Chapter 4

Systems of Health and Social Care

and the Role of Incentives to
Achieve Desired End-points
 Systems of Health and Social Care

• 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.
 Systems of Health and Social Care

 Even this simple arrangement can have alternatives on the payment side of
this transaction. Each of these will contain an incentive for certain types of
behaviour. For example, the person may pay for health care:
 by a fee per item of service: 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.
 for a package of care
 through pre-payment
 on an insurance basis, whereby in return for a fee, all services are covered
for a certain time period: contain an incentive for patients to demand more
health care, perhaps more than they need, but will contain an incentive for
the provider to attempt to supply less, perhaps less than the patient needs.
 These may even be mixed, for example an insurance premium plus a
reduced fee per item: a more balanced incentives for both parties.
 Systems of Health and Social Care

 Where the provider is a health care organisation, there are

alternative ways for them to pay the health professionals who
actually deliver the care. Again, these will contain incentives for the
health professional to behave in different ways.
 They may employ them directly and pay a salary.
 They may 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.
 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.
 Systems of Health and Social Care

 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,
 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.
 Systems of Health and Social Care

 There are two consequences of third party involvement.

1. 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.
2. 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.
 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
organizations.
• 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.
 Private Health Insurance
• 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 10 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.
 Private Health Insurance
• 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.
 Private Health Insurance
• There are three main problems with insurance:
 adverse selection,
 moral hazard, and
 reductions in competitive pressures in the healthcare
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.
 Private Health Insurance
 The problem of adverse selection may arise when the pooling of
risks actually contains people with different risks, 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.
 Private Health 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.
 Private Health 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.
 Private Health Insurance
 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.
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.
 Private Health Insurance
• 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.
 Private Health Insurance
 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 healthcare 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.
 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.
 Social Insurance
• 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
 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.

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.
 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 healthcare.
• 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.
 Public Funding
• 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.
• 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.