1. Application: Adverse selection and moral hazard in the finance and supply of health care

2. Objectives For you to be able to:
Explain how problems of adverse selection arise in relation to health insurance. Explain how the problems associated with adverse selection in relation to health insurance can be resolved. Explain why equity issues may arise as a result of the solutions to adverse selection employed by private insurance providers. Explain how these equity issues can be addressed.
Explain how consumer and supplier moral hazard arises in the context of health care provision. Using examples, discuss how the problems associated with moral hazard in health care provision can be resolved.

3. Suggested background reading
Allen et al Managerial Economics. Norton. Chapters 14-15
Kreps, D. M Microeconomics for Managers. Norton Chapters (16-17 provide more background)
Frank, R. H Microeconomics and behaviour. McGraw Hill. Chapter 6
Wall,S., Minocha, S. and Rees, B International Business, Pearson. Chapter 6
Grimes, P, Register, C. and Sharp, A Economics of Social Issues, McGraw Hill. Chapter 15
Rasmusen, E Games and Information, Blackwell. Chapters 7-9
And any introductory Health Economic text you can access e.g. Mooney, G., (2003) Economics, Medicine and Health Care, Dorset: Prentice Hall

4. Sources of imperfect and asymmetric information in health care markets
Health care finance: Health care providers (e.g. insurers, government) are relatively uninformed about a client’s health risk and health related behaviour
The doctor-patient relationship: The consumer/patient is relatively uninformed about health care treatments but the health practitioner is relatively informed
Implies potential for moral hazard and adverse selection - particularly in private health insurance markets
Problems vary depending on system
Asymmetric information and the principle agent model can be applied to the doctor-patient relationship. Leads to moral hazard, adverse selection in provision/supply and agency issues in demand e.g. the potential for supply induced demand
The rationale for public support is based on arguments and theory in health economics
Key are the particular characteristics of the market for health care and the potential for market failures that relate to these characteristics. In addition, part of the problem is that the demand for health care is both irregular and unpredictable plus risky (with some probability of death). It is also financially expensive and outcomes of treatment are uncertain
Points to consider:
Purchasing insurance is the utility maximising decision for a risk averse individual in an uncertain world;
Characteristics of the health care and health care insurance market are likely to lead to market failure;
Moral hazard is likely operate in a private health care insurance market
Measures to counter moral hazard have implications for equity in health care provision
Public intervention in health care provision may lead to greater social welfare than depending upon competition
Broad topics:
Market failure in Health care; Consumer and provider moral Hazard; Measures to counter Moral Hazard; Adverse selection
Uncertainty and health care; Utility maximisation under uncertainty
Private insurance in health care provision

5. Different health care systems
Pure market provision
Health care is like any other good and demand and supply respond efficiently to price - Embodies consumer sovereignty in a decentralised market
Private insurance based approach
Private Insurance (or no insurance) and minimal state control
Employer or individual based insurance plus private ownership of health care supply
The USA (although some publicly funded health as well; Medicare, Medicaid)
Culyer, Maynard and Williams (1981)
In a private system if a person has no insurance then consumption is constrained by price and income
If the insurer pays all the bills then consumption is not constrained by price and medics have no incentive to ration demand efficiently

6. Different health care systems
Public production, allocation and finance
Aim is improvement of health for the population
Health is a right and access is by need
Universal medical care
Public/tax financed - mostly free at point of service
Earnings related social-insurance contributions
Tax funding plus public ownership/control of health care supply e.g. UK, Sweden, New Zealand
Mixed public/private involvement e.g. private provision but public finance
government tax-based subsidies to a privatised system or tax-based national insurance
Compulsory cover through tax system supplemented by tax funding plus some private sector involvement in supply of healthcare e.g. Canada, Germany
Singapore (some government subsidy through taxation)
Culyer, Maynard and Williams (1981)
In a private system if a person has no insurance then consumption is constrained by price and income
If the insurer pays all the bills then consumption is not constrained by price and medics have no incentive to ration demand efficiently

7. Horses for courses?
Different countries may not want the same things from their health care system
All have different advantages and disadvantages
The US system has short waits but the UK NHS is more equitable/accessible
Life expectancy is more or less the same
Women: 80.4 in the UK, 79.8 in the USA
Men: 75.7 in the UK, 74.4 in the USA
Life expectancy data is for 2001 – data from OECD Health Data 2004
Table in Folland et al page 511 gives some comparative date on wait times, costs and access

