Information Problems and

Insurance Markets
Krishna Pendakur
Department of Economics
Simon Fraser University
 Outline
• The Economics of Information
• Insurance and Health Insurance

• Health Systems and Health Outcomes in Canada and

Around the World

• Note: midterm: Wednesday 18 Oct 1430-1720

• Note: Extra OH:
– Thursday 12 Oct 1100-1200
– Monday 16 Oct 1000-1100
– No OH Wednesday 18 Oct
 Information and Insurance

• Information problems are typically connected

to problems with risk where the desired
commodity is insurance.
– Information problems can be grouped under two
main headings:
• Hidden Action (aka Moral Hazard)
• Hidden Knowledge (aka Adverse Selection)
 Hidden Action
Hidden Action: buyers and sellers can do things,
without the knowledge of the other party, that
affect the value of the transaction.
• If I sell you a pile of steel, there is pretty much
nothing I can do to affect your enjoyment of it.
• However, if I sell you my economics instruction, I
can choose to work hard or to slack off, which will
affect your enjoyment of it and your learning.
– Between us, then, there is a hidden action problem.
Hidden Action as a Missing Market
• Hidden Action problems can be thought of as
an inability to contract over certain things. I
can promise to come to work, but can I
credibly promise to work hard?
• Suppose I cannot credibly promise to provide
effort. Since my effort is costly,
– if you offer me the minimum salary needed to get
me to show up,
– I will show up, but not put in the effort.
Hidden Action Induces Inefficiency
• We could both be better off if there were
some way to:
– Force me to put in the effort, but compensate me
for it.
– Force you to pay a little extra, to generate the
money to compensate me.
 Hidden Action in Insurance
• Suppose you are an insurer.
• If you insure a person against the costs of a
risk, they have less incentive to avoid that risk.
• If the actions they take to avoid risk are
hidden, then you have a problem.
• Hidden actions might affect the probability
that the insured risk happens, and the severity
of the event.
Hidden Actions for Types of Insurance
• Employment insurance insures you against the risk of
income loss associated with job loss
– But, you might not try hard to avoid layoff if you’re insured
• Annuity pensions insure you against dying in poverty.
– But, they might make you very expensive to insure
because you’ll want to live longer.
• health insurance insures you against the money cost of
health incidents
– But, might encourage smoking or skiing.
• fire insurance
– might encourage the disconnection of annoying fire
alarms.
 Hidden Action and Private Insurance
• private insurers have to raise the premium to
protect themselves from costly hidden actions
taken by buyers.
• What can government do that private
providers cannot do?
• Government can punish bad hidden actions
with tools that firms don’t have at their
disposal, e.g., fines and jails.
 Government and Hidden Action
• Now ask yourself, how many of those things are
provided privately? Not many.
• We have public health insurance. Government can tax
cigarettes (which raise health costs). A private insurer
could not do that.
• We have public employment insurance. Government
can punish fraudulent claims with jail. A private insurer
could not do that.
• These are arguments for government to either produce
the insurance directly, or for it to be very tightly
involved in its production, so that it can punish hidden
actions that are bad.
 Hidden Knowledge
• Hidden Knowledge: buyers and sellers know things
about themselves or the commodity being traded that
matter to the other party.
• This may give the buyer or seller an incentive to lie.
– If I sell you a pile of steel, there is nothing about me that
will affect how much you like the steel. If I were a lousy
steel producer, you would have noticed that the steel was
lousy and not bought it.
– However, if I sell you my economics instruction, I may or
may not be a smart or learned person. You cannot tell
whether or not I am, and so you have to worry all the time
that I am teaching you falsehoods.
 Open MOBLAB
• In this game, there are 2 roles: buyer and seller.
• Seller has a car they value at $500 to $5000
• “car quality”, or value to the buyer, is 150% of the
seller’s value
• Seller observes the value, sets the price.
• Buyer observes the car quality and the price.
• Buyer says yes or no.
• Play 4 rounds, see what your surplus is.
 Results Summary
• Graph

• Every car was potentially a pareto improving

deal: E.g., if the seller set the price at 1.25
times the value, everybody wins from the
trade.

• Accepted offers are depicted by a blue triangle

and rejected offers by a red square.
 MOBLAB: variation
• In this game, there are 2 roles: buyer and seller.
• Seller has a car they value at $500 to $5000
• “car quality”, the value to the buyer, is 150% of
the seller’s value
• Seller observes the value, sets the price.
• Buyer observes the price.
• Buyer says yes or no.
• Play 4 rounds, see what your surplus is.
 Results Summary
• Graph

• Accepted offers are depicted by a blue triangle

and rejected offers by a red square.

