The role of insurance in health care, part 2

1. The role of insurance in health care, part 2 Today: More on moral hazard Other issues in insurance Problems with insurance

2. Health care • Suppose that Angela has been admitted to the hospital after being in a car accident • She has a substantial MB for the first night in the hospital, due to the care that she needs

3. Health care • As Angela’s condition improves, her MB declines • When the demand hits the horizontal axis, she is completely better • Think of demand like MB • Think of supply like MC

4. 20 percent co-insurance • Assume that Angela pays 20% of her costs • This is also known as coinsurance • Angela will then decide to stay in the hospital as long as MB for each night exceeds its MC • She will want to stay in the hospital as long as her benefit is at least 20% of the hospital’s cost

5. What about a percentage co-payment? • What if Angela had to pay 20% of her costs while in the hospital • Her PRIVATE MC is two-tenths of MC curve (See dashed line) • Equilibrium is at the yellow circle 0.2 MC

6. Only a co-payment • Suppose that Angela’s insurance only mandates that she makes a co-payment • Angela’s PRIVATE MC is zero after being admitted • If hospital lets Angela stay in the hospital as long as she wants, equilibrium occurs at Q2 • MB and private MC are both zero here

7. What is optimal? • Angela’s optimal length of hospital stay occurs when the PUBLIC MC equals MB • This occurs at point A

8. Deadweight loss due to 20% coinsurance

9. Flat-of-the-curve medicine • Flat-of-the-curve • Spending that occurs with low MB • Is the US practicing this type of medicine? • Likely in some cases, due to insurance • Analysis across countries is more complicated • Countries with nationalized medicine may not provide some services with MB > MC • Malpractice costs • Health care costs for selected countries: See Figure 9.5, p. 200

10. Some final issues • Externalities • Graying of the population • Longer life expectancy • Retiring baby boomers • Improved technology • Reimbursement policies

11. Externalities • Externalities of health care exist in limited cases • Examples • Vaccination (positive) • Overuse of antibiotics (negative) • Staying home when sick (positive)

12. Graying of the population • The average age of the population is increasing for two reasons • Longer life expectancy • Retiring baby boomers • Older people generally have higher health care costs per person • This can increase premiums for everyone working for the same firm • More on this topic in later lectures • Government-provided health care • Social Security

13. Improved technology • Old methods of health care are often not expensive • Aspirin first marketed over 100 years ago • Modern drugs can have monthly price tags over $1,000 • Should someone that is unable to afford a new drug be left out of using it? • Commodity egalitarian arguments have led to price discrimination by pharmaceutical companies • Prices slightly above MC are charged to poor people

14. Reimbursement policies • Reimbursement policies for medical services to try to keep costs down • Review boards • Discharge criteria from hospitals

15. New directions for health insurance? • As health care costs continue to increase, consumers must pay for it one way or another • New methods to keep premiums down • Explicit reductions in benefits • More drug tiers • See readings on class website for more on this • Restructuring of benefits

16. Restructuring benefits • As we saw with Angela… • Over consumption of health care • Extra consumption passed on to others’ premium fees • How can we avoid this? • Provide accounts that carry over from year to year • Lower premiums but increase deductibles • Example that decreases moral hazard problem: Lower premiums by $2000 per year, but increase deductible by $2000 per year

17. What are the other issues of insurance? • Do some individuals have a discount rate that is too high? • Government insurance • Reimbursement rates • Talk about this more next week • Emergency rooms  Increased costs for all • How can costs be further controlled in the future?

18. Problems • Hospital demand given insurance (or lack thereof) • Deadweight loss due to insurance • Insurance problem

19. Problem 1 • If a day in the hospital costs $15,000 per day, and you demand hospital care based on the demand P = $30,000 – 1,000 Q, how many days will you stay in the hospital under each of the following situations • Full insurance with no co-payment • A co-insurance of 20% of your bill • No insurance

20. Problem 1 • Full insurance with no co-payment • With full insurance, the patient will stay in the hospital until MB = 0 • To find the number of days in the hospital under these conditions, set 0 = 30,000 – 1,000Q • Q = 30

21. Problem 1 • A co-insurance of 20% of your bill • With a 20% co-insurance payment, the patient will stay in the hospital until MB is 20% of the daily cost, or $3,000 • Set 3,000 = 30,000 – 1,000Q • Q = 27

22. Problem 1 • No insurance • With no insurance, set MC = MB • Set 15,000 = 30,000 – 1,000Q • Q = 15

23. Problem 2 • Using the information in the previous problem, what is the deadweight loss (DWL) due to insurance? • Note that there is no DWL when there is no insurance

24. Problem 2 • Note that above 15 days of care, MB is less than MC • With full insurance, the DWL triangle has base of 30 – 15, or 15 • The height of the triangle is the MC, or 15,000 • Area: ½ of 15 *15,000, or 112,500

25. Problem 2 • With a 20% co-insurance payment, the DWL triangle has base of 27 – 15, or 12 • The height of the triangle is the MC minus the 20%, which is 15,000 – 3,000, or 12,000 • Area: ½ of 12 *12,000, or 72,000

26. Problem 3 • Cautious George is so cautious • In fact, he is so cautious that he has the following risk-averse utility function • U(n) = n⅓

27. Problem 3 • Suppose that George could receive one of two possible payouts in the following gamble • $125 with 40% probability • $1,000,000 with 60% probability • What is the expected payout? • What is the expected utility? • How much is George willing to pay to be fully insured?

28. Problem 3 • Expected payout (Y) • $125 * 0.4 + $1,000,000 * 0.6 = $600,050 • Expected utility • U(125) = 5 • U(1,000,000) = 100 • Expected utility is 5 * 0.4 + 100 * 0.6 = 62

29. Problem 3 • We need to find some y such that U(X) = 62 • X⅓ = 62 • X = $238,328 • George is indifferent between taking $238,328 with certainty versus the previously-mentioned gamble

30. Problem 3 • George is willing to pay Z – X to be fully insured • Z = $1,000,000 (the higher of the two payouts) • X = $238,328 • George is willing to pay up to $761,672 to be fully insured

31. Problem 3 • Expected value of gamble (Y) • $600,050 • Certainty equivalent of the gamble (X) • $238,328 • George is willing to pay up to $761,672 to be fully insured

32. Next week • Monday: The role of government in health care • Read Chapter 10 • Wednesday: Social Security • Read pages 228, 232-236, and 240-251