Health Economics 6th Edition Santerre Test Bank

Health Economics 6th Edition Santerre Test Bank
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Chapter 6: The Market for Health Insurance
This chapter on health insurance is the first of three describing specific markets that play
important roles in medical care delivery and finance. Because the private health insurance
market is so critical in financing U.S. medical care, it is important to understand the principles
that govern the provision of insurance. The theory of private insurance demand is presented
utilizing the utility-of-income framework made popular by Friedman and Savage (1948).
Institutional features including the provision of group insurance and the practice of self-
insurance are also discussed. The plight of the uninsured is addressed—who they are, why they
do not have insurance, and how their lack of insurance affects their access to medical care.
Chapter Outline
a. The Market for Health Insurance

1. The Market for Health Insurance
b. Historical setting
1. Types of insurance
2. Health insurance providers
c. Private insurance demand
1. The theory of risk and insurance
2. Health insurance and market failure
3. Information problems
d. The optimal insurance plan
e. State-level insurance regulation
1. The economics of mandates
2. The practice of self-insurance
f. Medical care for the uninsured
1. Counting the uninsured
2. Demographics of the Uninsured
3. Small Group Factors
g. The Relationship Between Insurance & Health
h. The Safety Net for the Uninsured
i. Summary and conclusions
Profile: Uwe E. Reinhardt
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or
in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website for classroom use.
Issues in Medical Care Delivery Back-of-the-Envelope
• The Impact of The Affordable Care • The Economics of Opportunistic
Act on Health Insurance Premiums Behavior
• Health Status Insurance • The Economics of Employer
• The Impact of the ACA on Young Mandates
Americans • Employment Response to Increases
• Does Insurance Improve Health? in Labor Costs
• Who Are the Uninsured?
• The Welfare Loss from a Subsidy
Chapter Objectives
1. Explain the development of the employer-based insurance system that dominates the U.S.
health care delivery system.

2. Summarize and apply the theory of risk and insurance to the individual decision to buy
health insurance.
3. Explain the difference between social and indemnity insurance.
4. Identify the information problems that lead to market failure in health insurance markets.
5. Identify the economic incentives that lead groups to self insure.
6. Explore the issues related to the uninsured in America—their characteristics, reasons for
being uninsured, the number of uninsured, and limits to access to medical care because of
their insurance status.
7. Recognize the importance of asymmetric information in promoting market failure in
insurance markets.
8. Understand that moral hazard is the result of rational consumer behavior, not immoral
behavior.
Opening Videos
It’s all about the Money
The Rainmaker (1997)

