Factors Affecting the Demand for Health Insurance Discussion


Factors Affecting the Demand for Health Insurance

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Assignment one
Case study report one
Case study report and the case methods provide students with a well-organized approached to,
and methodology for, problem solving and decision making. The project will give students an
opportunity to identify important facts to solving the problem from assertions and opinions,
and when necessary, make assumptions supported by the facts in the scenario. Apply relevant
management disciplines and methodology and take the role of a healthcare manager or a
consultant when considering alternative solutions, offering recommendation, and planning
Adverse Selection
For health insurance companies to earn a profit, they need to be able to calculate the financial
risk of the insured population. Estimating risk is a challenge because the insurer typically
does not have complete information on the risk status of the people it is insuring. Different
insurance policies attract different types of individuals. A policy that offers a generous
benefits package is appealing to people with chronic and costly health conditions. Such a plan
is more expensive than other policies. Conversely, people who are in good health and expect
no major health problems opt for a less expensive policy. If the two pools are combined, the
insurance company will have a risk pool composed of many high-risk individuals and few
low-risk individuals. Because the high-risk purchasers use more costly medical care, the
insurer may raise premiums at the next opportunity. Higher premiums might dissuade lowrisk individuals from purchasing a plan and cause them to look elsewhere for insurance. On
the other hand, high-risk individuals may still believe that the higher-priced insurance is a
worthwhile purchase. This series of events is known as adverse selection. Adverse selection is
the tendency of consumers with high disease risks or medical conditions to systematically
select insurance plans that provide more comprehensive coverage.
1. Use sound economic reasoning to assess whether (and why) each of the following people
may prefer to purchase insurance individually or as part of a group:
a. 65-year-old male, lifelong smoker, with congestive heart failure
b. 25-year-old male, normal weight, no known health problems
c. 35-year-old female, married, no known health problems
2. Do you anticipate adverse selection to be a factor with person a, b, or c? Explain, and be
specific in your assumptions.
3. What can insurance companies do to discourage adverse selection?
Factors Affecting the Demand for Health Insurance
The purchase of insurance is a complicated decision. A lot of it depends on one’s
employment status, workplace location, and level of comfort with uncertainty.
Following are some factors that health economists believe influence the decision to
purchase insurance:
• Risk aversion. The more risk averse a person is, the more likely he is to purchase
insurance. Individuals who worry about the financial burden of medical care—even if
the probability of needing the services is low—are more likely to purchase insurance.
• Uncertainty. No one knows when they will get sick and what the costs of that illness
will be. If an individual is risk averse, then an increase in uncertainty will most likely
lead to an increase in the demand for health insurance.
• Income. Individuals with low income or high income are less likely to purchase
insurance. Individuals with low income have competing demands for their
discretionary income (e.g., food, shelter, transportation, childcare, other bills),
and their budget may not allow for the purchase of health insurance. Individuals
with high income, on the other hand, have the means to self-insure—to pay for
healthcare expenditures out of their own pocket rather than buy insurance from
an insurer.
• Price of insurance. Generally, people purchase a good or service if the benefit they
receive from the product is greater than the price they paid. This is also true for
insurance. If people value the expected benefit (including peace of mind) more than
the cost, they are more likely to purchase the insurance. Like they do for most
products, individuals are more likely to purchase insurance when the premium is set at
an actuarially fair level.
• Probability of a healthcare event. Individuals are less likely to purchase insurance
against high-probability events (e.g., semiannual dental visits) and low-probability
events (e.g., heart transplant). Remember, the actuarially fair premium is based on the
probability of the event multiplied by the dollar amount of the loss. If the probability
is high, the premium might be close to the full value of the financial loss. Therefore,
purchasing insurance against the financial loss does not make financial sense. If the
probability is low, then the expected loss is also low.
• Magnitude of the potential loss. Individuals are less likely to purchase insurance for
health conditions that result in small financial losses (e.g., the common cold). Tax
treatment. Often, individuals obtain health insurance through their employer.
Employer-provided insurance is paid for with pretax dollars. Thus, the insurance is
less expensive than if it were purchased using after-tax income.

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