Health Insurance and Health Care

1. 18 Health Insurance and Health Care

2. Previously • Behavioral economics questions the traditional economic model and invites a deeper understanding of human behavior. • Bounded rationality means that we are nearly (but not fully) rational. • Psychological barriers and biases may interfere with rational decision making. • Different people have different risk preferences and sometimes change these preferences in different circumstances.

3. Big Questions • What are the important issues in the healthcare industry? • How does asymmetric information affect healthcare delivery? • How do demand and supply contribute to high medical costs? • How do incentives influence the quality of health care?

4. Issues in the Healthcare Industry: History of U.S. Health Care • Why has life expectancy increased from less than 50 years to 80 years over the last 100 years? • Treatment of many infectious diseases now uncommon because of antibiotics • Since early 1950s, much better understanding of diseases and more precise diagnostic tests • Discoveries in biomedical engineering • Development of “miracle” drugs

5. Issues in the Healthcare Industry: Expenditure—1 • Anything striking about the numbers?

6. Issues in the Healthcare Industry: Expenditure—2 • Why does health care take up so much of our budget? • Private health insurance • Patients agree to additional tests or visits, and doctors are willing to order more tests. • Medicare and Medicaid • Increased demand by providing coverage to elderly and poor leads to higher prices.

7. Issues in the Healthcare Industry: Expenditure—3 • Why does health care take up so much of our budget? • The number of uninsured • The uninsured tend to delay treatment and use emergency care. • Demand for health care is very inelastic • Without competition, providers can charge what they want.

8. Issues in the Healthcare Industry: Expenditure—4 • Why does health care take up so much of our budget? • People are not proactive about their health • End of life efforts

9. Issues in the Healthcare Industry: Diminishing Returns—1 • What’s the relationship between health and the quantity of medical care? • As medical care increases, health improves, but at a diminishing rate.

10. Health Production Function

11. Issues in the Healthcare Industry: Diminishing Returns—2 • What is the optimal mix of expenditures on health care? • Would we get better outcomes by reallocating healthcare dollars?

12. The Nation’s Health Dollar

13. Skewed Healthcare Costs—1

14. Skewed Healthcare Costs—2

15. In addition, end of life care is expensive In 2008, Medicare spent $55 billion in health care for patients who were in the last two months of their lives (source) Thirty percent of Medicare is spent during the last year of the patient’s life (source) Should this spending be reduced? Tough question: What is the quality of this longer life? Tougher question: Is the societal benefit here worth the cost? Skewed Healthcare Costs—3

16. Practice What You Know—1 How is health care different from other goods we consume? Health care is usually optional. Health care is not a scarce good. Health care is often financed through intermediaries such as insurance companies. Health care is a derived demand.

17. Practice What You Know—2 Which of the following is a reason to explain why health care is such a large portion of GDP? The demand for health care is very elastic. Consumers are willing to consume more health care because insurance pays most of the marginal costs of care. Our population is getting younger, and young people take more risks. People are taking better care of themselves and buying a lot of home healthcare products.

18. Practice What You Know—3 Suppose you pay insurance premiums but do not get sick. What happens? The insurance company will refund your premiums. You will no longer have to pay premiums until you get sick. Your insurance company will drop you as a customer. The insurance company will use your premiums to pay the expenses of another insured consumer who did get sick.

19. Who’s Who in Health Care—1 • How is health care different from most goods? Why are the costs so high? • Four players • Consumers: Patients and government • Producers: Doctors, nurses, hospitals • Pharmaceutical companies • Intermediaries

20. How Intermediaries and Insurance Work—1 • Suppose you are sick. You go to your doctor. She checks you out, runs a few tests, and determines you have laryngitis. She tells you to get rest, and prescribes some drugs. • How are all these services paid for? • Most of the costs are directly paid by the insurance company, but you also pay. • How?

21. How Intermediaries and Insurance Work: Definitions—1 • Premium • A set monthly fee paid by the insured person • This is the insurance companies’ source of revenue • Copayments • Fixed amount the insured must pay when receiving medical care or prescriptions

22. How Intermediaries and Insurance Work: Definitions—2 • Deductible • Fixed amounts that the insured must pay before most of the policy’s benefits can be applied • Co-insurance payments • A percentage of the costs that the insured must pay after exceeding the deductible up to the policy limit

23. How Intermediaries and Insurance Work: An Example—1 • John visits the doctor to be treated for a kidney stone. • He pays nothing at the time of the visit. • The doctor bills the patient’s insurance company for the visit. • Total charge for doctor’s services: $215 • Allowable charge: $114.89 • The insurance company pays $74.89 • You get a bill for the remainder: $40 (copay)

24. How Intermediaries and Insurance Work: An Example—2 • The doctor also ordered an X-ray. • The radiologist bills the insurance company. • Total charge for radiologist services: $343 • Allowable charge: $124.98 • The insurance company pays $99.28 • You get a bill for the remainder: $25 (co-insurance)

25. How Intermediaries and Insurance Work: An Example—3 • And because your stone is too large to pass, you need surgery. • The hospital bills the insurance company. • Total charge for surgery: $3,619.52 • Allowable charge: $2,965.95 • The insurance company pays $2,125.12 • You get a bill for the remainder: $840.83

26. How Intermediaries and Insurance Work: An Example—4 • How does the insurance company cover what they have paid? ($2,299.99) • From the premiums paid by the insured • What if John only pays $1,200 in premiums for the year? • No problem. Jane also pays $1,200 in premiums, and incurred no medical expenses this year.

