1
Chapter 10 – Social
Insurance II,Health Care
Public Economics
2
What’s Special About Health Care?
? Health care costs are large and growing
fast
? Number of reasons why First Welfare
Theorem may be violated
– Poor information (physician induced demand)
– Adverse selection and moral hazard
– Disease externalities
3
What’s Special About Health Care?
? In the context of health care,moral
hazard can be analyzed in a conventional
supply-and-demand framework.
? Health insurance changes the price of
health care,and creates deadweight loss.
Figure 10.1
5
What’s Special About Health Care?
? Without insurance,consume M0 of health
care services.
? Insurance in this example lowers the
price of services to 20% of actual price,
With insurance,consume M1 of health
care services.
? Deadweight loss equals abh.
6
What’s Special About Health Care?
? Assumed that demand for health care
downward sloping (e.g.,health care use
is elastic with respect to the price).
? Assumed coinsurance rate of 20% -- the
amount the insured person pays out of
pocket.
? Social experiments find that the elasticity
of demand for health care is -0.20.
7
The U.S,Health Care Market
? Patchwork of public and private insurance.
? 13.2% of GDP
? Spending on hospitals is 32% of costs
? Spending on physician services is 22%
8
The U.S,Health Care Market,
Private Insurance
? Virtually all (93%) of private insurance for
the non-elderly is provided through the
employer.
– By-product of wage & price controls during
World War II
– Tax provisions subsidize employer
contributions
– Group market is less expensive than
individual market
9
The U.S,Health Care Market,
Private Insurance
? Link to employment potentially leads to,job lock”
– When you leave your job,you also lose your health
insurance
– May be difficult to get new insurance if you have a
“pre-existing” condition
– Kennedy-Kassenbaum Act mandated that employers
must include a new employee who previously had
health insurance,even if they have pre-existing
condition.
10
The U.S,Health Care Market,
Private Insurance
? Group market
– Possible that workers within a firm are fairly
heterogeneous,so adverse selection is less of a
concern
– On the other hand,employees not randomly
assigned
? An employer may shift-compensation toward wages,or
shift employee’s onto spouse’s plan by offering a less
generous package of benefits.
? More problematic at smaller firms.
11
The U.S,Health Care Market,
Private Insurance
? Cost-based reimbursement / Fee-for-
service
– Insurance policies that provide payments to
health care providers based on actual costs
of treating patient
– Little incentive to economize on methods for
delivering health care since fully reimbursed
12
The U.S,Health Care Market,
Private Insurance
? Managed Care
– Focus on supply-side (health care provider-side) of
market rather than on the demand size.
– Often patients face very little cost sharing (prices
close to zero)
– Quantity constraints (such as seeing a,gatekeeper”
primary care physician before seeing a specialist).
– Capitation based reimbursement – providers
received fixed,lump sum per patient,regardless of
actual utilization.
13
The U.S,Health Care Market,
Private Insurance
? Managed Care,continued
– Health Maintenance Organizations (HMOs)
– a group of physicians work only for a
particular plan and patients can only see
doctors within that plan
– Preferred Provider Organizations (PPOs)
– a group of physicians accept lower fees for
access to patient network; patients can go
out of the network at greater cost.
14
The Role of Government
? Medicare
? Implicit subsidy for employer health
insurance
? Medicaid
15
The Role of Government,
Medicare
? Enacted in 1965,provides health
insurance coverage to virtually all elderly
individuals and some disabled.
? $254 billion in 2002
? Adverse selection problems likely to be
largest for the elderly
16
The Role of Government,
Medicare
? Approximately 40 million enrollees
? Not means-tested
? Program divided into three parts:
– Part A,Hospital insurance (HI)
– Part B,Supplementary medical insurance (SMI) –
optional,but 99% of elderly take it up
– Part C,Medicare+Choice – optional,a managed care
arrangement where elderly get certain additional
benefits like prescription drug coverage and have
restricted choice of providers
17
The Role of Government,
Medicare
? Medicare does not cover:
– Long-term institutional services like nursing
homes
– Prescription drugs,though new legislation
was passed in 2003 that will phase-in
coverage
? Medicare beneficiaries spent $87 billion on
outpatient prescription drugs in 2002
18
The Role of Government,
Medicare
? Medicare financing paid for by payroll tax
on current workers
? Uncapped,totals 2.9% split evenly
between employer and employee
19
The Role of Government,
Medicare
? Medicare financing paid for by payroll tax
on current workers
? Uncapped,totals 2.9% split evenly
between employer and employee
? Medicare outlays have grown
dramatically over time – raises concerns
about its solvency
Table 10.1
21
The Role of Government,
Controlling the costs of Medicare
? Increasing burden on current
beneficiaries
? Price controls
? Complicated to administer
? May lead to access problems
? After Medicare reduced reimbursement by
5.4% in 2002,a substantial number of
medical practices stopped taking Medicare
patients
22
The Role of Government,
Controlling the costs of Medicare
? Managed care
– Only 15% of Medicare elderly choose managed care
arrangements
– A number of HMOs have backed out of providing
service
? Hospice and home health care
– End-of-life expenditures are 27% of Medicare costs,
May be less expensive to provide home health care
rather than expensive in-patient procedures
– Has not slowed the growth in Medicare costs
23
The Role of Government,
Controlling the costs of Medicare
? Medical Savings Accounts (MSAs)
– Consumers have very weak incentives to control
costs,the moral hazard issue
– MSAs are in effect a catastrophic insurance policy –
provides payments for very expensive illnesses,but
not the day-to-day health care needs
– Money in MSAs that is not used can be used for non-
medical purposes
– Leads to adverse selection,where the low-risks opt
into MSAs.
