Economists often describe health insurance as an imperfect market. To understand the concept we have to dwelt in deep the features of an imperfect market.
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Imperfect market refers to a market where information is not quickly disclosed to all participants in it and where the matching of buyers and sellers isn’t immediate. Generally speaking, it is any market that does not adhere rigidly to perfect information flow and provide instantly available buyers and sellers.
If we analyze the definition it means
- information is not quickly disclosed to all participants
- buyer and seller do not fully know each other
- matching of buyers and sellers are not immediate
- there is an element of risk in doing business
If we take into account other forms of insurance they mostly belong to perfect market. For example fire insurance, when the prospect approaches the insurance company for insurance of its property the insurance company knows that he has to insure that property and estimates the value of the property and accordingly quotes the premium. And generally people do not set their own properties on fire to get claim.
But in case of health insurance the scenario is completely different. It is a form of imperfect market. The information available to the insurer about the insured is not perfectly transparent or complete. So in order to save himself the insurer imposes lots of terms and condition. In turn due to lot of conditions policyholder is not able to understand the insurer. So there is a condition of distrust between them.
In order to keep the product portfolio profitable the insurer always wants to have lower risk. So it tries to insurer lives where the risk is minimal. We may term it as cherry picking or cream skimming. For example the insurer would like to choose lives where previous history of diseases is less.
Similarly if we take the point of the insured they purchase insurance when they fear that they may be affected from any disease or ailment. This results into adverse selection whereby the persons seeking insurance are not so healthy. Insurers have to apply strict underwriting rules in order to see that there is no adverse selection and the prospective insured does not have any pre-existing diseases.
Though an insured is required to submit details of all medical tests to show that he is fine and is not having health problems before taking the policy. But still it is very difficult on the part of the insurers to find the exact nature of disease which might not have been disclosed by the medical tests.
Apart from this moral hazard is a major factor which affects health portfolio. The health insurance policy is generally granted for one year and thereafter it is renewed. Once the policyholder takes a new policy and does not file any claim during the year he feels that premium paid by him was a total loss since he did not suffer from any disease during the year. So in order to realize that premium many times policyholders resort to filing of false claims.
In order to stop the trend of false claim insurers take extra precaution to weed out the fraud and in the result the honest policyholders who have genuine claims suffers.
The moral hazard may be of demand-side and supply-side. In demand-side the consumer seeks to accept more health care services than they would if they did not have health insurance, meaning had the policyholders did not have health insurance they would not have spent that amount as the healthcare expenses. Since they are having the policy they think that they are not going to pay from their pocket and they intend to spend more.
Similarly the supply-side moral hazards occur from health providers i.e. hospitals and doctors. Once the hospitals know that the patient is having Mediclaim they charge more amount than what they have usually done.
Both these hazard ultimately affect the insurance company. And since a third party is involved it is very difficult for the insurer to ascertain who is right. Often the policyholder in collusion with health providers inflates the bill to get more benefit out of health insurance.
This is why health insurance is regarded as an imperfect market.
