Econ+157+Topic+B+Demand+and+Supply+of+Health+Insurance

# Econ+157+Topic+B+Demand+and+Supply+of+Health+Insurance -...

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DEMAND AND SUPPLY OF HEALTH INSURANCE Econ 157 - Topic B Econ 157: Mortimer 1/27/2010 1

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Features of Insurance Insurance reduces the variability of the insured’s incomes. Terminology Premium and Coverage Copayment (\$ paid by the insured) and Coinsurance (% paid by the insured) Deductible: a minimum payment by the insured before benefits are paid Exclusions: services not covered by the insurance policy Limitations: maximum coverage by the insurance policy Loading Fees: costs of insurance business; e.g., sales, advertising, admin costs Deductibles and coinsurance may be used to design plans that can lead to desirable economic outcomes. Copayment Patients become more aware of true cost of medical care. Deductibles Patients are discouraged from making frivolous claims and/or visits. Econ 157: Mortimer 1/27/2010 2
Uncertainty and Expected Utility Theory Coin toss Heads with a probability of 0.5 with a payoff of \$100. Tails with a probability of 0.5 with a payoff of \$0. Expected value or payoff EV = p 1 R 1 +p 2 R 2 +… p n R n where p i is the probability of outcome i and R i is the return in the event of outcome i. EV = Are you willing to pay to play this game? Even though it is an (premiums = expected benefits) bet, many would say ‘no.’ Why? Because people are Econ 157: Mortimer 1/27/2010 3

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Uncertainty and Expected Utility Theory Initial wealth = \$100K Prob. of getting sick is 20% If sick, medical care will cost \$50K. EW = U(\$100K) = 500 U(\$90K) = 485 U(\$50K) = 300 EU = Econ 157: Mortimer \$100K \$50K Wealth Utility 300 460 485 500 \$90K Consumers do not like uncertainty. 25 units of utility are lost! 1/27/2010 4
Uncertainty and Expected Utility Theory In this type of analysis, we typically draw a line between two outcomes, A and B. The line tells us EU as a function of EW. Econ 157: Mortimer \$100K \$50K Wealth Utility 300 460 485 500 \$90K \$70K B A C 1/27/2010 5

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Consider full coverage insurance with an actuarially fair premium (\$10K). Is the consumer willing to pay more than the actuarially fair premium? Econ 157: Mortimer Utility \$100K \$50K Wealth 300 460 485 500 \$90K \$70K The consumer will purchase insurance even if the premium is more than actuarially fair. The expected wealth will be lower with insurance than without insurance. 1/27/2010
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Econ+157+Topic+B+Demand+and+Supply+of+Health+Insurance -...

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