Distributed by Paramount Pictures
Produced by Michael Douglas, Steven Reuther, and Fred Fuchs
Directed by Francis Ford Coppola
Written by John Grisham
Screenplay by Francis Ford Coppola
Cast:
Matt Damon as Rudy Baylor, young attorney handling his first case
Danny DeVito as Deck Shifflet, paralegal and Rudy’s law partner
Jon Voight as Leo F. Drummond, lead attorney for Great Benefit Life
Danny Glover as Judge Tyrone Kipler, presiding judge
Roy Scheider as Wilfred Keeley, CEO of Great Benefit Life
Synopsis:
A court room drama where recent law graduate Rudy Baylor teams up with Deck Shifflet, an
“ambulance-chasing” paralegal, who has failed the bar exam six times. From the beginning,
Rudy has misgivings about the questionable ethics of the type of client solicitation practiced by
Shifflet. When Rudy asks, “What’s wrong with ethics?” Deck answers, “Oh, nothing, I guess. I
mean I believe a lawyer should fight for his client, refrain from stealing money, and try not to
lie, you know, the basics.” With these rules of professional conduct guiding him, Rudy accepts
his first case, a lawsuit against Great Benefit Insurance Company. Great Benefit has been
selling its health policies door-to-door in low-income neighborhoods and denying most of the
presented claims, betting on the fact that none of their clients will file suit. For seven years, Dot
Black has paid the premiums, but when she files a claim for Donny Ray’s recently diagnosed
leukemia, Great Benefit denies the request for a bone marrow transplant. Great Benefit Life
refused to pay for the procedure on four grounds: that the leukemia was a pre-existing
condition, that due to his age (21) he was no longer a dependent and therefore not covered by
the policy, that his health status has been misrepresented on the original insurance application
four years before diagnosis, and that the procedure was “experimental.”
Film Clip:
Scene 28, “Deny All Claims,” starting at 151:30 to 1:59:05 (7 minutes, 35 seconds)
On the last day of the trial, Baylor questions Keeley on Great Benefit Life’s claims manual, which
directs claim handlers to “deny all claims within three days.” To prove his point, Baylor
provides the following statistics: out of the 98,000 policies in 1995, 11,462 claims were filed and
9,141 were denied (almost 80 percent). Previously, Drummond attempted to prove that the
insurance company denied the claim under the premise that the procedure was still
“experimental.” Now, Baylor asks Keeley to read his own suggestion to the board of Great
Benefit Life, which states, “Since bone marrow transplants have become standard procedure,
Great Benefit would be financially justified in investing in bone marrow clinics.” Should
insurance companies be able to deny claims when the spending is not financially justified?
What are the legitimate bases for denying claims? Is healthcare all about the money? What is
society’s obligation to the uninsured?
Discussion:
In the mid 1990s, bone marrow transplants were moving from the “experimental” category to
the “standard” category for the treatment of many conditions. Many health insurance
companies do have a policy that they will not cover experimental procedures because of the
health and monetary risk involved, but in this case, Great Benefit Life’s CEO not only considered
the procedure “standard,” but he suggested that the company invest in bone marrow
transplantation. In Gresham’s book, Donny Ray has a twin brother, which makes the bone
marrow transplant even more plausible. Should insurance be required to pay for experimental
procedures? At what point is a procedure no longer experimental? What is a pre-existing
condition?
Although insurance companies typically do not prey on low-income clients as Great Benefit Life
did here, some companies do sell insurance door to door and collect premiums in cash each
week. Should insurance companies target low-income neighborhoods for marketing basic
insurance?
Health insurance companies do seek healthy enrollees and turn away patients with pre-existing
conditions. To what extent should premiums be based on health status and demographic
factors such as age, sex, geographic region, and life-style choices?
I Just Want a Chance
ER, Season 4
Disc 4, Episode 16, “My Brother’s Keeper”
March 5, 1998
Created by Michael Crichton
Distributed by Warner Brothers
Directed by Jacque Toberen
Written by Jack Orman
Cast:
Maria Bello as Dr. Anna del Amico, ER resident physician
Anthony Edwards as Mark Greene, ER physician
Kathleen Lloyd as Dr. Mack, Chief of neurosurgery
Eric Saiet as Alex Dibble, son of trauma patient
James Hornbeck as Dr. David Zaccarria, neurosurgeon
Synopsis:
A John Doe involved in a motorcycle accident is transferred to County General with a head
injury.
Film Clip:
Scene 2, “Soda Can,” Starting at 8:07 to 8:50 (43 seconds)
Dr. del Amico suspects that a transferred patient admitted to the ER does not have a
concussion, but has been dumped because his insurance status is unknown. What does it mean
to “dump” a patient?
Scene 3, “Dumpster Diving,” Starting at 14:25 to 15:30 (1 minute, 5 seconds)

Dr. del Amico concurs with the neurosurgical resident on John Doe’s brain hemorrhage. A
lobectomy, the only surgical option, has a low probability of success and cannot be performed
without the authorization of Dr. Mack. Presumed to be uninsured, the anonymous patient is
monitored and Dr. del Amico waits for him to die. Do patients without insurance receive
substandard care relative to those with insurance? Does is make much difference in terms of
outcome?
Scene 4, “Chase,” starting at 25:51 to 26:47 (56 seconds) and starting at 29:09 to 30:55 (1
minute, 46 seconds)
John Doe’s son (Alex) shows up and it turns out that Tom Dibble is a member of the Teamsters’
Union and is well insured. After Dr. Mack refuses to authorize brain surgery because he has no
chance of survival, Alex Dibble demands a second opinion. Should patients be provided care
even though the chances for their survival are remote?
Scene 5, “Smoker’s Remorse,” Starting at 38:15 to 39:45 (1 minute, 30 seconds)

