Can we design a market for competitive health insurance? CHERE Discussion Paper No 53



CAN WE DESIGN A MARKET FOR COMPETITIVE HEALTH INSURANCE?

PROBLEMS IN HEALTH INSURANCE MARKETS

Insurance for health care arises as consumers face uncertain future events (illness) with the
possibility of high payouts (the costs of care for a particularly complex condition can easily be
beyond most individuals’ ability to pay). Health insurance is actually health care insurance, that
is the insurance covers all or partial reimbursement of health care expenses although one can
conceptualise health insurance as compensation for a loss in health status, such as a fixed
amount paid conditional on the occurrence of some event such as death, loss of a limb. However,
most health states are not as readily verifiable as the loss of a body part, so the basis for payment
is the use of health services, leading to a much greater degree of moral hazard than in more
general insurance markets (Pauly 2000). Another problem with verification, although not generally
recognised, (Hall, Viney 2000) is the urgency required for much health care treatment. Providers not
only verify the need for treatment, but also the type and extent of services required, and their cost.
Providers’ incomes are enhanced by insurance - in Australia, as in many other countries the origins
of health insurance lie in provider attempts to protect their incomes.

Informational problems also affect the relationship between insurers and consumers. To the
extent that insurers have limited capacity to verify health status, and therefore predict future health
expenditure, they are subject to adverse selection. However, there are some groups whose high
demand for health care is more certain, those with complex, chronic diseases and perhaps in
the future those with poor genetic inheritance, and these people will be excluded from the health
insurance market. In all developed countries except the US, the exclusion of certain groups from
health insurance and health care is simply not tolerated.

The health insurance market is thus subject to failure from a variety of sources, information
asymmetries, principal-agent problems, adverse selection, cream skimming, and distributional
concerns. In a free market, health insurers’ pursuit of profit and survival would not result in socially
efficient outcomes. Therefore, in most countries the health insurance arrangements involve a
complex, regulatory system with substantial government intervention. These can offer a choice of
(often private) insurers under which insurance is usually voluntary; or a public insurance model,
either financed by social insurance or by general tax revenue which is compulsory. These models
can be further categorised by the relationships between the funder and the providers: integration of
the funder and the provider; some contractual arrangement between the funder and the provider
which may involve fee for service or capitation payments; or reimbursement of the patient who then
pays the provider (Hurst 1991). These may involve varying extents of co-payments, and typically there
are some components of services, such as over-the-counter medications which rely entirely on out-
of-pocket payments.

IV



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