In the previous segment we discussed moral hazard.

We showed that in order to mitigate the moral hazard problem,

the insurer must transfer some of the risk back to the insured

the individual by offering partial coverage or cost sharing.

That is, the insurer and member share the costs of medical care expenditures.

We already discussed the common cost sharing arrangements,

deductibles, coinsurance and copays.

In this segment, we will discuss the impact of

these cost sharing arrangements on medical care consumption.

But before we do that let's quickly see what

moral hazard means in the case of health insurance.

The presence of health insurance lowers the effective price that people pay for care.

For example imagine you're coming down with a

cold and when visiting your primary care physician,

you're asked to pay $20 copay but does this visit really cost $20?

Of course not.

Let's say this visit really cost $300 and if you had to pay their full cost of the visit,

would you still go and see your physician.

Or would you try and use over the counter cold or cough medication.

But for you, the insured individual,

the effective cost of the visit is $20.

So why not go see your physician.

If you think about it, this is simply the law of demand.

If we had to pay $300 per visit,

we would have fewer visits than if we had to pay $20.

Therefore, moral hazard in health insurance refers to the idea that insured

individuals increase their consumption of

medical care specifically because they have insurance.

So let's revisit the role of cost sharing,

starting with co- insurance rates.

The fraction of the cost of a covered healthcare service that the policyholder pays.

Take the demand for specialist care visits.

Here is our downward sloping demand curve.

Let's assume that a visit costs $500.

If you're asked to pay this amount out-of-pocket

you would visit the specialist three times a year.

If the cost of a visit was $300,

you would increase your number of yearly visits to four.

Now imagine that you are insured and the coinsurance rate is 10 percent.

If the visit costs $500,

you pay $50 out-of-pocket and if the visit cost $300,

you pay $30 out-of-pocket.

The out-of-pocket payment is the price that consumers

see as insurance insulates them from the actual cost of the service.

So at $50 you would see a specialist 10 times a

year and for $30 you'll visit your specialist every month.

There is a disconnect between the real costs of care and the price that the member sees,

because the cost of care is not accurately represented.

It's as if we are on a different demand curve altogether.

In fact we can see that by linking the actual cost with the actual number of visits.

For example, under this 10 percent coinsurance rate we can link $500,

the actual cost with 10 annual visits.

And we can do the same for $300 and 12 annual visits.

It is easy to see that these two points belong on a higher demand function.

That is, the lower the coinsurance rate the greater is the demand for medical care.

Now let's discuss deductibles.

The amount you pay for

covered healthcare services before your insurance plan starts to pay.

With a $1,500 deductible you pay the first $1,500 of covered services yourself.

Once you are done paying your deductible,

you usually pay only a copayment or coinsurance for covered services.

Your insurance company pays the rest.

Some plans have separate deductibles for certain services, like prescription drugs.

Let's look at the demand for medical care.

We have price on the y axis and quantity on the x axis to simplify our analysis,

quantities measured in unspecified units of care.

Here is your insurance contract.

It involves a $1,500 deductible and a 10 percent coinsurance rate.

Let's assume that every unit of care costs $250.

If that is the case, how many units of care would

you have to consume before you have paid your deductible in full.

If you said six, you are correct.

We can represent the deductible as a rectangle with

unit price as its height and the number of units as its base.

This is the sum of money you would have to pay

out-of-pocket before your insurance plan starts paying.

So the price that members pay in this range is the actual cost of care, $250 per unit.

Beyond the first six units the member will pay 10 percent coinsurance,

in this case twenty five dollars for each additional medical care unit she consumes.

So what is the rationale behind the deductible.

Why not simply have a coinsurance rate from the get go.

To answer this question consider the following two demand curves.

The one on the left represents demand for

relatively minor medical interventions like visiting your primary care physician,

while the one on the right represents demand

for acute medical interventions like surgery.

The deductible creates an interesting situation where for minor events members must

internalize the real cost of care and be

somewhat calculated when making care consumption decisions.

However, for catastrophic events where Kerry is essentially

unavoidable they will be able to use

their insurance without worrying about its financial implications.

Minor events happen in a higher probability than major events and insurance

tend to be more effective as the events it

insurers against have a lower likelihood of occurring.

It is important to note that many plans pay for

certain preventive services before one meets their deductible.

These services typically include vaccinations,

screening checkups and disease management programs.

The reason for that is that insurance plans

benefit when health conditions are detected early.

And addressed using cheaper and less intense measures.

For these types of care,

the insurance would typically not require a copay or coinsurance.

So people pay zero out-of-pocket.

In other words, the insurance company is creating moral hazard for preventive care.

If people are generally under utilizing these services,

creating moral hazard to increase the use of these services is a good thing.

The key takeaway from this discussion is that the lower the insurance rate,

the higher is the consumption of medical care.

With this takeaway in mind,

in the next segment we will discuss

the elements that govern the pricing of insurance premiums.

Cost Sharing

The Economics of Health Care Delivery

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