HEALTH CARE

Chapter 9

2016 by McGraw-Hill Education Limited.

Learning Objectives
1. Describe the function of health insurance.
2. Calculate the actuarially fair insurance
premium.
3. Using a diagram, illustrate the conditions under
which an individual would purchase insurance.
4. Describe the role of insurance firms in pooling
risks.
5. Explain how adverse selection can lead to a
market failure in the market for health
insurance.

9-2

Learning Objectives
(cont)
6. Outline how government intervention can
address the adverse selection problem.
7. Demonstrate how the problem of moral hazard
can lead to inefficient levels of health services.
8. Outline how information, externality, and
equity concerns can give rise to problems in
privatized health care markets.
9. Discuss the current challenges facing Canadas
health care system and the difficulties
encountered when attempting to measure its
performance.
9-3

What is Special About

Health Care?

LO1

The role of insurance

Social insurance government programs that
protect people against a variety of adverse
events
Health insurance buyers pay money (insurance
premium) to providers of insurance, who agree
to disburse some money to the insured person
should an adverse health event occur
Other things being the same, the greater the
insurance premium, the more compensation the buyer
receives in the case of an illness

9-4

Expected Value
The amount of money an individual can
expect to receive on average when
she faces uncertain outcomes
Expected Value (EV) =
(probability of outcome 1)*(Payout in
outcome 1) + (probability of outcome
2)*(Payout in outcome 2) + + (probability
of outcome n)*(Payout in outcome n)

9-5

LO2

Why Buy Insurance?

Table 9.1

The actuarially fair insurance premium charges just

enough to cover the expected compensation for the
expenses ($3,000 in the example)
In general, option 2 is preferred as it provides the
same expected income but with more certainty
Diminishing marginal utility
9-6

Utility

Why People Buy

Insurance
Option 2
Full
insurance

UB
UD
UC

LO3

D
C

Expected
Utility

Option 1
No
insurance

UA

20,000
Figure 9.1

Risk
Smoothing

47,000 50,000 Income

9-7

Figure 9.2

46
,50
47 0
,00
0
50
,00
0

B
E
A

Income

40
,00
0
47
,00
0
50
,00
0

B. More risk
averse

20
,00
0

Utility

A. Less risk
averse

20
,00
0

Utility

Do People Buy Insurance if

Premiums are not Actuarially
Fair?

9-8

Do People Buy Insurance if

Premiums are not Actuarially
Fair?
Risk Aversion

The demand for insurance depends on the

curvature of the utility function

Risk premium the amount an individual is

willing to pay above the actuarially fair
premium
Loading fee the difference between an
insurance premium charged by a company
and the actuarially fair premium
Current average loading ratio for private
insurance companies = 1.20
9-9

LO4

The Role of Risk Pooling

Insurance in a small population
Insurance in a large population
Law of large numbers

9-10

Asymmetric Information in the

Health Insurance Market
Asymmetric information
Situation in which one party engaged in an
economic transaction has better information than
the other party

Adverse selection
Buyer has more information about the probability of
loss than the seller

Moral Hazard
The insured individual has more information about
actions that affect the probability of incurring loss
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How Adverse Selection CanLO5

Cause Failure in the
Insurance Market

Table 9.2

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LO6

Adverse Selection
Empirical evidence: A death spiral at Harvard?
Does adverse selection justify government
intervention?
Private market responses to adverse selection
Group coverage
Categorize risk - observable characteristics

Social insurance programs are compulsory

Not subject to the adverse selection process that arises
when individuals can use their private information
regarding their loss probability to choose their insurance
coverage

9-13

Utility

Low-Risk Individuals
Prefer Zero Coverage to
Social Insurance
B

UC

UF
A

Figure 9.3

50
,00
0

47
,00
0

45
,50
0
46
,50
0

20
,00
0

PMAX

Income
9-14

Moral Hazard and Market

Failure
Moral hazard
If people know they have insurance,
they may take less care to avoid risks
People have an incentive to overconsume because insurance pays for
some or all of the cost

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LO7

Price per unit

Market for Medical

Services
Coinsuran
ce rate
Expenditures in the absence of insurance
Deadweight Loss
a

P0

Sm

.2P0

Dm

M0

M1

Additional expenditur
induced by
insurance

Medical services per yea

Figure 9.4
9-16

Additional
Considerations

LO8

Does moral hazard justify government

intervention?
All third party payment systems generate
moral hazard

Other Problems in the Health Care Market

Poor information
Paternalism
Income redistribution
Externalities

9-17

National Medicare in
Canada
Medicare refers to Canadas national health insurance
program
The Canada Health Act
1.
2.
3.
4.
5.

Universality
Accessibility
Comprehensiveness
Portability
Public administration

The history of Canadian health care financing

Constitutionally, the provision of health care is the

responsibility of the provinces
Canada Social Transfer (CST) and Canada Health Transfer
(CHT)
9-18

Per Capita Health

Expenditure by
Provincial Governments
in 2014*

Figure 9.5
9-19

Trends in Health
Expenditures
Provincial and Territorial Government per
Capita Health Expenditures, 1975 to 2014
(constant 2002 dollars)

Figure 9.6

9-20

Trends in Health
Expenditures
Total Health Expenditures as a
Percent of GDP

Figure 9.7
9-21

Trends in Health
Expenditures
Percent Shares of Health Care
Expenditures by Category

Table 9.3

9-22

Comparing Health Systems

Around the World
Selected Health Statistics for OECD
Countries, 2011

Table 9.4
9-23

Challenges and Future

Directions

LO9

Is the Canadian health system in decline?

Challenges
Cost pressures facing the Canadian health system
Increasing wait times

What will the Canadian health care system look

like in the future?

Changing incentives
Defining medically necessary services
A national pharmacare program
Privatization
User charges
9-24

Wait Times Compared for

Selected Countries, 2013
(in percent)

Table 9.5

9-25

Percent of Patients
Receiving Care Within
Benchmark Wait Time

Table 9.6

9-26

Chapter 9 Summary
For a risk-averse person, an insurance plan that charges
an actuarially fair premium increases expected utility
because it allows risk smoothing.
The more risk averse an individual is, the more he or she
is willing to pay for an insurance policy.
By pooling individuals into one insurance program, an
insurance company can lower risk from a societal point
of view.
Health care services may be different from other
commodities and services for a number of reasons,
including adverse selection, moral hazard, and societys
desire to act paternalistically, to redistribute income, or
to internalize externalities.
9-27

Chapter 9 Summary
(cont)
Government can address adverse selection by
providing universal health insurance coverage.
Government provision of health insurance faces the
same moral hazard problem as private insurance,
because it too reduces the price of medical services
faced by patients.
Health care insurance is a provincial government
responsibility; The federal government contributes
transfers to support health care services.
The Canada Health Act lays out five conditions that
must be met for provincial health insurance schemes
to qualify for federal transfers.
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Chapter 9 Summary
(cont)
Compared with health systems in selected OECD countries,
Canadas health system produces average or above-average
outcomes at above-average cost.
As we look to the future of the Canadian health care system, we
note that the health of Canadians is generally improving over
time.
Significant future public cost pressures will come as a result of
the aging population; technical advances in health sciences,
which will expand the range of health problems that can be
treated; and the increasing reliance on public funding for drugs.
Current debates about future directions for the Canadian health
care system centre on changing incentives faced by physicians
and other health care providers, defining a list of medically
necessary services, the value of a national pharmacare
program, and the role of the private sector in health care
financing.
9-29