E&F - lecture 10

Question 1

What is insurance?

Answer 1

• Risk pooling;
• Transfer of risk;
• Destruction of risk: the law of the large numbers that for a given probability of illness, the distribution of the average rate of illness in the groups will collapse around the probability of illness as the group size gets larger and larger.

Question 2

Law of the large numbers

Answer 2

Frequency of the estimated proportion of hospitalized people in repeated samples with sample size N, with true value p:

The standard error of the estimated p becomes smaller the larger the sample size.

Question 3

Actuarially fair premium

Answer 3

component of the premium that is based on the expected costs, the claims that they have to reimburse.

Question 4

loading fee

Answer 4

personnel costs, advertising costs, housing costs etc.

Question 5

Actual premium

Answer 5

= loading fee + actuarially fair premium

Question 6

Demand for insurance exists if individuals are risk averse:

Answer 6

• The disutility of losing money exceeds the utility of gaining a similar amount;
• The individual’s marginal utility of wealth is diminishing;
• The individual’s utility function is concave (bowed out to the x-axis).

Question 7

• Actuarially fair premium (no loading fee)

Answer 7

= probability of ill * loss when ill (p*L)

Question 8

Moral hazard

Answer 8

• In general: indifference to a loss because of the existence of insurance.
• Health insurance: the use or provision of more (expensive) care because the insurer reimburses (a part of) the costs.

Question 9

Effect MH on demand for insurance

Answer 9

• If an insurer ex-ante sets its premium under the assumption of “no moral hazard”, while moral hazard occurs, the insurer will make a loss.
• If the premiums are based on moral hazard, ‘insurance’ is less worthy to the consumer. Therefore, moral hazard ceteris paribus reduces the demand for insurance. This reduction is larger the larger the absolute price-elasticity of the demand for healthcare.

Question 10

The demand for insurance depends on
(ceteris paribus  keeping all other factors equal, but we only change this component):

Answer 10

1. Moral hazard;
   – The higher moral hazard, lower demand for insurance
2. The consumer’s risk aversion;
   – If the consumer is less risk averse, the utility curve is less concave. The room between utility curve and expected utility line is smaller. If the consumer is less risk averse, the demand for insurance is lower.
   – The more risk averse, the higher the demand
3. The loss-probability;
   – If p moves towards zero, it means point E moves towards H. if p is zero, we are health. Is p is zero, you are not willing to pay loading fee
   – If p increases, then E moves towards I. if p is 1 is does not make any sense to pay loading fee, you just can pay L
4. The loading fee;
   – If loading fee increases, demand for insurance increases (see graph below)
5. The loss;
   – A small loss means that I and H are close to each other. The expected utility line is close to the utility curve. How smaller the loss, how smaller the demand for insurance
6. The consumer’s income/wealth.
   – If starting income is higher, we would be in the area where the utility curve is quite flat. It also means that the room between AB becomes smaller and smaller if your wealth/ income increases. Increase in income, decreases demand for insurance.

Question 11

(Dis)davantages of Health insurance

Answer 11

• Advantages of health insurance:
  – Welfare gain for risk-averse individuals;
  – Access to care that would otherwise be unaffordable.
• Disadvantages of health insurance:
  – High expenses due to undesired moral hazard;
  – High expenses due to loading fee.

Question 12

Premium and perfect competition

Answer 12

• Premium = risk premium + loading fee (incl. administrative costs, profits, etc.);
• Risk premium (or actuarially fair rate) = the expected loss based solely on the probability of the event occurring;
• With perfect competition the expected profits on each insurance contract will tend to zero (because competition minimizes predictable profits).

Question 13

Equivalence principle

Answer 13

The equivalence principle of a competitive insurance market implies that an insurer has to break even on each insurance contract, and therefore cannot organize ex-ante cross-subsidies among different risk groups.
 Risk rating (i.e. premium differentiation) and/or risk selection.

Question 14

community rated premium

Answer 14

everyone pays the same premium price within a certain area

Question 15

Classification criteria for health insurance

Answer 15

• Source of financing: public or private?
• In the Netherlands you pay to a private insurer, but it is seen as a public financing. Probably because it is mandatory.
• Mandatory or voluntary?
• Group or individual?
• Group: external entity that has a contract with an insurer on behalf of the group and in that contract, that entity pays the premium and insurer reimburses all costs of that group.
• Community-rated or experience rating?
• Community = everybody in the community pays the same premium
• Experience = rating for a group based on the experience of the group and for individual insurance it is risk adjusted: adjusted to the individual risk

Question 16

Social Health Insurance

Answer 16

Health insurance is social insurance. Health insurance is appropriately understood as social insurance and not casualty insurance. (…) Social insurance assures universal financial access to the decent minimum and requires the well to share in the cost of care of the sick. The element of cross-subsidy is essential.
Source: Enthoven (1988b) p. 4-5.

