Health Economics: 4 - Systems of Health and Social Care and the Role of Incentives to Achieve Desired End-points
From an economics point of view, health and social care systems are described by the economic relationships between agents involved in health care, for example patients, health care providers and health care funding bodies. These relationships are of various types and can be implemented in different ways. Economics suggests that these different ways provide different incentives for the agents to behave in an economic sense, with implications for the efficient and equitable distribution of health care resources.
The simplest type of relationship is when there is a transaction between two parties: a person who obtains health care and a health professional or health organisation that provides it. The person pays money in exchange for health care. Even this simple arrangement can have alternatives on the payment side of this transaction. For example, the person may pay for health care by a fee per item of service, for a package of care, through pre-payment or even on an insurance basis, whereby in return for a fee, all services are covered for a certain time period. These may even be mixed, for example an insurance premium plus a reduced fee per item. Each of these will contain an incentive for certain types of behaviour. For example, a fee per item will contain an incentive for patients to demand less health care, perhaps less than they need, but will contain an incentive for the provider to attempt to supply more, perhaps more than the patient needs. The opposite incentives will apply if care is provided on an insurance basis. One response to this problem might be to have a mixed payment system of the sort described.
Moreover, where the provider is a health care organisation, there are alternative ways for them to pay the health professionals who actually deliver the care. They may employ them directly and pay a salary; or pay for their services on a fee per item basis or a fee per patient, either during an episode of care or for care during a given period. Again, these will contain incentives for the health professional to behave in different ways. For example, a fee per patient, in the form of capitation may encourage health professionals to choose healthier patients, while salaries contain no incentive to work more than the minimum required. It should be noted that this refers only to economic incentives - health professionals may also be motivated by other concerns that counter these, at least to some extent.
In health care provision, such transactions between two parties do occur, but it is more usual to find that there is a third party involved on the funding side. Three different third parties are commonly involved: private insurance organisations, public insurance organisations and government. In some cases, more than one of these can be involved. The relationships are then more complicated, with even more alternatives for payment routes and mechanisms. For example, a private insurance company will collect premiums from the patient, but may pay some or all of the cost of any care received by the patient directly to the provider. Or it may reimburse the patient, who continues to pay the full cost to the provider. It may even pay the provider the full amount but charge the patient for some of that.
There are two consequences of third party involvement. The first is that the relationships become much more complicated, the alternative ways of arranging payments become more complicated and the incentives contained in them become more difficult to disentangle and to control. Secondly, the incentive problem gives the third parties a stake in the basic transaction and an incentive to intervene. For example, a third party might wish to control the way in which providers deliver care, so that their costs are reduced and therefore third party payments are lower. Payment systems and the incentives that they provide are crucial in this.
More generally, although no country has a single system for the provision of its health care, countries usually do have as a main model one of three very broad system types, based on the kind of third party that dominates health care financing.
4.1 Private health insurance
Under a purely voluntary private insurance system, people enter into a contract with an insurance provider, with premiums that are paid out of their own pocket. More commonly amongst countries where private insurance is the norm, employers pay for some or part of this for their employees as part of their salary package, and indeed employers may contract directly with the insurers. Insurance providers may be for-profit or non-profit organisations. Countries that have such systems often also have government funded schemes to cover those who do not have access to such employment-based schemes, although in practice these tend to be restricted not to those who are not employed but to people in greater need, such as poor people and older people.
Insurance payments can be complicated, both the way in which insurance is paid for and the way that services consumed by insured people are paid for. To understand why this is the case, it is necessary to examine the theory of how insurance works and the problems that arise from the use of insurance.
Health insurance works on the principle of risk pooling. Suppose that each member of a population has a 1% chance of having a particular illness during a year and, if they do, then they will incur costs of £10,000. So, for each group of 1,000 people, it is likely that ten of them will have the illness. Each will incur costs of £10,000, so the total cost for the group as a whole will be £100,000. If each person pays £100 into an insurance fund, then there will be £100,000, just enough to pay for all of the health care that they need. So, by pooling their risks, they can convert an uncertain loss of £10,000 for 10 of them into a certain loss of £100 for each of them.
