buy Insurance Instead of ‘Self Insuring’ (Pay Direct)? Expenditures can be significant –rebuilding a home –making up for lost income –having knee surgery to repair a torn ACL Uncertainty –can’t predict the future –insurance is only possible when uncertainty exists –numerous events are possible in the world

Uncertainty Uncertainty means there is some positive probability of experiencing an event –torn ACL –pregnancy –cancer –auto accident –home fire –airline crash

Buying Insurance v. Self Insuring Taking the Gamble Taking the Risk –Income = $30,000 –Injury costs $10,000 –Income if injury occurs = $20,000 –Income if injury does not occur = $30,000 Buying Insurance Give up $ (premium) to reduce or avoid uncertainty –Income = $30,000 –Injury costs $10,000 –Insurance costs $2,000 –Income after buying insurance = $28,000

Risk Aversion Risk averse individuals prefer to forego a bit of $ in order to reduce risk and financial exposure and to increase uncertainty –if this were not the case the insurance industry would not be so large The amount of $ one is willing to pay for insurance depends on how risk averse one is –more risk averse persons will pay more –less risk averse people will pay less

Statistical Concepts Used Throughout Course Probability - the relative frequency with which an event occur; the likelihood that an event will occur –probability of a ‘head’ on a coin flip is 0.5 Gamble - an uncertain situation –the probability of an event is <1

Statistical Concepts Used Throughout Course Expected Value - The average outcome of a ‘gamble’. –equal to the sum of the probabilities of events multiplied by the value of the outcomes of events Example –buy church lottery ticket for $1 –1/1000 will win $500 –999/1000 will lose $1

Statistical Concepts Used Throughout Course Expected Value Calculation –EV = 0.001($499) ($-1) = -$0.50 Actuarially Unfair Gamble –lose money on average (EV < 0) Actuarially Fair Gamble –break even on average (EV=0)

Actuarially Fair Insurance Cost of insurance policy is equal to the expected value Insurance companies could not exist if they sold actuarially fair insurance policies –would not cover administrative costs –would not earn a profit Consumers WILL buy actuarially unfair policies –consumers will pay a bit above the actuarially fair premium bc they are risk averse

Health Insurance in the US Source: 1997 MEPS Sources of Health Insurance –Private Insurance Employment based insurance Individually purchased insurance policies –Public Insurance Medicaid [poor (AFDC), poor elderly] Medicare [seniors ages 65+, disabled <65] Children (CHIP programs) –Uninsured about 45 million or 16% of US population

Insurance Characteristics of the US Population Source: 1997 MEPS

Prevalence of MC: Employment Based Insurance Source: KPMG 1998

Asymmetry of Information and Health Insurance Markets Asymmetry of Information –when one party to an insurance contract (e.g. the insurer or the insured) has information that the other party does not. Moral Hazard –one has private information about the actions they take that might mitigate insurance risks (e.g. smoking in bed) Adverse (or Favorable) Selection –enrollees are better informed about their health risk than insurers