Presentation on theme: "Antony Davies, Ph.D. Duquesne University Click here for instructions."— Presentation transcript:
Antony Davies, Ph.D. Duquesne University Click here for instructions.
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This unit is divided into several sections. Start with the micro-lecture. Then proceed onto each section. You can click on a link below to navigate to the section where you had recently left off. Micro-Lecture Section 1: Contracts & Insurance Section 2: Health Care Costs Section 3: Quality of Health Care Unit Summary & Assignment
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CONTRACTS & INSURANCE
Risk is a product. Like any other product, it can be bought and sold. People who want to get rid of risk can pay others to take the risk away. Humans have evolved many instruments for buying, selling, and tailoring risk such as: 1.Insurance contracts. 2.Futures contracts. 3.Options contracts.
An insurance contract is an agreement between an insurer and the insured in which the insurer agrees to pay the insured a sum of money, called the indemnity, if some event occurs (for example, the insureds house burns down, or his car is stolen). In return, the insured pays the insurer an amount of money periodically (typically each month or each year) called the premium. The insurer sets the premium based on his estimate of the likelihood of the event occurring and his estimate of what the indemnity amount will be.
For example, suppose that there is a 1% probability that the insureds house will burn down in a given year, that the indemnity is whatever amount is required to rebuild the house, and that the insurer estimates that it will cost $50,000 to rebuild the house. The insurer will charge the insured at least (1%)($50,000) = $500 per year to insure the house. Suppose that the house burns down after the first year. The insurer will incur a loss of $50,000 – $500 = $49,500. The insured will have his house replaced at a total cost to the insured of only $500. Suppose that twenty years go by without the house burning down. The insurer would have earned a profit of ($500) (20) = $10,000. The insured will have spent $10,000.
What is important to the insured is not whether or not he makes money on the insurance contract. What matters to the insured is that, by entering into the insurance contract, he has sold his risk to the insurance company. The insured no longer has to worry about what would happen if his house burned down. In exchange for the payment of $500 per year, the insured knows that, should his house burn down, the insurer will pay to rebuild the house.
A futures contract is a contract in which a buyer and a seller agree to the purchase of a product at a specified time in the future and at a specified price. With a futures contract, the buyer and seller agree to the terms of the sale today, but the actual sale occurs in the future. To the buyer and seller, a futures contract is like an insurance contract in that neither the buyer nor the seller has to worry about what the price of the product will be in the future since they have already agreed on a price.
Futures contracts are useful when (for example, in farming or construction) a long time will pass between when the two parties agree to buy and sell and when the sale actually occurs.
An options contract is a futures contract in which the contract is binding on only one party. If the contract is binding on the buyer, the contract is called a put option. If the contract is binding on the seller, the contract is called a call option.
For example, suppose it is Spring and a farmer has just planted a crop of corn. Last year, the price of corn was $5 per bushel. The farmer would like to enter into a futures contract so that he is protected in case, by the Fall, the price of corn has fallen below $5 per bushel. On the other hand, if the price rises above $5 per bushel, the farmer will not be happy if he is in a contract that requires him to sell at $5 per bushel. What the farmer would like is for the corn buyer to be required to pay $5 per bushel, but not for the farmer to be required to sell for $5 per bushel.
What the farmer wants is to enter into a put option. A put option requires the corn buyer to pay $5 per bushel, but does not require the farmer to sell at $5 per bushel. By the Fall, if the price of corn has fallen below $5 per bushel, the farmer will invoke the put option which requires that the buyer pay $5 per bushel. But, if the price of corn has risen above $5 per bushel, the farmer will find another buyer who will pay the higher price (or perhaps the original buyer will pay the higher price). Whereas a futures contract eliminates risk for the buyer and the seller, an options contract only eliminates risk for one of the two parties.
Futures and options contracts are standardized contracts for buying and selling common products. As a consequence, it is very easy to buy and sell futures and options contracts, which lowers the cost of buying and selling the contracts. Insurance contracts tend to be different because the things they insure are different. For example, even though the actual home insurance contract might be the same for everyone, the homes that the contracts insure are each different. For this reason, it is not as easy to buy and sell insurance contracts.
What is common about futures, options, and insurance contracts is that they all serve the same purpose – they enable people to buy and sell risk. In the same way that a society becomes better off when people are free to buy and sell products, society becomes better off when people are free to buy and sell risk.
An additional problem with insurance contracts is that they influence peoples behaviors. There are two types of behaviors that insurance contracts elicit: Adverse selection Moral hazard
Adverse selection is a behavior in which people who are at a higher risk for an event occurring will be more willing to purchase insurance than will people who are at lower risk for the event occurring. Moral hazard is a behavior in which, once a person is insured against an event occurring, the person will have incentive to alter his behavior so as to make the occurrence of the event more likely.