If the amount that each insured person paid to the insurer was in fact £100, this would be what is called a fair premium. In reality, insurance companies cost a certain amount to run, and may be profit making as well. The total premium that must be paid will, therefore, be above this. The theory of insurance is that insured people will only pay a premium above the fair premium if they are risk averse. However, it may be assumed that most people are risk averse and therefore willing to pay to reduce uncertainty. The extra amount that people are willing to pay on top of the fair premium is, therefore, called the risk premium.
There are three main problems with insurance: adverse selection, moral hazard and reductions in competitive pressures in the health care market. There is an additional problem with having a system based entirely on voluntary insurance if the aim is to meet health needs, since coverage depends on ability to pay as well as willingness to pay. Poorer people are therefore less likely to be covered and these may also include those who have the greatest health needs.
The problem of adverse selection may arise when the pooling of risks described above actually contains people with different risks, sometimes called community rating, and they are aware of that but the insurer is not. The insurer may charge what from their perspective is a fair premium, plus overheads that are at or below what most people are willing to pay as a risk premium. However, for people who know that they have a relatively low risk, the fair premium will be lower and the total premium may therefore be higher than they are willing to pay even if they have the same level of risk aversion as everyone else. This means that people with low risks have a disincentive to buy insurance, and only people who have a relatively high probability of illness will choose to buy it. The pay-outs by the insurer may, therefore, be greater than the premiums collected, so it would have to re-assess risk and raise the fair premium. This will be a disincentive for yet more relatively low-risk people to refuse insurance. In the extreme, adverse selection might mean that the average person will not buy insurance, and insurance premiums continually increase until insurance schemes contain only those people with the highest risks of illness. These may also be the people least able to afford to pay for insurance.
Insurers therefore have an incentive to deal with the problem of adverse selection by experience rating rather than using community rating. They may be able to set different premiums for different risk groups, for example, high, medium and low. This requires them to obtain extra information through, for example, access to medical and insurance records and health examinations. However, obtaining information is itself costly and would have to be added to the premium. Moreover, it would mean that people with high risks pay a high premium or are unable to obtain insurance at all - which from society’s point of view might be undesirable since this means that access to health care is worst for those most in need, especially if, as mentioned, these are also poorer members of society.
Another solution is to make health insurance compulsory, as everyone will be covered whatever their risk. In effect, people with low risks subsidise those with higher risks. That might be seen as desirable, but it could also be viewed as inequitable, especially if higher and lower risks of incurring health care costs are not necessarily directly related to higher and lower costs of ill-health, which, as will be explained, is the problem of moral hazard.
The fair premium is based on a fixed probability of ill-health and a fixed amount to be paid out in the event of ill-health. Moral hazard arises if it is possible for insured people to alter the probability, or the amount, or both, after they have taken out insurance. If so, they will have an incentive to raise them, since the benefits received by an insured person will be greater than the costs to them. The problem is that if either is raised, then the actual pay-outs will be greater than the total premiums requiring premiums to be raised. This might result in some people, who would be willing to pay the total premium required to cover normal risks, being unwilling or unable to pay actual premiums. In health, altering the probability might take the form of a lower incentive for prevention, thereby raising the probability of ill-health, but this is not regarded as a serious problem. Rather, it is the probability that a claim will be made for a given level of ill-health, in particular for less serious conditions. It is difficult to disentangle this entirely from what is regarded as the main problem of moral hazard in health care, which is changing the size of the pay-out that the insurer must pay. This takes the form of greater use of health care services, use of additional services or of higher cost services. This might result from actions by the insured, where it is known as consumer moral hazard or from actions by providers of health care, who might provide more services at higher costs to insured people, which is known as provider moral hazard. It is likely that there may be collusion between consumer and provider, as both have an incentive to behave in this way.
