The Private Health Insurance
Market
Insurance Design
• Insurance is designed to spread risk
• Individuals can self-insure and face chance of
paying for costs themselves or they can pay
known premium and push the costs onto an
insurer
• Risk averse individuals join pools to protect
against costly random events
• Expected loss is = (probability of loss) x $ Loss,
e.g., a 1% chance of losing $10,000 has
expected (average) loss of .01(10,000) = $100
• Most individuals are risk averse, i.e., the gain in utility of
extra $ is smaller than the loss in utility of the same $
• The premium charged by an insurance company will
equal the expected cost of loss + load (for administrative
costs and profit).
• Allocative efficiency occurs when the marginal benefits
of insurance coverage are > marginal costs (i.e., MB >
MC).
• Insurance plans should not cover high probability events,
low cost losses and remote probability events because
MB < MC.
• Private health insurance coverage mirrors MB > MC
considerations somewhat. Insurance pays 97% of
hospitalization costs, 85% of MDs, 2/3s of Rx drugs, &
less than 50% of dental and eyeglasses.
Health Insurance and Market
Failure
1.
2.
3.
4.
5.
6.
7.
8.
Income tax treatment effects
Consumers lack information
Premium Setting
Adverse Selection
Moral hazard
Other Supply – Side Failures
Insurer Responses
The Uninsured
1. Income tax treatment affects the way we buy
insurance
– 94% of private plans are employer based with
an employee share usually 25-40% of the
total cost
– Remainder is funded by wage reductions
– Result is over-reliance on employer decision
making and overly comprehensive insurance
(MB < MC) plans that try to cover all risks
– Tax benefits = > $200 Bil./yr. =less income &
payroll tax for workers and less payroll tax for
employers
– Tax benefits accrue most to high income
individuals, none to uninsured and low income
workers
2. Consumer Ignorance
• For markets to work efficiently,
consumers must be well informed
• Medical information is difficult to gather
and difficult to understand. Little
information on prices, quality and
appropriate treatments. Health providers
& insurers don’t want to provide info.
• Cost of poor information is very
expensive
3. Premium Setting – Community and
Experience Rating
•
Community rating
– Expected medical benefits - based on the risk
characteristics of the entire plan membership
• Not on the health history or risk status of a
particular person
– May differ across individuals
• Geographical location - cost-of-living
considerations
• Type of contract (individual or family)
• Benefit design (level of copayments,
coinsurance, deductibles, and benefits covered).
• Experience rating
– Individuals - different risk categories based on
various identifiable personal characteristics
• Age, gender, occupation, and prior
illnesses.
– Premiums - based on
• Geographical location, type of contract,
benefit design
• Relation between risk category and
expected health care costs
4. Adverse Selection
•
•
•
Arises because individuals have more
information about likely medical spending than
insurers.
Higher risk groups choose high coverage
policies if their premiums are based on average
risks (both low & high users),i.e., when
community rated.
Premiums can be experience rated or
community rated, which cross-subsidizes high
users by low users.
• Low users with community rating will
choose cheaper, low coverage plans (or to
be uninsured). This leads to undesirable
turnover between plans and a race to the
bottom in terms of plan quality leading to a
loss of choice.
• High users will end up in pools with few
low users, leading to high premiums or
lack of insurance.
• Employer group policies are experience
rated, limiting adverse selection effects.
• Experience rating effects
– Price - closer to the expected medical benefits
– More efficient - creates an incentive for
people to adopt favorable lifestyles
– Can reduce the practice of adverse selection
– Low users will be able to purchase both high
and low benefit plans
– High users won’t be able to afford insurance,
which is inequitable
• Community Rating Effects
– High users have greater access to health
insurance
– Low users have to cross-subsidize high
users, which is inequitable
– Low users have to pay higher premiums,
which leads to more uninsured
– Less diversity in type of plan coverage,
i.e., race to the bottom.
5. Moral Hazard
• Insurance coverage increases medical care
spending because it decreases the out of
pocket cost
• Medical care will be demanded as long as MB
> MC, but private MC is not the total true cost
of care, just the copay. This leads to
excessive and wasteful spending.
• Higher insurance premiums decrease %
insured
• Efficiency requires some kind of cost sharing
by consumer, namely copays and deductibles.
