Download Expected Utility Risk Smoothing

CHAPTER 9
The Health
Care Market
McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Figure 9.1: US expenditures of selected goods and services as share of Gross Domestic Product (19602004)
18
16
Percentage of GDP
14
12
10
8
6
4
2
0
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
Year
Health
Food
Clothing and Shoes
Housing
SOURCE: US Census Bureau [2006, pp. 98, 443], and National Income and Product Accounts (http://www.bea.gov/bea/dn/nipaweb/index.asp.
9-2
Social Insurance

Social insurance - government programs that
provide insurance to protect against adverse
events

Examples

Medicaid

Medicare

Social Security

Unemployment Compensation
9-3
How Health Insurance Works

Insurance premium

Expected Value

Expected value (EV) = probability of outcome 1)
* (Payout in outcome 1) + probability of outcome
2)*(Payout in outcome 2) + … + (probability of
outcome n)*(Payout in outcome n)
9-4
Expected Value Computation
Draw cards from deck of cards
Draw heart and receive $12
Draw spade, diamond or club and lose $4
Probability of drawing heart = 13/52 = ¼
Probability of drawing spade, diamond or club = 39/52 = ¾
EV = (1/4)($12) + (3/4)(-$4) = $0
9-5
Why Buy Insurance?
(A)
Insurance
Options
Income
Probability
of Staying
Healthy
Probability
of Getting
Sick
Option 1: No
Insurance
$50,000
9 in 10
Option 2: Full
Insurance
($3,000
premium to
cover $30,000 in
losses
$50,000
9 in 10
Income
if She
Stays
Healthy
(B)
(C)
Income if
She Gets
Sick
Expected
Value
1 in 10
Lost
Income if
She Gets
Sick
$30,000
$50,000
$20,000
$47,000
1 in 10
$30,000
$47,000
$47,000
$47,000
Actuarially Fair Insurance Policy
9-6
Utility
Why People Buy Insurance
B
UB
UD
UC
D
C
• Expected
Utility
A
• Risk
Smoothing
UA
20,000
47,000 50,000
Income
9-7
Do People Buy Insurance with Loading Fees?
• Risk Aversion
• Risk Premium
• Loading Fee
9-8
The Role of Risk Pooling

Insurance in a small population

Insurance in a large population

Law of large numbers
9-9
Adverse Selection in the Health Insurance Market

Asymmetric information
9-10
Asymmetric Information and Adverse Selection
(A)
Insurance Buyer
(B)
(C)
(D)
(E)
(F)
Expected Benefit
Expected Benefit
Expected Benefit
Probability of
Lost Income
Expected
Minus Premium
Minus Premium
Minus Premium
Getting Sick
if Sick
Lost Income
(Differential
Premiums)
(Premium = $3,000)
(Premium = $4,500)
Emily
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Jacob
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Emma
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Michael
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Madison
1 in 5 (High Risk)
$30,000
$6,000
$0
$3,000
$1,500
Joshua
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Olivia
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Matthew
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Hannah
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
Ethan
1 in 10 (Low Risk)
$30,000
$3,000
$0
$0
-$1,500
$0
-$15,000
Insurer's Net Profits
$0
9-11
Does Adverse Selection Justify Government
Intervention?

Experience rating

Experience rating and equity

Community rating
9-12
Insurance and Moral Hazard

Moral hazard

Deductible

Co-payment

Co-insurance
9-13
Price per unit
Moral Hazard
Flat-of-the-curve medicine
deadweight loss
P0
a
b
h
.2P0
0
Sm
Dm
M0
M1
Medical services per year
9-14
Health Care Expenditures and Health Outcomes
9-15
Additional Considerations

The Elasticity of Demand for Medical
Services

Does Moral Hazard Justify Government
Intervention?

Third Party Payment
9-16
Other Market Failures in the Health Care Market

Information Problems

Externalities
9-17
Do We Want Efficient Provision of Health Care?

Paternalism

The Problem of the Uninsured

Who are the uninsured?

Does health insurance improve health
9-18
High Health Care Costs
Health Expenditures as Percentage of GDP
Figure 9.5: Expenditures on health care as share of Gross Domestic Product, selected countries
(1960-2004)
16
14
12
10
8
6
4
2
0
1960
1970
1980
1990
2000
2004
Year
Australia
Canada
France
Germany
Japan
United Kingdom
United States
9-19
Causes of Health Care Cost Inflation

The Graying of America

Income Growth

Improvements in Quality

Commodity Egalitarianism
9-20