Private Health Insurance
Farid Abolhassani
Learning Objectives
After working through this chapter, you will be able to:
 Explain the economic rationale for insurance and how
insurance works in health care
 Give examples of how insurance companies try to
counteract moral hazard and adverse selection
 Distinguish between the main types of managed care
organizations
 Suggest reasons why private insurance fails to provide
equity and efficiency
Key Terms
Actuarial (experience) rating Premium based on an individual’s
risk of illness.
Community rating Insurance premium based on pooled risk of a
defined group of people.
Diagnosis related group (DRG) Classification system that assigns
patients to categories on the basis of the likely cost of their episode
of hospital care. Used as a basis for determining the level of
prospective payment by the purchaser.
Health maintenance organization (HMO) Organization that
provides comprehensive health care for a fixed, periodic per capita
payment.
Preferred provider organization (PPO) Private insurance that
restricts choice to approved providers.
Key Terms
Out-of-pocket (direct) payment Payment made by a patient
directly to a provider.
Over the counter (OTC) drugs Non-prescription drugs
purchased from pharmacists and retailers.
Regulation Government intervention enforcing rules and
standards.
Universal coverage Extension of health services to the whole
population.
Unofficial payments Spending in excess of official fees, also
called ‘under the table’ or ‘envelope’ payments.
Public and private methods of
financing health care
Health care
financing systems
Privately financed
Out of pocket
payment
Publicly financed
Private health
insurance
Social insurance
Taxation based
systems
Copayment and
user fees
Group/individual
schemes
Single fund
General taxes
Full payment
HMOs/PPOs
Multiple funds
Hypothecated
taxes
The Premium
Administration cost
P=p×c+a
Premium
The cost to
cover the loss
Probability of the
insured event
P = 0.01 × 1500 + 5 = 20
The Premium Formula Validity
Conditions
 There needs to be a large number of subscribers to pool the
risks.
 The insured risks need to be independent.
 The probability of the insured event must be less than 1.
 People should not be able to influence their risk (moral
hazard) and there should be no adverse selection.
Moral Hazard
Households
Health Care
Financial
intermediary
 Free or low cost health
care at the point of
consumption
 Full reimbursement based
on FFS
Supplier-induced Demand
Providers
Neither the consumer nor the
provider has an incentive to
be cost-conscious
Cost-sharing or Co-payment Schemes
 A flat rate charge for each unit of service;
 Co-insurance (the insured individual has to pay
a certain proportion of each unit of health care
consumed);
 A deductible (the individual pays 100 per cent
of all bills in a given period up to some
maximum amount beyond which insurance
benefits are paid in full);
Reduction of the
overall impact of
supplier induced
demand
 A combination of the last two.
People in low-income or high-utilization groups may be
excluded from consumption as a result of lack of ability to pay
Prospective Payment Schemes to
countervail supplier-induced demand
 DRG-based payment
 Managed care:
 Health Maintenance Organizations (HMOs)
 Preferred Provider Organizations (PPOs)
Health Maintenance Organizations
HMOs provide (or arrange and pay for)
 Comprehensive health care;
 For a fixed, periodic per-capita payment (or premium) which is
paid by the consumer (usually with a subsidy from employers or
social security).
 Consumers do not usually pay charges at the point of use.
 The premium is set in advance and is independent of the volume
of services provided to the individual during the period.
 Providers can be salaried or paid by FFS (fee-for-service).
Types of HMO
 Staff model, in which all doctors are employed and/or
contracted directly by the HMO;
 Group model, in which the HMO contracts with an
independent group to provide services;
 Network model, in which more than one independent group
is contracted to provide services;
 Independent practice association in which the HMO
contracts several doctors in independent practice
Preferred Provider Organizations
 Premiums are paid either by employers or are shared between
employer and employee.
 Price at the point of use of services is zero.
 Insurers contract selectively with providers (e.g. primary care
doctors and hospitals who provide care below a certain cost per
case).
 The contract is on the basis of both a negotiated fee schedule
which the preferred providers accept as payment in full and
acceptance of utilization review.
 User charges and deductibles tend to be lower in PPOs than under
previous private insurance arrangements.
Medical Savings Accounts
 An individual- (or household-) specific account with
balances earmarked for health care expenses
 A high-deductible, catastrophic insurance plan to cover
expenses above the deductible.
Main sources of failure in private
insurance markets
 Moral hazard relates to potential changes in attitude of both
consumers and providers under insurance arrangements, which may
result in excess demand for health care.With full reimbursement of
bills through insurance, neither the consumer nor the provider has an
incentive to contain costs.
 Adverse selection arises from consumers having more complete
information than insurers on their own health status, which may
result in selecting plans that give them the greatest benefit. On the
other hand, insurers can profit by excluding high-risk individuals.
 Diseconomies of small-scale operations
Regulation of private insurance
markets
 Premium regulation
 Benefit package regulation
 Profit regulation
 Offering tax relief to firms who enroll their employees in
private insurance