9. Problems for all health systems
Cost containment: Most countries (except the UK) have seen an escalation in health expenditure
E.g USA medical spending as a % of GDP was 14.6%; Canada 9.6%; UK 7.7%; France 9.7%
(OECD Health Data,
Possible explanations:
Availability of new and expensive technology
Third-party payment due to asymmetric information as well as uncertainty and risk
Both doctor and patient have an incentive to consume health care as long as there is some positive benefit---this is a moral hazard problem
Doctors are paid a fee for services by a third party e.g. insurance company or government (not the patient) so marginal cost of health care is ‘free’ to the patient and doctor is not constrained by patient’s ability to pay – can lead to high service costs and fees – SID.
Maybe less of a problem when there are state imposed spending limits (as in the UK, Canada)
UK has escaped this problem through government control of expenditure
OECD Health Data 2004: A comparative analysis of 30 countries, Paris: OECD (
E.g. In 1985 spending on physician services was 72% higher, fees (in all categories) were 239% higher and the net incomes of doctors were also higher in the US compared with Canada but the quantity of care per capita was lower in the US (Fuchs, V. R. and Hahn, J. S., 1990, How does Canada do it? A comparison of expenditures for physicians’ services in the United States and Canada, New England Journal of Medicine, 323: in Folland et al page 505).

10. Adverse selection and moral hazard in health-care
Adverse selection due to imperfect information about individual risks
Consumer moral hazard as people can influence the probability of ill health
Producer/supplier moral hazard as doctors do not bear the costs of treatment:
Moral hazard and adverse selection are agency problems. In relation to finance and insurance an asymmetry in information arises due to the patient being better informed about their own state of health

11. Adverse selection in private health insurance
Adverse selection arises from the information asymmetry about health risks between the insurance company and the insured person
Insurance company (principal) only knows average risk in a population
Individual (the agent) knows more about own health risk
Adverse selection results from asymmetric information about health risks but insurance companies are just trying to minimise their costs.
Solutions have significant and generally undesirable, implications for social welfare.
some people will be uninsured – the most at risk
Adverse selection is a market failure – the methods insurance companies use to circumvent adverse selection are a consequence but mean high risk people will not be able to afford insurance – separating instead of pooling contracts

12. Adverse selection in private health insurance
If insurance contracts/premiums based on average risk (community ratings)
only people of average or higher than average risk will buy the insurance - more than averagely healthy people will not buy expensive insurance
Implies adverse selection
puts the insurance companies at risk of paying out more than they receive
Negative impact on profits as premiums based on average risk not high risk of the people who actually buy the insurance.
Adverse selection results from asymmetric information about health risks but insurance companies are just trying to minimise their costs.
Solutions have significant and generally undesirable, implications for social welfare.
some people will be uninsured – the most at risk
Adverse selection is a market failure – the methods insurance companies use to circumvent adverse selection are a consequence but mean high risk people will not be able to afford insurance – separating instead of pooling contracts

13. Solutions for the insurance companies
Insurance companies use ‘screening’ methods to identify high and low risk people e.g. base premium calculations on medical examinations, individual experience of ill-health, lifestyles (smoking, occupation) and other characteristics e.g. age, ethnicity, gender, wealth.
This can lead to premiums that are too high for many sick people (or those most at risk) to afford
Highest premiums unaffordable by poorer people but they are at the most risk so they are the people likely to be charged higher premiums
Implies rationing by price, income and risk
Some people unable to acquire private insurance because they are high risk and/or too poor

14. Rationing in a private market for health care: no excess supply/demand at the equilibrium price but this does not mean everyone is covered
Price
S = MC
D = MWP
Uninsured demand
due to rationing by price Pp
See Folland et al (2007: page 231) for a discussion of some of the myths about the uninsured in the USA. In million or 18.7% of the US non- elderly population was uninsured (the elderly are insured though Medicare). Over 1/3 of uninsured people need care but don’t get it and nearly half postpone it. Less than a ¼ of families with at least on uninsured member report having received care for free or at reduced rates. If not covered by job- related health insurance costs for the individual are high – average annual cost for a family was about $3,300 in 2005.
See
Public provision addresses some of these issues by pooling risk Qp
Quantity

15. Problematic side of private based system like the one in the USA
Coverage problems
More than 20% of the US population are without health care coverage
Highest infant mortality rate of developed countries.
Myths about the uninsured in the USA:
uninsured-fact-sheet.pdf

16. Why, if at all, does it matter if poorer and/or sicker people are not covered by health insurance? If it does matter, what possible solutions are there for this coverage problem?

