1. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Health Insurance Revisited: On the implications
of the US Health Care Reform.
Mireia Jofre-Boneta,c
Alistair McGuireb
aProfessor at the Department of Economics, City University
bProfessor at LSE Health and Social Care
cSenior Associate Research LSE Health
AES Valencia June 2010

2. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Organisation of this talk
First part (AJM):
• Health Care Reform
– Health insurance in practice
– Insurance Exchange
– Separating Equilibrium
– Separating equalisation with subsidy
– Competitive insurance with adverse selection
AES Valencia June 2010 2

3. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Organisation of this talk - 2
Second part (MJB):
Reflection of welfare and potential effects in the
European setting
• Health Insurance Exchange and search costs versus
tax and subsidies
• Health Insurance Exchange with supplementary
health insurance setting
AES Valencia June 2010 3

4. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Health insurance in practice
• Pooling of wealth to mitigate financial loss of adverse events in
risk adverse individuals
• What do we know about insurance?
– A lot
• Arrow (1963) optimal insurance includes a deducible
• Rothschild and Stiglitz (1979) pooling and separating equilibria
• Raviv (1979)
– maximum acceptable premium (actuarially fair premium + loading) for
individual is lower the larger his wealth (if diminishing risk aversion)
– If coverage of insurance can be chosen, then chosen to point where expected
utility increment of additional unit of cover is zero, and this is generally less
than full cover
• Nyman (2002) income re-distribution is more important than compensating
risk
– Income effect fully dominates substitution effect
– So optimal coverage tends not to be full coverage and income re-
distribution is important

5. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
USA Health Care Reform
• Problems
– High % population uninsured (c50m)
– High catastrophic payments
– High health care costs (the elephant in the room…)
• Require most US citizens to have health insurance
– Tax penalty for individuals without coverage
• some exemptions
– Require employers with >50 employees to offer cover
• some exceptions
– Create state-based American Health Benefit Exchanges
• Provide information on plans and allow purchase through premiums
and tax credits

6. Health Insurance Revisited
Expansion of population coverage Mireia Jofre-Bonet
Alistair McGuire

7. Health Insurance Revisited
Insurance exchange Mireia Jofre-Bonet
Alistair McGuire
• Different (current) proposals
• Objectives
– Single point of entry to insurance market
– Choice over benefit plans
– Disseminate information specifically over coverage and price
– Support price competition
• Coverage must be appropriate
– Only to uninsured?
– All who have tax credit subsidies
– Option for all in state/country
• Offer of standardised options
– Keene’s work on lack of contract knowledge
• Act as a bargainer or informer
• Protect against adverse selection
– Premium and cost sharing subsidies = $350billion (2010-2019)
– Underwriting expenses = $106billion (2010-2019)

8. Health Insurance Revisited
Premiums, subsidies and other matters Mireia Jofre-Bonet
Alistair McGuire
• Non-group policies estimated to rise 10-13%
(compared to existing)
– 27-30% rise because of increased benefit coverage
– 7-10% reduction due to bigger pools (exchanges), lower
administration costs, increased competition
– 57% of individuals would receive subsides
• Subsidies to those with income 133-400% of FPL
• Subsidies will help limit adverse selection
• Employment based market
– Small group (<50 employees)
• Broadly neutral effect on premiums
– 13% receive subsidy
» Tax credits for small businesses
– Large market
• Broadly neutral in premium (3% savings)
– No subsidies
– Tax on high premium plans (c10% of plans after 2016)

9. Health Insurance Revisited
…other matters Mireia Jofre-Bonet
Alistair McGuire
• Adverse selection in nongroup
market/exchanges…may be low
– Annual open enrollment
– Enrollment of broad range of individuals
– Subsidies extensive
– Reinsurance system for high-cost enrollees limtie
premium increases
• Little on health care costs
– Provider responses

10. Health Insurance Revisited
…other matters Mireia Jofre-Bonet
Alistair McGuire
• Dutch system
– Mandatory health insurance through private insurers
– Open (annual) enrolment and community rating
– Risk-equalisation subsidises
– Insurers can contract selectively with providers
• Problems
– Consumer premiums rising
– Insurers reporting losses
– Patient satisfaction not high
– Health care providers cream skimming
• Subsidy issues in Mass. USA

11. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Rothschild-Stiglitz separating equilibrium
• Each insurer observes all offers on market
• Pure Nash strategies
• Pooling not possible
• Separating equilibrium
– Depends on self-selection; high-risks prefer their contract
to the low-risk contract
– Break-even condition
– No entry condition
– Depends on the proportion of low risks in the market
• Separating equilibrium may not exist
– If costs of separating are high to the low cost risks
• If it does it is not necessarily second-best

12. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Rothschild-Stiglitz separating equilibrium -2
AES Valencia June 2010 12

13. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Wilson-Miyazaki-Spence separating equalisation
with subsidy
• Does not depend on proportion of low risks in
market
– Low risks must signal their true risk and subsidise high-
risks
– Firms drop (potential) loss making policies
• Wilson foresight firms drop policies which will become
unprofitable with exit
– Not possible to design new profitable contracts which
change behaviour
• Frontier all the zero aggregate transfer points
• Bold sub-set are second-best (Pareto) optimal

14. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Wilson-Miyazaki-Spence separating
equalisation with subsidy
AES Valencia June 2010 14

15. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
PART 2: Motivation
Previous presentation explained the main
features of the US Health Care Reform
This part of the talk aims at:
• calculating the potential welfare effects
• reflect on the possible spill-over effects of the
reform to the supplementary health insurance
market in Europe
AES Valencia June 2010 15

16. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Organisation of the talk
• Pooling, taxes and subsidies versus increased
competitiveness, standardization and reduced
search costs
• Expected Welfare Effects?
– In the US
– Europe, supplementary health insurance and the
question
AES Valencia June 2010 16

17. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Pooling, taxes and subsidies in the Health
Insurance Market
• Snow and Crocker (1985) construct a simple system of
lump sum taxes and subsidies levied against firms to
achieve Nash Equilibrium for any proportion of high
risks.
– insurance contracts : (α1,α2):
• α1 premium, α2 reimbursement if ill
– proportion of high risk population: λ
– probabilities of being low risk and high risk:
• pL & pH with 0<pL <pH <1
– average probability of loss: p = λ p H + (1 − λ ) p L
AES Valencia June 2010 17

18. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Pooling, taxes and subsidies in the Health
Insurance Market -2
• Then, there is a simple system of lump sum taxes and
subsidies levied against firms:
π H if ρ > p for High risk individuals


t = 0 if ρ=p
 L
π
 if ρ < p for High risk individuals
Low
such that the regulator runs a balanced budget:
H L
λπ + (1 − λ ) π = 0
AES Valencia June 2010 18

19. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Pooling, taxes and subsidies in the Health
Insurance Market -3
• Graphically:
AES Valencia June 2010 19

20. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Pooling, taxes and subsidies in the Health
Insurance Market -4
• Too many risk groups may mean taxes in the
lowest risks’ end may become unbearably high
– Thus, there is a need to make groups quite mixed,
to spread the load of the high risk groups
• the forced pooling of 3:1 imposed in the American
Reform
AES Valencia June 2010 20

21. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Health Insurance Exchange and search costs -
1
• Diamond (1985) and Stiglitz (1989)
– Search costs in a homogeneous commodity market
can result in monopolistic pricing by sellers
– Resulting prices can be substantially higher than
marginal costs even with
• Modest search costs
• Non collusive sellers
AES Valencia June 2010 21

22. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
HI Exchange and search costs in a
differentiated market
Bakos (1997)
• The creation of electronic marketplaces
– Lowers buyer’s costs to acquire information about seller prices
and products
– Reduces inefficiencies caused by buyer search costs
– Reduces ability of sellers to extract monopolistic profits
– Provides a more optimal allocation of resources as allows a better
allocation of buyers to differentiated products matching their
tastes
• More literature reinforces these findings
– Mortensen and Wright (2000) generalise Wolinsky, Rubinstein
and Gale’s, model’s and reach similar conclusions
AES Valencia June 2010 22

23. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
HI Exchange and search costs in a
differentiated market - 2
• The effects of standardisation
– Standardisation of product
• Easier to compare products
– Reinforcement of increased competition between suppliers
AES Valencia June 2010 23

24. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
HI Exchange and search costs in this context
• In our context, prior to HI Exchange, search
costs for consumers, lack of standardisation,
etc. we should observe:
– A premium α1s higher than it will be with the
exchange α1ex
– Thus, an endowment E’ lower (to the left of) than
the E
• Thus, the indifference curves attainable by
individuals prior to exchange had to be lower
AES Valencia June 2010 24

25. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Taxes and subsidies and HI exchange in the
Health Insurance Market
• Graphically:
F’
R’H
E’ E’
AES Valencia June 2010 W- α1s W- α1ex 25

26. Health Insurance Revisited
Mireia Jofre-Bonet
Taxes and subsidies and exchange in the Alistair McGuire
Health Insurance Market - 2
• The overall effect of introducing the HI
exchange (removing search costs, etc.)
AND taxing the low risks to subsidize the
high risks will depend on:
– the proportion of the high risks and low risks
– whether the increase in efficiency by removal
of search and other costs reduces premia
SUFFICIENTLY for the low risks
AES Valencia June 2010 26

27. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Welfare effects
• Expected Welfare Effect of reducing search
costs
– Undeniably positive for high and low risks
• Pooling and subidization
– Previously uninsurable high risks gain
– Insured high risks may gain?
– Insured and uninsured low risks may gain or not
• Depending on whether reduced premia offsets tax
AES Valencia June 2010 27

28. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Welfare effects - 2
• Overall effect:
– It will depend on how much HI exchange translates
into increased competitiveness and reduction of
search costs for all consumers
– A proportion of population (low risk) would always
have preferred no insurance or partial insurance to
compulsory grossly pooled one
• Net effect on welfare will depend on
magnitude of premium reduction and the
proportion of each risk type
AES Valencia June 2010 28

29. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
Spill-over effects for Europe
• Europe:
– Cross-subsidisation is done through taxes
• Supplementary Health Insurance
– Preference driven
• Possibly more differentiated products
– Potential lower impact of standardization through exchange
– Similarly, welfare gains from exchange still hold
AES Valencia June 2010 29

30. Health Insurance Revisited
Mireia Jofre-Bonet
Alistair McGuire
AES Valencia June 2010 30

31. Health Insurance Revisited
Summary Mireia Jofre-Bonet
Alistair McGuire
1. Compulsory 2. Supplementary 3. Private Insurance
Insurance
Full participation Partial participation Partial participation
Restriction of preferences Fuller coverage meeting Fuller coverage meeting
- Not full insurance preferences preferences
coverage - but co-pays - but co-pays
Subsidy means:
a. low risk individuals Adverse selection Adverse selection
may be over-paying
b. benefit coverage is Moral hazard Moral hazard
“low”
Adverse selection Welfare gain compared Welfare gain to 1&2
- Depends on provider to 1. unclear as it depends on
arrangements risk preferences and
Moral hazard distribution of risk types
in population