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Unformatted text preview: Demand and Supply of Demand and Supply of Health Insurance
Class 13 Loyola University Chicago Prof. Tim Classen February 18, 2011 Class Outline
Markets for Health Insurance Risk preferences Demand for Health Insurance Supply of Health Insurance Read Chapters 8 & 11 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 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 markets for Factors influencing markets 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 (larger potential 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 likely less than 1) and lower variance, so rate of those having dental insurance is lower Supply of Health Insurance Supply of Health Insurance Two main tasks Process claims & payments Level of complication of plans can increase Manage risk not desired by clients Pooling reduces average risk these costs (and, hence, loading fees) Independent risks distributed over larger population reduces risk per person Community (employee group) rating of risk results in all having access to same premium Supply of Insurance Supply of Insurance How insurance firms determine price of policies Expectations on likelihood of illness of policyholders Risk adjustment Premiums must at least cover expected payouts E(B) = (1C) x pm x m* where C is client’s copayment rate But what if m* depends on C? A form of “Moral Hazard” Generates welfare loss from insurance (MC>MB) Pricing of Health Insurance Pricing of Health Insurance
HI Premiums = (1+loading fee) X Expected benefits = (1+L) X (1C) X pm X m* Loading fees reflect risk for insurers Loads are very large for individual plans (60 100%) vs. 520% for group plans L = 0 is “actuarially fair” insurance Giving customers E(I) in earlier example But insurance companies have operating costs Average Annual Worker and Employer Contributions to Premiums and Total Premiums for Family Coverage, 19992010
$5,791 $6,438* $7,061* $8,003* $9,068* $9,950* $10,880* $11,480* $12,106* $12,680* $13,375* $13,770* * Estimate is statistically different from estimate for the previous year shown (p<.05). Source: Kaiser/HRET Survey of EmployerSponsored Health Benefits, 19992010. Trends in premiums relative to Trends in premiums relative to earnings growth and inflation Cumulative Changes in Health Insurance Premiums, Workers’ Contribution to Premiums, Inflation, and Workers’ Earnings, 19992010 Source: Kaiser/HRET Survey of EmployerSponsored Health Benefits, 19992010. Bureau of Labor Statistics, Consumer Price Index, U.S. City Average of Annual Inflation (April to April), 19992010; Bureau of Labor Statistics, Seasonally Adjusted Data from the Current Employment Statistics Survey, 19992010 (April to April). Problems for Health Insurers Problems for Health Insurers Asymmetric Information Leads to Adverse Selection (ex., used car market) People most adverse (least desirable) to an insurance company’s profitability are most likely to select, or apply for, the insurance being offered Higher rates of illness than forecast by actuaries (premiums must be adjusted) Design a variety of plans to attract different risks to different plans (or positive selection) Moral Hazard Reduces welfare loss of healthy from being pooled with unhealthy in uniform plans Change health behaviors after insured Policies for Moral Hazard Policies for Moral Hazard
Deductibles Copayments Customary/usual fees Managed care Stoploss Health Savings Accounts Max out of pocket payments, but may increase MH for high spenders ...
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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