17. Why access to health care matters
Poorer people are more likely to suffer from ill-health – poverty as a cause of ill-health
The poor tend to be ill more often and more severely ill than the rich. They live shorter lives and are in poorer health while they are alive
“A boy born in Hackney, next to Newham, is more than twice as likely to die in the first year of his life as a boy born in Bexley, in the south-east suburbs.” Carvel, 2001
A strong relationship between health and economic status within and between countries
“First and foremost there is a need to reduce greatly the burden of excess mortality and morbidity suffered by the poor” WHO, 1999
WHO, 1999, The World Health Report, Geneva, WHO

18. 2 way causality
The links between poverty and ill-health are not just one way
Ill-health can cause or worsen poverty
but if good health care reaches the poor, it can help to relieve poverty
Policy directed to health can therefore have positive economic implications for individuals and countries
Externality effects: Ill-health leads to a decline in productivity and earnings
The loss from AIDS death in Zaire has been estimated to equal 10 years of average per capital income
A typical Tanzanian AIDS death has been estimated to involve a loss of 18.3 years of average per capita income.
See Over, Mead et al 1988 The direct and indirect cost of HIV infection in developing countries: The cases of Zaire and Tanzania, 4th International Conference on AIDS, Stockholm, June 12-16

19. Why access to health care matters --equity issues
People are concerned about the health of others and inequalities in health – more so than inequalities in income
A kind of externality - humanitarian overspill
Leads to general support of a health-care system that is redistributive or at least provides a safety net
Enabling people on low incomes to access more health-care than they could afford to buy in a competitive health care market
Gives a role of government in health-care

20. Why access to health care matters - global public health issues
Externality effects of ill-health that extend beyond national borders
Transmission of diseases (e.g. HIV/AIDS, tuberculosis, malaria)
Heightened by travel but incidence and impact highest in Sub-Saharan Africa, Middle East and India
Threat of bio-terrorism
The emergence of drug-resistant strains of disease e.g. tuberculosis, Malaria and leprosy
See Johnson-Lans, S., 2006: chapter 13 A Health Economics Primer, Pearson-Addison Wesley USA

21. Social insurance as a policy solution to the coverage problem
Potential for adverse selection in health care and related coverage problems weakened by public provision
AS and related coverage problem  spread of compulsory/universal social insurance schemes in health:
Social insurance schemes enable risk pooling - the state insurse the ‘uninsurable’ by compelling universal coverage
Reduces the risk of adverse selection
The state = third party in the relationship between patients and health practitioners
i.e compel coverage of low risk and rich people as well as high risk people

22. Moral hazard in health care provision and finance
Consumer moral hazard
Supplier moral hazard

23. Consumer Moral Hazard
Consumer moral hazard arises because insurance (private and social) reduces the cost of consuming health care at the point of consumption.
As the cost of consumption falls, the cost of being ill is reduced
incentives to reduce the risk of falling ill are reduced
people take risks with their health through health related (bad) behaviour
Smoking, driving recklessly, poor diet, less exercise

24. Consumer Moral Hazard
Less personal investment in health implies higher consumption of health care than if there were no insurance
Socially inefficient outcome
Higher costs for private (and public) health insurance companies – lower profits (higher taxes)

25. Measures to counter consumer moral hazard
Insurance based
Insurance + organisation based
Non-price rationing (state provision)

26. 1. Insurance based solutions
Co-payments, coinsurance and deductibles - The insured person pays some fraction of the cost of the procedure - out of pocket expenditures.
Co-payments: flat rate charges (e.g. prescriptions)
Coinsurance (% share of total cost)
Deductibles (e.g. excesses)
Limitations: Fixed maximum coverage schemes; the financial exposure of the insurer is fixed.
E.g. life time coverage limited
The insured have an incentive to ensure that costs remain within the agreed value as excesses will have to be met by them.
Evidence from health insurance experiments have found that utilisation is reduced by some of these kinds of methods
Like and excess agreement.
Deductibles: Not all provision covered by insurance
Co-insurance: consumer pays a fraction of bill
Can also get combinations of deductibles and coinsurance