24
The Role of Government:
Implicit Subsidy for Health
Insurance
? Employer contributions for health care plans are
not subject to taxation
– If employer increases wages by $2000,employee
only keeps (1-t)x$2000,where t=marginal tax rate
– If employer provides health insurance worth $2000,
tax bill does not increase
? Provides incentive to substitute away from
wages and towards fringe benefits like health
insurance.
25
The Role of Government:
Implicit Subsidy for Health
Insurance
? Because of subsidy:
– More firms provide employer-provided health
insurance
– Firms provide more generous health
insurance
26
The Twin Issues,Access and
Cost
? Access to health care
– 83% of non-elderly have some form of health care
– 17% of non-elderly (41 million people) are uninsured
– Uninsured are diverse group
? Most are employed
? Less than half are poor
? Absence of health insurance different from
absence of health care
27
The Twin Issues,Access and
Cost
? Costs
– Table 10.2 shows the rapid growth in health
care over time
– Table 10.3 and Figure 10.2 show that the
U.S,has much higher levels of health care
expenditure than other developed countries,
but the rate of growth is not out of line
Table 10.2
Table 10.3
Figure 10.2
31
The Twin Issues,Access and
Cost
? Why are costs growing?
– The,Graying” of America – older populations require
more health care
– Income growth – health care is a normal good
– Third party payments – insurance coverage may
have changed
– Improvements in quality – treatments are very
different (better & more expensive) than in previous
decade
32
New Directions for Government’s
Role in Health Care
? Individual mandates
– States force their residents to purchase
automobile insurance,so why not health
insurance?
– Heritage Foundation’s plan would have an
individual mandate,replace the implicit tax
subsidy to employer-provided health
insurance with vouchers,and keep Medicare
and Medicaid intact.
33
New Directions for Government’s
Role in Health Care
? Individual mandates
– Analogy with automobile insurance is tenuous.
? Automobile accidents clearly cause fiscal externalities –
damages to other vehicles,passengers,and property,
The consequences of getting sick are largely
internalized.
? States remove the highest risks (e.g,those who have
drunk driving convictions and those under age 16,etc.)
from the insurance pool by restricting their ability to
drive,The high health risks are not removed in any
way.
34
New Directions for Government’s
Role in Health Care
? Individual mandates
– Enforcement of mandate is unclear
– What happens if someone did not purchase
insurance?
– If someone chooses not to drive or own an
automobile,there is no mandate that they
buy insurance.
35
New Directions for Government’s
Role in Health Care
? Single Payer
– One provider of health insurance,funded by tax
collections.
– Eliminates adverse selection problem,and is used in
many developed countries.
– Analog in U.S,would be to extend Medicare.
– Prices are not used in this case to ration health care,
and often rationing is done by impose constraints on
the supply side (e.g.,waiting lists for health care).
36
New Directions for Government’s
Role in Health Care
? Single Payer
– Also,denial of treatments for some patients
? In United Kingdom,patients over age 65 are
generally not permitted kidney dialysis
– Health care costs are growing at about the
same rate in these countries as in the U.S.
37
New Directions for Government’s
Role in Health Care
? Incremental changes to current system
– Medicare prescription drug benefit
? How generous should the program be?
? Should the program be means-tested?
? How important is adverse selection?
? How expensive will it be?
? Would greater use of prescription drugs lead
to substitution away from physicians and
hospitals,and lower overall costs?
38
Recap of Social Insurance II,
Health Care
? What’s special about health care?
