30508– Public Finance

2024/2025

Chapters 15 + something

Healthcare
Simone Ghislandi
Total Healthcare Spending in the OECD Nations, 2012
Total Healthcare Spending in the OECD Nations, 2012

In 2012, the United States devoted nearly twice as much of its economy to
health care as did Italy, Sweden or the United Kingdom.
Life expectancy at birth, total population (2019)
HLI= Human Life Index: Life Expectancy with more weight to child mortality
Healthcare Public Expenditure, % of Total H. Expenditure
«out-of-pocket» healthcare expenditure
% of total healthcare expenditure
Americans’ Source of Health Insurance Coverage, 2013

People (millions)
Private 201.1
Employment-based 169.0
Direct purchase 34.5
Public 107.6
Medicare 49.0
Medicaid 54.1
TRICARE/CHAMPVA 14.1
Uninsured 42.0
Nearly two-thirds of insured Americans have private health insurance, largely
through employers. Roughly one-sixth of Americans are uninsured.
APPLICATION: Finding the Inefficiency in U.S.
Healthcare - International Comparison of Indicators of Health
System Outcomes

The United States is a major outlier in international terms

when it comes to health care spending.
APPLICATION: Finding the Inefficiency in U.S.
Healthcare - International Comparison of Indicators of
Health System Outcomes
The United States lags behind other countries
internationally.
• The United States has the highest per person health
care costs of this set of countries.
• The United States has the highest rate of infant
mortality.
• The United States has the highest rate of preventable
death.
• The United States has the highest rate of going
without care over the past year because of cost.
APPLICATION: Finding the Inefficiency in U.S.
Healthcare - High Prices

The United States

pays higher prices on
average for services
and drugs.
APPLICATION: Finding the Inefficiency in U.S.
Healthcare - Why Are Prices So Much Higher?

Prices are higher because:

• Price elasticity for healthcare is very low (very inelastic
demand, especially for life-saving treatments)
• Other nations impose much stronger regulatory
controls on the prices of medical services and drugs.
• Medical goods and services in the United States reflect
a hybrid mix of public price setting and private
competition, which results in higher overall prices.
• There is the higher intensity with which U.S. patients
are treated, leading to both unnecessary and
inefficiently delivered care.
 Perfect competition?

Il sistema sanitario
21
The Uninsured

Who are they?

• There are 42 million in the United States without any
insurance coverage.
• The uninsured have lower-than-average incomes.
• However, not all uninsured are poor (16% of uninsured
have income>$75000)
• In 2012, nearly two-thirds of the uninsured came from
families where one or more members were full-time
workers.
• About 7.6% of the uninsured are children.
Facts in the US
% of non-insured among employees,
by employer dimension
Adverse selection?
Why Are Individuals Uninsured?

• They may be counting on uncompensated care

o Uncompensated care: The costs of delivering
health care for which providers are not reimbursed
• Insurance may cost too much, given risks and prices.
• Insurers may be unwilling to insure the worst risks
because of fears of adverse selection.
• They are not appropriately valuing insurance coverage.
Why Care about the Uninsured?

There are several reasons to care about the uninsured.

• There are physical externalities associated with
communicable diseases.
• There is a significant financial externality imposed by
the uninsured on the insured. (after ObamaCare
uncompensated care spending fell by 21%)
• Care is not delivered appropriately to the uninsured.
• Paternalism and equity motivations.
How Health Insurance Works: The Basics