27. Evidence relating to hospital use and different payment schemes: RAND Health Insurance Experiment
Randomized families to health insurance plans that varied cost sharing from none ("free care") to a catastrophic plan that approximated a large 95% family co-insurance deductible (with a stop-loss limit of $1,000 in late-1970s dollars - scaled up for the low-income population).
The participants in the large-deductible plan (95 percent coinsurance) used percent fewer services than those in the free-care plan….
23 percent less likely to be hospitalized in a year
Substantial reductions in use were found among all income groups
But how did this impact on health?
The RAND HIE was an experimental study of health care costs utilization and outcomes in the United States, which assigned people randomly to different kinds of plans and followed their behaviour, in As a result, it provided stronger evidence than studies that examine people afterwards who were not randomly assigned. It concluded that cost sharing reduced "inappropriate or unnecessary" medical care, but also reduced "appropriate or needed" medical care. It did not have enough statistical power to tell whether people who got less appropriate or needed care were more likely to die as a result.
Stop-loss limit sets limit to pay out – i.e. it’s a loss limit in this case for insuree
A limit on the amount that a policyholder must make in coinsurance and out-of-pocket payments per year on an insurance policy. Generally the stop-loss limit is stated as a flat dollar amount (e.g, $5,000). Once the stop-loss limit has been reached, the health insurance company picks up all remaining expenses for the year.

28. Evidence relating to health status: RAND Health Insurance Experiment
For most people enrolled in the RAND experiment (mainly typical of Americans covered by employment-based insurance) the variation in use across the plans appeared to have minimal to no effects on health status.
But for those who were both poor and sick (might be covered by Medicaid or lacking insurance) the reduction in use was harmful.
E.g. Hypertension was less well controlled among that group, sufficiently so that the annual likelihood of death in that group rose approximately 10 percent.

29. Impact of the RAND Health Insurance Experiment
There is still a debate over the appropriate role for patient cost sharing… whether any reduction in use induced by increased cost sharing was among "necessary" or "unnecessary" services and therefore whether it adversely affected health.

30. Alternative solutions to consumer moral hazard: Managed care agreements
Insurers enter into volume discount contracts with specific providers.
Insured must pay extra to use ‘non-preferred providers’ e.g. US arrangements.
Managed Care Plans (Health maintenance organisations, HMOs) and Preferred provider agreements (PPOs)
Fairly comprehensive care but either
all care is delivered through the plan’s network e.g. in HMOs primary care physicians authorise services
coverage greater (costs lower) e.g. when when using the PPO’s provider network
Common in the US and also some south American countries e.g. Argentina
In the USA PPOs are now more prevalent than HMOs
Some evidence that costs lower for consumers and less use of expensive resources with managed care but selection bias problems and issues related to quality of care(see Drummond et al pp 256-9)

31. No patient is refused access to health care But…………
Alternative solutions to consumer moral hazard: Non-price rationing (public finance/provision)
No patient is refused access to health care
But…………
Capacity is fixed leading to waiting lists for certain therapies.
People pay a time cost which should discourage unnecessary use.

32. Rationing under social provision : excess demand at the administered price, Pa → waiting lists
S: inelastic as determined by state
Price
Excess demand
= Waiting lists or time based rationing
D = MWP Pc Pa
= Unmet demand
Supply is not price sensitive
Pc is the market clearing price – since this is above Pa there is excess demand which in this case implies time related rationing.
In the UK waiting lists/excess demand have lead to the development of private health markets for services for those who have the appropriate ability to pay (i.e. at a price higher than Pa and probably higher than Pc as well since supply is price responsive)
Qp Q*
Quantity

33. Rationing under social provision can also lead to a private market for health care - a useful safety valve for the state system?
Price
S = MC
D = MWP
Revenue to private system Pp
This is what happens in the UK. In Canada there was no private alternative until 2005 though some Canadians can use the US health system if they want to avoid waiting and can afford to.
Qpr < Q* - Qp
Quantity

34. Provider moral hazard
Provider moral hazard derives from the infrastructure of modern health care, where a third party (insurance or state) pays for the health care provided by the doctor.
The payer may have different priorities to either the doctor or patient.
Systems will reflect the payer’s utility function; e.g. maximising population health gain
Impacts on pay contracts (for medics) e.g. treatment fees

35. Implications of third party payment
If doctors are paid a fee for services by a third party (insurance company or government - not the patient) then the marginal cost of health care is ‘free’ to the patient and doctor is not constrained by patient’s ability to pay
Moral hazard can arise because:
Information asymmetry between doctor and the patient
The doctor does not know the cost of medical care
The doctor has a financial or similar incentive to increase consumption of health care e.g. fee for service arrangements,
Can lead to supplier induced demand (SID); demand higher than socially efficient
i.e. Institutional arrangements are important in determining the relevance of agency literature to understanding incentives and observed behaviours in the health care system.

