Health Care

Health Care (guest Lecture) Health care expenditures over time Single largest expenditure category for households Exceeds expenditures on food, clothing, housing How does healthcare differ from other goods Role of insurance Buyers pay a fee (premium) at some regular interval (i.e. once a month) for the promise of payment if an adverse event happends Why do people buy insurance? Definition Expected value, E(x): Amount a person can expect to receive on average when facing an uncertain outcome, X Ex: card game (draw from deck of cards) Outcome 1 ? heart, probability (heart) = 1/4th (win $12) Outcome Z ? nonheart, probability (non heart) = 3/4th (lose $4) E(x) = (1/4) ($12) + (3/4)(-$4) E(x) = $3 -$3 = 9 In general E(x) = prob(X1) * X1 + prob (X2) * X2 Definition Actuarilly fair premium Expected value of the loss from insuring a person ****EX Suppose Emily has a probability of getting sick = 10% and med expenses if sick are $30K Compute Emily?;s actuarially fair premium E(loss) =(.10)($30K) + (.90)($0) E(Loss) = $3,000 Note *Emily is willing to pay atleast $3,000 per year for insurance Risk neutral Risk Averse E(loss) = $3,000 ? insurance company Perspective ? 1 out of 10 will get sick 1 person get paid $30,000 per year Charge $3,000 to each so that revenus = $30k per 10 people Note: actuarially fair premium = ?break even? premium Ex of why Health Care market is inefficient because asymmetric information (imperfect information) buyer or the insured knows his/her health status, but seller doesn?t ***Adverse Selection Seller can?t distinguish who is high rick versus low risk, Set premium = E(loss) Across the population Low risk people opt-out High risk stay (though some are kicked out because of preconditions) Premiums rise over time Ex Buyer High risk E(loss) = (.20)(30K)+(.80)($0) =$6,000 Actuarially fairprimium if insurance cost companies can?t observe who is Low/High rick, but know 50% in each category E(loss) = = $4,500 Set the premium = $4,500 Low risk opt out (because willing to pay might only be $3,000) Some high risk excluded Fewer covered in the market than would be efficient Solution would be mandatory insurance? Year % of GDP 1960 5% 2007 16% Buyer Prob(sick) Med Exp if sick E(Loss) Low risk 10% $30K $3,000 High risk 20% $30K $6,000