Health Economics

Lecture 6Health Care Systems

and Institutions

1. What would you prefer?

A. WIN 500 riyals

or

B. Flip a coin:

50 percent chance you WIN 1,000 riyals

50 percent chance you lose nothing

2. What would you prefer?

A. LOSE 500 riyals

or

B. Flip a coin:

50 percent chance you lose nothing

50 percent chance you LOSE 1,000 riyals

Who gets the Benefits?Me Not Me

Me

NotMe

Who pays the Costs?

Balanced Too Cautious

Too Risky Don’t Care

Milton Friedman(1912 - 2006)

Nobel Prize1976

Friedman MatrixWho’s Money?

My Not Mine

Me

NotMe

Spent on Who?

Price: YesQuality: Yes

Price: NoQuality: Yes

Price: YesQuality: No

Price: NoQuality: No

Heath Care SystemThe organizational

arrangements and processes through which a society makes choices about the production, consumption, and distribution

of health care services

Four Questions

Who decides? Who finances?

How reimbursed?How produced?

Claims

BuyersConsumers

Patients

SellersProducersProviders

Medical Services

Fees

Insurers or Third-Party Payers

Money - Fixed orVariable

PremiumsCoverage Government or Employer

Taxes or lower wages

Premiums

Direct Relationship to Indirect with two intermediaries

Adds complexityChanges incentives

Centralized Decentralized

Who makes the choice?

Government Individual

AdvantagesEconomies of scale

Everyone equal

Lots of choicesCompetition

Simple

Disadvantages

No incentivesNo innovation

High costs of collecting informationComplexity

Lack of efficiency

Private Government

Choice Voluntary Mandatory

Financing Premiums Taxes

Payment Based on risk Same for all

NormalMarket

MedicalMarket

Planned Yes No

Know Price Yes No

Guarantee Yes No

Equal Information Yes No

Medical events are random and unpredictable

However, with a large number of people, the average can be

predicted fairly accurately

Insurance

Sharing risk

Does not eliminate riskSpread around risk

Risk Aversion

A dislike of uncertainty

Estimating Expected Cost

1. Estimate the cost of an event 2. Estimate the probability of an event3. Expected Cost = Cost x Probability

1. 1002. 1 in 20 or 1÷ 20 or 5% or .053. 100 x .05 = 5

Estimating Expected Cost

1. 50002. 1 in 303. Expected Cost ?

= 5000 x .03333= 166.67

5000 or 30 x 166.67?

Progress is Risky

Insurance allows us to share the risk

Therefore, insurance allows us to be more risky

Therefore, insurance allows us to make progress

Insurance Problems

Asymmetric InformationAdverse Selection

Moral Hazard

Asymmetric Information

Parties to a trade do not have the same

information

Not Equal

Adverse Selection

Making a bad choice due to asymmetric

information

Moral Hazard

Changing behavior after an agreement

Temptation to abuse the other party

Diversification

Replace one large risk with lots of smaller

unrelated risks

Deductible Pay first fixed amount

CopaymentPay fixed amount for

each incident

CoinsurancePay fixed percentage for

each incident

Three Types of Coverage

Incentives to Keep Costs LowType of

Reimbursementfrom Insurer

Fixed Variable

Low

HighOut-of-Pocket

costs to Patient Provider

worriesNobodyworries

PatientworriesBoth worry

Health

Medical Costs

LargeGain

Diminishing Marginal UtilityHealth and Medical Costs

SmallGain

For-Profitvs.

Not-for-Profit

For-Profit Not-For-Profit

InformationPerfectlyInformed

ImperfectInformation

Equity Ability to Pay Need

Externalities None Several

For-Profit Not-For-Profit

Initial Capital Shareholders Donations

Profits Distribute Retain

Sale Easy Difficult

Taxes Liable Exempt

Type of Goods No restrictions Restricted

Summary

Decision Individuals or government

Financing Out-of-pocket, Premiums, or Taxes

Reimbursement Fixed or Variable

Produced For-profit, Not-for-profit, or Public