36. Supplier Induced Demand (SID)
“Supplier induced demand is the amount of demand created by doctors, which exists beyond that which would have occurred in a market in which consumers are fully informed.” Donaldson & Gerard (1992)
“Supplier induced demand exists when the physician influences a patient’s demand for care against the physicians interpretation of the best interest of the patient.” McGuire, T. (2000)
Doctors have the potential to induce demand for health care
The empirical evidence tends to support the existence of SID – but it is not conclusive.
It may not be possible to prove the existence of SID
T. G McGuire Handbook of health economics, in: AJ Culyer and JP Newhouse, Editors, Handbook of Health Economics, Elsevier, Washington DC (2000) – Also see RP Ellis and TG McGuire (1986) Provider behavior under prospective reimbursement, Journal of Health Economics 5 (1986), pp. 129–
Donaldson C. and Gerard K., (1992) The Visible Hand: The Economics of Health Care Financing, London: Macmillan

37. Diagrammatic illustration
E0 = Initial equilibrium
Following an increase in overall supply (to S1) due to an increase in funding (new doctors or hospitals etc), doctors increase demand (to D1) to maintain (or increase) target income.
E1= resulting equilibrium S0 S1 E1 E0
Empirical Evidence e.g. Fuchs, Birch, Norwegian Primary Care, Australia
If demand is inelastic (which is probably the case as it’s a necessity) the increase in supply leading to a decrease in price) will lower revenue/income
See appendix: SID can also result in a decrease in demand D1 D0
Q Q1 Q

38. Implications SID (excess demand) can lead to:
Higher service costs and fees: rising health care costs
Higher usage of new and expensive technology
Potentially less of a problem when there are state imposed spending limits (as e.g. in the UK, Canada)
The NHS is cheap by international standards and health outcomes not that much different - supply side incentives to economize through budgets and method of doctor payment (Doctors are not paid directly for medical activity)
E.g. In 1985 spending on physician services was 72% higher, fees (in all categories) were 239% higher and the net incomes of doctors were also higher in the US compared with Canada but the quantity of care per capita was lower in the US (Fuchs, V. R. and Hahn, J. S., 1990, How does Canada do it? A comparison of expenditures for physicians’ services in the United States and Canada, New England Journal of Medicine, 323: in Folland et al page 505).
The empirical evidence tends to support the existence of SID – but it is not conclusive.
It may not be possible to prove the existence of SID as the direction of causality could go either way

39. Questions to consider: 1
Questions to consider: 1. What sort of health system is in place where you are (or where you come from)? and; 2. how does this system address potential problems of adverse selection and moral hazard? 3. what are the advantages and disadvantage of this system?

40. Policy implications: Social insurance as an alternative to market provision
Market failures in health care due to asymmetric information lead to problems associated with moral hazard and adverse selection
Also other market failures due to:
Externalities; Uncertainty; Economies of scale; Entry barriers leading to a near monopoly of control by medical practicioners
Explains the spread of compulsory and universal social insurance schemes in health provision:
Reduces the risk of adverse selection: the state can insure the ‘uninsurable’ by compelling universal coverage - risk pooling
Reduces some moral hazard problems: the state can act as a third party in the relationship between patients and health practitioners
The characteristics of health care are not consistent with the assumptions of the competitive market model. Distinguishing characteristics of the medical care market that imply imperfections and potential for market failure (Arrow 1963)
General Interdependence – externalities; Increasing returns to scale – diseconomies of small scale (need large numbers to pool risk); Entry restrictions; Routine price discrimination;
Imperfect information
Therefore, it is unlikely that a competitive market model will produce health care in an efficient manner; There is potential for market failures. Where the market fails, Arrow argues that social welfare will be best served by the state providing health care insurance of some sort
Risk pooling via universal coverage i.e. compel coverage of low risk and rich people as well as high risk people
E.g. Law of large numbers applies in insurance: enough people need to be insured in order that risks are pooled
Payouts are potentially very large in the case of infectious diseases

41. Does this approach imply an idealised view of public system
…its guiding principle the improvement of the health of the population at large; it allows selective access according to effectiveness of health care in improving health (need). It seeks to improve the health of the population at large through a tax financed system free at the point of service. It allows public ownership of the means of production subject to central control of budgets; it allows some physical direction of resources; and it allows the use of countervailing monopsony power to influence the rewards of suppliers.”
Culyer, Maynard and Williams, 1981

