5007Assymetric Information

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Asymmetric information Trade-off and Solutions to Health

Insurance Problems

*Dr.S.Padmavathy

Hugh the Elder Chamberlin from the Peter Chamberlin family proposed the

concept of Health insurance in 1694. In the late 19th century, early health insurance was

actually disability insurance in the sense that it covered only the cost of emergency claim

for injuries that could lead to a disability. This payment model continued until the start

of the 20th century in some jurisdictions (like California), where all laws regulating

Health insurance actually referred to disability insurance. Patients were expected to pay

all other health care cost out of their own pockets, under what is known as the fee-for-

service business model. During the middle to late 20th century traditional disability

insurance evolved into modern health insurance program.

Health insurance is also called as accident and health insurance, accident and

sickness insurance or disability insurance. At present health insurance is classified into

three categories. They are Medical expense insurance simply called as health insurance.

Long term care insurance

Disability income insurance also called as loss of time or loss of income

insurance.

Health insurance in a narrow sense would be "an individual or group purchasing

health care coverage in advance by paying a fee called premium" In its broader sense, it

would be any arrangement that helps to defer, delay, reduce or altogether avoid payment

for health care incurred by individuals and households.

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*Research Officer, Tamilnadu State Council for Higher Education


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But health insurance has not succeeded in achieving the objective both in

developed and developing countries of the world mainly due to the presence of market

imperfections. The headlines and articles in news to day are "Health coverage continues

to Decline" "Employment based coverage Drops" etc. In a normal market the erosion of

one source of supply would enhance the opportunities of other suppliers. So if

employment based coverage drops, this means that there will be an increased demand for

individual insurance.

For most of the population, health insurance means mediclaim policy, which is

fraught with restricted facilities stringent exclusions and the reluctant delays in

reimbursements, not to speak of practioner malpractices and the lack of standards. Main

issues that are being faced by the general public with regard to health insurance are

Quality of Service: Especially when facilities are owned by the plan giver

Reimbursement delays: In cases where the insured has settled the expenses

and/or rejection of claims.

Limitation of Services: Either monetary restrictions on the amount available per

years or exclusion of certain pre-existing and chronic ailments.

Inadequate information: Regarding health, ailment, procedures, techniques,

treatments and costs.

Provider malpractices

High cost: for comprehensive total care and advanced age.

Low penetration levels.

What the consumers need?

Affordability of premiums

Flexibility in paying procedure, with paying procedure being adapted to the local

requirement eg. instalment payments, payments by charitable institutions,

payments by relatives etc.


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Community participation may be through a tie up with an organisation having

experience in financial services and social protection, is well accepted by the

insurable population.

Simple and transparent claims handling procedure.

Existence of a viable health care provider, with well recognised quality of care.

An important assumption of the perfectly competitive model is that both buyers and

sellers are well informed. Insurance is a complex business, where neither buyers nor

sellers appearing to have as much information as they need. Two information problems

that exist in insurance market are (1) asymmetric information and (2) non existent

information problem.

The level of health care services provided within a nation corresponds to the stage of

economic development within the country. Developed market economy countries or

industrialised countries with relatively high per capita income have modern health care

services available to most of the population. A country may finance services for certain

portions of the population differently from the way it finances services for other portions.

The real problem with regard to health insurance is that health care is extremely

expensive. In the employment based market the employer makes a significant

contribution towards premium, thus shielding the employee from the true cost of

insurance. In the individual insurance market, the individual pays the entire premium,

resulting in a reluctance by the individual to purchase the insurance policy.

In India though the government has been extensively funding the health care

system we find today that the private health care spend is around 80% of the total health

care spend. India spends about 6.5 to 7% of its GDP on health care out of which 1.3% is

in the government sector and 4.7% in the private sector. The market share of health

insurance is a mere 1.2% of the total spenders on health.

India nurtures 16 per cent of the world population but is burdened with 21 per

cent of the world area. The sanitation level is 9 percent in rural and 49.3 per cent is

urban area. In rural India 98 per cent of the population have access to safe drinking water


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whereas 90.2 per cent get it in urban India. Even though the percentage of people living

below poverty line is 26 for the country it is 27.09 in rural and 23.62 in urban area. That

means people getting less than Rs.327.56 in rural and Rs.454.11 in urban are 27.09 per

cent and 23.62 per cent respectively.

