Module 11.3 Asymmetric Information in Health Insurance Lecture

Asymmetric Information in Health Insurance

• Definition of Asymmetric Information: A situation where one party in a transaction has more or better information than the other.

• Moral Hazard: When individuals engage in riskier behavior when insulated from risk due to insurance coverage. This leads to increased costs for insurance companies.

• Example: A person might take more risks (like sports or neglecting health) knowing they have health insurance that will cover them.

• Aligning Incentives: To better align policyholders' incentives with those of insurance companies, patients should share in some of the costs involving their health care.

  • Co-payments: Fixed fees paid for each service (e.g., $20 per doctor's visit).
  • Deductibles: Amount paid out-of-pocket before insurance coverage kicks in (e.g., first $5,000 of expenses).
  • Coinsurance: Policyholder pays a percentage of the service fees until a limit is reached (e.g., 20% up to a certain cap).

• Health Care Cost Drivers in the US: Due to insurance, patients often face low marginal costs, leading to higher consumption of health services, often unnecessarily.

Tripartite Structure of Health Care

• Major Parties Involved:

  • Patients: Buyers of health insurance who want extensive health care.
  • Insurance Companies: Entities providing coverage and footing the bill for claims.
  • Doctors/Providers: Medical professionals delivering care, often incentivized by payment structures to provide more services.

• Incentive Misalignment: Patients desire maximum care; doctors may over-provide services due to monetary incentives while insurance companies are the only parties that benefit from limiting costs. This can result in unnecessary tests or treatments, termed a principal-agent problem, where the decision-maker (doctor) is not the one bearing the cost.

Adverse Selection and Its Remedies

• Adverse Selection: Occurs when individuals have different levels of risk for consuming health care, leading insurers to either charge high premiums or risk bankruptcy.

  • If healthy individuals leave the insurance market because premiums do not reflect their risk level, only higher-risk individuals remain, driving up premiums further.

• Insurance Evaluation: Insurance companies assess the risk of potential clients through health indicators (age, smoking status, historical health issues) to charge appropriate premiums.

• Avoiding Death Spirals: The risk of dwindling participation due to adverse selection can be mitigated through:

  • Market segmentation: Tailoring insurance products to different clientele based on their health status.
  • Mandates: Legally requiring individuals to purchase insurance to ensure a mixed-risk pool, thus preventing healthy individuals from dropping out.

Challenges in Health Care Systems

• Complexity of Systems: There is no perfect system for health care and insurance:

  • Privately run systems struggle with profit motives and consumer needs.
  • Publicly run systems can face bureaucratic inefficiencies.
  • The hybrid American system introduces its own complexities, leading to challenges in equitable access and cost control.

• Need for Understanding: Awareness of issues like asymmetric information is crucial for evaluating health care reforms, guiding towards potentially superior policy solutions.