Health insurance is a form of insurance cover that caters for surgical and medical expenses that are incurred by the insured. Health insurance can either pay the care provider directly or reimburse the insured for expenses incurred from injury or illness. Some employers use it as a non-monetary benefit package to attract highly qualified employees. There are various types of health insurance plans. Nevertheless, all plans are expected to offer a minimum level of coverage. Some plans are comprehensive implying that they provide a variety of services. The coverage offered could be dental coverage, maternity coverage and prescription drug coverage. The various types of health plan include Indemnity plan, Conventional indemnity plan, Preferred provider organization, Exclusive provider organization, Health maintenance organization, Point-of-service plan and Physician-hospital organization. The cost of insurance premiums is deductible from the payer and the benefits received are not taxed.
Inefficiencies in health insurance are as a result of information asymmetry. This is a situation in which one party in a transaction is more informed in comparison to the other. In most cases, the seller is always more informed about the conditions and quality of the product he is selling. There is therefore; a possibility of one party, mostly the seller, taking advantage of the other party`s lack of adequate information. However, with the increased advancements in technology, information asymmetry has declined tremendously since more people are able to access information easily. Information asymmetry causes an imbalance in the market since all parties do not have adequate information which they can use as a basis of decision making. Health insurance inefficiencies as a result of asymmetric information can be broken down into adverse selection, moral hazard, supplier induced demand.
Adverse selection in the context of health insurance refers to a situation when a group of buyers have information about their risk which the sellers do not have. A seller usually prices the insurance package at an average cost. The consumers in the group which have more information about their risk will impose less than average cost in purchasing the insurance cover. The rest of the people will impose above average cost. The insurer will therefore have to set high prices. This will make most consumers to decline the insurance package. The customers who have extremely high expected costs are the ones who will buy the full coverage. However, in case there was symmetric information, the insurer would charge each individual his or her expected cost. This would enhance the elimination of risks through diversification by pooling a large number of risks.
Adverse selection can be reduced through screening. Individuals are expected to give all the information regarding their health. The screening practice by insurance firms, however, hinders the achievement of an efficient risk pooling among individuals. The governments, therefore, offer obligatory public health insurance. This is because adverse selection leads to insufficient insurance coverage for those who most in health insurance. In most cases health expenditure is concentrated within a small section of the population. Therefore, it would be preferable to force all individuals into the same insurance pool.
Another source of market inefficiency in health insurance is moral hazard. Moral hazard occurs when consumers demand more health care than they actually require. This is because all or part of the cost of the services is borne by a third party. This could be the government or an insurance company. In most cases, consumers will consume the services as long as the additional costs are fairly lower in comparison to the value of the additional services they receive. The excessive consumption of the health services than what is required is a problem. Moral hazard leads to the worsening of the consumer`s health. This is because the consumer will continually take unhealthy actions. For instance, if a smoker expects the costs of illness as a result of smoking to be catered for partly or wholly by a third party, he may not quit smoking. An elderly individual may also be reluctant to seek preventive care if he knows that his treatment would be covered by a third party. In both the two instances, the consumers will make insurers incur more costs in future, hence increased costs of health insurance. The rise in health costs will be borne by consumers increased premiums or taxes. In case health insurance providers were able to make high volume consumers incur more costs, the consumers would take precautionary actions such as not smoking, consuming healthy foods and exercising. However, the problem of moral hazard has even grown worse since insurers set premium at an average cost without taking an individual’s actions into account. Therefore, consumers lack the incentive to maintain healthy living standards.
Nevertheless, there has been an attempt to reduce the effects of moral hazard through establishing health maintenance organization which merges health care provider and third party payers. Although this system is criticized on grounds that the doctor assumes the role of the residual claimant and the care giver, it attempts to control excessive demand and overconsumption. The government on the other hand attempts to eliminate moral hazard through price and quantity rationing.
Supplier Induced Demand
The information asymmetry in the patient-doctor relationship is another case of inefficiency. Information asymmetry leads to unusual relationship between doctors and patients. Technically, doctors are more informed about the health conditions of their patients. There is always an agency relationship between doctors and patients. Patients rely on doctors who act as their agents. This implies that doctors are expected to not only maximize patients’ interests but also maximize his own interests since he is the seller of health services. Doctors are motivated by the profit motive. In a perfect market situation, doctors will exploit patients by advising more treatment than is required, using reciprocal referrals to specialists in other fields and prescribing more expensive drugs to gain favour with pharmaceutical companies to with an aim of increasing income. This is known as supplier induced demand. Nevertheless, doctors operations are governed by a professional code and are expected to behave ethically. They are obliged to maximize patients` interests and not their own. However, if doctors were to behave like other business persons without any code of conduct, there would be supplier induced demand.
If supplier induced demand takes place due to lack of a strong system to ensure that doctors behave ethically, the market will fail to operate efficiently. This is because doctors and patients cannot trade efficiently if one side of the transaction can be charged or manipulated due to lack of adequate information. However, with enhanced technology, the market system will punish those doctors who tend to exploit patients. This will be as a result of no repeat seeking of services by patients. The doctors who can verify that they honestly convey their information will be rewarded through established long term relationships. There is therefore need to ensure that all doctors are competent to offer medical care. The governments require doctors to be licensed to practice by an authorized board and graduate from an accredited medical institution.
All the same, patients still lack an assurance that licensed and competent doctors will not use their informational advantage for personal growth. Patients may also have a false sense of assurance that leaves them more subjected to exploitation. This is as a result of agency problem. In general, the agent has various desires and motivations. Principals will have to bear extra costs of either establishing incentives for agents or monitoring the agents to perform their duties more appropriately.
In general, information asymmetry in health insurance leads to adverse section, moral hazard and supplier induced demand. These result into market failure since the equilibrium is distorted. Supplier induced demand for instance is a source of consumer exploitation. Doctors will in this case take advantage of patients’ lack of knowledge to make them consume more services than they need. Adverse selection on the other hand will make a group of consumers to incur high costs as another group enjoy subsidized costs. Adverse selection also makes some individuals shy away from subscribing to health insurance due to the high average costs. Lastly, moral hazard worsens individual’s health as they do not take precautionary measures against their health. This is because they expect insurers to pay for the costs of treatment in the future. Moral hazard also leads to overconsumption.
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