the role of insurance in health care, part 2 today: more on moral hazard other issues in insurance...
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The role of insurance in health care, part 2
Today: More on moral hazard
Other issues in insurance
Problems with insurance
Health care
Suppose that Angela has been admitted to the hospital after being in a car accident
She has a substantial MB for the first night in the hospital, due to the care that she needs
Health care
As Angela’s condition improves, her MB declines
When the demand hits the horizontal axis, she is completely better
Think of demand like MB
Think of supply like MC
20 percent co-insurance
Assume that Angela pays 20% of her costs This is also known as coinsurance
Angela will then decide to stay in the hospital as long as MB for each night exceeds its MC She will want to stay in the hospital as long as her
benefit is at least 20% of the hospital’s cost
What about a percentage co-payment? What if Angela had to
pay 20% of her costs while in the hospital Her PRIVATE MC is
two-tenths of MC curve (See dashed line)
Equilibrium is at the yellow circle
0.2 MC
Only a co-payment
Suppose that Angela’s insurance only mandates that she makes a co-payment
Angela’s PRIVATE MC is zero after being admitted
If hospital lets Angela stay in the hospital as long as she wants, equilibrium occurs at Q2 MB and private MC are
both zero here
What is optimal?
Angela’s optimal length of hospital stay occurs when the PUBLIC MC equals MB This occurs at point A
Deadweight loss due to 20% coinsurance
Flat-of-the-curve medicine
Flat-of-the-curve Spending that occurs with low MB
Is the US practicing this type of medicine? Likely in some cases, due to insurance
Analysis across countries is more complicated Countries with nationalized medicine may not provide some
services with MB > MC Malpractice costs Health care costs for selected countries: See Figure 9.5, p.
200
Some final issues
Externalities Graying of the population
Longer life expectancy Retiring baby boomers
Improved technology Reimbursement policies
Externalities
Externalities of health care exist in limited cases
Examples Vaccination (positive) Overuse of antibiotics (negative) Staying home when sick (positive)
Graying of the population
The average age of the population is increasing for two reasons Longer life expectancy Retiring baby boomers
Older people generally have higher health care costs per person This can increase premiums for everyone working for the
same firm More on this topic in later lectures
Government-provided health care Social Security
Improved technology
Old methods of health care are often not expensive Aspirin first marketed over 100 years ago
Modern drugs can have monthly price tags over $1,000 Should someone that is unable to afford a new
drug be left out of using it? Commodity egalitarian arguments have led to price
discrimination by pharmaceutical companies Prices slightly above MC are charged to poor people
Reimbursement policies
Reimbursement policies for medical services to try to keep costs down Review boards Discharge criteria from hospitals
New directions for health insurance? As health care costs continue to increase,
consumers must pay for it one way or another
New methods to keep premiums down Explicit reductions in benefits More drug tiers
See readings on class website for more on this Restructuring of benefits
Restructuring benefits
As we saw with Angela… Over consumption of health care Extra consumption passed on to others’ premium
fees How can we avoid this?
Provide accounts that carry over from year to year Lower premiums but increase deductibles
Example that decreases moral hazard problem: Lower premiums by $2000 per year, but increase deductible by $2000 per year
What are the other issues of insurance? Do some individuals have a discount rate that
is too high? Government insurance
Reimbursement rates Talk about this more next week
Emergency rooms Increased costs for all How can costs be further controlled in the
future?
Problems
1. Hospital demand given insurance (or lack thereof)
2. Deadweight loss due to insurance
3. Insurance problem
Problem 1
If a day in the hospital costs $15,000 per day, and you demand hospital care based on the demand P = $30,000 – 1,000 Q, how many days will you stay in the hospital under each of the following situations Full insurance with no co-payment A co-insurance of 20% of your bill No insurance
Problem 1
Full insurance with no co-payment With full insurance, the patient will stay in the
hospital until MB = 0 To find the number of days in the hospital under
these conditions, set 0 = 30,000 – 1,000Q Q = 30
Problem 1
A co-insurance of 20% of your bill With a 20% co-insurance payment, the patient will
stay in the hospital until MB is 20% of the daily cost, or $3,000
Set 3,000 = 30,000 – 1,000Q Q = 27
Problem 1
No insurance With no insurance, set MC = MB Set 15,000 = 30,000 – 1,000Q
Q = 15
Problem 2
Using the information in the previous problem, what is the deadweight loss (DWL) due to insurance? Note that there is no DWL when there is no
insurance
Problem 2
Note that above 15 days of care, MB is less than MC
With full insurance, the DWL triangle has base of 30 – 15, or 15
The height of the triangle is the MC, or 15,000
Area: ½ of 15 *15,000, or 112,500
Problem 2
With a 20% co-insurance payment, the DWL triangle has base of 27 – 15, or 12
The height of the triangle is the MC minus the 20%, which is 15,000 – 3,000, or 12,000
Area: ½ of 12 *12,000, or 72,000
Problem 3
Cautious George is so cautious In fact, he is so cautious that he has the
following risk-averse utility function U(n) = n⅓
Problem 3
Suppose that George could receive one of two possible payouts in the following gamble $125 with 40% probability $1,000,000 with 60% probability
What is the expected payout? What is the expected utility? How much is George willing to pay to be fully
insured?
Problem 3
Expected payout (Y) $125 * 0.4 +
$1,000,000 * 0.6 =$600,050
Expected utility U(125) = 5 U(1,000,000) = 100 Expected utility is
5 * 0.4 + 100 * 0.6 =62
Income
Util
ity
Y Z
UA
UC
UD
UBD
C
B
A
X
Willingness to pay (WTP) for insurance is Z – X, which is more than Z – Y
Problem 3
We need to find some y such that U(X) = 62 X⅓ = 62 X = $238,328
George is indifferent between taking $238,328 with certainty versus the previously-mentioned gamble
Income
Util
ity
Y Z
UA
UC
UD
UBD
C
B
A
X
Willingness to pay (WTP) for insurance is Z – X, which is more than Z – Y
Problem 3
George is willing to pay Z – X to be fully insured Z = $1,000,000 (the
higher of the two payouts)
X = $238,328 George is willing to
pay up to $761,672 to be fully insured
Income
Util
ity
Y Z
UA
UC
UD
UBD
C
B
A
X
Willingness to pay (WTP) for insurance is Z – X, which is more than Z – Y
Problem 3
Expected value of gamble (Y) $600,050
Certainty equivalent of the gamble (X) $238,328
George is willing to pay up to $761,672 to be fully insured
Income
Util
ity
Y Z
UA
UC
UD
UBD
C
B
A
X
Willingness to pay (WTP) for insurance is Z – X, which is more than Z – Y
Next week
Monday: The role of government in health care Read Chapter 10
Wednesday: Social Security Read pages 228, 232-236, and 240-251