• Is there a pattern. Are some cars likelier to be

sold than others?
 Lemons and Missing Markets
• If I try to sell you a used car, should you really
believe me when I say that it is a great car?
• How can a really great used car ever get sold?
(George Akerlof got a Nobel prize for this.)
• The market for high-quality used cars
disappears: it is a missing market
• All we are left with is the market for lemons
(bad used cars)
Hidden Information and Insurance
• What commodity is truly ‘pure’ in the sense
that you know everything you need to know
about it before you buy it?
• hidden knowledge matters to insurance:
– Suppose some people are ‘low-risk’ and some
people are ‘high-risk’. The insurer wants to sell
insurance to all the ‘low-risk’ people, but the
‘high-risk’ people will all pretend to be low-risk.
 Hidden Information and Missing
Markets
• In private insurance systems, however, the insurer
would be very suspicious of you if you came knocking
on their door looking for insurance.
– They would think you had hidden information that made
you a bad risk.
– On the other hand, they would think that all the people
who did NOT come knocking on their doors were good
risks, and they would try to find these people instead.
– The whole market would collapse under this inability to
match buyers with sellers.
• There will be no market for insurance for low-risk
people.
 Government Insurance
• Now ask yourself, how much insurance do we see in the
public sector?
– Pensions: Insurance against dying in poverty.
– Employment Insurance: Insurance against income loss due to
job loss.
– Health Insurance: insurance against expenditures due to health
surprises.
– Auto Insurance (in BC), Progressive taxation (higher tax rates for
rich than poor) can be thought of insurance against low income,
farm output insurance (wheat board), counter-cyclical
government spending (insurance against economy-wide
surprises).
• What can the government do that a private insurer could
not do?
 Social Insurance
Social Insurance is a mandatory, single-policy,
government-monopolist provided insurance.
• Mandatory means that government forces
everyone to buy into the single insurance
contract.
• Thus, the insurer need not face the hidden
information problems in the insurance market:
nobody is trying to hide anything because
everyone is forced to buy the same contract.
Social Insurance and Redistribution
• Social insurance is redistributive from low-risk to high-
risk people.
– Everyone has to buy the same contract, but low-risk
people think it is expensive and high-risk people think it is
cheap.
• E.g., single-policy tax-funded health insurance is a bad
deal for the young.
– You pay a lot, and don’t use much health care on average.
– If you were seeking private insurance, you wouldn’t buy
much.
– But, in public systems, you don’t have the option to buy
less.
 Efficiency of Social Insurance
• There are conditions under which social
insurance is efficient, but they are pretty strong
(lower bound on people’s value for insurance;
complete unwinding of the private market).
• Generally, we don’t think social insurance is
efficient
• Rather we think it is “better” than a missing, or
super-expensive, market for private insurance.
 Income-Tested Benefits
• We say a public benefit is income-tested if there is
an income threshold above which the benefit is
smaller or unavailable.
• We say a public benefit is clawed back if it is
taxed at a rate higher than the regular income tax
rate above a certain level.

• E.g., Old Age Security benefits are income-tested,

because the benefit is smaller for incomes above
$80k; Old Age Security is clawed back above an
income of $80k. The claw-back rate is 15%.
 Rationed Benefits
• We say a good is rationed if not everyone who
wants it can get it.
• We say it is rationed by some mechanism that
determines who gets it and who doesn’t.

• In private markets, goods are rationed with

money; public benefits usually are not.
• Public health care services in Canada are
rationed by waitlists.
 Federal Government Pensions
Insures risk of outliving your savings and dying in poverty

•Old Age Security (OAS) and Guaranteed Income Supplement (GIS)

• income-tested
• OAS is $691/month or $760/month for 75+, clawed back above $135k
• GIS, raises income to roughly $1700/month if income is less
• About $70 billion per year, on-budget, no special revenue base (2022)

•Canada Pension Plan

• Based on past income, not income-tested for receipt
• 11.7% payroll tax up to roughly $60k (half worker, half firm contribution)
• In 2019, replaced 25% of covered income; by 2024, replaces 33% of covered
income.
• In 2019, max payout was $1150/month (25% of 55k)
• In 2025, max payout will be $1950/month (33% of 71k)
• About $50 billion per year, off-budget (2022)
 Federal Employment Insurance
Insures risk of losing income due to job loss

• Paid for 3.2% payroll tax (half worker, half

firm)
• Pays up to 45 weeks for unemployment spells
• Requires 900 hours of work before
unemployment spell
• About $27 billion per year (2022)
 Provincial Health Insurance
Insures money cost due to risk of bad health
events
• About $330 billion per year (2022)
• Rising faster than other government
expenditures
• Not income-tested, but wait lists are
everywhere.
• Rationed with waitlists
 Health Systems
• Who pays?
• Who produces?
• What is covered?
• Who is covered?
• What is overall public and private spending?
• How effective is it? How good are health outcomes?
• Health inequalities?

