lec6 dem ins handout

8/2/2019 Lec6 Dem Ins Handout

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The Demand for Medical InsuranceThe Demand for Medical Insurance

Professor Vivian Ho

Health Economics

Fall 2009

These slides draw from material in Santerre & Neun, Health Economics: Theories,

Industries and Insights, Thomson, 2007


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Topics to cover:Topics to cover:

qA theoretical model of health insurance

q When theory meets the real world...


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LogicLogic

q The consumer pays insurer a premiumto cover medical expenses in coming

year For any one consumer, the premium will be

higher or lower than medical expenses

q But the insurer can pool or spread riskamong many insureesThe sum of premiums will exceed the sum

of medical expenses


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Characterizing Risk AversionCharacterizing Risk Aversion

q Recall the consumer maximizes utility,with prices and income given

Utility = U (health, other goods)

health = h (medical care)

q Insurance doesnt guarantee health, but

provides $ to purchase health careq We assumed diminishing marginal utility

of health and other goods


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q In addition, lets assume diminishingmarginal utility of income

Utility

Income


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qAssume that we can assign a numerical

utility value to each income levelqAlso, assume that a healthy individual

earns $40,000 per year, but only

$20,000 when ill

$20,000

$40,000

70

90

Income Utility

Sick

Healthy


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Utility

Income$20,000 $40,000

90

70

Utility whenhealthy

Utility whensick

A

B


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q Individual doesnt know whether she willbe sick or healthy

q But she has a subjective probability ofeach event

She has an expected value of her utility in

the coming year

q Define: P0 =prob. of being healthy

P1 =prob. of being sick

P0 + P1 = 1


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qAn individuals subjective probability ofillness (P

1

) will depend on her health

stock, age, lifestyle, etc.

q

Then without insurance, the individualsexpected utility for next year is:

q E(U) = P0U($40,000) + P1U($20,000)= P090 + P170


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q For any given values of P0 and P1, E(U)

will be a point on the chord between Aand BUtility

Income$20,000 $40,000

70

90A

B


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qAssume the consumer sets P1=.20

q Then if she does not purchaseinsurance:

E(U) = .8090 + .2070 = 86

E(Y) = .8040,000 + .2020,000 = $36,000

q Without insurance, the consumer hasan expected loss of $4,000


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Utility

Income$20,000 $40,000

90

70

A

B

$36,000

C

86


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q The consumers expected utility for nextyear without insurance = 86 utils

q Suppose that 86 utils also representsutility from a certain income of $35,000

Then the consumer could pay an insurer$5,000 to insure against the probability ofgetting sick next year

Paying $5,000 to insurer leaves consumer

with 86 utils, which equals E(U) withoutinsurance


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Utility

Income$20,000 $40,000

90

70

A

B

$36,000

C

86

$35,000

D


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qAt most, the consumer is willing to pay$5,000 in insurance premiums to cover$4,000 in expected medical benefits

$1,000 loading fee price of insurance

q Covers

profits administrative expenses

taxes


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Determinants of Health InsuranceDeterminants of Health Insurance

DemandDemand1 Price of insurance

In the previous example, the consumer will

forego health insurance if the premium isgreater than $5,000

2 Degree of Risk Aversion

Greater risk aversion increases thedemand for health insurance


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Utility

Income$40,000$20,000

A

B

If there is no risk aversion, utility = expected utility,and there is no demand for insurance


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3 Income

Larger income losses due to illness willincrease the demand for health insurance

4 Probability ofILLNESS

Consumers demand less insurance forevents most likely to occur (e.g. dentalvisits)

Consumers demand less insurance forevents least likely to occur

Consumers more likely to insure againstrandom events


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Utility

Income

The horizontal distance between the utility function andthe chord represents the loading fee that the consumeris willing to pay


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Estimates of Price & IncomeEstimates of Price & Income

Elasticities for Demand for Health Ins.Elasticities for Demand for Health Ins.q Price elasticities b/w -.03 and -.54

At the individual level

Enrollment or premium expenditure

Elastic or Inelastic demand?

q Income elasticities b/w 0.01 and 0.13

From S&N, Table 6-2


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Estimates of Price & IncomeEstimates of Price & Income

Elasticities for Demand for Health Ins.Elasticities for Demand for Health Ins.q What about when employees are

choosing between the menu of plans

offered by their employer? Range of choices is more limited

Price elasticites are found to range

between -2 and -8.4, depending on age,job tenure, medical risk categoryq Dowd and Feldman 1994, Strombom et al. 2002


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Assumptions underlying the theoreticalAssumptions underlying the theoretical

model of health insurance demandmodel of health insurance demand

q Consumers bear the full cost of theirown health insurance

q Insurance companies can appropriatelyprice policies

q Individuals can afford health

insurance/health careThe above 3 assumptions do not always

hold in the real world


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The majority of Americans have employer-The majority of Americans have employer-

provided health insuranceprovided health insurance

q Employer-paid health insurance isexempt from federal, state, and Social

Security taxesEmployee will prefer to purchase

insurance through work, rather than on

his own


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Example: Insurance and take-homeExample: Insurance and take-home

pay when income is $1,000 per weekpay when income is $1,000 per week

and income tax rate is 28%and income tax rate is 28%q Employee Purchased

q $1,000q 28% tax

q after tax 720

q insurance q net pay 670

q Employer Purchased

q $1,000q insurance

q subtotal 950

q 28% tax q net pay 684


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Employer Health Insurance Coverage ofEmployer Health Insurance Coverage of

