Thirdly, the fact that patients have limited
OA 6091 Economic Analysis of the Public
Sector
Poiicy Focus: How best ro organise health
insurance?
Health care expenditures have risen very rapidly
in developed and developing countries. As a
proportion of GDP, health care expenditures
have more than doubled since 1960 in OECD
countries. There are a number of factors
explaining this upward trend. These include
demographic changes, a sustained rise in living
standards and demand for health care, and
scientific and technological development. In
developing countries. the epidemiological
transition places further pressures on health care
provision. Given this rising trend in health
expenditures, many countries have implemented
health reforms aimed at containing health costs,
improving efficiency in health systems. and
expanding access to health care. This piece
focuses on designing health insurance to ensure
containment of health expenditures.
JV!1.1· are health care systems weak on cost
containment?
Research has drawn attention to three main
factors.
firstly, the demand for health care is largely
determined by health care professionals, rather
than by patients directly. Health care
professionals diagnose illness and identify
appropriate treatment. To the extent that these
professionals are not directly concerned with the
costs of treatment, they may no have a strong
incentive for cost containment. Moreover, in
situations where they are paid a fee for service
the) may have an incentive to over prescribe
treatments or tests. This contributes to the rise in
COS!.S.
This can be shown in figure 1 below. In the
Figure, 'true supply costs and demand are
shown as ss and dd. Supply induced demand may
result in a rightward shift of the demand curve
shown by the A arrow.
Secondly, the presence of full insurance may
encourage patients to take full advantage of the
services available from the health system. This is
because the cost to tlie patient of demanding
extra services is zero. This is shown by the new
demand curve dd ..
medical knowledge and experience means that
health professionals are free to pursue their own
objectives where these may be different from
those of the patients. This is known as the
'principal-agent· problem, and arises because
information asymmetry frees the agent to pursue
independent objectives. This happens, for
example, where health professionals show a
preference for expensive equipment or
sophisticated treatments that may not add much
to a pati enc s health status, but imp rove the status
of the professionals themselves. This can be
referred to as 'X-inefficiency' and is shown as an
upward shift of the supply curve. or the Barrow
in the Figure.
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The purchase-provider split
The upward trend in costs which arises from
'supply induced demand.' and from 'X-
inefficiency· can be addressed by inserting an
agent who is independent of providers to act on
behalf of patients. This can be achieved by
separating out purchasers and provider; of heal th
care. In the UK's health reform, general
practitioners (GPs) are provided with per capita
budgets used to contract services from providers.
Providers are Health Trusts (hospitals. clinics)
and private providers. Purchasers and providers
negotiate renewable contracts to cover the health
care required. There are two kinds of contracts.
Bloc contracts cover a given population group
for specified services. A different type of
contracts is for a specific number of a given
service. GPs have incentives for cost
containment because they are entitled to spend
budget surpluses (residual).
The purchaser-provider split has a number of
benefits: attention is drawn to the costs of
services, pricing and accounting mechanism for
health care arc developed, and sometimes limited
competition is possible. There are drawbacks as
well. Markets are expensive, and contract
negotiation is usually seen as wasteful by health
professionals.
Addressing moral hazard through co-insurance.
co-payments and deductibles
The moral hazard prob I em of insurance has a
different set of potential solutions. The problem
here is that the marginal cost of services to the
insured are zero, generating excessive demand
for services. In Figure 2 below, the costs and
demand for a specific treatment are shown.
Whereas the optimal level of service provision is
given by q , a fully insured person would
demand q'' .
Raising the marginal cost of using services can
ameliorate the impact of moral hazard. One
method extensively used in insurance is to
require th': insured to pay ,, fraction of the costs.
Th is is known as co-insurance. In Figure 3, a one
third co-insurance payment is shown. As an
exercise you should find the new level of service
provision.
Sometimes, instead of specifying a fraction of
the costs, the insurance contract may specify a
fixed amount to be paid by the insurer and the
insured. This is known as a co-payment, and
applies especially to situations in which there is a
tariff for services agreed with providers.
A different method is to require users to pay the
costs in ful I up to a given amount before the
insurance cover applies. This is very common in
car insurance as a means of reducing small
claims, and it is known as a 'deductible'. In
Figure 4 health expenditures up to d are paid by
the user in full, but between d and d' the
insurance covers the costs. Above d' cover is
exhausted and again the user pays the costs in
full. As an exercise consider the incentives for
health professionals and users generated by
deductibles.
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health expenditure �r�
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Questions:
I. How effective is the purchaser-provider split
in containing health care costs?
2. Speculate on the equity impact of
introducing co-insurance. co-payments, and
deductibles in health care.
3. Is cost containment in health expenditures a
problem in developing countries?
References:
Gertler, Paul. J. [1998] On the Road to Health
lnsuranc: the Asian Experience, in World
Development 26(4) 717-732
H Oxley and M.Macfarlan [1994] Health Care
Reform: Controlling Spending and Increasing
Efficiency, Economics Department Working
Papers I 49, OECD. Paris