A perfectly competitive insurance market must have the following characteristics.

Large number of buyers and sellers.

Sellers having freedom of entry and exit from the markets

Sellers produce identical products.

Buyers and sellers are to be well informed about the products.

But the insurance market in India does not have the above mentioned

characteristics and hence it is an imperfect market. This paper isolates one of the most

important features, which is essential for a perfect market, the symmetric information. In

insurance market there is information problem and the information problems can be

divided into Asymmetric information and Non-existent information. The asymmetric

information problems are

Lemons

Adverse Selection

Moral Hazard

Principal Agent

Due to the presence of market imperfections Health insurance has not succeeded in

achieving the objective both in developed and developing countries of the world . The

objective of a market oriented economy is efficient allocation. Such an economy provides

a variety of choices to consumers and the benefits of efficient allocation reaches the

consumers. The buyers decide what to purchase based on full information about the


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quality and price of goods and services. Buyers decide on purchasing the product based

on the relative quality and price of the good as well as on their willingness and ability to

pay. In the absence of such a competitive market condition the consumers lose the

benefits. The comparison of the health care market with a perfectly competitive market

provides insight into how cost and quality problems arise, and facilitates, identifying

potential inefficiencies that can lead to service quality or pricing problems that negatively

affects patients, providers and insurers within the health care system. In the health

insurance sector the presence of imperfections in the market has led to market failure.

Asymmetric information problems arise when one party to a transaction has relevant

information that the other does not have. Asymmetric information problems drive most

insurer operations and also are the bane of most life and health insurance customers,

driving much of the regulation in insurance.

Lemons problem - Here the insurance customer knows less than the seller about the

seller and its products. The nature of the insurance transaction involves a contract that

makes a present promise of future performance upon the occurrence of stipulated events.

Individuals purchase policies in good faith, relying on the integrity of the insurance

company and its representatives. Even assuming that policy owners could be induced to

rate an interest in the financial condition of their insurers, few are sufficiently

knowledgeable to do so. Insurers and their representatives have little incentive to disclose

adverse information to potential customers. Doing so will hurt sales.

Information asymmetries also exist with respect to the price of medical services.

Consumers generally have limited incentives to be well informed about the price of

medical services because third parties pay for most medical services. Even when

consumers attempt to price and compare services, it is often difficult to determine in

advance the total cost of services.

Insurance operates on the basic premise of uncertainty. To that extent the condition

of pre existing diseases in a policy holder is out of the purview of the coverage. The


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clauses pertaining to the coverage of pre-existence should be explicitly classified rather

than claiming its inclusion as a differentiating factor to gain an advantage in a

competitive scenario.

The second type of asymmetric information problem is the adverse selection

problem in which the customer knows more than the seller about the customers situation.

It is the principal reason that insurers seek such extensive information about proposed

insureds. They want to know as much as practical about the loss potential of those to

whom they issue insurance. The price charged will be fair to the proposed insured and to

others in the insurance pool, each of whom is expected to pay premiums that reflect their

loss potentials. If some insureds are able to secure a price that is lower than the expected

value of their losses, they impose costs on other insureds and cause a distortion of

pricing. In the extreme, adverse selection can cause the insurance mechanism to break

down altogether.

The insurance company cannot be certain that the buyer is disclosing all relevant

information. Proposed insureds have incentives to secure the most favourable possible

terms, conditions and prices. To do so they may not disclose all that they know about

their insurability, especially if the insurer does not ask. The challenge for insurers is to

obtain sufficient information to assess insurability properly but to do so without incurring

unwanted expense.

Private health insurance markets are vulnerable to adverse selection. Individuals have

a great deal more information about their individual health status and likely need for

medical services than do insurers. This informational disadvantage to insurers

frequently results in adverse selection. Information on individual health status is

relatively expensive to obtain. Adverse selection occurs when individuals with higher

than average health risks seek insurance and insurers unaware of their risk levels, fail to

charge an adequate premium by classifying them inaccurately. As a result adverse

selection leads to individuals with lower risks subsidising those with higher risks.


