pub econ lecture 15 health ins i

8/3/2019 Pub Econ Lecture 15 Health Ins I

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Public Finance

Dr. Katie Sauer

Health Insurance


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Figure 15-1: Health Spending in OECD Nations


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Figure 15-2: US Health Expenditures (2007)


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Table 15-1:


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Why Employers Provide Health Insurance

To make money, insurance firms need to be able to

predict the distribution of risk of the insured.

- looking for large risk pools of people to insure

- reduce adverse selection

- law of large numbers

Employees of large firms make up a favorable risk pool.

- particularly sick people dont all choose to work

at the same firm


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1. Insurance firms want to sell large, group policies to

employers.- large risk pool

- administrative costs are fixed


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2. employer-provided health insurance gets a tax subsidy

Workers are taxed on any wage compensation but are not

taxed on compensation in the form of health insurance.

- good for workers who want insurance

- doesnt hurt the firms bottom line


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- Suppose a competitive labor market (w = MRP)

- a worker earns $30,000

- tax rate is 33% (flat tax)- no employer-provided health insurance

- private insurance costs $4,000

taxes =30,000 x 0.33 = 10,000

after-tax wage =

30,000 10,000 = $20,000

net income =

20,000 - 4,000 = $16,000


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Marginal

Revenue

Product

employer

health

insurance

spending

pre-tax

wage

after-tax

wage

personal health

insurance

spending

net

income

no insurance $30,000 $0 $30,000 $20,000 $4,000 $16,000


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Now suppose that the employer offers health insurance for

$5,000.

- reduce wages by $5,000

- total compensation remains $30,000

taxes =

25,000 x 0.33 = $8333.33

after-tax wage =

25,000 8333.33 = $16,666.67

net income =

$16,666.67


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Marginal

Revenue

Product

employer

healthinsurance

spending

pre-taxwage

after-taxwage

personal health

insurance

spending

net income

no insurance $30,000 $0 $30,000 $20,000 $4,000 $16,000

employer insurance $30,000 $5,000 $25,000 $16,666.67 $0 $16,666.67


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How Generous Should Health Insurance Be?

The most generous insurance plans offerfirst-dollar

coverage.

- little or no patient payment

Most plans cover some services fully, some not at all,

and some with cost-sharing.


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The Utility ofWealth

This utility of wealth

function exhibits

diminishing marginal

utility.

- 2x the wealth

doesnt make you

2x as happy

- describes an individual

who is risk averse (will

not accept an actuarially

fair bet) Wealth

Total Utility of

Wealth

10,000 20,000

140

200 TU


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Suppose that your income is $20,000.

You have a 10% chance of becoming sick.

If you become sick, you will spend $10,000 as you pay

medical expenses and miss work.

Calculate your expected utility and expected wealth.


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Wealth

Total Utility of

Wealth

10,000 20,000

140

200 TU

194

19,000

EU

In a world with risk,$19,000 of wealth would

give you an expected

utility of 194.

In a world without risk,

the same $19,000 would

yield a higher utility.


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Wealth

Total Utility of

Wealth

10,000 20,000

140

200 TU

194

19,000

EU

A

The horizontal distance

between the expectedutility line and the total

utility line represents

your risk aversion.

At point A, you would be

willing to pay up to

$4,000 for insurance that

protects against areduction in wealth from

illness.16,000


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How much are people willing to pay for insurance?

When the probability of being well is 100%, then there are

no gains from insurance.

When the probability of being sick is 100%, then there are

no gains from insurance.

- might as well set money aside


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Wealth

Total Utility of

Wealth

10,000 20,000

140

200 TU

EU

The horizontal

distance between the

certainty utility curve

and the expected

utility curve is the

marginal gain frominsurance.

The marginal gains

increase, thendecrease.

no gain from

purchasing insurance

no gain from


max gain from



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Wealth

Total Utility of

Wealth

10,000 20,000

140

200 TU

EU

Some events can

substantially reduce

wealth.