Adverse selection is a behavior in which people who are at a higher risk for an event occurring will be more willing to purchase insurance than will people who are at lower risk for the event occurring. Adverse selection causes the cost of insurance to rise. As more high risk people and fewer low risk people seek to buy insurance, the cost to the insurance company of insuring the people rises and so the insurance company must increase the price it charges for insurance.
For example, suppose an insurance company offered insurance against peoples houses burning down. Lots of people who smoked, who heated with wood stoves, and who did not live near a large water source would want to buy the insurance. But, fewer people who did not smoke, who heated with electricity, and who did not live near a large water source would want to buy the insurance. Because high risk people want the insurance, but low risk people do not, the insurance company will expect that it will be paying a lot in indemnities and so the company will charge a high price for the insurance.
Moral hazard is a is a behavior in which, once a person is insured against an event occurring, the person will have incentive to alter his behavior so as to make the occurrence of the event more likely. Moral hazard causes the cost of insurance to rise. When people become insured, they have less incentive to guard against bad events and so the likelihood of the bad events occurring rises. As the likelihood of bad events occurring rises, the cost to the insurance company of insuring the people rises and so the insurance company must increase the price it charges for insurance.
For example, suppose an insurance company offered insurance against peoples houses burning down. People who do not have insurance are very careful not to let fires start in their houses. But, people who do have insurance have an incentive to be less careful. Because insured people have less incentive to be careful, the insurance company will pay more in indemnities and so the company will charge a higher price for the insurance.
Where insurance contracts are concerned, people sometimes call on the government to regulate the buying and selling of risk. With respect to insurance, two ways the government might regulate insurance is by imposing mandates and by making insurance mandatory. An insurance mandate is a requirement that an insurance contract cover specific contingencies. For example: a health insurer may be required to provide dental coverage; a home insurer may be required to provide insurance against insect damage. When government makes insurance mandatory, it requires that certain people buy insurance. For example, in some countries car insurance is mandatory for people who own cars.
Failing to understand how markets work and the nature of insurance, we might seek to have the government impose insurance mandates or to make insurance mandatory as a means of helping the uninsured or those who do not have enough insurance. As we saw with price controls, such regulation can end up hurting the very people we seek to help.
Insurance mandates require insurance companies to cover specific contingencies. This increases the cost of providing insurance and, in turn, the price that insurance companies charge people. Because of adverse selection, as the price of insurance rises, low risk people drop out of the market. As low risk people drop out of the market, the cost to the insurer of providing insurance increases because the average insured person is more risky than before. This causes a further increase in the price of insurance.
To make insurance mandatory is to require people to buy insurance. This keeps the low risk people from leaving the market. Because low risk people are prevented from leaving the market, the price of insurance does not rise making insurance mandatory prevents adverse selection. But, because the low risk people have been forced to buy insurance that the did not want, what we achieve is the same result we would have achieved if we had taken money from the low risk people and given it to the high risk people.
The call for mandated and mandatory insurance is most keenly felt in the markets for health insurance and car insurance because: Bad health events and bad car events can be extremely costly to the people who suffer them. The likelihood of bad health events and bad car events occurring is high. For these reasons, people ask governments to help to control the costs of health care and health insurance, and to control the cost of car insurance.
HEALTH CARE COSTS
The price of a product is determined by two things: The intensity with which buyers desire the product, and The cost which sellers incur to provide the product. Observing the price of a product rising over time does not necessarily mean that it is becoming more costly to produce the product. It may, in fact, simply be that buyers desires for the product are becoming more intense.
One way to determine which factor is causing the price to rise is to observe what is happening to the quantity of the product people are consuming. If the quantity is falling, then price is rising because it is becoming more costly to provide the product. If the quantity is rising, then price is rising because peoples desire for the product is becoming more intense.
On the following slide, you will see the amount per person that people spend on health care in various countries. The data suggest that the rising price of health care is driven largely by the increasing desire for health care.
On average, developed nations spend ten times the amount per person on health care as do developing nations. In turn, developing nations spend ten times the amount per person on health care as do under developed nations. Source: World Bank, World Development Indicators, 2002.
In the U.S., the cost of health care has been rising steadily for several decades. In developed countries, the cost of health care has been rising faster than peoples incomes. In lesser developed countries, the cost of health care has been rising more slowly.
Source: Bureau of Labor Statistics (www.economy.com) In the U.S., the price of medical care has increased 349% since 1980 versus 135% for other consumer prices.
