1. 317_L11, Jan 30, 2008, J. Schaafsma 1 Review of the Last Lecture began our discussion of health insurance and its impact on the healthcare market Defined proportional insurance, indemnity insurance, insurance rate, co-insurance rate, annual deductible, per loss deductible purpose of deductibles: reduce administrative costs, control moral hazard then began our discussion of proportional insurance => rotates the demand curve clockwise => equilibrium P and Q rise

2. 317_L11, Jan 30, 2008, J. Schaafsma 2 Effect of Insurance on P and Q, and Welfare Loss Insurance coverage drives up P and Q and total expenditure on HC (see diagram) Creates a welfare loss: the cost of the additional HC consumed as a result of insurance exceeds the value placed on the additional benefits (see diagram) Also creates additional producer surplus: a payment to factors of production in excess of what is needed to have them produce HC (see diagram) in this case. The producer surplus is a transfer from the insured to the providers. have ignored the wealth effect of buying insurance, premium reduces income => demand curves for all goods shift left.///

3. 317_L11, Jan 30, 2008, J. Schaafsma 3 The Slope of the Demand and Supply Curves and the Effect of Proportional Insurance on P & Q the size of the welfare loss depends on the slopes of the demand and supply curves the steeper the demand curve the less the increase in P & Q from proportional insurance if the supply curve is vertical insurance only increases P if the supply curve is horizontal insurance only increases Q

4. 317_L11, Jan 30, 2008, J. Schaafsma 4 A User Fee and the Welfare Loss suppose there is 100% insurance coverage ~> P to the consumer = 0 get the maximum welfare loss (see diagram) user fee ~> an amount paid by the patient per unit of HC consumed even a modest user fee can reduce the welfare loss substantially (see diagram) Reason ~> user fee reduces consumption of HC units with the largest per unit welfare loss, i.e. it eliminates the most wasteful spending.///

5. 317_L11, Jan 30, 2008, J. Schaafsma 5 Proportional Insurance and Shifts in Supply As noted earlier: proportional insurance rotates the demand curve clockwise and increases its slope shifts in supply thus have larger P effects and smaller Q effects (explain the economics with a diagram) the steeper the demand curve Implication: with proportional insurance rising costs on the supply side are easier to pass forward through a higher market P (show). ///

6. 317_L11, Jan 30, 2008, J. Schaafsma 6 Indemnity Insurance and Demand Indemnity insurance reimburses for a loss at a pre-specified unit rate, e.g., $50 for a GP visit, $20 for a flu shot if the actual unit price is greater, the consumer pays the difference if the actual unit price is less, the consumer keeps the difference assume DC without the indemnity is Q = a - bP e P e = effective price with indemnity P e = P-I ~> DC is Q = (a+bI) - bP P = product price indemnity insurance shifts the DC  by the amount of the indemnity, or to the right by bI (see diagram) equilibrium P & Q , extent depends on slopes of the S & D curves (show) Indemnity insurance also creates a welfare loss and additional producer surplus (show).///

7. 317_L11, Jan 30, 2008, J. Schaafsma 7 The Economic Effect of an Annual Deductible three cases: 1. Annual deductible large relative to expected expenditure, believe deductible will never be exceeded ~> consumption decision based on the full price 2. Annual deductible small relative to expected expenditure, believe deductible will be exceeded ~> already from Jan 1 consumption decision based on P(1-ir). 3.Problem area ~> initially believe deductible won’t be exceeded ~> consumption based on the full price. However, as deductible used up ~> may come to believe it will be exceeded after all ~> switch to consumption based on P(1-ir). Why a problem? ~> don’t know if (when), this switch will be made.

8. 317_L11, Jan 30, 2008, J. Schaafsma 8 Maximum Payment Limits some insurance policies have insurance limits ~> maximum payout maximum payout could be per person by type of treatment e.g. orthodontic work could be a maximum lifetime payout, e.g. extended health benefits covered to a maximum of $1,000,000 over the insured’s lifetime. Problem: lose catastrophic coverage, i.e., very large losses may not be covered, however, these are the very losses you want to insure for. max payment limits ~> place an upper limit on the insurance company’s losses.///

9. 317_L11, Jan 30, 2008, J. Schaafsma 9 Stop Loss a stop loss is the opposite of a maximum insurance limit => a stop loss places an upper limit on the loss a consumer can incur e.g., B.C. Pharmacare limits total personal liability for approved prescription drug costs For example, suppose a family’s income tested deductibles are as follows: if expenditures on pharmaceutical drugs are: $0 – 1000 the family pays 100% pharmacare pays 0% $1001 – 2000 the family pays 30% pharmacare pays 70% $2001+ the family pays 0% pharmacare pays 100% Stop loss here is $1300 per annum (max amount paid by family).///

10. 317_L11, Jan 30, 2008, J. Schaafsma 10 Price Elasticity of Demand for HC Key issue: how responsive is Q d to P? ~> P elasticity of demand? % change in Q d in response to a % change in P (show on diagram) Expect: demand is P inelastic since HC is a necessity P elasticity of demand for HC has been extensively analyzed for: aggregate HC expenditures, and by component (see table 8.2, Text, p. 177) General agreement: P matters to the consumer Also, elasticity estimates are generally less than 1 (demand is price inelastic) but vary substantially across studies, and some estimates show elastic demand. Not clear why.///