Information Asymmetry in Health Care

Demand & Health Insurance

SMITA SINGH
BA(H) ECONOMICS
III SEMESTER
A20018222005
CONTENTS
1. Introduction
2. Information asymmetry in health care demand
3. Adverse selection in healthcare insurance
4. Moral hazard in health insurance and its effect on health care
utilization
5. Strategies to mitigate information asymmetry in health care
demand and health insurance market
6. Bibliography
 01
Introduction
 Information asymmetry refers to a situation where one party involved in a
transaction possesses more or better information than the other party.

When it is not easy to know about the quality of goods or it is costly to get
information about them and the buyers and sellers of goods are not equally
informed about the quality of goods, then there is asymmetric information.

Thus, asymmetric information means the market situation when the buyers and
sellers have a different information while making a transaction.
Introduction
 02
Information Asymmetry in Healthcare
Demand
Information asymmetry in healthcare demand occurs when the insurance company
has less information about the state of health of the individuals who want to get
their life insured or want insurance for sickness or in case of general insurance
about the accident proneness of their cars, etc.

Insurance companies do not get unbiased selection of individuals who buy

insurance policy and it is only the high-risk individuals who purchase it.

In such a situation the insurance claims will mostly be made by the individuals
with high risk and as a result the insurance company who charges premium rate on
the basis of average risk of both kinds of individuals with high-risk and low risk of
illness will go bankrupt.
 03
Adverse Selection in Health Insurance and its
Influence on Premium Pricing
Adverse selection occurs when individuals with higher health risks are more likely to seek
insurance coverage, while those with lower risks may opt out. This leads to an imbalance in the
risk pool, causing insurers to raise premiums to compensate for the higher expected costs.
Information asymmetry plays a crucial role in adverse selection, as individuals may possess
private information about their health status that insurers are not aware of, leading to
inaccurate risk assessment and pricing.
Adverse selection is a phenomenon that occurs in the health insurance market when individuals
with higher health risks are more likely to enroll in and retain insurance coverage compared to
those with lower health risks. This can lead to imbalanced risk pools and have significant
implications for premium pricing.

Adverse selection arises due to information asymmetry between insurers and individuals
seeking health insurance. Insurers have limited information about an individual's health status
and risk profile at the time of enrollment. However, individuals typically have a better
understanding of their own health risks and are more likely to seek insurance coverage if they
anticipate higher healthcare needs or costs.

As a result, individuals with pre-existing conditions, chronic illnesses, or other health risks may
be more motivated to obtain health insurance coverage. They recognize the potential financial
protection that insurance provides for their healthcare expenses.
On the other hand, individuals who perceive themselves as having lower health risks may be
more inclined to opt out of insurance coverage, especially if they consider the premiums to be
relatively high compared to their anticipated healthcare needs.

The presence of adverse selection can create imbalanced risk pools within insurance plans. Risk
pools ideally consist of a diverse mix of individuals with varying health risks, allowing for the
spreading of costs across the population. However, if the risk pool is dominated by individuals
with higher health risks, insurers face higher expected healthcare costs for the enrollees. To
compensate for this increased risk, insurers may adjust their premium pricing accordingly.
Premium pricing in the presence of adverse selection tends to be higher overall. Insurers need
to set premiums at levels that account for the expected healthcare costs of the high-risk
individuals in the risk pool. This can result in higher premiums for all enrollees, including those
with lower health risks. As a consequence, individuals with lower health risks may perceive the
premiums as less favorable relative to their anticipated healthcare needs and costs, leading to a
further propensity to opt out of insurance coverage. This dynamic exacerbates the adverse
selection problem.
 04
Moral Hazard in Health Insurance and its Effect
on Healthcare Utilization
Moral hazard in health insurance refers to the phenomenon where
individuals alter their behavior and increase healthcare utilization
once they have insurance coverage. This increased utilization can
lead to higher healthcare costs. Information asymmetry
exacerbates moral hazard, as individuals may overconsume
healthcare services or engage in risky behaviors, assuming that
insurance will cover the costs.
Moral hazard is a concept that arises in health insurance when individuals alter their behavior
and increase their utilization of healthcare services once they have insurance coverage. The
presence of insurance reduces the financial burden on individuals for medical expenses, which
can lead to changes in their healthcare-seeking behavior.

