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Systems of Health and Social Care and the
Role of Incentives to Achieve Desired End-
points
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
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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 alsoinclude
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 adverseselection,
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
Techniques of economic appraisal
(including cost-effectiveness analysis
and modelling, cost-utility analysis,
option appraisal and cost-benefit
analysis, the measurement of health
benefits in terms of QALYs and related
measures e.g. DALYs) ›
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
 
 
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