42. Criticisms of the UK NHS
Consumers have no choice (the NHS is a monopoly)
But patients can change doctors and ask for second opinions
Spends too much on bureaucracy
Spending is low by international standards
Rationing problems: not enough resources are allocated to the NHS leading to waiting lists
Funding has risen and is now budgeted to reach 9.4% of GDP
Allocation problems
The way it allocates resources to different treatments
Perverse incentives, over-centralisation, lack of accountability and inflexibility
The way resources are allocated to different geographical regions
Equalisation or by need? The latter is currently the aim
Perverse incentives e.g. consultants don’t necessarily gain more resources if they treat more patients
Centralisation: e.g. pay agreements leading to staffing problems, lack of coordination between NHS and related activities paid for by social security budget e.g. caring
Lack of accountability: what do things costs and are budgets being kept?
Inflexibility: difficulty to close a ward/hospital that is not needed

43. Does the alternative suggest an idealised view of private system
“..guiding principle consumer sovereignty in a decentralised market, in which health care is selective according to willingness and ability to pay. It seeks to achieve this sovereignty by private insurance; it allows insured services to be available freely at time of consumption; it allows private ownership of production and has minimal state control over budgets and resource distribution; and it allows the reward of suppliers to be determined by the market.”
Culyer, Maynard and Williams, 1981

44. Rationing and allocation are problems (all types of systems)
Conflict between maintaining quality and incentives to cut costs; being cost effective
Conflict between limited resources and coverage - implies a need for some kind of rationing
Even more of a problem if also trying to maintain universal coverage and if rationing is not by price then who receives treatment and when?
E.g. costs are rising in Canada as well and the federal government is looking to either reduce costs or raise taxation. But goals to be met through planning (e.g. reductions in capacity, substitution of outpatient for inpatient care, regionalisation) rather than competition.

45. Rationing problems under social provision
Limited resources in public health care systems mean that policymakers need to address allocation problems
For instance, should public health care systems fund cosmetic surgery or very expensive surgery that leaves patients with low life expectancy?
What are the consequences of this kind of funding?

46. Case study 1
Jake and Bunty both need kidney transplants but there is only enough capacity to treat one of them, even though both will die quickly if untreated.
How would you decide which patient to treat?
What information would you ask for before making a decision?

47. Suppose you know that Jake is younger than Bunty but Jake is heavier drinker

48. Case study 2
Jessie and Rosie both need medical treatment. Jessie requires a relatively cheap hip replacement but Rosie requires expensive heart surgery. Capacity is limited and it is only possible to treat one of them over the short-term (6 months). Rosie will die quickly if untreated. Jessie won’t die but she is in severe pain.
How would you decide which patient to treat?
What information would you ask for before making a decision?

49. Suppose you know that Rosie is older and has other health issues but Jessie is otherwise healthy

50. Criteria for rationing
The ‘Fair Innings’ argument
Younger people given priority in health care
Consistent with QALY maximisation
Responsibilities (Etzioni, 1988)
Smokers given lower priority in health care
Social contracts and fairness (Rawls, 1972)
Health care goes to people because they need it: a ‘needs’ approach
Inconsistent with QALY maximisation
First come first served subject to budgets
A lottery
Etzioni, A., 1988, The Moral Dimension: Towards a New Economics, New York, Free Press
Rawls, J., 1972, A Theory of Social Justice, Oxford, Oxford University Press
According to Mooney (2003: 51)The ‘needs’ approach is related to the idea of ‘merit goods’ and reflects judgements of some elite in this case medical people
Difficult to establish priorities under a ‘needs’ approach is target setting an alternative?
Williams proposed the fair inning argument (1997); in which QALYs ‘received’ should be considered in order to equalise life time expected QALYs.
Dolan (1998) reports that individuals weight health gain to those with the worst health profile more highly
Shift from 0.2 to 0.4 has the same value as a shift from 0.4 to 0.8.
Tsuchiya (2001) reports differential weights for young and old
5 year olds = 1.8; 35 years = 1; and 70 years = 0.6