• Individuals, or firms on their behalf, pay monthly

premiums to insurance companies.
• In return, the insurance companies pay the providers
of medical goods and services for most of the cost of
goods and services used by the individual.
• There are three types of patient payments:
o Deductibles—limit to cost individual pays
o Copayment—fixed payment individual pays
o Coinsurance—percentage of each bill individual
pays
 Demand for Insurance: variables
Two states of the world: health (good) and illness (bad)
Income perspectives for agent: W=(Wbad ,Wgood)
Wbad = w-d (d = damage, monetary loss from illness)
Wgood = w
Probability of the negative event p
Insurance contract (m,b):
Reimbursement in case of negative event: b
premium per unit of reimbursement m; total premium mb
Define:
Complete coverage: b=d
Partial coverage: b<d
Actuarially fair premium: p= m
Demand for Insurance: full insurance
Life is a lottery with: E(U) = p U(Wbad) + (1- p) U(Wgood)
Remember, we are risk adverse. Then we prefer to pay
something in order to smooth our income and get always a
certain wealth W.
Full insurance requires that

b*=d ⇒ Wgood = Wbad

That is, there is no lottery anymore. The states of the world

are the same. Full insurance insulate the individual from the
consequences of risky negative events.
 Supply of insurance:
the market solution
Insurance companies are profit maximizers. Their job is to offer
contracts characterized by the premium m and the premium
coverage b, which is uncertain.
We can identify the Expected Profit of a company serving N
people all with the same risk profiles:
E(P)=Nmb-Npb

If p=m, E(P)=0. This is the situation that we have seen from

the demand side.
Risks are independent
The company does not have further administrative costs.
 Supply of insurance:
the market solution
• The basic idea of market-oriented approaches relies on two main
assumptions:
Welfare is maximized if p=m (minimum possible price). This
happens under perfect competition among insurance companies: If
company A offers mA>p, company B can offer mB<mA and get
all the demand. This game goes on until there is more room
for price drops, that is when the premium is actuarially fair.
The firm can not be risk adverse, otherwise it will not get into
the game. We assume that the firm is risk neutral: sometimes
it looses, sometimes it wins, but on average profits are zero.
This is enough to stay in the market.
 Equilibrium
By using the right assumptions we have “proven” that the
market for health insurance works:
Risk adverse consumers get what they want:
a coverage that will protect them against possible catastrophic
expenditures, at the minimum possible cost.
Companies are happily competing with each other.
Free choice is preserved. No rationing, no constraint.
Everyone is choosing what is best for himself/herself.
Government and taxations are out of the way, as they should
always be in decent pareto-optimal worlds!
 PRIVATE VOLUNTARY INSURANCE:
PROBLEM 1 (NOT IN THE BOOK)
• In a competitive market, premiums should be fair: the
premium per unit of reimbursement should be equal to
the probability of the negative event.
• However, what is the probability that between 80 and 85
one would consume some form of healthcare? What
about chronic conditions?
• If the probability is close to 1, the premium per unit of
reimbursement should be close to one too. That means
that we should ask someone to pay an overall premium
close to the reimbursement she will almost certainly ask
for.
• De facto, the insurance market does not exist for these
people (Heterogeneity)
 PRIVATE VOLUNTARY INSURANCE:
PROBLEM 1 (NOT INTHE BOOK)
Two solutions:
1. To impose some risk pooling while also making it
compulsory to accept high risks. However, this does not
eliminate the cream skimming problem.
2. Public insurance through general taxation. In this way,
the risk profile does not affect the payments for the
insurance.
 PRIVATE VOLUNTARY INSURANCE:
PROBLEM 2 (NOT IN THE BOOK)

• Insurance companies might be able to select the good

(low) risks.
– expliticly
– Even when selection is forbdden, it can be done implicitly
• Cream skimming: companies can offer contracts by which
the good risks self-select themselves.
– Special treatment for healthy, young people
– Selection of hospital/doctors/technology specifically for certain
treatments
• Cream skimming is a problem even when insurance is
mandatory.
 PRIVATE VOLUNTARY INSURANCE:
PROBLEM 2 (NOT IN THE BOOK)

• Two main solutions to cream skimming:

1. Single insurer (Gorvernment). This of course eliminates
the problem.
2. Risk adjustment: companies subsidize the competitors
that accept bad risks. For example, companies that have
insured with a high average age receive money from the
others, or from the government, hence reducing the
incentives to select the young only.
Medicare