- heart attack

Some events wont

substantially reduce

wealth.

- hang nail

The expected utility line

will reflect that.

EU


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When comparing types of losses at any given

probability, the larger the expected loss, the larger the

gain from having insurance coverage.

insurers marginal cost

Wealth

Consumers Expected Marginal Gain $,

Insurers Marginal Cost $

Marginal Gain for Heart

Attack Insurance

Marginal Gain for

Hangnail Insurance

When the marginal gains to the consumer exceed the

insurers marginal cost, insurance coverage will exist.


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Moral Hazard

So far we have assumed that the amount of a loss is

fixed.

But, buying insurance often lowers the out-of-pocket

price of services.

(buy more services!)


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Q of health

care

price

Q1 Q3

p1

Suppose you pay all of your

expenses out of pocket. If the

price is p1, then you wouldconsumeQ1 units of health care.

Your total expense

would be (p1)(Q1).

Demand

(assume p1 is

marginal cost

of production)


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Suppose the probability you will need to see adermatologist is 0.50.

You should be willing to pay the actuarially fair price of

(0.50)(p1)(Q1)

for insurance that would cover all of your losses.

However, now additional medical care costs you nothing.


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At a price of zero, you would consumeQ3

units of health care.

Your care would cost (p1)(Q3) in terms

of resources.

Price of care

Quantity

P1

Q1 Q3


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If your insurance charged (0.5)(p1)(Q1) they would be

losing money.

The expected payout is larger than the expected

premium.

(0.5)(p1)(Q3) > (0.5)(p1)(Q1)

If the company charged (0.5)(p1)(Q3), then you may not

buy the insurance.


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Any insurance premium has two components:- premium for protection from risk

- resource cost due to moral hazard

Moral hazard analysis helps us predict the types of

insurance that are likely to be provided.

1.developed first for inelastic services

2. more coverage for inelastic services


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Price of care

Quantity

P1

Q1 Q2 Q3

If you must pay a

deductible before care isfree to you:

if the deductible is small

you will consume anamount in between Q1 and

Q3. (perhapsQ2)

if the deductible is large,you may decide to self-

insure and will consume

Q1.

Deductibles


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Coinsurance

Coinsurance is the consumers out-of-pocket payment

rate. (higher coinsurance means consumer pays more)

With marginal cost P1 and

no insurance, the consumerwill demand Q1 units of

care.

The consumers marginalbenefit will be equal to the

marginal cost.

MC

Demand with 100%

coinsurance (MB)

price

quantity

p1

Q1


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With 20% coinsurance, theprice the consumer pays out

of pocket falls to P2.

Q2 units will be

demanded

A new demand curve is

generated to reflect the 20%

coinsurance.

Demand with 20%

coinsurance (MB)

MC

Demand with 100%

coinsurance (MB)

price

quantity

p1

Q1

p2

Q2


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The additional resource

cost is:

The additional benefits tothe consumer are:

The additional costs exceedthe additional benefits.

Demand with 20%

coinsurance (MB)

MC

Demand with 100%

coinsurance (MB)

price

quantity

p1

Q1

p2

Q2


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The role of health care in society is ultimately a

production question.

How does health care contribute to the health

status of the population?

health status =f(health care, lifestyle, environment,)

- many ways to measure health status

ex: # disability days

mortality rates / morbidity rates

# healthy days in the population per capita

life expectancy


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The production function for health

HS

HS

0.96

0.95

0.92

0.85

0.75

Health Care Inputs

0 1 2 3 4

Health Care Inputs

0 1 2 3 4

MP

0.10

0.07

0.030.02

MP


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Takeaway:

The total contribution of health care is substantial while themarginal contributions may be small.

- on the flat of the curve

The margin is often of interest to policy makers.

- Many government programs encourage health

care use (especially certain populations).

-What effect would an increase (or decrease) of $1

billion in health spending have?

pub econ lecture 15 health ins i

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