Question 17

The essential aspect of SHI: cross-subsidies. (healthy to sick or young to elderly)
Other aspects of SHI can be:

Answer 17

Ø Standardized benefits package;
Ø mandatory;
Ø taxes;
Ø Open enrolment;
Ø community-rating;
Ø earmarked contribution.

Question 18

Low income countries

Answer 18

• Many low income countries have a kind of public health care system have a kind of public health care system;
• Nevertheless, people in these countries often pay a high proportion (often >50%) of total medical spending out of pocket
• The high out-of-pocket expenses are NOT only concentrated among the high-income consumers; also among low-income families (although to a less extent).
• Out-of-pocket payments form a large share of family income for families who have out-of-pocket expenses.

Question 19

Major reasons for the government failure to provide adequate financial protection for its citizen and adequate access to care: (low income)

Answer 19

1. Insufficient public resources for public schemes;
2. Imperfect tax system (large informal sector; corruption).

Question 20

Why not buying health insurance?

Answer 20

1. People do not understand the concept of insurance
2. People do not (sufficiently) trust insurance companies
3. People display a low willingness to pay for health insurance (covering a potential future health problem) but a high willingness to pay for catastrophic health expenses in case of an existing major health problem
4. Willingness to buy health insurance may be low because moral hazard – both consumer and supply induced substantially increases the premium
5. Moral hazard may be more easily limited in small, informal community health schemes with social controls than in large, impersonal pooling mechanisms like insurers.
6. The willingness to buy health insurance may be low because people are not (very) risk averse
7. The willingness to buy health insurance may be low because the loading fee is too high, either absolutely or as a fraction if the total premium
8. There is no supply of insurance products that are attractive to low-income people
   a. One reason for this shortage may be that insurers think there is no market for their products among the poor
   b. Another reason may be: restrictions on supply because of regulation (sometimes resulting in regulation-induced death spiral)
9. High risk individual and groups cannot afford to buy health insurance because of risk-rated premiums
10. “insurance” against becoming a high future risk can be better handled within small, informal community health schemes than in a competitive insurance market
11. Cultural or religious believes: certain cultures or religions actively discourage or preach against purchasing insurance of whatever kind (motor, home, health, etc.)

Question 21

Tools for scaling up health insurance

Answer 21

1. Providing information about “what insurance is”
2. Regulation of the insurance market (e.g. concerning solvency requirements)
3. Tools to reduce (supply induced) moral hazard
4. Providing subsidies (meeting 13)
5. Mandatory community rating
6. Mandatory health insurance

Question 21

Advantages community rating (everyone in the community pays the same premium)

Answer 21

1. Transparency
2. Low transaction costs
3. Implicit cross-subsidies are mostly not considered as ‘public finance’ (like explicit contributions)
4. It is believed to be a good guarantee for making health insurance affordable for high risks (holds only in the short term)

Question 21

Disadvantages community rating

Answer 21

1. Selection (meeting 13); low risk will not buy if it is voluntary
2. Cross-subsidies most likely disproportional:
   a. Also cross-subsidies for risk factors such as oversupply and inefficiency
   b. Also subsidies to high-income high-risks
3. Indirect premium differentiation via product differentiation
4. The regulator forbids the high risks to pay extra premium so that they are financially attractive for insurers

Question 22

Why is community rating so popular?

Answer 22

• The direct effect on affordability is immediately visible;
• Implicit cross-subsidies: no ‘public finance’ (‘taxation via regulation’);
• Potential indirect effects, such as poor quality care or high premiums for the high risks may only show up after some years.
• Unawareness of the disadvantages;
• The perception that risk selection is not a problem (however, see Meeting 13).

Conclusion: The justification of community rating is less straightforward than its popularity in practice

Question 23

Motives for mandatory insurance

Answer 23

Economic arguments to make health insurance mandatory (assuming health insurance is affordable)

1. The prevention of free riding ( some people may purposely not buy health insurance)  abuse altruistic preferences of other: other people feel more happy if they see that people can have it
2. A lack of foresight (individuals do not always know what is in their best interest, which may lead to underinsurance)
3. Transaction costs of organizing cross subsidies
4. Prevention of adverse selection  prevent low risk do not take health insurance