? U.S,Health care market
? Role of government
? Access and costs
? Policy proposals
Chapter 10 – Social
Insurance II,Health Care
Public Economics
2
What’s Special About Health Care?
? Health care costs are large and growing
fast
? Number of reasons why First Welfare
Theorem may be violated
– Poor information (physician induced demand)
– Adverse selection and moral hazard
– Disease externalities
3
What’s Special About Health Care?
? In the context of health care,moral
hazard can be analyzed in a conventional
supply-and-demand framework.
? Health insurance changes the price of
health care,and creates deadweight loss.
Figure 10.1
5
What’s Special About Health Care?
? Without insurance,consume M0 of health
care services.
? Insurance in this example lowers the
price of services to 20% of actual price,
With insurance,consume M1 of health
care services.
? Deadweight loss equals abh.
6
What’s Special About Health Care?
? Assumed that demand for health care
downward sloping (e.g.,health care use
is elastic with respect to the price).
? Assumed coinsurance rate of 20% -- the
amount the insured person pays out of
pocket.
? Social experiments find that the elasticity
of demand for health care is -0.20.
7
The U.S,Health Care Market
? Patchwork of public and private insurance.
? 13.2% of GDP
? Spending on hospitals is 32% of costs
? Spending on physician services is 22%
8
The U.S,Health Care Market,
Private Insurance
? Virtually all (93%) of private insurance for
the non-elderly is provided through the
employer.
– By-product of wage & price controls during
World War II
– Tax provisions subsidize employer
contributions
– Group market is less expensive than
individual market
9
The U.S,Health Care Market,
Private Insurance
? Link to employment potentially leads to,job lock”
– When you leave your job,you also lose your health
insurance
– May be difficult to get new insurance if you have a
“pre-existing” condition
– Kennedy-Kassenbaum Act mandated that employers
must include a new employee who previously had
health insurance,even if they have pre-existing
condition.
10
The U.S,Health Care Market,
Private Insurance
? Group market
– Possible that workers within a firm are fairly
heterogeneous,so adverse selection is less of a
concern
– On the other hand,employees not randomly
assigned
? An employer may shift-compensation toward wages,or
shift employee’s onto spouse’s plan by offering a less
generous package of benefits.
? More problematic at smaller firms.
11
The U.S,Health Care Market,
Private Insurance
? Cost-based reimbursement / Fee-for-
service
– Insurance policies that provide payments to
health care providers based on actual costs
of treating patient
– Little incentive to economize on methods for
delivering health care since fully reimbursed
12
The U.S,Health Care Market,
Private Insurance
? Managed Care
– Focus on supply-side (health care provider-side) of
market rather than on the demand size.
– Often patients face very little cost sharing (prices
close to zero)
– Quantity constraints (such as seeing a,gatekeeper”
primary care physician before seeing a specialist).
– Capitation based reimbursement – providers
received fixed,lump sum per patient,regardless of
actual utilization.
13
The U.S,Health Care Market,
Private Insurance
? Managed Care,continued
– Health Maintenance Organizations (HMOs)
– a group of physicians work only for a
particular plan and patients can only see
doctors within that plan
– Preferred Provider Organizations (PPOs)
– a group of physicians accept lower fees for
access to patient network; patients can go
out of the network at greater cost.
14
The Role of Government
? Medicare
? Implicit subsidy for employer health
insurance
? Medicaid
15
The Role of Government,
Medicare
? Enacted in 1965,provides health
insurance coverage to virtually all elderly
individuals and some disabled.
? $254 billion in 2002
? Adverse selection problems likely to be
largest for the elderly
16
The Role of Government,
Medicare
? Approximately 40 million enrollees
? Not means-tested
? Program divided into three parts:
– Part A,Hospital insurance (HI)
– Part B,Supplementary medical insurance (SMI) –
optional,but 99% of elderly take it up
– Part C,Medicare+Choice – optional,a managed care
arrangement where elderly get certain additional
benefits like prescription drug coverage and have
restricted choice of providers
17
The Role of Government,
Medicare
? Medicare does not cover:
– Long-term institutional services like nursing
homes
– Prescription drugs,though new legislation
was passed in 2003 that will phase-in
coverage
? Medicare beneficiaries spent $87 billion on
outpatient prescription drugs in 2002
18
The Role of Government,
Medicare
? Medicare financing paid for by payroll tax
on current workers
? Uncapped,totals 2.9% split evenly
between employer and employee
19
The Role of Government,
Medicare
? Medicare financing paid for by payroll tax
on current workers
? Uncapped,totals 2.9% split evenly
between employer and employee
? Medicare outlays have grown
dramatically over time – raises concerns
about its solvency
Table 10.1
21
The Role of Government,
Controlling the costs of Medicare
? Increasing burden on current
beneficiaries
? Price controls
? Complicated to administer
? May lead to access problems
? After Medicare reduced reimbursement by
5.4% in 2002,a substantial number of
medical practices stopped taking Medicare
patients
22
The Role of Government,
Controlling the costs of Medicare
? Managed care
– Only 15% of Medicare elderly choose managed care
arrangements
– A number of HMOs have backed out of providing
service
? Hospice and home health care
– End-of-life expenditures are 27% of Medicare costs,
May be less expensive to provide home health care
rather than expensive in-patient procedures
– Has not slowed the growth in Medicare costs
23
The Role of Government,
Controlling the costs of Medicare
? Medical Savings Accounts (MSAs)
– Consumers have very weak incentives to control
costs,the moral hazard issue
– MSAs are in effect a catastrophic insurance policy –
provides payments for very expensive illnesses,but
not the day-to-day health care needs
– Money in MSAs that is not used can be used for non-
medical purposes
– Leads to adverse selection,where the low-risks opt
into MSAs.
