Life is a gamble. Suppose we were to flip a coin. If it comes up "heads," you lead a healthy, normal life. If it comes up "tails," you become seriously ill. Medical science can return you to the healthy state, but medical science is not cheap. Treatment will cost you $20,000, plus some associated pain and suffering. Are you willing to buy a health insurance policy to attenuate the financial consequences of your potential bad luck?
The correct response is "maybe." It depends on the price of the policy and the nature of the coverage. In this article, we present the theory of health insurance and develop four hypotheses about the conditions under which we would be willing to buy coverage. At first blush, the theory of health insurance appears inconsistent with real-world experience. This is largely because the simple theory abstracts from real-world complexities. In particular, it ignores adverse selection, employer-sponsored health insurance, and the special tax treatment of health health insurance. We will anticipate future articles by introducing these topics and the roles they play in the demand for health insurance.
Friedman and Savage and Ehrlich and Becker viewed the demand for health insurance as reflecting the maximum we would pay, over and above the expected loss, to avoid the consequences of the loss. The expected loss is the amount we would expect to pay, on average, if the event occurred many times. Thus, if we would have to pay $20,000 every time we flip a coin and "heads" occurs and pay $0 whenever "tails" appears, then the expected loss for 100 flips of our coin is $10,000 on each flip. Sometimes, we will have to pay nothing; we win. Sometimes, we will have to pay $20,000; we lose. On average, we will pay $10,000 per flip.
Again, consider the question of health insurance against the financial consequences of the coin flip. Are you willing to pay more than $10,000 to avoid the coin flip? If so, you are like most of us and are risk averse. You are willing to pay more than the expected loss to avoid the consequences of the loss. Stated somewhat differently, you are willing to pay some "loading fee" over and above the actuarially fair premium to avoid the consequences.
Insurance exists because there are enough of us who feel that way. The extra amount we are willing to pay, often called a "risk premium," means that there is the potential for someone to come in and get a hundred or more of us to buy an health insurance policy from her. Her "claims costs" will be $10,000 on each policy, on average. The risk premiums we are willing to pay will compensate her for running the program.
Our simple health insurance model suggests that many of us would pay a risk premium [plus the expected loss] to avoid the consequences of the coin flip. What is the maximum amount you would be willing to pay? It depends on three factors: how "chicken" you are, how much you would lose if the bad outcome occurred, and how great the chances are that the bad outcome will actually occur. How chicken you are is merely a reflection of your unwillingness to bear risk. The more chicken that is, the more risk averse you are the larger will be the risk premium and the more you are willing to pay to get coverage. This raises an important point. Everyone does not have the same demand for health insurance.
Some will prefer broader and/or deeper coverage. Others will prefer to buy much less. Some may prefer to buy none at all. We need to formalize this discussion a bit. When we say that someone is risk averse, what we mean is that the loss of $1 reduces their well-being by more than the gain of $1 increases it. This is just another way of saying that risk-averse individuals have diminishing marginal utility of wealth. Each dollar of wealth makes them better off, but each additional dollar is not as satisfying as the one before. This idea is no different than the discussion you undoubtedly had in an introductory economics class, except there the discussion revolved around the diminishing marginal utility of beer, or pizza, or ice cream cones consumed at a single sitting.
In addition to the four classic rationales for the purchase of health insurance presented here, Nyman [1999] argued for a fifth consideration: the access motive. The argument is straightforward. Some health conditions, should they occur, are so expensive that they exhaust your wealth. Since you could not pay for such treatment in the first place, under the traditional rationales, you would not buy health insurance to avoid the consequences of the event occurring. Nyman argued that health insurance may be the only mechanism whereby you could obtain such treatment and that people do buy coverage to have such treatments available to them, should they need them.
People who are more risk averse will buy more health insurance.
People will be more likely to buy health insurance for events that have large financial consequences.
People will be less likely to buy health insurance for events that are very unlikely or very likely to occur.
People will be less likely to buy health insurance as their wealth position increases
Our website is not responsible for the information contained by this article. Webworldarticles.com is a free articles resource thus practically any visitor can submit an article. However if you notice any copyrighted material, please contact us and we will remove the article(s) in discussion right away.
This article was sent to us by:
Art Lee at
09112010
1. What is a (copayment) copay in Health Medical Plans
All articles in this directory are property of their respective authors. Additionally, read our Privacy Policy
© 2010 WebWorldarticles.com - All Rights Reserved. Partners: Gunblade Saga