Dr. Zaccarria, the physician who initially refused to see Mr. Dibble when he thought he was
uninsured, now agrees to perform the surgery.
Discussion:
Should cost be a consideration when someone’s life is on the line? Dr. Mack considered the
surgery futile. Dr. Zaccarria was willing to give Mr. Dibble a chance by operating. Who was
right? Why did Dr. Zaccarria change his mind? Were the circumstances different?
What Do You Mean I Don’t Have Insurance?
John Q. (2001)
Distributed by New Line Cinema
Produced by Mark Burg and Oren Koules
Directed by Nick Cassavetes
Written by James Kearns
Cast:
Denzel Washington as John Q. Archibald, father whose son requires a heart transplant
Kimberly Elise as Denise Archibald, wife and mother
Anne Heche as Rebecca Payne, the hospital administrator
Synopsis:
John Q. Archibald, head of a hard-working blue collar family, finds himself in a difficult situation
when his son, Michael, collapses at a baseball game. They learn that Michael will need a heart
transplant and their health insurance will not cover the procedure. Desperate to get his son on
the transplant list and exhausting all options, he takes everyone in the emergency room
hostage and demands that the transplant proceed.
Film Clip:
Scene 6, “Runaround,” starting at 24:05 to 28:20, (4 minutes, 15 seconds)
John Q. learns from his benefit manager that his company has switched coverage for its
workers from a PPO to an HMO, a less expensive plan. To make matters worse, John has been
reclassified as a part-time worker (without his knowledge), which further limits his coverage to
a maximum spending of $20,000. Dutifully, he follows instructions – filing an appeal with the
HMO, seeking financial aid from the hospital, and applying for welfare. Thinking he has
received an approval for coverage from his insurance plan, John takes his appeal notification to
the hospital administrator Rebecca Payne who informs him that he has filed the wrong paper
work, and that he must file a “grievance” with his insurance company if he expects to receive
aid.
Discussion:
John Q. Archibald finds himself in a situation where he thought he and his family had insurance
coverage, but after his son falls ill discovers that his insurance is limited. How many people in
the United States find themselves underinsured at any one time?
Teaching Suggestions
• This is another good place to introduce the “crisis” discussion. Does the United States have
a health care financing crisis?
• Clearly distinguish between indemnity and social insurance. You will be laying the
groundwork for future policy discussions.
• Why do people buy insurance? Spend some time developing the theory of private
insurance demand using the utility-of-income approach. Most students have limited
background in the theory of insurance. Here economics majors and non-majors are
generally on more equal footing. It is a technical discussion. Avoid the urge to gloss over
the details. Your better students appreciate the rigor and everyone ends up with a better
appreciation of the purpose of insurance.
• A simple exercise in determining a premium for a group is instructive. The addition of a
smaller group of high-risk participants drives home the effect on the premium everyone
pays.
Suggested Approaches to End-of-Chapter Questions
1. Medical losses are almost always a matter of pain and suffering, and at times, life and
death. The traditional indemnity insurance model where you suffer a loss, get a damage
estimate, and fix the problem may not be totally applicable.
2. All of these concepts are defined in the glossary. Moral hazard, adverse selection, and
asymmetric information make the task of underwriting risk more difficult. With respect to
moral hazard, how much will quantity demanded increase when insurance is present? For
the latter two, should individuals be able to hide their true health status and force
insurance companies to sell them policies at premiums far below the expected loss? Third-
party payers create the moral hazard problem and cream skimming is a way that insurers
try to avoid high-risk users.
3. Deductibles and coinsurance are the insurance underwriters’ way of minimizing moral
hazard. Unless premiums are charged based on the quantity demanded at a zero price,
they are necessary.
4. The different types of insurance are discussed on pages 175-176.