51. Economics based criteria - micro level efficiency
The cost/quality/coverage conflict suggests there is a role for economic evaluation to maximise the use of limited resources
E.g. health economic evaluation methods such as Quality Adjusted Life Years (QALYs)
Multidimensional measure/index of health that combines quantity of life (life expectancy) with quality of life in a single index
What should be the priorities? E.g self-esteem, dignity, prevention, physical exercise, community building
Should there be more incentives to be more efficient?
QALYs help to judge relative priorities:
Treatments with the same costs but higher QALYs should get priority
If costs per treatment for the same health problems are different, marginal costs per QALY can be compared and treatments with cheapest QALYs given priority
Treatments for different health problems with lower marginal costs per QALY should get priority
QALY league tables devised
QALY league tables helping to answer questions like:
If there are no more resources available, can some amount of resources be moved from programme X to programme Y and as a result increase total benefits?
If more resources become available where should they be allocated in order to increase total benefits most?
If resources are cut from which programmes should resources be withdrawn in order to minimise the impact on total benefits?
But criticisms of QALYs e.g. more information needed about costs and benefits and also:
The view that health status cannot be measured -methods may need to go beyond just measuring health i.e. wider individual and social benefits as well as cost
Even if it can be measured, QALYs are an inadequate way of doing so
But what are the alternatives in terms of outcome/output measurement?
There has to be priority setting since health care resources are scarce – choices have to be made

52. Criteria for rationing applied to case study 1
QALY maximisation and the Fair Innings argument would dictate that in case study 1Jake would have priority if he were younger (assuming that either patient would have a similar quality of life)
But isn’t Bunty’s claim just as legitimate? Would we have to give Jake priority? What if Jake was only a few years/weeks younger than Bunty?
As Jake is a heavier drinker the responsibilities argument would favour Bunty
but what if he only drinks a little more than Bunty?
Nevertheless, resource constraints mean equal rights to treatment cannot be recognised – choices have to be made
Or equity of access – in the Margolis (1982) context of allowing a concern for ‘doing our fair share’
Margolis H (1982) Selfishness, Altruism and Rationality, Cambridge: Cambridge University Press

53. Final points and questions: is any kind of health care system is optimal?
How should health care systems balance the ever- increasing benefits provided by scientific research, the costs of provision and the protection of human rights?
New drugs, equipment and treatments are solutions to health problems but they are expensive
Poorer people can be excluded under private insurance but there are limited resources in publicly funded systems
No health care system is perfect.
The problems of health systems in different countries are to some extent predictable outcomes of their chosen health-care strategy
Is some kind of managed competition (an internal market) within a publicly funded system a solution or should some aspect be completely privatised?

54. Test your understanding
Try to answer the following:
In the context of health care insurance explain how adverse selection problems can arise and how they could be resolved.
Explain how consumer and supplier moral hazard can arise in the context of health care provision. How can the associated problems be resolved
How can and how should health care be rationed?

55. Extra material on the advantages and disadvantages of different health care systems – for background only

56. Questions to consider
What are the advantages/disadvantages of public health care systems?
What are the advantages/disadvantages of private systems?
What would be your preferred health care system and why?
No health care system is perfect. The problems of the health system in each country are predictable outcomes of its chosen health-care strategy. Discuss with examples from at least two countries.

57. Advantages of public health systems not related to asymmetric information
Most social insurance schemes also redistribute from the rich to the poor through income related payments
They promote equity in health care
E.g. by promoting early diagnosis as treatment is mostly free
may enhance fairness in society
But if individual choice is weighted more highly then this is better served under a privately funded or perhaps a mixed system

58. Other specific and tangible advantages of public health systems
They Avoid the need for safety-net facilities
They promote universal coverage and by doing so improve health and productivity of the population through accessibility
Weakens the link between poverty and ill health if health care is provided on the basis of need rather than income
By delivering health care to low-income people – more than they could buy
Evidence
Countries that rely more on private insurance (e.g. the USA, Switzerland) have regressive health care financing systems overall
Health care finance is more unequal than pre-tax incomes: people on low incomes buy less insurance but pay on average a higher proportion of their income for it
More variation in countries where there is social insurance:
In France and the UK health care finance is progressive; in Germany and the Netherlands it is regressive
See Rice T., 2002 The Economics of Heath Care Reconsidered, Health Administration Press: Chicago

59. Other specific and tangible advantages of public health systems
Cheaper admin costs as no need to verify eligibility
Give provider monopsony power to the provider to enable lower costs/charges
E.g. monopsony power of NHS keeps prices low (e.g. drugs, equipment)
See Rice T., 2002 The Economics of Heath Care Reconsidered, Health Administration Press: Chicago

60. Resource/service cost determination under competition on buyers side
Price
D = MWP
S = MC Pc
Expenditure or Resource costs under competition
Quantity Qc