6.
Other Supply Side Market Failures
• Medical providers are consolidating, i.e., hospitals
and specialists
– Federal judges have ruled nonprofit mergers are OK
even if they result in monopolies
• State regulations are increasing, because local
politicians are more susceptible to industry
demands
– Mandatory benefits, providers, licensing, training
– Community rating, any willing provider laws
• Patient and/or MD ignorance
– Specialists in the same area provide widely differing
care to patients with the same diagnoses.
Inadequate diagnosis or treatment knowledge ?
• Fee for service payments
14
6. Insurer Responses
To limit adverse selection and moral hazard
problems, insurers
• Charge deductibles and copays
• Exclude preexisting conditions
• Limit choice of hospitals & doctors
• Charge more for individual than group policies
• Limit panels to new or only a few specialists
• Create and market high benefit and low benefit
policies to separate high users from low users
• Implemented managed care and consumer driven
health plans
7. Medical Care for the Uninsured
2007
Group
All Persons
Nativity
Native
Naturalized Citizen
Non-Citizen
Age:
Under 18 years
18 to 24 years
25 to 34 years
35 to 44 years
45 to 64 years
65 years and over
Income:
Less than $25,000
$25,000 to $49,999
$50,000 to $74,999
Over $75,000
Race:
White, Non-Hispanic
Black
Asian and Pacific
Islander
Hispanic origin
Uninsured
(000)
Percentage
of Group
2006
Percentage
of Total
Uninsured
(000)
Percentage
of Group
Percentage
of Total
45,657
15.3
100.0
46,995
15.8
100.0
33,269
2,651
9,737
12.7
17.6
43.8
72.9
5.8
21.3
34,380
2,384
10,231
13.2
16.4
45.0
73.2
5.1
21.8
8,149
7,991
10,329
7,717
10,784
686
11.0
28.1
25.7
18.3
14.0
1.9
17.8
17.5
22.6
16.9
23.6
1.5
8,661
8,323
10,713
8,018
10,738
541
11.7
29.3
26.9
18.8
14.2
1.5
18.4
17.7
22.8
17.1
22.8
1.2
13,539
14,515
8,488
9,115
24.5
21.1
14.5
7.8
29.7
31.8
18.6
20.0
13,933
15,319
8,459
9,283
24.9
21.1
14.4
8.5
29.8
32.6
18.0
19.8
20,548
7,372
2,234
10.4
19.5
16.8
45.0
16.1
4.9
21,162
7,652
2,045
10.8
20.5
15.5
45.0
16.3
4.4
14,770
32.1
32.3
15,296
34.1
32.5
Source: United States Census Bureau, Income, Poverty, and Health Coverage in the United States: 2007, P60-235,
August 2008.
• 60% of uninsured are working
• Only 10% of uninsured have preexisting
conditions who can’t afford/get coverage
• Typical spell w/o insurance is about 6
months w/ 1/3 uninsured for > 1 year.
• Lots of turnover, w/ maybe 85 million w/o
coverage at some point over 4 year
period.
• Job lock because of employer-sponsored
group health insurance
4 Reasons for Being Uninsured
• By choice (voluntary) - employer doesn’t offer
insurance and individual doesn’t want to pay
premium
• Frictional – individual drifts in and out of jobs
offering group health insurance (or part timer,
probationary)
• Structurally uninsured because of chronic
illnesses, preexisting conditions, and/or insufficient
income.
• Cyclically uninsured as the macroeconomy
normally expands and contracts in the short term
Uninsured and Health Status
• Research is inconclusive
• Some research suggests lack of insurance
doesn’t seem to affect health status. 2/3s
less MD visits and ½ fewer hospitals but
same kind of mortality and morbidity
statistics. Uninsured are generally
younger and healthier.
• Others find less access w/o insurance
leading to poor health.
• Uninsured receive emergency care even if
they don’t have $. Uncompensated care
about $50 billion per year.
• Paid by municipalities for public hospitals
and cost-shifting at private hospitals.
• It’s getting more difficult to shift costs for
uncompensated care as competition
increases between providers and insurers.
This is creating a crisis for medical care
providers, particularly hospitals who treat
the uninsured.