HCA 586 Lecture Packet 5

why do people buy insurance?

• the purpose of health insurance is to enable people to get rid of uncertainty

  • insurance does not protect against the probability of an accident

  • instead, insurance protects against the monetary loss associated with the accident

• individuals can convert this relatively rare possibility of a large loss into a small but certain loss by buying health insurance

  • most individuals choose this option because they are risk-averse

why do firms sell insurance?

• insurance companies are paid to assume risk

• the risk can be managed by spreading it over a large pool of the insured

  • insurance companies receive guaranteed premiums to insure against infrequent payouts

• insurance markets exist when consumers are willing to pay enough to induce insurance companies to assume risk

risk

• possibility of substantial monetary loss from an event where the probability of an occurrence is small

  • ex. auto accidents are common in the US, however, the likelihood is quite small that in a given year a specific individual will have a car accident

  • even though the risk is small, people buy insurance to insure against risk

insured

protected against risk (beneficiary)

insurer

agency that assumes risk

underwriting

systematic technique for evaluating, selecting (or rejecting), classifying, and rating risks

indemnity plan

• reimburses the beneficiary for services covered under the plan

  • cash is paid directly to the beneficiary. the beneficiary then pays the provider

  • if expenses are more than the indemnity amount, the beneficiary will have to pay the rest out of pocket

reasons for erosion of indemnity plans

• the cost of health insurance

• the use of allowed (contract) amounts in health insurance

defined benefit plan

• employee receives a defined benefit package, and the employer/employee pay a premium

• the premium is adjusted annually based on employee usage (experience)

• concept of the past

defined service/ contribution plan

• employees typically choose from a variety of healthcare plans

  • only a specified amount of health benefits is paid for by the employer

• the employee pays for any costs above the contributed amount

• defined contribution plans shift more of the financial responsibility to the employee

  • this type of health sinruance is widely used today and is gaining in popularity

cost sharing

• employer/employee share cost of providing health insurance

  • cost sharing is usually in the form of deductibles, copayments, and the use of co-insurance

deductible

• amount the insured pays before the policy benefits are active

  • deductibles lowers the insurance premium because it eliminates many of the small medical expenses that most families have each year

  • as a result, most people do not use indurance for small claims

  • this occurrence allows the insurer to lower its administrative costs

copayment

• the amount the insured must pay each time health services are received

  • ex. usually a defined amount: $20 copay for primary care, $30 for specialty

• the patient has an incentive to use fewer services because he/she will have to balance the value of additional visit against its cost

coinsurance

• usually consists of an 80-20 ratio of cost sharing between the plan and the insured

  • instead of defined/predetermined amount, proportions of medical costs are incurred

  • believed to expose customers to the true cost of medical services

stop loss

• maximum amount of out-of-pocket liability an insured person would incur in a given year

• after a certain amount of out-of-pocket expenses are met, the plan will pay 100% of costs

maximum payment limit

• a cap on how much the insurance company will pay for a certain procedure

• this has been changed due to the passage of the PPACA

PPACA

• as a result, there are no lifetime or annual dollar limits on the following essential benefits:

  • emergency services

  • hospitalizations

  • lab services

  • maternity care

  • mental health and substance abuse treatment

  • outpatient or ambulatory care

  • pediatric care

  • prescription drugs

  • preventative care

  • rehabilatative services

  • vision and dental care for children

catastrophic coverage

• major medical expenses (hospital care)

• comprise the tail end of medical expenditures

  • are usually only incurred by a small percentage of families

• def of catastrophic expenses is relative

  • it depends on the patient’s family income

  • a $2,000 expense may be a catastrophic expense to some but not others

community rating

• everyone pays the same insurance premium

  • risk is spread among the whole group

  • based on the utilization experience of the entire group

  • healthy people subsidize the care of sicker people

experience rating

• premiums are based on an individual’s medical experience

expected value

• what an individual will be willing to pay for health insurance, or an individual’s expected value of a health insurance policy

• when a certain outcome is not known, but a series of outcomes may occur with different probabilities, then one computes an expected value of the outcome

expected value assumptions

• very rational way of thinking

• outcomes are mutually exhaustive

• that all outcomes can be converted to numerical values

• a definite probability/percentage of chance can be assigned to each value

risk aversion

• these people will be willing to give up income to avoid risk

• buying insurance assures a person of having similar income, whether or not there is a loss

• having a certain amount of money with certainty is preferable to having an expected value of that amount of money

  • expected utility vs expected value

insurance purchase decision making

• actual premium>pure premium

  • this occurs because the actual premiums contain in a loading charge

• the size of the loading charge often determines if people will buy the health insurance for some medical expenditures but not for others

• if individuals could buy health insurance at a pure premium, most people would buy health insurance for almost everything because it would reflect on average, what they would likely spend anyway (rationality assumption)

• however, when charges more than the pure premium, the individual must decide whether to buy health insurance or self-insure

  • going without insurance

  • factors in play: degree risk aversion, price of the actual premium

• the higher the loading charge relative to the pure premium, the less insurance the individual will buy

• the individual will buy only what they can afford, not what they need or want

  • main factor which leads to underinsurance

moral hazard

• after purchasing insurance, the insured person’s cost for purchasing medical services has decreased

• the demand for certain medical procedures may be elastic

  • ex. cosmetic surgery

• reductions in what the consumer pays may cause large increases in quantity demanded

  • over-purchase of insurance causes a loss of well-being for society, it represents a waste of scarce resources

the degree of moral hazard may increase if

• physicians consider a patient’s insurance status when determining the appropriate treatment to prescribe

  • supplier-induced demand

• the procedures are price elastic

  • the more price elastic the demand for medical care, the less desirable it is to insure against that risk with normal types

protecting against moral hazard

• do not provide insurance for procedures with very elastic demand

• offer different co-insurance rates for various procedures

  • the more elastic the procedure, the higher the copayment

• add additional costs to procedures with elastic demand

  • increase wait times for gastric bypass

• consider a gatekeeper system

adverse selection

• refers to a situation where sellers have information that buyers do not, or vice versa

• in the case of health insurance, adverse selection is the tendency of those who are sicker or have a higher probability of getting sick to seek to purchase health insurance

  • the higher the likelihood of illness, the more incentive for individuals to purchase insurance

ways to account for adverse selection

• to keep premiums low, the probability of actual payout must be low

  • as a result, the bulk of customers must be low-risk

• high-risk costomers raise the average probability of payout for the whole group

• increasing premiums too much may cause low-risk customers to leave

  • death spiral

    • a condition of the insurance market in which costs rapidly increase as a result of changes in the covered population. it is a result of adverse selection in insurance policies in which lower-risk policyholders choose to change policies or be uninsured

• if you could identify the high-risk people charge them a higher premium or remove them from the pool

• analyze identifiers for high-risk conditions

  • third floor walk up and health insurance coverage for seniors

  • refuse to insure for pre-existing conditions

  • also investigate BMI, age, risk behaviors

  • prior to the PPACA, gender has been used

preferred risk selection

• cream skimming

• insurers seek out individuals who have lower than average risks

• focus on areas such as offer things that attract relatively affluent and healthy individuals

  • store discounts, gym memberships, cooking classes, and maternity services