Lecture 6: Health Care Flashcards
How health insurance works
Insurance premium: Money paid to an insurance company in exchange for compensation if an adverse event occurs
Willingness to pay for insurance depends on:
Expected value = (probability of outcome 1) * (pay out in outcome 1) +…+(probability in outcome n)*(pay out of outcome n)
Why people buy insurance
Risk adverse individuals: Concave utility function with respect to income (decreasing marginal utility of income/consumption)
Decreasing marginal utility of income: The utility gain of obtaining an extra Euro is less than the utility loss from losing a euro
Maximum premium
An individual is willing to pay = (E+y)-C -> Income in case of no-loss minus certain equivalent (which is the “outcome” if individual buys insurance
Actuarially Fair Insurance Policy
-y*Pr(loss)=(E+y)-I -> Actuarially fair Insurance premium = expected pay out/reimbursement by the insurance (in the previous example: 1/10 probability of a loss equal to 30.000. Hence Actuarially fair insurance policy policy is 3000) = Income in case of no-loss minus expected income
Risk Aversion
a preference for paying more – a risk premium – in order to guarantee compensation if an adverse event occurs. An individual would be willing to pay any insurance who is offering a utility above its expected utility with no insurance
Do people buy insurance with loading fees?
Loading fee: The difference between an insurance premium charged by a company and the actuarially fair premium
(The differente between the actual premium charged and the expected premium pay out)
Maximum loading fee: Maximum premium an individual is willing to pay – Actuarially fair Insurance premium = Expected Income – Certain Equivalent = (E+y) - C - [(E+y)-I]= I-C
Current average loading ratio for private insurance companies = 1.20
The more risk averse an individual is, the lower their certain equivalent. Hence, the more they will be willing to pay to get an insurance
Why might government intervention be needed in the health insurance market
Asymmetric information
- An individual knows their own illness risk, but the insurer does not: this my lead to adverse selection
- Once an individual has subscribed an insurance, they may not be as careful as before and may engage in opportunistic behaviour; This may lead to Moral Hazard
Adverse Selection
Adverse selection: The uninformed side of a deal gets exactly the wrong people trading with it
Hence: In the context of health insurance, insurance companies don’t know the health risk (quality) of individuals. If they charge an insurance premium equal to the average expected loss from health accidents of individuals in the population: Only high-risk individuals will find it worthwhile to get insured. But then no insurance company will offer any insurance.
Moral Hazard
When obtaining insurance against an adverse outcome leads to an increase in the likelihood of the outcome
Strategies for reducing moral hazard
Deductible: Out-of-pocket payment of health costs before the insurance company pays
Co-Payment: Fixed amount paid by the insured for a medical service
Co-Insurance: A % of the cost of a medical service that the insured must pay
Risk smoothing
Risk smoothing: Paying money in order to guarantee a certain level of consumption should an adverse event occur
