Transcript Essentials of Health Economics

Good Health
• Everyone desires good health, both for the sake of
quality of life and because it contributes to our
remaining productive years and earning income
• Improving health is not the only characteristic of
health care that health economics takes into
account
– Many types of health care may impact on other
aspects of people’s welfare—for example,
providing reassurances or reducing anxiety
about their state of health, whether or not their
health has changed
• Formulating the basis for the demand for health
provides the basis for the demand for health care
Health as a Form of Human
Capital
• The most important and powerful insight is that in
addition to health care being an economic good,
health itself can be thought of as a good, albeit
one with special characteristics
– Health can be regarded as a fundamental
commodity: one of the true objects of people’s
wants. Tangible goods and services—such as
health care—are simply a means to create it
• If it is accepted that health is a fundamental
commodity, we can analyze the demand for
improvements in health in very similar ways to
the analysis of demand for other goods and
services
Health as a Form of Human
Capital
• The most important and powerful insight is that in
addition to health care being an economic good,
health itself can be thought of as a “good,” albeit
one with special characteristics
– Health can be regarded as a fundamental
commodity: one of the true objects of people’s
wants. Tangible goods and services—such as
health care—are simply a means to create it
• If it is accepted that health is a fundamental
commodity, we can analyze the demand for
improvements in health in very similar ways to
the analysis of demand for other goods and
services
The Demand for Health Care
• The demand for health care depends on the
particular production function for health
• The effect of education on the demand for health
care is not predictable
– If education makes a person more efficient in
producing health, an increased awareness of
the value of good nutrition and prevention of
disease will reduce the quantity of health care
required to produce a given stock of health
The Demand for Health Care
– Education can also increase the demand for
health itself
• The more educated will demand more
health, but less health care, if the effect of
education on the productivity of inputs into
health outweighs the shift in health care
demand
• The effect of age on the demand for health care
has been found to vary by type of health care
required
• Health insurance influences the price of health
care, which is a movement along a given
demand curve for health care
The Demand for Health Care
• In analyzing the demand for health care, it is
important to take into account the concept of
need when considering both the characteristics
of health policy and an individual’s consumption
of health care
– Needs and demands can therefore be
regarded as two very different ways of
viewing matters
Asymmetry of Information and
Imperfect Agency
• Information is itself an economic good
• The relationship between doctor and patient is
often presented as a principal-agent problem
– The doctor is the agent acting on behalf of a
principal, who is the patient, in making
decisions about what health care to purchase
• If doctors made these decisions in a
manner fully consistent with patients’
preferences, unaffected by the
consequences for themselves, they would
be acting as perfect agents
Estimates of the Price Elasticity
of Demand for Health Care
• We measure the responsiveness of consumers
to changes in the price of a good or service by
the price elasticity of demand
• The formula for elasticity of demand with
respect to price is:
• % change in the quantity of health care
demanded
• % change in price of health care
• In general, goods and services, which are close
substitutes, have higher price elasticities, and
complementary goods and services have lower
price elasticities.
Estimates of the Price Elasticity
of Demand for Health Care
• The highest price elasticity estimates observed
are for those demanding hospital outpatient
services and for nursing home services
• The lower number of substitutes for hospitals
make the elasticity for hospital services lower
than that for physician services
– However, once a physician is chosen, this
also limits the number of hospitals that the
patient can utilize as well, due to the limits on
admitting privileges of physicians
Aggregate Demand for Health
Care
• It is clear that there is a positive relation
between income and the demand for
health care: the richer the country, the
greater the demand for health care
• In the U.S., health insurance has been the
means by which the employed have met
their health care needs
The Insurance Market
• People buy insurance because they are risk-averse
– Buying insurance allows a person to pay a certain
known amount in order to transfer the risk of a much
larger expenditure (in the case of an adverse event)
to an insurer, known as a third party payer
• There are a number of types of risk associated with
health
– Risk to one’s health and life associated with illness or
disease
– Risk that if one undertakes treatment, it may or may
not cure or alleviate symptoms of disease
– The costs associated with the treatments of illness
and disease
The Insurance Market
• People can insure themselves against some or all
of the financial loss associated with the treatment
of illness by buying health insurance policies
– Even people with extensive wealth buy
insurance due to the fact that most people are
“risk-averse”
• Economists define risk aversion as a characteristic of
people’s utility (satisfaction) functions
• People are more likely to buy insurance to cover
low-probability events (large losses) than high
probably events (small losses)
Setting Insurance Premiums
• The price that an insurance company charges
for an insurance policy, or premium, is based on
the expected payout (amount paid out on
average for a large group of insured persons),
plus administrative costs, reserve funds, and
profits or surpluses of the insured company
– Premiums charged generally exceed the fair
value of the risk that the insurance company
has assumed, where the fair value is the
expected payout
Experience versus Community
Rating
• One common method of pricing insurance is
experience rating
– Insurance companies base premiums on past
levels of payouts, which is often done in the
case of car or homeowners’ insurance.
