The Theory of Demand for Health Insurance

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Stanford University Press, 2003 - Business & Economics - 201 pages
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Why do people buy health insurance? Conventional theory holds that people purchase insurance because they prefer the certainty of paying a small premium to the risk of getting sick and paying a large medical bill. Conventional theory also holds that any additional health care that consumers purchase because they have insurance is not worth the cost of producing it. Therefore, economists have promoted policies—copayments and managed care—to reduce consumption of this additional, seemingly low-value care.

This book presents a new theory of consumer demand for health insurance. It holds that people purchase insurance to obtain additional income when they become ill. In effect, insurance companies act to transfer insurance premiums from those who remain healthy to those who become ill. This additional income generates purchases of additional high-value care, often allowing sick persons to obtain life-saving care that they could not otherwise afford.

Regarding risk, the new theory relies on empirical studies showing that consumers actually prefer the risk of a large loss to incurring a smaller loss with certainty. Therefore, if consumers purchase insurance, it is not because they desire to avoid risk. Instead, the new theory suggests consumers simply pay a premium when healthy in exchange for a claim on additional income (effected when insurance pays for the medical care) if they become ill.

Health insurance is substantially more valuable to the consumer under the new theory. The new theory moreover implies that copayments and managed care—central health policies of the last 30 years—were directed at solving problems that largely did not exist. Because these policies either reduced the amount of income transferred to ill persons or limited access to valuable health care, they may have done more harm than good. The new theory also provides a solid theoretical justification for insuring the uninsured and for implementing national health insurance.

  

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Contents

Introduction
1
Overview of the New Theory
2
Overview of the Book
3
Intuition
5
Notes
7
Conventional Theory and Anomalies
8
Von NeumannMorgenstern vNM Utility Function
12
Conventional Expected Utility Theory
16
New Demand Curve Price Effect
92
Coinsurance Rate
93
Medical Care Spending Share
95
Income Elasticity of Demand
97
Estimates of the Relative Welfare Loss
98
Implications
99
Notes
101
Welfare Gain from Moral Hazard
102

The Moral Hazard Welfare Loss
19
Anomalies
21
ContingentClaims Insurance Payoffs Have No Income Effects
22
Consumers Prefer Certain Losses
24
Risk Preferences Derive Only from Diminishing Marginal Utility
25
Insurance at Current Coverage Parameters Is Welfare Decreasing
26
Summary
27
Notes
29
New Theory
30
Graphical Model
34
Decision to Purchase Insurance
37
Extreme Case and Examples
38
ContingentClaims versus PricePayoff Insurance Contracts
41
The Physician and Substitutability of Medical Care for Other Goods and Services
43
Payoffs Treatment Costs and Full Coverage
44
Welfare Consequences at the Margin
46
Summary
47
Note
48
Expected Utility Theory from a Quid Pro Quo Perspective
49
Derivation of the Quid Pro Quo Specification
53
Prospect Theory
54
Focusing on the Insurance Contract
56
Additional Considerations
58
Importance and Implication
60
The Gain Specification
63
Note
66
Access Value of Health Insurance
67
Model
68
Prevalence of the Access Motive
70
Access Valuation of a Given Procedure
71
Estimating Willingness to Pay
72
Valuing Outcomes
73
Specific Disease Example
74
Access Value from CostUtility League Tables
75
Access Value Using the NMES
77
Charity Care
78
Importance of the Access Motive
79
Note
80
Welfare Loss from Moral Hazard
81
Paulys Moral Hazard Welfare Loss
82
Overview of the Rest of the Chapter
84
Hicksian Decomposition Holding Utility Constant
85
FriedmanSlutsky Decomposition Holding Real Income Constant
86
New Decomposition Holding Nominal Income Constant
87
Welfare Loss from Insurance
88
Mathematical Expression of the Welfare Loss
90
Marshallian Demand Curve Price Effect
91
Moral Hazard as Specific Health Care
103
Evaluating Moral Hazard
107
An Estimate of the Welfare Gain
109
Literature on Health Insurance and Health
110
Estimating the Welfare Gain
112
Refinements of the Analysis
114
The Welfare Gain from Moral Hazard Diagrammatically
116
Conclusions
118
Notes
120
Why Health Insurance is Sometimes Not Purchased
122
Charity and Medicaid
123
Risk
126
Digression on Gambling and Insurance
128
Separating Risk Preferences from the Bernoulli Utility Function
133
Loading Fees and Premiums
136
PriceRelated Moral Hazard
137
Adverse Selection
139
PhysicianInduced Demand
140
Notes
142
Policy Implications
143
Cost Sharing
144
Coinsurance and Moral Hazard
145
Calculating the Effect of Coinsurance on Efficient Moral Hazard
147
Rices Theory
149
Managed Care
151
A PriceReduction Strategy
152
Optimal Health Insurance Design
153
Insuring the Uninsured
155
Medicare
156
The Case for Tax Subsidies
157
Technology Growth as Moral Hazard
159
Conclusions
161
Notes
162
Conclusions
164
The Value of Health Care and National Health Insurance
166
Potential Weaknesses
167
Blank Check Argument
169
Consumers Income Payoff Test
170
Limitations
171
Future Empirical Work
172
A Cautionary Word
174
Intuition Revisited
177
Notes
179
References
180
Index
195
Copyright

Common terms and phrases

Popular passages

Page 185 - Hafner-Eaton, C. (1994). Patterns of hospital and physician utilization among the uninsured. Journal of Health Care for the Poor and Underserved 5, 297-315.
Page 181 - Berk, Marc L., Alan C. Monheit, and Michael M. Hagan. 1988. "How the US Spent Its Health Care Dollar: 1929-1980.
Page 185 - What We Don't Know About Why Health Expenditures Have Soared: Interaction of Insurance and Technology.

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About the author (2003)

John A. Nyman is Professor of Health Services Research and Policy at the University of Minnesota.

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