Source: Bureau of Labor Statistics (www.economy.com) The rise in health care prices is driven mostly by the rise in the cost of hospital services and the cost of pharmaceuticals. Hospital services+ 576% Drugs and supplies+ 402% Physician services+ 282% Other consumer prices+ 135%
Source: Bureau of Labor Statistics (www.economy.com) In the U.S., the rise in the price of medical care exceeds the rises in the costs of housing, food, and gasoline.
As with any product, what matters is not whether or not the price has risen but whether or not the rise in price is worth the increase in the quality of the product. Worldwide, over the past fifty years, the quality of health care has improved dramatically.
QUALITY OF HEALTH CARE
While people understand, intuitively, that the quality of health care has risen, it is not entirely clear how one should measure the quality of health care. 1.What does quality mean? 2.How do we account for health care that may become routine but didnt exist in the past (e.g., pre-natal care)? 3.How do we weigh qualities of different types of care (e.g., how do we compare improvements in dental care with improvements in transplant surgery)?
An easy and composite measure of the effectiveness of health care is the mortality rate. Although some health care may have little or no impact on the mortality rate (e.g., dental care), it is reasonable to assume that the qualities of other types of health care grow at rates similar to improvements in the mortality rate.
Source: Statistical Abstract of the United States, 2008, Table 77. From 1960 to 2006 in the U.S., infant mortality fell 70%.
Source: United Nations Economic Commission for Africa. Infant mortality rates in Africa have been falling over time.
Although infant mortality rates in Africa are almost ten times what they are in the United States, mortality rates are declining in Africa at about the same rate as they are in the United States. Source: CIA World Factbook.
Deaths by Influenza and Pneumonia (per 100,000 population) Source: Statistical Abstract of the United States, 2008, Table 110. From 1960 to 2004, deaths due to influenza and pneumonia in the U.S. fell 60%.
Source: Statistical Abstract of the United States, 2008, Table 77. From 1960 to 2006, the mortality rate in the U.S. fell by 15%.
Source: IndexMundi. Worldwide mortality rates have been falling faster than mortality rates in the U.S.
This evidence suggests that the question, Why is the cost of health care rising? is the wrong question to ask. The right question is, What has the rising cost of health care bought us? On the next slide, you will see two data lines. One shows the actual number of deaths that have occurred each year in the United States since The other shows the number of deaths that would have occurred each year had the quality of health care remained unchanged since The difference in the two lines is the number of U.S. lives that have been saved each year due to the increased quality of health care.
Source: Derived from Statistical Abstract of the United States, and the Bureau of Economic Analysis. 400,000 lives saved annually If the quality of health care in the U.S. today were the same as it was in 1960, 400,000 more people would die each year in the U.S.
Applying the same analysis to worldwide mortality rates, if health care throughout the world today were of the same quality that it was just ten years ago, 4.5 million more people would die each year. What you have learned in this and previous units is that everything is scarce, that every choice involves a tradeoff, and that prices communicate valuable information that enables society to put its limited resources to their best possible use.
In this unit, you have seen that, what appears to be cause for concern – the rising cost of health care – is, in fact, the result of something that is good – the rising quality of health care. These lessons, taken together, suggest that governments should be very cautious in attempting to regulate health care and health insurance for fear creating a problem where one does not exist.
In this unit, you learned that risk is a good that can be bought and sold like any other good. Instruments that people use to buy and sell risk include insurance contracts, options contracts, and futures contracts. You also learned that, where health insurance is concerned, as the price of health insurance rises, people who are more healthy will, on average, choose not to buy health insurance. This increases the proportion of less healthy people who are insured and so increases the cost and price of insurance. Finally, you learned that the rising cost of health care comes along with the rising benefit of better health care.
Pick a country (preferably your own) to research. Referring to the mortality rate, the change in the mortality rate over time, incidence of major diseases over time, number of hospitals over time, spending on health care over time, and major health care issues, describe both the state of health care in the country and major improvements (or declines) in the quality of health care. Keeping in mind the principles you have learned, comment on efforts undertaken in the country to improve health care. Post this on the JPIC 220 Wiki.JPIC 220 Wiki HOW TO POST ONTO WIKI 1.Click on the Wiki discussion link above. 2.Sign into Wikispaces so that you are able to post via the Sign In link. 3.Type your response in the reply box at the bottom of the page
Respond to a health care issue in the country you selected. What is the issue? What are the implications of the issue? How many people are affected by the issue? What measures are being done to resolve the issue (or what measures have been enacted to previously resolve the issue)? These are some questions to think about in your response. Post your response to the JPIC 220 Wiki.JPIC 220 Wiki HOW TO POST ONTO WIKI 1.Click on the Wiki discussion link above. 2.Sign into Wikispaces so that you are able to post via the Sign In link. 3.Type your response in the reply box at the bottom of the page