24
The Role of Government:
Implicit Subsidy for Health
Insurance
? Employer contributions for health care plans are
not subject to taxation
– If employer increases wages by $2000,employee
only keeps (1-t)x$2000,where t=marginal tax rate
– If employer provides health insurance worth $2000,
tax bill does not increase
? Provides incentive to substitute away from
wages and towards fringe benefits like health
insurance.
25
The Role of Government:
Implicit Subsidy for Health
Insurance
? Because of subsidy:
– More firms provide employer-provided health
insurance
– Firms provide more generous health
insurance
26
The Twin Issues,Access and
Cost
? Access to health care
– 83% of non-elderly have some form of health care
– 17% of non-elderly (41 million people) are uninsured
– Uninsured are diverse group
? Most are employed
? Less than half are poor
? Absence of health insurance different from
absence of health care
27
The Twin Issues,Access and
Cost
? Costs
– Table 10.2 shows the rapid growth in health
care over time
– Table 10.3 and Figure 10.2 show that the
U.S,has much higher levels of health care
expenditure than other developed countries,
but the rate of growth is not out of line
Table 10.2
Table 10.3
Figure 10.2
31
The Twin Issues,Access and
Cost
? Why are costs growing?
– The,Graying” of America – older populations require
more health care
– Income growth – health care is a normal good
– Third party payments – insurance coverage may
have changed
– Improvements in quality – treatments are very
different (better & more expensive) than in previous
decade
32
New Directions for Government’s
Role in Health Care
? Individual mandates
– States force their residents to purchase
automobile insurance,so why not health
insurance?
– Heritage Foundation’s plan would have an
individual mandate,replace the implicit tax
subsidy to employer-provided health
insurance with vouchers,and keep Medicare
and Medicaid intact.
33
New Directions for Government’s
Role in Health Care
? Individual mandates
– Analogy with automobile insurance is tenuous.
? Automobile accidents clearly cause fiscal externalities –
damages to other vehicles,passengers,and property,
The consequences of getting sick are largely
internalized.
? States remove the highest risks (e.g,those who have
drunk driving convictions and those under age 16,etc.)
from the insurance pool by restricting their ability to
drive,The high health risks are not removed in any
way.
34
New Directions for Government’s
Role in Health Care
? Individual mandates
– Enforcement of mandate is unclear
– What happens if someone did not purchase
insurance?
– If someone chooses not to drive or own an
automobile,there is no mandate that they
buy insurance.
35
New Directions for Government’s
Role in Health Care
? Single Payer
– One provider of health insurance,funded by tax
collections.
– Eliminates adverse selection problem,and is used in
many developed countries.
– Analog in U.S,would be to extend Medicare.
– Prices are not used in this case to ration health care,
and often rationing is done by impose constraints on
the supply side (e.g.,waiting lists for health care).
36
New Directions for Government’s
Role in Health Care
? Single Payer
– Also,denial of treatments for some patients
? In United Kingdom,patients over age 65 are
generally not permitted kidney dialysis
– Health care costs are growing at about the
same rate in these countries as in the U.S.
37
New Directions for Government’s
Role in Health Care
? Incremental changes to current system
– Medicare prescription drug benefit
? How generous should the program be?
? Should the program be means-tested?
? How important is adverse selection?
? How expensive will it be?
? Would greater use of prescription drugs lead
to substitution away from physicians and
hospitals,and lower overall costs?
38
Recap of Social Insurance II,
Health Care
? What’s special about health care?
? U.S,Health care market
? Role of government
? Access and costs
? Policy proposals