• Community rating applies when each member
of an insurance pool pays the same premium
per person or per family for the same coverage
– Community rating is inefficient in the sense
that the price of insurance to an individual
subscriber does not reflect the marginal costs
of that individual to the insurer.
Moral Hazard
• Moral hazard refers to the phenomenon of a
person’s behavior being affected by his or her
insurance coverage
– Moral hazard is known to exist is in all types
of insurance markets
• People may be more careless with property
that is insured
• The main way that moral hazard comes
into play in the health insurance market is
through an increase in demand for
healthcare services utilized
Moral Hazard and the Structure of
Health Insurance Contracts
• Some degree of moral hazard exists when the
price elasticity of demand for covered healthcare
services is greater than zero
– In theory, the problem of moral hazard should
be greater in the case of policies covering a
broader range of services, including more
discretionary or elective ones, because the
price elasticity of demand for these services is
believed to be higher
Moral Hazard and the Structure of
Health Insurance Contracts
• The reason that moral hazard operates
differently in the health insurance market than in
other insurance markets is that health insurance
contracts differ from most other forms of
insurance
Moral Hazard and the Structure of
Health Insurance Contracts
• Major healthcare services contracts also differ
from most types of insurance in that they
generally cover more than just unlikely
catastrophic events, fulfilling a function
analogous to that of a service contract on an
automobile
– they also include reimbursement for annual
physical exams, vaccinations, treatment for
chronic conditions, and various types of
routine tests
Cost Sharing to Offset Effects of
Moral Hazard
• Deductibles. A deductible is a level expenditure
that must be incurred before any benefits are
paid out
– Health insurance policies generally have
yearly deductibles, which is less effective in
removing moral hazard
• Coinsurance. Coinsurance is the proportion of
the total expenditure that is paid by the insured
– Coinsurance helps to reduce the moral
hazard factor for the insured that have spent
more than their deductible because health
care is not free to them
Cost Sharing to Offset Effects of
Moral Hazard
• Use of Usual, Customary Fees to Limit Payments. It
has become common practice for insurance policies
that reimburse on the basis of fee-for-service to limit
payment for covered services to customary or usual
fee within given geographic markets
• Managed Care. Care is actually managed or
rationed using such mechanisms as “gatekeepers,”
who are primary care physicians that make all
referrals to specialists, limit coverage to service
providers with whom the insurance company has a
contractual agreement, and require precertification
or approval from the insurance company before
services are rendered
Cost Sharing to Offset Effects of
Moral Hazard
– Controls are on the supply side as well
as the use of risk-sharing arrangements
with providers of health care
• Stop-Loss Provisions. Many policies also
have annual limits on out-of-pocket
expenditures (per person or per family)
that must be borne by the insured
– Stop-loss provision
Integration Between Third Party
Payers and Healthcare Providers
• There are three different kinds of integration between third
party payers and healthcare providers
– First, the third party payer and provider are separate
entities with separate aims and objectives
– Second, there is selective contracting, with the thirdparty payer agreeing to steer individuals insured on their
plans to selected providers, and, in turn, the selected
providers charge lower prices to the insurers
– Third, there is vertical integration in which the insurance
provider and healthcare provider merge to become
different parts of the same organization
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