Chapter%206:%20The%20Demand%20for%20Medical%20Insurance%20%20%20Health%20Economics

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Chapter 6The Demand for Medical
InsuranceHealth Economics
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Topics to cover

• A theoretical model of health insurance.
• When theory meets the real world...

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Logic

• The consumer pays insurer a premium to cover
  medical expenses in coming year.
• For any one consumer, the premium will be higher
  or lower than medical expenses.
• But the insurer can pool or spread risk among
  many insurees.
• The sum of premiums will exceed the sum of
  medical expenses.

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Characterizing Risk Aversion

• Recall the consumer maximizes utility, with
  prices and income given.
• Utility U (health, other goods)
• health h (medical care)
• Insurance doesnt guarantee health, but provides
  to purchase health care.
• We assumed diminishing marginal utility of
  health and other goods.

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• In addition, lets assume diminishing marginal
  utility of income.

Utility
Income
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• Assume that we can assign a numerical utility
  value to each income level.
• Also, assume that a healthy individual earns
  40,000 per year, but only 20,000 when ill.

Income
Utility
20,000
70
Sick
40,000
Healthy
90
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Utility when healthy
Utility
90
A
B
70
Utility when sick
Income
20,000
40,000
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• Individual doesnt know whether she will be sick
  or healthy.
• But she has a subjective probability of each
  event.
• She has an expected value of her utility in the
  coming year.
• Define P0 prob. of being healthy
• P1 prob. of being sick
• P0 P1 1

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• An individuals subjective probability of illness
  (P1) will depend on her health stock, age,
  lifestyle, etc.
• Then without insurance, the individuals expected
  utility for next year is
• E(U) P0U(40,000) P1U(20,000)
• P090 P170

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• For any given values of P0 and P1, E(U) will be a
  point on the chord between A and B.

Utility
A
90
B
70
Income
20,000
40,000
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• Assume the consumer sets P1.20.
• Then if she does not purchase insurance
• E(U) .8090 .2070 86
• E(Y) .8040,000 .2020,000 36,000
• Without insurance, the consumer has an expected
  loss of 4,000.

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Utility
90

A

86
C
B

70
Income
20,000
40,000
36,000
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• The consumers expected utility for next year
  without insurance 86 utils.
• Suppose that 86 utils also represents utility
  from a certain income of 35,000.
• Then the consumer could pay an insurer 5,000 to
  insure against the probability of getting sick
  next year.
• Paying 5,000 to insurer leaves consumer with 86
  utils, which equals E(U) without insurance.

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Utility
90

A
D

86

C
B

70
Income
20,000
40,000
36,000
35,000
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• At most, the consumer is willing to pay 5,000
  in insurance premiums to cover 4,000 in expected
  medical benefits.
• 1,000 ? loading fee ? price of insurance
• Covers
• profits
• administrative expenses
• taxes

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Determinants of Health Insurance Demand

• Price of insurance
• In the previous example, the consumer will forego
  health insurance if the premium is greater than
  5,000.
• Degree of Risk Aversion
• Greater risk aversion increases the demand for
  health insurance.

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If there is no risk aversion, utility expected
utility, and there is no demand for insurance.
Utility
A
B
Income
40,000
20,000
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• Income
• Larger income losses due to illness will increase
  the demand for health insurance.
• Probability of ILLNESS
• Consumers demand less insurance for events most
  likely to occur (e.g. dental visits).
• Consumers demand less insurance for events least
  likely to occur.
• Consumers more likely to insure against random
  events.

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The horizontal distance between the utility
function and the chord represents the insurance
premium the consumer is willing to pay.
Utility
Income
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Assumptions underlying the theoretical model of
health insurance demand

• Consumers bear the full cost of their own health
  insurance.
• Insurance companies can appropriately price
  policies.
• Individuals can afford health insurance/health
  care.
• The above 3 assumptions do not always hold in the
  real world.

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The majority of Americans have employer-provided
health insurance.

• Employer-paid health insurance is exempt from
  federal, state, and Social Security taxes.
• Employee will prefer to purchase insurance
  through work, rather than on his own.