• Medicare: A federal program that provides health

insurance to all people over age 65 and disabled
persons under age 65.
Every citizen who has worked for ten years in Medicare-
covered employment (and their spouse) is eligible for
Medicare at age 65.
Medicare is financed by a payroll tax on employees and
employers.
Medicaid

• Medicaid: A federal and state program that provides

health care for the poor.
• Medicaid benefits are targeted at several groups:
o Those who qualify for cash welfare programs
o Most low-income children in the United States
o Most low-income pregnant women
o All very low-income families
o The low-income elderly and disabled
Medicaid
Medicare
Health Insurance Coverage
 PRIVATE VOLUNTARY INSURANCE:
PROBLEM 3: ADVERSE SELECTION
(Ch 12.2)
• Adverse selection: The fact that insured individuals
know more about their risk level than does the insurer
might cause those most likely to have the adverse
outcome to select insurance, leading insurers to lose
money if they offer insurance.
• Selling to both requires that low-risk people subsidize
high-risk people.
• Low-risk people may not want to do this.
• Sometimes, only high-risk people end up with
insurance.
 HEALTH INSURANCE:
PROBLEM 4: MORAL HAZARD
Trade-off of health insurance: the gains in terms of consumption smoothing
versus the costs in terms of overuse of medical care
Price of visit

Deadweight loss

A B Supply =
$100
social marginal cost

Demand =
social marginal benefit
C
10 Private marginal cost

0 Q1 Q2 Number of visits
to doctor’s office
 MORAL HAZARD REVISITED

●The disturbing assumption of this literature is that individuals

can always choose whether to buy or not an insurance. If they
don't, it is just because their utility is higher than under the
insurance scenario.
However:
●

–Moral hazard is measured only by the substitution effect

of social insurance programs.
–Insurance might affect behavior through an income effect:
People use care that is now affordable.
 The Italian Healthcare System
(Topic not in the book)
Italian Constitution:
Art. 32 The Republic safeguards health as a fundamental right of the
individual and as a collective interest, and guarantees free medical care
to the indigent.
• Although free medical care only for the indigent,
Italy has implemented a fully universal system to
better guarantee the fundamental right to health.
• 1978 - creation of Servizio Sanitario Nazionale
(SSN) financed through general taxation, in place of
the mutualistic (aka Bismark) system.
• Since then all international institutions ranked Italy
higher and higher for health outcomes, quality of
care and efficiency of the system
http://www.who.int/hea
lthinfo/paper30.pdf
Quasi Markets in Health

Government

Adjusted fixed transfer per

regional citizen + transfers for
out-of-region patients

Public Buyers
Regional Health Authorities
Choose/
Pay DRG for
Competition
patient
Patients Choose/
Competition
Health Service Providers:
Patient receives hospitals, doctors etc.
Care
 How does the Italian system work?
• Ministry of health decides on healthcare levels and
prevention
• Regions (e.g. Lombardia, Sicilia, Lazio) organize and run
the healthcare system.
• Regions decide also on how to finance/purchase medical
care for patients
• Hospital care is paid through Diagnosis Related Group
(DRG), fixed price based on diagnosis and treatment.
• This system allows public administration to purchase
treatment from public and private hospitals at the same
price (competition within public universal system)
• 20 heterogenous healthcare systems
• Patients are free to choose which regional care to get
(competition between regions)
Payment mechanisms (how are
providers paid?).
• Prospective payment: Diagnosis Related Groups (DRG). It
is a pre-defined price for each medical intervention.
– Incentive for efficiency.
– Incentive for over-treatment.
– Quality?

• Cost: Insurance reimburses the costs.

– Incentive for quality
– No incentive for efficiency, no incentive for over-
treatment
Homework and study info

• Chapter 15: drop 15.2 and 15.3

• Slides