1. Private Health Insurance14
Farid Abolhassani

2. Learning Objectives
After working through this chapter, you will be able to:
Explain the economic rationale for insurance and how insurance works in health care
Give examples of how insurance companies try to counteract moral hazard and adverse selection
Distinguish between the main types of managed care organizations
Suggest reasons why private insurance fails to provide equity and efficiency

3. Key Terms
Actuarial (experience) rating Premium based on an individual’s risk of illness. Community rating Insurance premium based on pooled risk of a defined group of people. Diagnosis related group (DRG) Classification system that assigns patients to categories on the basis of the likely cost of their episode of hospital care. Used as a basis for determining the level of prospective payment by the purchaser. Health maintenance organization (HMO) Organization that provides comprehensive health care for a fixed, periodic per capita payment. Preferred provider organization (PPO) Private insurance that restricts choice to approved providers.

4. Key Terms
Out-of-pocket (direct) payment Payment made by a patient directly to a provider. Over the counter (OTC) drugs Non-prescription drugs purchased from pharmacists and retailers. Regulation Government intervention enforcing rules and standards. Universal coverage Extension of health services to the whole population. Unofficial payments Spending in excess of official fees, also called ‘under the table’ or ‘envelope’ payments.

5. Public and private methods of financing health care
Health care financing systems
Privately financed
Out of pocket payment
Copayment and user fees
Full payment
Private health insurance
Group/individual schemes
HMOs/PPOs
Publicly financed
Social insurance
Single fund
Multiple funds
Taxation based systems
General taxes
Hypothecated taxes

6. The Premium P = p × c + a P = 0.01 × 1500 + 5 = 20 Administration cost
The cost to cover the loss
Probability of the insured event
P = 0.01 × = 20

7. The Premium Formula Validity Conditions
There needs to be a large number of subscribers to pool the risks.
The insured risks need to be independent.
The probability of the insured event must be less than 1.
People should not be able to influence their risk (moral hazard) and there should be no adverse selection.

8. Financial intermediary
Moral Hazard
Free or low cost health care at the point of consumption
Full reimbursement based on FFS
Households
Health Care
Financial intermediary
Supplier-induced Demand
Neither the consumer nor the provider has an incentive to be cost-conscious
Providers

9. Cost-sharing or Co-payment Schemes
A flat rate charge for each unit of service;
Co-insurance (the insured individual has to pay a certain proportion of each unit of health care consumed);
A deductible (the individual pays 100 per cent of all bills in a given period up to some maximum amount beyond which insurance benefits are paid in full);
A combination of the last two.
Reduction of the overall impact of supplier induced demand
People in low-income or high-utilization groups may be excluded from consumption as a result of lack of ability to pay

10. Prospective Payment Schemes to countervail supplier-induced demand
DRG-based payment
Managed care:
Health Maintenance Organizations (HMOs)
Preferred Provider Organizations (PPOs)

11. Health Maintenance Organizations
HMOs provide (or arrange and pay for)
Comprehensive health care;
For a fixed, periodic per-capita payment (or premium) which is paid by the consumer (usually with a subsidy from employers or social security).
Consumers do not usually pay charges at the point of use.
The premium is set in advance and is independent of the volume of services provided to the individual during the period.
Providers can be salaried or paid by FFS (fee-for-service).

12. Types of HMO
Staff model, in which all doctors are employed and/or contracted directly by the HMO;
Group model, in which the HMO contracts with an independent group to provide services;
Network model, in which more than one independent group is contracted to provide services;
Independent practice association in which the HMO contracts several doctors in independent practice

13. Preferred Provider Organizations
Premiums are paid either by employers or are shared between employer and employee.
Price at the point of use of services is zero.
Insurers contract selectively with providers (e.g. primary care doctors and hospitals who provide care below a certain cost per case).
The contract is on the basis of both a negotiated fee schedule which the preferred providers accept as payment in full and acceptance of utilization review.
User charges and deductibles tend to be lower in PPOs than under previous private insurance arrangements.

14. Medical Savings Accounts
An individual- (or household-) specific account with balances earmarked for health care expenses
A high-deductible, catastrophic insurance plan to cover expenses above the deductible.

15. Main sources of failure in private insurance markets
Moral hazard relates to potential changes in attitude of both consumers and providers under insurance arrangements, which may result in excess demand for health care. With full reimbursement of bills through insurance, neither the consumer nor the provider has an incentive to contain costs.
Adverse selection arises from consumers having more complete information than insurers on their own health status, which may result in selecting plans that give them the greatest benefit. On the other hand, insurers can profit by excluding high-risk individuals.
Diseconomies of small-scale operations

16. Regulation of private insurance markets
Premium regulation
Benefit package regulation
Profit regulation
Offering tax relief to firms who enroll their employees in private insurance