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Minimising the impact of adverse selection underlies basic contract design and

company underwriting processes relating to health insurance coverage.

Another critical information problem for insurers, the moral hazard problem, is

the tendency of individuals to after their behaviour because of insurance. Just because

they are insured, they may not take care of their health condition. Even if they are

affected by health problems, they can get the treatment with the assistance of the insurer.

Hence they fail to take any preventive measures. There are several diseases for which

preventive measures can be taken. Most of the health insurance contracts especially the

mediclaim in India, envisage payment of the insurance amount only if there is a

hospitalisation and beyond a threshhold level at that.

Another asymmetric information problem in insurance can arise when one person

represents another. The person who represents another is the agent. The person whom

the agent represents is the Principal. The Principal agent problem arise when the agent

knows more about his or her own actions than does the principal. Because of this

information asymmetry, the agent can take advantage of the Principal. The issue of how

to ensure that agents do not misrepresent or withhold required information about the

customer from the company is principal agent problems. Inefficiencies can arise when

the interests of the agent and the interests of the principal diverge. The key to

minimizing the problem lies in arranging incentives such that the interests of this agent

align with those of the principal.

The lemons problem is perhaps the most critical market failure in insurance.

Individuals and small businesses are not well equipped to evaluate and monitor the

financial condition of insurance enterprises. If an insurer is incurring financial

difficulties the principal - agent problem of managers withholding the bad news from its

sales people and share- holders exacerbates the consumers asymmetric information

problem.

There are various factors which are directly or indirectly affecting the health

condition of the human population viz the global warming, occupational stress, pollution

levels, poverty, unemployment etc. In the light of these, underwriting in the domain and


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the pricing of the health insurance products has become a great challenge for the

insurers.

Another important factor for the failure in this area is the poor medical

underwriting standards prevailing in the market. While accepting the ground realities

that moral hazard and adverse selection play a huge role in the claims ratios of insurance

companies, every insurance literate person would not doubt that loss prevention and loss

minimisation measures keep a great check on the extent and amounts of claims,

especially in the non-life classes. If there are any opportunities that would obviate the

affliction of a certain disease, the insurance company should not hesitate to provide an

incentive to the policy holder to adopt such measures.

Solutions:

India being a vast country with huge population customer base can be easily

widened. This will help the insurers in reducing the loss due to adverse selection

problem.By bringing in the credit card holders under the health insurance scheme the

insurer can widen the customer base.Collection of premium amount is made easy as it

can be collected along with card payment. Insurers can join with the banks in this regard.

Another possibility is linking health insurance with cellular phone services. In

India cellular phone usage is very common and a collection of a percentage for health

insurance provides the much needed insurance protection to the people and at the same

time widens customer base.

Fixing premium on the basis of the preference of hospital by the insured. This will

help both the parties involved from the problems of asymmetric information.While fixing

the premium a thorough medical check up can be done so that fisrt hand information will

be made available to the insurer and the insured.

Insuring adults along with young ones can go a long way in reducing the loss to

the insurer if there is adverse selection problem.


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Just like life insurance students in colleges can be brought under health insurance

scheme. A small amount may be collected from them as premium. This will apart from

widening customer base provide health benefits to student community.

Along with the loans given for various purposes the farmers can be protected

from health hazards though the collection of a fixed some for health insurance

Self-Help Group is functioning efficiently in Tamilnadu . The members of these

groups may be brought under health insurance scheme through a contribution from group

members and a part from the government.

References

Kenneth black, jr.& Harrold D.Skipper Jr. Life and Health

Insurance, Pearson Education (Singapore) Ptd Ltd Delhi 2003.

Rangachary N (2001) The concept of health insurance: health

and population perspectives and issues 24(2) .

IRDA journals

Government of India (2002) Health insurance issues and

challenges, Report of the sub-group, Ministry of Finance, New

Delhi (Internet sources).

Arman Oza, Health Insurance, Awaiting Congruence, Insurance

Chronicle, January 2006

Samuel Sekar, The insurance insured knowledge gap, Insurance

Chronicle, December 2006

Ranson Kent& Jowett Mathew "Developing health insurance in

India" Prepared for government on India workshop on health

insurance -2003.

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