5. Answers to these questions will vary depending on the student’s perspective on the role of
private insurance. A more advanced answer may refer to the mapping of genes undertaken
by the Human Genome Project. After all 100,000 genes are mapped, every person is likely
to have 6-10 defective genes. Does that mean that everyone will be denied insurance
coverage?
6. This question may be answered with the discussion beginning on page 195-197.
7. Asymmetric information exists when there is an unequal distribution of information
between the two parties in a transaction. One person has information that the other does
not. Patients may try to hide their true health status from providers and insurers.
8. Self insurance is a way of avoiding paying insurance loading costs, many state mandates,
and participation in state-run high risk pools.
9. At the level of economic development present in the United States, more medical care may
not improve health status all that much. Obviously, free health care will improve the health
status for the poor, leading to lower blood pressure levels, better oral health, and improved
pulmonary health. It may not, however, result in significant improvements in mortality
rates.
10. Deductibles and coinsurance are devices to increase out-of-pocket spending by patients. It
is meant to counter the problem of moral hazard.
11. Out-of-pocket payments are designed to mitigate moral hazard.
Additional Questions for Discussion and Evaluation
1. How should society deal with the conflict between genetic predisposition and insurability?
2. What is the difference between “experience rating” and “community rating” in insurance
underwriting? What difference does the choice between the two methods of rating affect
the availability of health insurance?

3. How do the provisions of the income tax code influence the health insurance decision—
whether or not to insure, how much to buy, who pays?
4. “Health insurance policies that provide first-dollar coverage for medical expenses are not
really health insurance policies at all. They are merely health plans providing pre-paid
medical expenses.” Comment.
5. A “qualified health plan” under the Affordable Care Act may not include pre-existing
condition exclusions. People with chronic conditions may not be denied coverage because
of their illnesses and insurance companies may not cancel a policy should a person become
ill.
a. What is guaranteed issue? Guaranteed renewability?
b. If policies have these features, what sort of behavior is encouraged?
c. What added risk do insurance companies face if policies have these features? How is
this risk mitigated?
6. Barry met with his company’s benefit manager to sign up for the health insurance provided
through his employer. He had worked for the firm for over 2 years, but was one of many
who chose not to take the offer to participate in the plan, because he considered his share
of the premiums too expensive. In the intervening interview the subject turned to pre-
existing conditions. Yes, Barry’s wife was eight months pregnant. Yes, he wanted insurance
to cover the expenses of the impending childbirth (expected to cost $10,000). Barry was
incredulous when he found out that there was a 90 day waiting period before any
preexisting condition could be covered. “Well, something is really wrong with this country if
you can’t even buy insurance when you need it.”
a. Is Barry justified in his criticism?
b. What is the purpose of insurance? Is Barry looking for insurance in this instance? What
is he looking for?
c. Why doesn’t insurance cover preexisting conditions?
d. Using the appropriate terminology explain how the ACA deals with pre-existing
conditions? Will it work?
7. When employers pay for health insurance as part of the total compensation package
provided its employees; who really pays—employers, employees, taxpayers? Explain.
8. Over 75 percent of all Americans who have contracted HIV belong to one of two groups—
gay and bisexual males or IV-drug users. Should sexual orientation or a history of drug use
be a factor in determining whether a person can get health insurance coverage and the
premium they pay? Explain.
9. How does provision of health insurance through place of employment contribute to
increased health care spending?
10. Why do employers offer health insurance to their employees? (Note that the alternative is
to increase salaries.) Discuss tax implications. Why is it better to buy insurance as a
member of a group as opposed to purchasing an individual health insurance plan?
11. Explain how health insurance results in the overuse of health care? (Answer should discuss
the moral hazard issue associated with health insurance.) Does health and prescription
drug insurance result in the inefficiently poor diets and little exercise? If so, how can we
measure this inefficiency?
12. Explain why providers are willing to set prices for insurance companies and the government
above marginal cost, but below average cost. Should the uninsured pay higher prices for
medical procedures than those with insurance or should they pay rates negotiated by the
government? Explain.
13. How does health insurance coverage affect the incentive to reduce medical expenses? For
the insured person? For the provider of services? What happens to the incentive to hold
down medical expenses once the initial insurance deductible is met?

