Transcript Chapter 8 Demand and Supply of Health Insurance

Chapter 8 Demand and
Supply of Health Insurance
6.
1.
What is Insurance
2.
Risk and Insurance
3.
The demand for Insurance
4.
The supply for Insurance
5.
The case of Moral Hazard
Health Insurance and the efficient allocation of
resources
Characteristics of Insurance
Program
• The number of insured should be large
and they should be independently
exposed to potential lost
• The losses covered should be definite in
time, place and amount
• The chances of loss should be
measurable
• The loss should be accidental from the
viewpoint of the person who is insured
Insurance Terminology
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Premium, Coverage
Coinsurance and Copayment
Deductible
Exclusion
Limitation
Pre-Existing Conditions
Pure Premium
Loading fees
Risk and Insurance
• Expected value (expected return)
E=p1R1+p2R2+…+pnRn
• Acturaially fair insurance
• The marginal utility of wealth is diminishing (Figure 8-1)
• Example (Initial wealth=20000)
a. Expected Wealth corresponding with Point D
E(W)=0.95*20000+0.05*10000=19500
b. Expected Utility
E(U)=0.95*200+0.05*140=197 (Point C)
loss due to risk = 199 -197=2 unit of utility
• Q: is it a good deal for premium=500?
Yes, Net wealth of 19500=> certainty utility is 199>197
• The maximum amount to pay for risk: the distance FC
The demand for Insurance
• How much insurance ? (Figure 8-2)
Marginal Benefit (cost) curve, MB1(MC1), is downwardsloping
optimal insurance purchase=q*(MB1=MC1)
• Changes in premium
Higher premium by reducing optimal coverage from q* to
q** (MB2=MC2)
• Changes in Expected loss
The expected loss will increase the amount of insurance
purchased at Z, q***(MB3=MC1)
• Changes in Initial wealth
more initial wealth
MB1=>MB2 ( at higher wealth, smaller increment in utility)
MC1=>MC3 (premium cost less in foregone marginal utility
relative to the increased wealth)
new equilibrium may be higher or lower than q*
The supply of Insurance
• Profit=Revenue-Payout=aq-(pq+t)
where a : the premium, in fractional terms; p: the
probability of payout ; q: the amount of payout is q; t: a
processing cost
• With perfect competition, profit=0, so
a=p+(t/q)
the competitive value of a equals the
probability of illness plus loading costs as
a percentage of policy value
• actuarially fair base if t/q approach zero
=> a=p under perfect competition (with no loading cost)
• (1)Wealth (if well)=initial wealth-a*q
(2) Wealth (If ill)=initial wealth- loss + q (coverage or
insurance reimbursement)-a*q (insurance premium)
Max the expected utility=> (1)=(2)
q*=loss (optimal coverage=full health w/o transactions
costs)
The case of Moral Hazard
• Figure 8.3 A: with inelastic demand, insurance
has no impact on quantity ;B with elastic
demand, insurance increases quantity from Q1
to Q3. This is moral hazard
if premium is 0.5*P1Q1 (<0.5*P1Q2), then
insurance company lose money. However, if
premium is 0.5*P1Q2, agent chose “self-insured”
• Theory suggest
1. deeper (more complete) coverage for services
with more elastic demand
2. first choose services with most inelastic
demand and later for those with more elastic
demand
Effects of Coinsurance and
deductibles
• Premium=500, pay 0P1BQ1. The gain is
Q1BQ2 (induced demand)
• Deductibles is raised from 500 to 700, the
incremental health care from Q1 to Q3,
(1)welfare loss=Q1BDQ3-Q1BFQ3=BDF
(2)welfare gain=Q3FQ2
decision rule: buy insurance if (1)>(2)
Health Insurance and the Efficient Allocation of
Resources
• The impact of coinsurance (Figure 8-4)
Point A (no insurance) is an efficient allocation.
Insurance shift the demand curve with new
equilibrium point C. The incremental amount
spent is ABQ1Q0. The incremental benefit is
ACQ1Q0. Thus, the social welfare loss is ABC
=> agent is led by insurance to act as if he is not
aware of the true resources cost of care he
consumers
• Figure 8-6 shows the effect of insurance cost
sharing with upward sloping price
1. price increase due to moral hazard
2. deadweight loss=JFK
The demand for Insurance and the
price of care
• Feldstein (1973):the interaction of
insurance and price of care (see Figure 7-8)
I curve refer to impact of price of care on
quantity of insurance; P curve refers to the
impact of insurance on price of care
through induced demand
A->B: (1) increased care price due to moral
hazard by insurance (vertical arrow); (2)
induced demand from insurance (horizontal
arrow)
The welfare loss of excess Health
insurance
• Feldstein (1973) estimated welfare gain is
27.8 billion per year if average
coinsurance rate is from 0.33 to 0.67
• Q: why will society support insurance
policy that seem only to result in
misallocations of resources?
A: the protection again risk