U.S. Population (percent)U.S. Population (percent)

55

5657

58

59

60

61

62

63

64

65

Total Employment Based

1995

1998

2000

2002

2005

2008


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Consequences for costsConsequences for costs

q Too many services were covered byinsurance

Coverage of more small claims increasedadministrative costs

Employers offering more than 1 plan often

fully subsidized the more expensive plans


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Empirical EvidenceEmpirical Evidence

q Long & Scott (1982) Regression analysis of the determinants of

% of compensation paid to employees ashealth insurance

Annual U.S. data 1947-1979qN=32


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PCTHLINS = -8.64 + .0284 MTR + .0498 RFRAMINC (6.22) (3.98) (1.14)

-.0094 UNION + .088 PCTFEM + .1283 PCTSERV

(.57) (3.72) (5.52)

R2 = .9968PCTHLINS = % of compensation as health insurance

MTR = average marginal tax rate

RFAMINC = average real family income

UNION = % of labor force unionized

PCTFEM = % employees female

PCTSERV = % employees in service industries


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q

How does an increase in the marginal taxrate affect the workers compensationpackage?

q The implied elasticity of PCTHLTINS withrespect to MTR is 0.41. If a cut in theincome tax rate is approved, will demandfor health insurance rise or fall?


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Physicians & Managed CarePhysicians & Managed Care

q Traditional fee-for-service givesphysicians incentive to overutilizemedical services

Managed care: A broad set of policiesdesigned by 3rd-party-payers to controlutilization and cost of medical care:

xutilization reviewxalternative compensation schemes

xquality control


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Managed care and Physician IncentivesManaged care and Physician Incentives

q

HMOs are a type of managed careorganization, but there are a variety ofHMOs

Staff model: Physicians employed byHMO on a salary basis

No incentive to over-provide care

Group model: HMO contracts w/ grouppractice, which is paid by capitation

Incentive to limit services


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Network model: HMO contracts w/ >1group practice, all paid by capitation.

Incentive to limit services

IPA model: HMO contracts w/ multipledocs in various practices; paid bydiscounted fee-for-service

Some incentive to over-utilize


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Types of Managed Care OrgsTypes of Managed Care Orgs

S t a f f M G r o u p N e t w o r I P A M

H M O P P O

M a n a g


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Preferred Provider OrganizationPreferred Provider Organization

q Insurer contracts w/ multiple physicians:but enrollees can pay higher deductible

or copay to see physician outsidenetwork

Discounted fee-for-service

Some incentive to over-utilize


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Point-of-Service Plan (POS)Point-of-Service Plan (POS)

q Insurer contracts w/ multiple physicians:but enrollees can pay higher deductibleor copay to see physician outside

network Like a PPO

q However, enrollees are also assigned a

primary caregiver who acts as agatekeeper to specialists and inpatientcare


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Source: KaiserEmployer Health Benefits 2006 Annual Survey, Section 5


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Practice QuestionPractice Questionq If you had the choice between a traditional

FFS plan with a 10% copay and a staffHMO with no copay, at what percentagedifference in premiums (10%, 20%, 30%)would you be indifferent between the 2plans? Do you think your choice is afunction of your age/health status?

q If you were elderly and/or sick, which planwould you prefer if they cost the sameamount? Why?


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Provider Management StrategiesProvider Management Strategies

q Selective contracting MCOs will contract with an exclusive set of

providers

Based on quality or cost-effective practicepatterns

q Physician profiling

MCOs monitor physicians track recordregarding referrals, quality, patientsatisfaction


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Provider Management StrategiesProvider Management Strategies

q Utilization review

determine whether specific services aremedically necessary and whether they aredelivered at an appropriate level of

intensity and costq Practice guidelines

Inform providers of the appropriate medical

practice in certain situationsq Formularies

restricted list of drugs physicians may

prescribe

Performance of MCOs: Are theyPerformance of MCOs: Are they


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Performance of MCOs: Are theyPerformance of MCO s: Are they

good or not??good or not??

q

Ideally, MCOs should encouragepreventive and coordinated primarycare, which reduces the need for moreexpensive specialty/inpatient care

q But most MCOs are concerned withshort-term profitability

Why pay for cholesterol-lowering pills whenthe enrollee is likely to leave your HMOyears before he has a heart attack?

Performance of MCOs: Are theyPerformance of MCOs: Are they


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Performance of MCOs: Are theyPerformance of MCO s: Are they

good or not??good or not??

q

In general, studies show that HMOsprovide medical cost savings of 15-20%, mostly through reduced hospitalcare

q The impact of HMOs on quality of careis less definite

Health care providers treat patientsbelonging to a variety of plans

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