14. What happens to an employee’s incentive to hold down his or her medical expenses once
the insurance deductible is met?
15. Define the two concepts “moral hazard” and “adverse selection.” Describe separately how
the existence of each affects the market for health insurance and medical care. What are
some of the ways that insurance companies try to protect themselves against these two
phenomena?
16. Addressing the needs of the uninsured and underinsured is the primary focus of the
Democrats in passing the Affordable Care Act. In contrast, Republicans consider the
fundamental problem to be rapidly rising spending and the only way to ensure access to
affordable health insurance is to control spending. Which one of these two problems do
you consider the most important? Why?
a. If you argue that the biggest problem is covering the uninsured, demonstrate your
understanding of the problem by discussing the demographics of the uninsured, the
reliability of the Census estimates of the size of the group, the effect of not having
insurance on the health of the uninsured, and other issues that you consider important.
b. If you think spending as the main problem, address the size and nature of the spending
problem and how you would go about slowing the rate of growth in U.S. health care
spending.
Multiple Choice
1. Early in U.S. history health insurance was provided to cover

a. income loss due disability or disease.
b. hospital expenses.
c. routine physicians’ services.
d. the catastrophic cost of medical care including hospitalization and physicians’
services.
e. medical costs due to specific diseases such as tuberculosis and alcoholism.
2. A prepaid hospital plan created by Baylor Hospital for a group of Dallas public school teachers
in 1929 is considered the forerunner of what was later called
a. managed care.
b. Blue Cross.
c. Blue Shield.
d. the health maintenance organization.
e. major medical insurance.
3. Mid-1960s amendments to the Social Security Act created

a. managed care.
b. Medicare and Medicaid.
c. major medical insurance.
d. Blue Cross and Blue Shield.
e. tax exemptions for health insurance as an employee benefit.
4. Indemnity insurance
a. reimburses for certain types of losses including fire and theft.
b. in the basis for most of the health insurance coverage in the U.S.
c. is often experience-rated with premiums based on expected losses.
d. is sometimes called “casualty insurance.”
e. all of the above.
5. Social insurance
a. is the basis for most government redistribution programs.
b. is usually community-rated with premiums based on ability to pay.
c. is the basis of the provision of medical care to the poor, elderly, and other
vulnerable population groups in the U.S.
d. requires mandatory participation to be effective.
e. all of the above.
6. Premiums based on experience ratings

a. are uniform across age groups.
b. are based on the loss experience of the insured.
c. vary depending on the income of the insured.
d. are illegal in most states in the U.S.
e. are only used in property-casualty insurance underwriting.
7. People buy insurance

a. because they are risk averse.
b. to defer consumption.
c. because of externalities.
d. to maximize their welfare.
e. to ensure against poor health.
8. One result of asymmetric information in health insurance markets is

a. an optimal number of insurance policies sold.
b. adverse selection.
c. externalities in consumption.
d. a low marginal benefit of additional information for the buyer of insurance.
e. The principal-agent problem.
9. Moral hazard and adverse selection are both examples of

a. the principal-agent problem.
b. externalities in consumption.
c. efficiency in markets.
d. perfect information.
e. asymmetric information.
10. Insurers try to minimize moral hazard by
a. only selling policies to individuals with high ethical standards.
b. requiring advance payments of premiums.
c. charging higher premiums to individuals than to groups.
d. charging deductibles and coinsurance.
e. refusing to sell insurance to individuals with chronic illnesses.
11. The goal of health insurance is to

a. redistribute income from the sick to the healthy.
b. spread risk over a large group of people.
c. equally distribute the probability of loss over a large number of people.
d. collect sufficient premiums to cover all possible losses.
e. equalize the availability of medical care across population groups.
12. Insurance works best in situations where there is

a. a high probability of a small loss.
b. a low probability of a small loss.
c. a high probability of a large loss.
d. a low probability of a large loss.
e. the level of probability and the size of the loss are irrelevant.
13. Analysts cite figures on the number of uninsured in the U.S. as low as 10 million and as high
as 60 million. Which of the following is a true statement?
a. The uninsured are all free riders.
b. Most of the uninsured have health problems and are not able to get private health
insurance.
c. Most of the uninsured have some labor-force connection—either working or a
dependent of someone who is working.
d. The lack of health insurance means that the individual has virtually no access to
medical care.
e. Once you lose your health insurance it is extremely difficult to get reinsured.
14. The highest incidence of those without health insurance occurs in which age category?
a. Under 18 years of age.
b. 18-34 years of age.
c. 35-44 years of age.
d. 45-64 years of age.
e. Over 65 years of age.
15. Many individuals without health insurance receive “free” care. What are the sources of
most of the care they receive?
a. Public hospitals and clinics.
b. Private, not-for-profit hospitals.
c. Private, for-profit hospitals.
d. Multi-specialty physicians’ practices.
e. Solo practitioners and their associates.
16. A major factor contributing to the growth in employee-based health insurance in the United
States has been
a. greater than average economic growth leading to increased demand for labor.
b. the tax free treatment of health insurance as an employee benefit.
c. legislation requiring all firms to provide health insurance to all full-time workers.
d. the long standing tradition in the United States of providing a generous package of
benefits to all workers.
17. A group of 100 people seek out an insurance company to underwrite health insurance for
its members. If expected medical spending for the group is $150,000, what will the average
premium be if the health insurance company estimates the premium adding net loading costs
of 20 percent?
a. $1,200
b. $1,500
c. $1,800
d. $3,000
18. Continuing from the question above, an additional 10 people join the group who have
expected medical spending of $5,000 per person on average. The new premium will be
approximately
a. $1,500
b. $2,200
c. $2,500
d. $4,500
19. Firms self-insure to