Material for this section drawn from OECD sources and from
– By AARON E. CARROLL and AUSTIN FRAKT, SEPT. 18, 2017 “The
Best Health Care System in the World: Which One Would You
Pick?”, New York Times.
 Health Systems
• In Canada,
– government finances health insurance, insurance is run at the province level
• Government pays about 70% of all health care expenses; all health is about 12% of GDP
(2022)
– the private sector delivers a lot of the care.
– many Canadians have supplemental private insurance through their jobs to
help pay for prescription drugs, dentists and optometry

• In Britain,
– Government finances health care
• Pays about 80% of all health care expenses; all health is about 10% of GDP
– Produces it through the National Health Service.
– Coverage is broad, and most services are free to citizens, with the system
financed by taxes
– there is a private system that runs alongside the public one.
– About 10 percent buy private insurance.
 Health Systems
• In the United States
– private insurance through employment;
– single-payer Medicare mainly for those 65 and older; state-
managed Medicaid for many low-income people;
– private insurance through exchanges set up by the Affordable
Care Act
• Policies are offered by private insurance companies, community rated
and guaranteed-issue, with prices varying by things like breadth of
network, size of deductible and ease of seeing a specialist.
– about 28 million people without any insurance at all.
– Hospitals are private (for-profit and non-profit), except those
run by the Veterans Health Administration.
– Government pays about 40% of health expenses; all health is
about 18% of GDP
 Health Systems
• Singapore
– Basic care in government-run hospital wards is cheap,
sometimes free,
– deluxe care in private rooms available for those paying extra.
– Singapore’s workers contribute around 37 percent of their
wages to mandated savings accounts that may be spent on
health care, housing, insurance, investment or education, with
part of that being an employer contribution.
– The government uses bulk purchasing power to spend less on
drugs, controls the number of medical students and physicians
in the country, and helps decide how much they can earn.
– Singapore’s total health spending is about 5% of GDP
 Health Systems
In France
• France covers more services than in any other health care system, pays for about 75% of total
health costs.
• Everyone in France must buy health insurance, sold by a small number of nonprofit funds, which
are largely financed through taxes.
• The Ministry of Health sets funds and budgets; it also regulates the number of hospital beds, what
equipment is purchased and how many medical students are trained. The ministry sets prices for
procedures and drugs.
• The French health sector accounts for 11.8 percent of GDP
In Australia
• Australia provides free inpatient care in public hospitals, access to most medical services and
prescription drugs.
• There is also voluntary private health insurance, giving access to private hospitals and to some
services the public system does not cover.
• The government pays for at least 85 percent of outpatient services, and for 75 percent of the
medical fee schedule for private patients who use public hospitals. Patients must pay out of pocket
for whatever isn’t covered.
• Most doctors are self-employed, work in groups and are paid fee-for-service. More than half of
hospitals are public.
• Health care accounts for 9 percent of GDP.
 Health Systems
In Switzerland
• requires all to buy insurance. The plans resemble those in the
United States under the Affordable Care Act: Almost 30 percent of
people get subsidies offsetting the cost of premiums, on a sliding
scale pegged to income.
• Although these plans are offered on a nonprofit basis, insurers can
also offer coverage on a for-profit basis, providing additional
services and more choice in hospitals.
– For these voluntary plans, insurance companies may vary benefits and
premiums; they also can deny coverage to people with chronic
conditions.
• Most doctors work on a national fee-for service scale, and patients
have considerable choice of doctors, unless they've selected a
managed-care plan.
 Health Spending
• https://data.oecd.org/healthres/health-
spending.htm
• Spending per capita, and as share of GDP
– https://data.oecd.org/chart/5sD8
– https://data.oecd.org/chart/5sD7
 Canadian Health Systems
• Overview of spending patterns over time,
space, people, types in Canada.
• Largely drawn from
– National Institute for Health Information, 2018,
National Health Expenditure Trends.
Overall Health Spending
As a share of GDP
% of GDP by Country
Drugs are a Rising Share
 Administration Costs in the USA
• A study in New England Journal of Medicine
used data from 1999 to estimate that about
30 per cent of American health care
expenditures were the result of
administration.
• Even if you add up administration, research
and other, you only get about 10 per cent in
Canada.
Old People Are Expensive
People are getting Older
BC Auditor General Says
 Health Outcomes
• Canada vs the USA
• Very different health systems
– Spending level (12% vs 18% of GDP)
– Organization (social insurance vs mixed)
– Inequality of insurance (very similar vs highly diverse)
• Drawn from O'Neill, J.E. and O'Neill, D.M., 2008,
April. Health status, health care and inequality:
Canada vs. the US. In Forum for Health Economics
& Policy (Vol. 10, No. 1). De Gruyter.
Canadians live 2 or 3 years longer
Canadian Babies are Heavier
Fewer Canadians are Obese (kg/m2>30)
 Fewer Canadians are Obese

Shields et al 2007, https://core.ac.uk/download/pdf/144161611.pdf

Heart Disease Kills More Americans
Depression and Pain
Getting Treatment Matters
Supply of Machines: CT scanners
Ration with Money or Wait Times
FYI, wait times here are much longer
than in 2007
Health Inequalities: The Non-Elderly
Health Inequality: The Elderly