Lecture 10A
Insurance:
● Risk pooling
● Transfer of risk
● Destruction of risk → the law of the large numbers shows that for a given
probability of illness, the distribution of the average rate of illness in the
groups will collapse around the probability of illness as the group size gets
larger and larger.
The standard error of the estimated p becomes smaller the larger the sample size.
Demand for insurance exists if individuals are risk averse:
● The disutility of losing money exceeds the utility of gaining a similar amount
● The individuals’ marginal utility of wealth is diminishing
● The individual’s utility function is concave (bowed out to the x-axis)
○ The marginal utility of wealth is decreasing → risk averse
,Lecture 10B
Moral hazard:
● In general → Indifference to a loss because of the existence of insurance.
● Health insurance → the use or provision of more (expensive) care because
the insurer reimburses (a part of) the costs.
The demand for insurance depends on →
● Moral hazard → the higher the moral hazard, the lower the demand for
insurance.
● The consumer’s risk aversion → The less risk-averse a person is, the less is
the demand for insurance.
● The loss-probability → when this is exactly 0 (no risk of illness) or 1
(certainty of illness), people are not willing to pay a loading fee. People
between p1 and p2 will buy insurance.
● The loading fee → the higher the loading fee, the lower the demand for
insurance.
● The loss → if the loss decreases, the demand for insurance also decreases.
● The consumer’s income/wealth. → the higher the income or wealth, the
lower the demand for insurance.
Advantages of health insurance:
● Welfare gain for risk-averse individuals
● Access to care that would otherwise be unaffordable
Disadvantages of health insurance:
● High expenses due to undesired moral hazard
● High expenses due to loading fee
Lecture 10C
● Premium = risk premium + loading fee (incl. administrative costs, profits)
● Risk premium (or actuarially fair rate) = the expected loss based solely on the
probability of the event occurring.
, ● With perfect competition the expected profits on each insurance contract will tend to
zero (because competition minimizes predictable profits).
The equivalence principle of a competitive insurance market implies that an insurer has to
break even on each insurance contract, and therefore cannot organize ex-ante cross-
subsidies among different risk groups.
→ risk rating (i.e. premium differentation) and/or risk selection.
A free unregulated competitive insurance market tends towards risk-rated premiums, i.e.
premiums adjusted to the consumer’s risk (e.g. age, health)
Lecture 10D
Classification criteria for health insurance:
● Source of financing → public or private?
● Mandatory or voluntary?
● Group or individual?
● Community-rated (for everyone the same) or experience rating (risk-adjusted)?
The essential aspect of social health insurance → cross-subsidies.
Other aspects of SHI can be:
● Standardized benefits package
● Mandatory
● Taxes
● Open enrolment
● Community-rating
● Earmarked contribution
Often a distinction is made between social and private health insurance.
Distinct health care systems prior to 1989:
● Bismarck system (Germany, 1883) → social insurance system
○ Contributions from both employers and employees. Contracts between
sickness funds and providers of care. Compulsory for workers with an income
below a certain level. Government determines the conditions that govern the
relations between sickness funds, providers and consumers.
Insurance:
● Risk pooling
● Transfer of risk
● Destruction of risk → the law of the large numbers shows that for a given
probability of illness, the distribution of the average rate of illness in the
groups will collapse around the probability of illness as the group size gets
larger and larger.
The standard error of the estimated p becomes smaller the larger the sample size.
Demand for insurance exists if individuals are risk averse:
● The disutility of losing money exceeds the utility of gaining a similar amount
● The individuals’ marginal utility of wealth is diminishing
● The individual’s utility function is concave (bowed out to the x-axis)
○ The marginal utility of wealth is decreasing → risk averse
,Lecture 10B
Moral hazard:
● In general → Indifference to a loss because of the existence of insurance.
● Health insurance → the use or provision of more (expensive) care because
the insurer reimburses (a part of) the costs.
The demand for insurance depends on →
● Moral hazard → the higher the moral hazard, the lower the demand for
insurance.
● The consumer’s risk aversion → The less risk-averse a person is, the less is
the demand for insurance.
● The loss-probability → when this is exactly 0 (no risk of illness) or 1
(certainty of illness), people are not willing to pay a loading fee. People
between p1 and p2 will buy insurance.
● The loading fee → the higher the loading fee, the lower the demand for
insurance.
● The loss → if the loss decreases, the demand for insurance also decreases.
● The consumer’s income/wealth. → the higher the income or wealth, the
lower the demand for insurance.
Advantages of health insurance:
● Welfare gain for risk-averse individuals
● Access to care that would otherwise be unaffordable
Disadvantages of health insurance:
● High expenses due to undesired moral hazard
● High expenses due to loading fee
Lecture 10C
● Premium = risk premium + loading fee (incl. administrative costs, profits)
● Risk premium (or actuarially fair rate) = the expected loss based solely on the
probability of the event occurring.
, ● With perfect competition the expected profits on each insurance contract will tend to
zero (because competition minimizes predictable profits).
The equivalence principle of a competitive insurance market implies that an insurer has to
break even on each insurance contract, and therefore cannot organize ex-ante cross-
subsidies among different risk groups.
→ risk rating (i.e. premium differentation) and/or risk selection.
A free unregulated competitive insurance market tends towards risk-rated premiums, i.e.
premiums adjusted to the consumer’s risk (e.g. age, health)
Lecture 10D
Classification criteria for health insurance:
● Source of financing → public or private?
● Mandatory or voluntary?
● Group or individual?
● Community-rated (for everyone the same) or experience rating (risk-adjusted)?
The essential aspect of social health insurance → cross-subsidies.
Other aspects of SHI can be:
● Standardized benefits package
● Mandatory
● Taxes
● Open enrolment
● Community-rating
● Earmarked contribution
Often a distinction is made between social and private health insurance.
Distinct health care systems prior to 1989:
● Bismarck system (Germany, 1883) → social insurance system
○ Contributions from both employers and employees. Contracts between
sickness funds and providers of care. Compulsory for workers with an income
below a certain level. Government determines the conditions that govern the
relations between sickness funds, providers and consumers.