a. save money on premiums.
b. avoid state level insurance regulation.
c. create uniform benefit packages for employees who live in different states.
d. all of the above.
Structured Discussion:
Resolved: The fact that health insurance premiums are not taxable distorts the
purchase decision. Thus, health insurance benefits should be treated as ordinary
income for tax purposes.
Resolved: Health insurance premiums should be higher for smokers that for
nonsmokers.
Resolved: Health insurance premiums charged to individuals born with genetic defects
(that result in above average use of medical care) should be higher than those charged
to individuals without such defects.
Resolved: Insurance companies should be required to cover all applicants regardless of

health condition and not allowed to charge sicker individuals higher premiums.
Resolved: Third-party payment results in patients using services whose costs exceed
their benefits, and this excess of costs amounts to a substantial percentage (3-5%) of
total health care spending.
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Health Economics 6th Edition Santerre Test Bank

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a. The Market for Health Insurance

Profile: Uwe E. Reinhardt

health care delivery system.

3. Explain the difference between social and indemnity insurance.

5. Identify the economic incentives that lead groups to self insure.

their insurance status.

7. Recognize the importance of asymmetric information in promoting market failure in

It’s all about the Money

The Rainmaker (1997)

I Just Want a Chance

Scene 3, “Dumpster Diving,” Starting at 14:25 to 15:30 (1 minute, 5 seconds)

Scene 5, “Smoker’s Remorse,” Starting at 38:15 to 39:45 (1 minute, 30 seconds)

What Do You Mean I Don’t Have Insurance?

a health care financing crisis?

groundwork for future policy discussions.

appreciation of the purpose of insurance.

Suggested Approaches to End-of-Chapter Questions

estimate, and fix the problem may not be totally applicable.

try to avoid high-risk users.

they are necessary.

4. The different types of insurance are discussed on pages 175-176.

and participation in state-run high risk pools.

pulmonary health. It may not, however, result in significant improvements in mortality

is meant to counter the problem of moral hazard.

11. Out-of-pocket payments are designed to mitigate moral hazard.

Additional Questions for Discussion and Evaluation

the availability of health insurance?

whether or not to insure, how much to buy, who pays?

medical expenses.” Comment.

a. What is guaranteed issue? Guaranteed renewability?

b. If policies have these features, what sort of behavior is encouraged?

this risk mitigated?

you can’t even buy insurance when you need it.”

a. Is Barry justified in his criticism?

conditions? Will it work?

provided its employees; who really pays—employers, employees, taxpayers? Explain.

premium they pay? Explain.

9. How does provision of health insurance through place of employment contribute to

increased health care spending?

to increase salaries.) Discuss tax implications. Why is it better to buy insurance as a

member of a group as opposed to purchasing an individual health insurance plan?

measure this inefficiency?

down medical expenses once the initial insurance deductible is met?

the insurance deductible is met?

you consider the most important? Why?

understanding of the problem by discussing the demographics of the uninsured, the

1. Early in U.S. history health insurance was provided to cover

3. Mid-1960s amendments to the Social Security Act created

6. Premiums based on experience ratings

7. People buy insurance

8. One result of asymmetric information in health insurance markets is

9. Moral hazard and adverse selection are both examples of

11. The goal of health insurance is to

12. Insurance works best in situations where there is

19. Firms self-insure to