1. ©2016 by McGraw-Hill Education Limited.
HEALTH CARE
Chapter 9
©2016 by McGraw-Hill Education Limited.

2. Learning Objectives Describe the function of health insurance.
Calculate the actuarially fair insurance premium.
Using a diagram, illustrate the conditions under which an individual would purchase insurance.
Describe the role of insurance firms in pooling risks.
Explain how adverse selection can lead to a market failure in the market for health insurance.

3. Learning Objectives (cont)
Outline how government intervention can address the adverse selection problem.
Demonstrate how the problem of moral hazard can lead to inefficient levels of health services.
Outline how information, externality, and equity concerns can give rise to problems in privatized health care markets.
Discuss the current challenges facing Canada’s health care system and the difficulties encountered when attempting to measure its performance.

4. What is Special About Health Care?
LO1
What is Special About Health Care?
The role of insurance
Social insurance – government programs that protect people against a variety of adverse events
Health insurance – buyers pay money (insurance premium) to providers of insurance, who agree to disburse some money to the insured person should an adverse health event occur
Other things being the same, the greater the insurance premium, the more compensation the buyer receives in the case of an illness

5. Expected Value
The amount of money an individual can expect to receive “on average” when she faces uncertain outcomes
Expected Value (EV) =
(probability of outcome 1)*(Payout in outcome 1) + (probability of outcome 2)*(Payout in outcome 2) +… + (probability of outcome n)*(Payout in outcome n)

6. LO2
Why Buy Insurance?
Table 9.1
The actuarially fair insurance premium charges just enough to cover the expected compensation for the expenses ($3,000 in the example)
In general, option 2 is preferred as it provides the same expected income but with more certainty
Diminishing marginal utility

7. Why People Buy Insurance
LO3
Why People Buy Insurance
Option 2
Full insurance B
Utility UB U D UD UC C
Expected Utility
Risk Smoothing A
Option 1
No insurance UA
20,000
47,000
50,000
Income
Figure 9.1

8. Do People Buy Insurance if Premiums are not Actuarially Fair?
A. Less risk averse
B. More risk averse
Utility B
Utility B E E’ C C A A
Income
20,000
46,500
47,000
50,000
20,000
40,000
47,000
50,000
Figure 9.2

9. Do People Buy Insurance if Premiums are not Actuarially Fair?
Risk Aversion
The demand for insurance depends on the curvature of the utility function
Risk premium – the amount an individual is willing to pay above the actuarially fair premium
Loading fee – the difference between an insurance premium charged by a company and the actuarially fair premium
Current average loading ratio for private insurance companies = 1.20

10. The Role of Risk Pooling
LO4
The Role of Risk Pooling
Insurance in a small population
Insurance in a large population
Law of large numbers

11. Asymmetric Information in the Health Insurance Market
Situation in which one party engaged in an economic transaction has better information than the other party
Adverse selection
Buyer has more information about the probability of loss than the seller
Moral Hazard
The insured individual has more information about actions that affect the probability of incurring loss

12. How Adverse Selection Can Cause Failure in the Insurance Market
LO5
How Adverse Selection Can Cause Failure in the Insurance Market
Table 9.2

13. Adverse Selection Empirical evidence: A death spiral at Harvard?
LO6
Adverse Selection
Empirical evidence: A death spiral at Harvard?
Does adverse selection justify government intervention?
Private market responses to adverse selection
Group coverage
Categorize risk - observable characteristics
Social insurance programs are compulsory
Not subject to the adverse selection process that arises when individuals can use their private information regarding their loss probability to choose their insurance coverage

14. Low-Risk Individuals Prefer Zero Coverage to Social InsuranceB
Utility E UC F C UF A
PMAX
20,000
45,500
46,500
47,000
50,000
Income
Figure 9.3

15. Moral Hazard and Market Failure
If people know they have insurance, they may take less care to avoid risks
People have an incentive to over-consume because insurance pays for some or all of the cost

16. Market for Medical Services
LO7
Market for Medical Services
Coinsurance rate
Expenditures in the absence of insurance
Price per unit
Deadweight Loss a b Sm P0
Additional expenditures
induced by
insurance
Axes and labels
1st click – Dm
2nd click – Sm,
3rd click - brown rectangle
4th click - .2P0
5th click - gray rectangle
6th click – deadweight loss triangle
7th click – “Flat-of-the-curve medicine” h
.2P0 Dm M0 M1
Medical services per year
Figure 9.4

17. Additional Considerations
LO8
Additional Considerations
Does moral hazard justify government intervention?
All third party payment systems generate moral hazard
Other Problems in the Health Care Market
Poor information
Paternalism
Income redistribution
Externalities

18. National Medicare in Canada
Medicare refers to Canada’s national health insurance program
The Canada Health Act
Universality
Accessibility
Comprehensiveness
Portability
Public administration
The history of Canadian health care financing
Constitutionally, the provision of health care is the responsibility of the provinces
Canada Social Transfer (CST) and Canada Health Transfer (CHT)

19. Per Capita Health Expenditure by Provincial Governments in 2014*
Figure 9.5

20. Trends in Health Expenditures Provincial and Territorial Government per Capita Health Expenditures, 1975 to 2014 (constant 2002 dollars)
Figure 9.6

21. Trends in Health Expenditures Total Health Expenditures as a Percent of GDP
Figure 9.7

22. Trends in Health Expenditures Percent Shares of Health Care Expenditures by Category
Table 9.3

23. Comparing Health Systems Around the World Selected Health Statistics for OECD Countries, 2011
Table 9.4

24. Challenges and Future Directions
LO9
Challenges and Future Directions
Is the Canadian health system in decline?
Challenges
Cost pressures facing the Canadian health system
Increasing wait times
What will the Canadian health care system look like in the future?
Changing incentives
Defining medically necessary services
A national pharmacare program
Privatization
User charges

25. Wait Times Compared for Selected Countries, 2013 (in percent)
Table 9.5

26. Percent of Patients Receiving Care Within Benchmark Wait Time
Table 9.6

27. Chapter 9 Summary
For a risk-averse person, an insurance plan that charges an actuarially fair premium increases expected utility because it allows risk smoothing.
The more risk averse an individual is, the more he or she is willing to pay for an insurance policy.
By pooling individuals into one insurance program, an insurance company can lower risk from a societal point of view.
Health care services may be different from other commodities and services for a number of reasons, including adverse selection, moral hazard, and society’s desire to act paternalistically, to redistribute income, or to internalize externalities.

28. Chapter 9 Summary (cont)
Government can address adverse selection by providing universal health insurance coverage.
Government provision of health insurance faces the same moral hazard problem as private insurance, because it too reduces the price of medical services faced by patients.
Health care insurance is a provincial government responsibility; The federal government contributes transfers to support health care services.
The Canada Health Act lays out five conditions that must be met for provincial health insurance schemes to qualify for federal transfers.

29. Chapter 9 Summary (cont)
Compared with health systems in selected OECD countries, Canada’s health system produces average or above-average outcomes at above-average cost.
As we look to the future of the Canadian health care system, we note that the health of Canadians is generally improving over time.
Significant future public cost pressures will come as a result of the aging population; technical advances in health sciences, which will expand the range of health problems that can be treated; and the increasing reliance on public funding for drugs.
Current debates about future directions for the Canadian health care system centre on changing incentives faced by physicians and other health care providers, defining a list of medically necessary services, the value of a national pharmacare program, and the role of the private sector in health care financing.