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Example Cost of insurance when income is 1,000
per week and income tax rate is 28

• Employee Purchased
• 1,000
• 28 tax lt280gt
• after tax 720
• insurance lt50gt
• net pay 670

• Employer Purchased
• 1,000
• insurance lt50gt
• subtotal 950
• 28 tax lt266gt
• net pay 684

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Employer Health Insurance Coverage of U.S.
Population (percent)
Projected. Source Altman et al. 1998, Health
Admin. Press
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Consequences for costs

• Too many services were covered by insurance.
• Coverage of more small claims increased
  administrative costs.
• Employers offering more than 1 plan often fully
  subsidized the more expensive plans.

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Empirical Evidence

• Santerre Neun, page 129.
• Long Scott (1982)
• Regression analysis of the determinants of of
  compensation paid to employees as health
  insurance.
• Annual U.S. data 1947-1979.
• N32.

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Empirical Evidence

• PCTHLINS -8.64 .0284 MTR .0498 RFRAMINC
• (6.22) (3.98)
  (1.14)
• -.0094 UNION .088 PCTFEM .1283 PCTSERV
• (.57) (3.72)
  (5.52)
• R2 .9968
• PCTHLINS of compensation as health insurance
• MTR average marginal tax rate
• RFAMINC average real family income
• UNION of labor force unionized
• PCTFEM employees female
• PCTSERV employees in service industries

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Empirical Evidence

• How does an increase in the marginal tax rate
  affect the workers compensation package?
• The implied elasticity of PCTHLTINS with respect
  to MTR is 0.41. If the proposed Republican tax
  cut is passed, will demand for health insurance
  rise or fall?

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Physicians Managed Care

• Traditional fee-for-service gives physicians
  incentive to overutilize medical services.
• Managed care A broad set of policies designed by
  3rd-party-payers to control utilization and cost
  of medical care
• utilization review
• alternative compensation schemes
• quality control

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Managed care and Physician Incentives

• HMOs are a type of managed care organization, but
  there are a variety of HMOs.
• Staff model Physicians employed by HMO on a
  salary basis.
• No incentive to over-provide care.
• Group model HMO contracts w/ group practice,
  which is paid by capitation.
• Incentive to limit services.

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• Network model HMO contracts w/ gt1 group
  practice, all paid by capitation.
• Incentive to limit services.
• IPA model HMO contracts w/ multiple docs in
  various practices paid by discounted
  fee-for-service.
• Some incentive to over-utilize.

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Types of Managed Care Orgs
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Preferred Provider Organization

• Insurer contracts w/ multiple physicians but
  enrollees can pay higher deductible or copay to
  see physician outside network.
• Discounted fee-for-service.
• Some incentive to over-utilize.

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Point-of-Service Plan (POS)

• Insurer contracts w/ multiple physicians but
  enrollees can pay higher deductible or copay to
  see physician outside network.
• Like a PPO
• However, enrollees are also assigned a primary
  caregiver who acts as a gatekeeper to specialists
  and inpatient care.

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Practice Question

• If you had a choice between a traditional
  fee-for-service (FFS) plan with a 10 copay, vs.
  a staff HMO plan with no copay, which plan would
  you expect to have a higher monthly health
  insurance premium?
• If you were elderly and/or sick, which plan would
  you prefer if they cost the same amount? Why?

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Provider Management Strategies

• Selective contracting.
• MCOs will contract with an exclusive set of
  providers.
• Based on quality or cost-effective practice
  patterns.
• Physician profiling.
• MCOs monitor physicians track record regarding
  referrals, quality, patient satisfaction.

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Provider Management Strategies

• Utilization review
• determine whether specific services are
  medically necessary and whether they are
  delivered at an appropriate level of intensity
  and cost.
• Practice guidelines
• Inform providers of the appropriate medical
  practice in certain situations.
• Formularies
• restricted list of drugs physicians may
  prescribe.

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Performance of MCOs Are they good or not??

• Ideally, MCOs should encourage preventive and
  coordinated primary care, which reduces the need
  for more expensive specialty/inpatient care.
• But most MCOs are concerned with short-term
  profitability.
• Why pay for cholesterol-lowering pills when the
  enrollee is likely to leave your HMO years before
  he has a heart attack?

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Performance of MCOs Are they good or not??

• In general, studies show that HMOs provide
  medical cost savings of 15-20, mostly through
  reduced hospital care.
• The impact of HMOs on quality of care is less
  definite.
• Health care providers treat patients belonging to
  a variety of plans.