Lecture Health economics - Chapter 6: The demand for medical insurance

Lecture Health economics - Chapter 6: The demand for medical insurance. This chapter presents the following content: A theoretical model of health insurance, when theory meets the real world.

The Demand for Medical Insurance

Professor Vivian HoHealth Economics

Fall 2009

These slides draw from material in Santerre & Neun, Health Economics: Theories, Industries and Insights, Thomson, 2007

Topics to cover:

A theoretical model of health insuranceWhen theory meets the real world

The consumer pays insurer a premium

to cover medical expenses in coming

Characterizing Risk Aversion

Recall the consumer maximizes utility, with prices and income given

– Utility = U (health, other goods)

– health = h (medical care)

Insurance doesn’t guarantee health, but provides $ to purchase health care

We assumed diminishing marginal utility

of “health” and “other goods”

In addition, let’s assume diminishing marginal utility of income

Utility

Income

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

$20,000

$40,000

70 90

Income Utility Sick

Healthy

Utility when sick

A B

Individual doesn’t know whether she will

Define: P0 = prob of being healthy

P1 = prob of being sick

P0 + P1 = 1

An individual’s subjective probability of illness (P1) will depend on her health

stock, age, lifestyle, etc

Then without insurance, the individual’s

expected utility for next year is:

E(U) = P0U($40,000) + P1U($20,000)

= P0•90 + P1•70

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

Assume the consumer sets P1=.20

Then if she does not purchase

insurance:

E(U) = 80•90 + 20•70 = 86

E(Y) = 80•40,000 + 20•20,000 = $36,000Without insurance, the consumer has

an expected loss of $4,000

The consumer’s 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

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

Determinants of Health Insurance Demand

1 Price of insurance

– In the previous example, the consumer will forego health insurance if the premium is greater than $5,000

2 Degree of Risk Aversion

– Greater risk aversion increases the

demand for health insurance

– Consumers demand less insurance for events least likely to occur

– Consumers more likely to insure against random events

Income

The horizontal distance between the utility function and the chord represents the loading fee that the consumer is willing to pay

Estimates of Price & Income

Elasticities for Demand for Health Ins.

Price elasticities b/w -.03 and -.54

– At the individual level – Enrollment or premium expenditure – Elastic or Inelastic demand?

Income elasticities b/w 0.01 and 0.13

From S&N, Table 6-2

Estimates of Price & Income

Elasticities for Demand for Health Ins.

What about when employees are

choosing between the menu of plans offered by their employer?

– Range of choices is more limited

– Price elasticites are found to range

between -2 and -8.4, depending on age, job tenure, medical risk category

Dowd and Feldman 1994, Strombom et al 2002

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

The majority of Americans have provided health insurance

employer-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

Example: Insurance and take-home

pay when income is $1,000 per week and income tax rate is 28%

Employer Health Insurance Coverage of

U.S Population (percent)

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

Empirical Evidence

Long & Scott (1982)

– Regression analysis of the determinants of

% of compensation paid to employees as health insurance

–

– Annual U.S data 1947-1979

RFAMINC = average real family income

UNION = % of labor force unionized

PCTFEM = % employees female

PCTSERV = % employees in service industries

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

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

• Network model: HMO contracts w/ >1 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

Types of Managed Care Orgs

M a n a g e d C a r e

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

Point-of-Service Plan (POS)

Insurer contracts w/ multiple physicians: but enrollees can pay higher deductible

or copay to see physician outside

Source: Kaiser Employer Health Benefits 2006 Annual Survey, Section 5

plans? Do you think your choice is a

function of your age/health status?

If you were elderly and/or sick, which plan would you prefer if they cost the same

amount? Why?

Provider Management Strategies

– MCOs monitor physicians’ track record

regarding referrals, quality, patient

satisfaction

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

Performance of MCO’s: 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

Performance of MCO’s: 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