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Unformatted text preview: Demand for Health Insurance Demand for Health Insurance
Class 12 Loyola University Chicago Prof. Tim Classen February 16, 2011 Class Outline
Markets for Health Insurance Risk preferences Demand for Health Insurance Read Chapters 8 & 11 Sources of Payment for Health Care
50% 45% 40%
Private Insurance Out of Pocket Medicare Medicaid Share of Total NHE 35% 30% 25% 20% 15% 10% 5% 0% Projections Medicare Part D 19 65 19 68 19 71 19 74 19 77 19 80 19 83 19 86 19 89 19 92 19 95 19 98 20 01 20 04 20 07 20 10 20 13 20 16 20 19
Year 19 62 How Insurance Benefits How Insurance Benefits Everyone Involved Health insurance benefits three main parties: patients, providers, and insurance companies. Patients receive affordable health care and transfer risk of large financial/health losses. Providers receive increased demand for their services and a predictable form of payment. Insurance companies earn profits from the premiums paid by their pool of consumers. Everyone Pays for Health Care Everyone Pays for Health Care People may believe that when insurance pays for something, it’s free. That is clearly not the case. Every dollar spent on health care comes from individuals, whether obtained via premium payments, tax dollars, higher service charges for those who can afford them, or some other method. Thus, insurance doesn’t reduce the cost of medical care; rather, it redistributes costs so that different people end up paying. Think of insurance as transferring payments over time for an individual (pay premiums for many years and then get benefit when unhealthy) OR at a point in time, healthy people pay for care of sick. Demand for Health Insurance Demand for Health Insurance
Uncertainty over future health Risk aversion Alternative view: Access to expensive procedures Financial risk from loss of health requiring medical care Can’t insure “health” Financial Risks with No Insurance Financial Risks with No Insurance Individuals seek to avoid variation in their medical expenses and income. Individuals also bear the highly variable risk of their own health status. Without insurance, people are fully responsible for personally paying for all of their medical expenses. This means they run the risk of becoming very ill and incurring expenses they cannot afford. Assumption of risk aversion leads to demand for health insurance Risk Aversion Risk Aversion Risk aversion is willingness to incur relatively small but certain loss to avoid risk of a catastrophic loss. Most people are risk averse with respect to health. Risk averse people will pay premiums greater than actuarially fair value of health insurance because it allows them to transfer their financial risk to another party (the insurance company). Willing to pay a monthly premium to avoid the risk of large financial losses from health care bills. Risk premium Risk preferences lead to Risk preferences lead to insurance demand
Insurance transfers income between healthy and unhealthy states of the world (or individuals) Marginal utility of income declines as income increases How about risk loving? Diminishing marginal utility as before Prefer less risk to more risk Go to Las Vegas Decision to Insure Decision to Insure Risk averse will pay risk premium to avoid financial risk of health loss Income is I2 if healthy, I1 if sick (I2 HC cost)
U(E(I)) U(I) Utility U(I2) E[U(no insure)] U(I1) If f = Pr(well), then E(I) = f*I2+(1-f)*I1 E(I)
Risk Premium E(I)-I* I1 I* E(I) I2 U(E(I)) > f*U(I2)+(1-f)*U(I1) = E[U(no insurance)] E[U(no = U(I*)
Income Example of Decision to Insure Example of Decision to Insure Assume U(I) = I Income of $40,000. Good health with prob. .9, health costs of $30,000 with prob. of .1. U($37k) = 192.35 U(I) = sqrt(I) Utility 200 190 100 E(I) = .9*$40k+.1*$10k = $37,000 $37,000
U($37k) > .9*U($40k)+.1*U($10k) .9*U($40k)+.1*U($10k)
Risk Premium $900 $10k $36.1 $37k = E[U(no insurance)] = 190 E[U(no = U(I*) so I* = $36,100 Actuarially fair costs $3,000
$40k Income Factors influencing the demand Factors influencing the demand for health insurance The more price elastic the demand for medical care is, the less desirable insuring against health losses is The more variance in health outcomes (higher financial risks), the more health insurance is demanded Hospital care has inelastic demand and high risk, so it is most common form of health insurance Bigger welfare losses (larger moral hazard) Dental care has more elastic demand (but still less than 1) and lower variance, so rate of those having dental insurance is lower ...
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This note was uploaded on 04/14/2011 for the course ECON 329 taught by Professor Classen during the Spring '11 term at Loyola Chicago.
- Spring '11