61. Resource/service cost determination under competition and monopsony
Price MC
D = MWP
S = AC
Expenditure or Resource costs under monopsony
Monopsonist equates MC (higher than S = AC since average resource price/costs rise as more are demanded/bought – all supply factors are paid more) and MR = D
Price lower, total costs lower, but less resources bought. Pm
Quantity Qm

62. Less tangible advantages of public health systems
Titmuss (1970) described the establishment of the UK NHS in the following way:
“The most unsordid act of British social policy in the twentieth century has allowed and encouraged sentiments of altruism, reciprocity and social duty to express themselves; to be made explicitly and identifiable in measurable patterns of behaviour by all”
He showed that supplying blood through voluntary donation was more effective/more efficient than the commercial alternative
Behaviour characterised by altruism has wider positive effects?
Public health systems encourage altruism; A kind of positive caring externality?
Titmuss 1970 The Gift Relationship (From Human Blood to Social Policy)

63. Disadvantages of public health systems
Medical practitioners don’t face up to resource constraints; provider moral hazard remains an issue
Need better incentives to be efficient – but how?
Market? Community?
People’s expectations of the health service are unrealistic
Redistributive social insurance schemes may be perceived negatively
Compels coverage of low risk and rich people (as well as high risk people)
Mooney, 2003 page 130

64. Example of more market based system: the USA
Primarily a private enterprise based health care system but four public health care funding streams:
Medicare – health care funding for the elderly
Federal health care funding
Medicaid – health care funding for the poor
Collaboration between Federal Government and the States.
Veterans Administration Health Care
Federal Government funding for veterans of the armed services.
Health insurance for federal and state employees.
USA
Medicare is a federal program of subsidised medical insurance for senior citizens designed to resemble the coverage they had via insurance plans while in work. Financed through taxation. Enacted in Part A is mandatory and covers acute care hospital services (up to 150 days) and some posy-hospital services (mostly time limited). Part B is voluntary and is a subsidised plan covering medical expenses other than hospital bills.
Medicaid – provides health care to certain low-income families and individuals – largest group of people covered is children but most expenditure is for the disabled and the second largest expenditure goes to the elderly poor for nursing home and home care. Most poor families do not qualify for Medicaid. Some pregnant women are covered by Medicaid. Finance is federal and state taxation. All benefits are means tested and the means testing includes personal property.
Insurance
Private health care insurance
Comprehensive; Insurance with co-payments and/or deductibles
Health care providers separate from insurance companies
High administration costs
Private For-Profit hospitals and private Not-for-Profit hospitals
Public Hospitals (state rather than federal)
Primary Care Doctors
Care provided on a Fee-for-Service basis.
Managed care e.g. Health Maintenance Organisations, Preferred Provider Agreements
HMOs: firms’ of doctors provide insurance and health through pre-payment systems; provides complete pre-specified health care package to subscribers - Managed care in this way is similar to idea of GP fundholders in the NHS (1991) (replaced by Primary Care Trusts in 1997)
PPOs provide two tier insurance, no physician gatekeepers but coverage greater (costs lower) when using the PPOs provider network

65. Problematic side of USA system
As well as coverage problems as already discussed
More than 20% of population without health care coverage
Also too expensive – perhaps due to consumer and supplier moral hazard
highest utilisation of high tech health care.
More than 17% of GDP spent on health care.

66. Alternative more mixed systems; Canada
National Health Insurance system with universal coverage
Collaboration between provincial and national governments.
75% of health care expenditure Province/territory administration of comprehensive and universal care supported by grants from federal government
Hospitals are private institutions but budgets approved by provinces
Most physicians are in private practice but paid by provinces on nationally agreed fee-for-service base under negotiated fee schedules
System is generally seen as less costly and more effective than the US system
the Canadian system as a yardstick/benchmark
? Essentially publicly funded. Called Medicare as well: no financial barriers to access and portable across provinces.
Originated in 1930s but reforms in 1957, 1966 and 1972
Not all services are free at point of use to all i.e. not all services covered under the publicly funded system. But these supplementary health benefits such as prescription drugs, dental care, vision care, appliances etc are free to seniors, children and social assistance recipients.
And administration cost is relatively low.

67. Some comparative statistics
Which system is the most successful?

68. Theoretical appendix: SID can also imply reductions in demand in response to changes in funding
E0 = Initial equilibrium
Following a reduction in supply (funding); doctors reduce demand to maintain target income. E1 = resulting equilibrium
Following an increase in supply doctors increase demand to maintain target income. E2= resulting equilibrium S1 S0 S2 E1 E0 E2 D2 D0 D1 Q