The likelihood of moral hazard problems can be reduced by requiring some element of user charges for use of services, which can take a number of forms. Coinsurance means that the insured pays a proportion of the amount of the claim. A deductible, also called an excess, is a fixed amount to be paid by the insured when a claim is made irrespective of the size of the claim. Insurance policies may also stipulate a maximum amount that can be claimed. No claims bonuses offer insured people a rebate or reduced future premiums if they do not claim, which in effect raises the cost to the insured of making a claim. In every case, these offer a disincentive to insured people to make more and higher claims, thereby reducing moral hazard. Of course, if the aim of the health system is to meet needs, regardless of willingness to pay, then such methods will not necessarily be regarded as desirable since they may discourage use of services that are needed.
Insurance may also reduce the incentives that consumers and providers of health care have to choose low-cost ways of producing health care by reducing competitive pressures in the health care market. Because the price of care is no longer directly important to consumers, they have no incentive to seek lower cost providers for the same health outcomes. Instead, they will look for providers that have the highest perceived quality, in terms not only of perceived health outcomes but also of process of care factors such as comfortable facilities and additional amenities. Providers will therefore have an incentive to compete by perceived quality, which will raise health care costs. Increased competition in the health care market will therefore raise costs rather than lower them.
In general, the problems of health insurance mean that there are incentives towards a high cost system, and these higher costs are exacerbated by the need to devise and implement means to combat those problems. Insurance systems are therefore characterised by a high level of deadweight loss, that is, a high proportion of the cost of health being spent on administrative processes rather than on health care, as well as expenditure on services that might be regarded as being in excess of those required to meet health needs.
4.2 Social insurance
Social insurance is, in its purest form, based on the notion of solidarity, whereby employees, employers and governments all contribute to a social insurance fund that is used to pay for health care for those employees and their dependents. Countries that have such systems usually also have government schemes to cover those who are not covered by employment-based insurance, which are paid directly from taxation revenue or from the insurance funds themselves. Usually, social insurance is compulsory, although in some countries it is not available to richer members of the population. In some countries, there are several different social health insurance funds; people may be free to choose which fund they join or will be assigned to one on the basis of their occupation or region of residence. Contributions from employed people will be deducted from their salary and payments by employers are often collected in the form of a payroll tax proportional to the employer’s wage bill. Self-employed people pay a proportion of their reported income.
Social insurance retains some of the problems of private insurance, in particular pressures towards higher costs induced by moral hazard and reduction of competitive pressures as well as administrative overheads. However, the strength of the government as a third-party stakeholder is important in reducing these, if that is the will of the government. There may also be problems of adverse selection, although this is usually less important. In general, social insurance systems have a good track record in delivering access to comprehensive high quality care to the whole population, though often at a high cost.
4.3 Public funding
In publicly funded systems, the main source of funds is taxation, which may include both general and health-specific taxes. This will be collected and set by national, regional or local government authorities, or all of these. In some countries, this may be supplemented by social insurance contributions and user charges. The government will in effect be both the main provider of insurance and the main purchaser of health care. Private insurance usually also exists as well, but its role is to enable people to buy what are regarded as non-essential services, or a perceived better process of care. A national health service was usually reserved as the term for a system in which care was not only publicly funded but also provided by nationally-owned provider organisations. This distinction is now used less, as publicly funded systems that were dominated by such an arrangement seek a more mixed set of providers.
Publicly funded systems have their own versions of incomplete coverage, moral hazard, adverse selection and low competitive pressures. The main advantage of this, in theory, is that the government is the most powerful third party possible to deal with these problems and can do so without such a large administrative overhead. The difficulty is that using this power requires detailed centralised information and systems of control, which will be expensive, and any errors made in the exercise of this central power will be felt throughout the system instead of just locally.
© David Parkin 2017