When individuals have health insurance, they may be more likely to seek medical care for
conditions that they might have otherwise ignored or managed differently. The reduced out-of-
pocket costs associated with insurance coverage create an incentive to utilize healthcare
services more frequently or for less urgent or necessary reasons. This increased utilization can
include visits to healthcare providers, diagnostic tests, procedures, and treatments.
Moral hazard can have several effects on healthcare utilization:

1. Overutilization of Healthcare Services: Insurance coverage can lead to overutilization of

healthcare services, including unnecessary tests, procedures, or consultations. Individuals may
be more inclined to seek medical care for minor or self-limiting conditions that would resolve
without intervention. This overutilization can strain healthcare resources and contribute to
increased healthcare costs.

2. Increased Healthcare Expenditures: The increased demand for healthcare services due to
moral hazard can drive up healthcare expenditures. Insurance companies need to cover the
costs associated with the additional services utilized by individuals, which can lead to higher
premiums for all policyholders.
3. Distorted Allocation of Resources: The overutilization of healthcare services driven by moral
hazard can result in the misallocation of resources within the healthcare system. Resources that
could have been directed towards more medically necessary or cost-effective treatments may
instead be allocated to unnecessary or low-value services.

4. Potential Harm to Patients: Unnecessary or excessive healthcare interventions resulting from

moral hazard can expose patients to potential risks and side effects. Unwarranted tests or
procedures can lead to false positives, unnecessary invasive interventions, and increased
exposure to healthcare-associated infections.
 05
Strategies to Mitigate Information Asymmetry in
Healthcare Demand and Health Insurance Market
1. Signalling

The existence of asymmetric information often leads to the problem of adverse selection and this leads to
market failure. One way in which the buyer and seller can deal with this problem is through market signalling.
The concept of market signalling is where the buyer or the seller signals the other uninformed party, to increase
their information about the product in trade.
Market signalling has been proposed as a solution to this problem. If sellers of high-quality products, low-risk
individuals, or more productive workers can communicate their superior quality to potential customers, the
problem of adverse selection can be mostly overcome.
A firm can send signals that indicate the high quality of its products to potential buyers by adopting brand
names and offering guarantees and warranties. However, firms whose products are of low quality cannot offer
guarantees and warranties since it would be very costly to do so.
Education is a crucial indicator of worker productivity, and Michael Spence suggests that sellers can
communicate product quality to potential buyers in certain markets.
In a labour market with asymmetric information, firms may not know who are more productive workers and
less productive workers until after they have been hired and worked for some time.
This lack of information may lead to adverse selection, as explained earlier in the context of the market for used
cars and insurance market.
Spence's model of signalling suggests that education is a good signal for employers to distinguish between high-
productivity workers and low-productivity workers.
A person's education level can be easily measured by the number of years of schooling, degrees obtained, the
college or university where they studied, and the grade or marks obtained.
Education can still serve as a useful indicator of productivity, even if it doesn't directly improve it.
More productive individuals are more intelligent, motivated, and hard-working, and their higher education
levels can be used as a signal of their productivity, enabling them to secure lucrative jobs.
This is because education is easier and less costly for more productive individuals.
2. Screening
There is another way to take care of the information asymmetries, which is when uninformed parties initiate
communication by conducting a test either for the informed parties or the goods those parties seek to trade.
Similarly, a life insurance company can gain information regarding the health of an insurance policy applicant
by obtaining the applicant’s medical records, contacting his current physician, or subjecting him to a physical
examination.
Another common way of implementing screening is by designing and offering different contracts for the
different types of agents with hidden information, instead of offering one homogenous contract.
In this way each agent’s type gets revealed.
There is one significant difference between signalling and screening.
In signalling it is the more informed party that initiate the communication, whereas in screening the
communication intended to make up for the information asymmetries is initiated by the less informed.
 Bibliography
1. https://www.sciencedirect.com/topics/economics-econometrics-and-
finance/asymmetric-information#:~:text=Asymmetric%20informatio
n%20in%20insurance%20refers,which%20leads%20to%20market%
20failure
.
2. Ahuja HL, Modern Microeconomics
3. IGNOU
4. https://mru.org/courses/principles-economics-microeconomics/soluti
ons-moral-hazard-example
Thank You!