Session 2: Insurance
Timothy F Christian, MD, MPA
Insurance: Pooling Eq.
• Components of Insurance pricing:
• 1. Actuarial fair premium price
• 2. + degree of risk aversion present in
population
• Total cost of premium is a pooling equilibrium
of these 2 forces resulting in unequal fairness
in policy price for some.
Pooling eq. 2
• Actuarial fair price calculation:
• Risk of MI= 1% in group, Cost of MI care=$30,000
• Fair actuarial price of premium
= $30,000 x 0.01= $300
• but price may be higher if population is wealthy and
risk adverse.
• For eg. the willingness to pay (WTP) for risk
avoidance may be $100 (peace of mind).
• WTP Premium = $400
Law of Large Numbers
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Cost = Prob event (P) x cost event (L)
With insurance, Premium = P/N x L
N= number of people in pool, bigger is better
Eg: (N=100) Prem = 0.01/100 x $100,000 = $10
• Eg2: (N=50,000) Prem = .01/50,000 x 100,000
= .02 (2 cents): a 500-fold reduction in cost!
• Implications for LDCs, National Plans
Distortions in the Insurance
Market
Adverse Selection
• Adverse selection: Information is asymmetric;
the individual knows their risk whereas as the
insurer does not (and cannot by law often).
• Consequently sick and healthy clients look the
same to insureres but sick pts are more likely
to buy insurance
• they know they will need it in the short-term
so those that buy insurance are an adverse
population that will file claims
Adverse Selection Example
• Group H (n=100) risk of event 0.5%/yr
• Group U (n=100) risk of event 5%/yr
• Anticipated claims=(H100x0.005x$30,000) +
(U100x0.05x$30,000)= $165,000
For the system to work fairly, the insurance company
will charge the low risk group $30,000 X 0.005= $150
and the high risk group $30,000 X 0.05= $1500
• But, The Insurance companies cannot Identify
who is H and who is U
• =Community Rating and guaranteed Issue
AS: Race to the Bottom
• To Keep all in pool, insurance charges all pts
$150 (30,000x0.005)=$150,000
• Actual claims will be $165,000=$15,000
shortfall: company fails
• In order to recoup $165,000 Ins Co. assigns a higher
premium to all participants: $165,000/200= $825.
Now high risk are paying $675 less than actual cost of
$1500 and low risk are paying $675 more than fair cost
of $150
• No incentive for Healthy to stay in the pool (separating
eq) unless MANDATED-see Obamacare
Race to the Bottom 2
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!00 healthy pts leave pool
Total payout = 100 X .05 X $30,000= $150,000
Total take in from premium =100 X $825= $82,500
$82,500-$150,000= -$67,500. Company fails
unless premiums raised.
• New premium=150,000/100=$1500
• Another group of more risk tolerant pts leave pool
• Cycle repeats with ever higher residual risk pool
Moral Hazard
• Moral Hazard: Occurs once insurance is in place
(regardless of mechanism)
– Events tend to increase because policy holders take risks
they might not otherwise take if uninsured (minor)
– Consumption of health care increases by policy holder as
more likely to utilize health care system (major issue)
– Providers generate waste by providing or prescribing more
health care for those with insurance (major)
• All of the above shown to always increase health care
spending when insurance coverage is expanded.
• Outweighs preventative strategies (ER Utilization)
Insurance Failure in LDCs
Why the LDCs pay the highest out-of pocket for HC
1. Affordability argument: Countries are too
poor to provide national insurance programs
2. Political choice: spending funneled into
favored programs or lost to corruption
3. Inferior tax instruments: no precedent in tax
revenue, revenue raising mechanisms, and
economies too frail to survive the dead
weight loss of any tax.
RAND Health Insurance Experiment
Copayment level will be critical in Vermont with universal coverage
The ER Myth
• Covering the uninsured will reduce costs as
care will switch from ER to prevention
• Reality: that costs go up as coverage increases
secondary to moral hazard.
Why is Health Care Market Failure?
1.
2.
3.
4.
5.
Prices for services are fixed by insurers/Gov
Assymetric information consumer/producer
Inelastic demand element for health-care
Subsidies by Government
Consumer price shielding thru insurance &
deficit spending
6. Pharmaceutical and device monopolies/IPR
7. Social insurance=redistribution of wealth
The Inefficiency Inherent in anyTaxation
S
Price
P+T
1
DWL
P*
2
At P* and Q*
the area 1 + 2
is maximized
D
Q*
Quantity
ITF 110
Types of insurance
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Private monopoly
Private competition model
HMO type: Minn.
Private annual policy: India
Social Insurance
– Single Payer National: Medicare, Vermont
– Multi-payer National: Israel
– Private-payer Mandate: ACA, Mass.
Social Insurance
• A non-voluntary transfer of wealth using
pooling equilibrium.
• Mandatory participation, universal coverage
• Requires strong government
– Gov. as enforcer of penalties for noncompliance
– Legal framework and infrastructure to carry out
– Economy of scale
– Paternalistic approach
Single Insurance Payer
Advantages
Disadvantages
• Broad coverage potential
• Cost Containment via
centralized board
•  in Administrative costs
• Ease for Providers
• Monitor for abuse
• Standardize metrics for
quality
• Can be a tax vs mandate
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Lack of competition, choice
Eliminates jobs
Concentration of authority
 incentive for innovation
Business: fewer options to
recruit employees
• Conflicts with Federal
Programs and statutes
• Social insurance