27. How Intermediaries and Insurance Work—2 • Insurance companies use premiums from all consumers to pay medical suppliers • If you don’t get sick, your premiums pay the expenses of people who do get sick • If you get sick, other people’s premiums pay for your expenses • Insurance companies use statistical analysis to estimate profitable pricing based on probabilities of illness

28. How Intermediaries and Insurance Work—3 • Health Maintenance Organization (HMO) • Provides managed care by assigning a primary care physician to customers • HMO monitors the physician to confirm that unnecessary care is not prescribed, keeping costs lower • Medical malpractice insurance • Doctor pays a fee • Insurer pays damages from malpractice claim

29. Who’s Who in Health Care—2 • Why are medical costs so high? • Consumers have an incentive to demand more care than necessary • Doctors have an incentive to prescribe more care than necessary • Government caps on reimbursements for Medicare and Medicaid

30. Economics in South Park, “Cherokee Hair Tampons” • Miss Information offers a “natural” cure when Kyle needs a kidney transplant.

31. Economics in Bud Light Commercial, “Hitchhiker” • Would you pick up a hitchhiker who may be an ax murderer if he has a case of Bud Light?

32. How Does Asymmetric Information Affect Healthcare Delivery? • Asymmetric information • An imbalance in information that occurs when one party knows more than the other. • Examples: • Used car markets • Firm and potential employee • Manager and worker

33. Adverse Selection • Adverse selection • Occurs when one party has access to some aspect of product quality that the other party does not have. • The party with full information may try to take advantage of the other party. • The market adversely selects the poor quality product to be exchanged. • How can buyers and sellers reduce the potential problems?

34. Adverse Selection with Health Care • How can patients reduce some of the risk associated with adverse selection? • Search out doctors with good reputations • Learn about their conditions and possible treatments • Ask questions

35. Adverse Selection with Insurance • How can insurance companies reduce some of the risk associated with adverse selection? • Higher risk buyers are more likely to buy insurance. • Buyer may have an incentive to be dishonest about health, family history, and risks. • Insurance companies gather information about a new client to minimize risks.

36. Principal-Agent Problem • Principal-agent problem • Arises when a principal entrusts an agent to complete a task and the agent does not do so in a satisfactory way • There is asymmetric information because the principal cannot perfectly monitor the agent’s actions • Shareholders (principal) vs. manager (agent)

37. Principal-Agent Problem in Health Care • Patient is the principal. Doctor is the agent. • Patients often cannot directly observe their health management by doctors and insurers • Gives incentives for doctors and insurers of goals that don’t directly benefit the patient • Doctors concerned about malpractice instead of patient health • Insurance company more concerned about profits rather than health. May economize on treatment costs.

38. Economics in The Simpsons, “King-Size Homer” • Homer finds a way to get out of an exercise program at work.

39. Moral Hazard • Moral hazard • The lack of incentive to guard against risk where one is protected from its consequences • The party that is protected from risk behaves differently than if it had to face the risk • Automobile insurance

40. Moral Hazard in Health Care • Patients visit doctors more often with insurance since they don’t have to pay full costs. • Solving moral hazard in health care • Higher copays for visits • Encourage healthy habits • Payment limits on preventable treatments

41. Ex ante moral hazard You disregard own health because of insurance.“Let’s be reckless because we have insurance! They pay if we get hurt!” Ex post moral hazard You use more health care as a result of insurance and change your behavior. “Let’s wait to have a baby until I get a job that has health insurance.” Moral Hazard in Real Life

42. Practice What You Know—4 How could the problem of adverse selection in insurance markets be solved? increase the price of premiums so fewer people will buy insurance make the insurance industry more competitive increase the supply of health care require everyone to buy insurance

43. Practice What You Know—5 Which of the following situations illustrates an example of moral hazard? Patti waits to have a baby until she has health insurance that will cover a hospital visit. Roger is afraid of going to the dentist. Doug gets a flu shot because he doesn’t want to get sick. Skeeter is having terrible stomach pains, so he goes to the emergency room.

44. Economics in John Q • “Give a father no options, and you leave him no choice.”

45. Demand and Supply for Health Care • Two main aspects of the market for health care lead to high costs: • Demand is strongly inelastic. • Supply is limited.

46. Demand for Health Care • Nature of healthcare demand • Necessity, no good substitutes • Very inelastic (elastic coefficient is −0.17) • Elasticity depends on severity and urgency • Demand increasing • Aging population with more expensive care • People want newest technologies, best care, longer lives

47. Demand and Third-Party Payments—1 • Allison and Bart get sick five times per year. • The cost of a visit to a doctor is $100. • Allison has no insurance. Bart does with a $10 copayment. • How does this affect the demand for health care and overall costs?

48. Price and Quantity Demanded

49. Demand and Third-Party Payments—2 • How does this affect the demand for health care and overall costs? • If neither has insurance, total costs would be $600. • But, since Bart is insured, he sees the doctor two more times than Allison, so total costs increase to $800.

50. Healthcare Supply—1 • How is health care similar to other industries? • Goal is to maximize profits • As price rises, the quantity supplied rise. • Producers often enjoy significant market power. • No direct competition • Economies of scale • Availability of specialized services • Entry barriers such as medical licensing