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Economics Healthcare

Health Economics Part II – Insurance

In part one of my series about health economics I gave an overview of the drivers of demand in the medical care market. In this post, I will go beyond a general interpretation of demand and give you an in-depth overview of a specific and expensive issue: the rising cost of public liability insurance.

Public liability insurance (PLI) is an interesting and important topic because its costs are far-ranging and complex. PLI covers claims made by the public against a business for injury, death, and lost or damaged property as a result of business negligence. Unfortunately, these claims often result in long and costly legal battles due to the occasional misappropriation of fault by the claimant, or the dismissal of negligence by the business. The total cost of PLI is a result of the frequency of claims made, the size of damages awarded, legal costs, and insurance company profits. This results in an insurance system that can be very expensive for businesses or individuals looking to insure themselves, and the consequences of this expense spill into society.

Society suffers from expensive PLI due to a reduction in the amount of beneficial activities and events that get organised. Imagine a charity is looking to book a local hall to hold a bake-sale or some such event for its members. Unfortunately, the hall’s owners may have had to raise the price of booking the hall due to the rising cost of public liability insurance for locations with high probability of public injury. Therefore, the charity cannot book the hall, and utility is lost for the entire community. Additionally, the cost of liability insurance in the medical industry may result in doctors who are unwilling to perform complex procedures upon individuals if there is a foreseeable chance of injuring the patient. This potentially results in negative health outcomes for these patients who are unable to obtain treatment. Ultimately, no one benefits from the high cost of public liability insurance.

There are two possible solutions, both of which involve the government stepping in. On the one hand, the government may decide to act as an insurer of last resort by underwriting public liabilities. On the other hand, it may legislate to impose compulsory no-fault insurance schemes. No-fault insurance means that regardless who is at fault in an incident, the insurance company will pay for damages. Government involvement has several benefits and costs. On the upside, governments are able to pool risk, better guarantee compensation delivery, and reduce the transaction costs that stem from individuals, businesses, insurance companies, and lawyers all having to interact to make the public liability insurance scheme work successfully. However, on the downside, government involvement has the potential to affect the behaviour of individuals if they are guaranteed compensation regardless of fault. People could act more recklessly without regard to personal consequences, resulting in a greater net cost to society (in economics, this problem is famously known as “moral hazard”). Additionally, no-fault insurance often provides compensation for personal injury, but requires the individual to waive their right to sue. This waiver of right to sue is an important caveat that many people find off-putting when considering no-fault insurance.

Thus, here is a brief interlude to talk about tort law. Tort law has two goals, to compensate parties suffering loss and provide loss-causers with an incentive to avoid acts that that can cause harm. Tort law is efficient if the benefit of a reduction in adverse events is greater than the costs associated with the legal process. In the tort law system insurance exists due to the potential massive costs associated with the adverse events that a business is responsible for. The no-fault system reforms this process, is expected to reduce transaction costs, and is funded out of levies imposed on potential loss-causers or from general taxation.

No-fault systems are common where the probability of a loss occurring is small and the cost is unpredictable, such as in the case of a natural disaster. Unfortunately, even natural disaster insurance can cause moral hazard as cities may be expanded into natural disaster-prone regions due to a lack of responsibility of those involved to pay the costs resulting from a subsequent natural disaster. No-fault systems also involve a dilemma – they are intended to ensure certainty of compensation and to reduce transaction costs, but they remove the information base that the system relies on (insurance company / legal system data). To get around this problem, no-fault systems would have to implement their own data collection systems, which would be very costly. Therefore, no-fault systems theoretically should only exist where they have close to no influence on the probability or size of claims, or where they can work in tandem with public liability insurance schemes.

Tort law systems have greater transaction costs (legal fees), but greater incentives for precaution (penalties extracted). In contrast, no-fault insurance schemes have lesser transaction costs, but also lesser incentives for precaution and costly monitoring systems. So, which scheme works better in practice?

Fortunately, this question can be tested by looking at the real world outcomes of countries adopting different policies over time. My home country of New Zealand has no-fault, government underwritten accident compensation insurance administered by the Accident Compensation Corporation (ACC). However, New Zealand’s original scheme was much like a tort law system. This allowed researchers at Australian National University to publish a 2002 research paper [pdf] comparing the performance of New Zealand before and after the adoption of ACC. In the original system, workers needed to prove negligence to receive claims, which meant that less than 1% of claims for compensation ended up being successful. The legal costs were high, delays were long, businesses had more power and better lawyers than their workers, and the rewards from successful litigation were unpredictable.

The ACC system was adopted in 1974. It requires no proof of fault and at the same time removes the right to sue. However, penalties and sanctions remain in criminal circumstances. This system does have its issues. There are no incentives for individuals or employers to take due care, and it cannot be adjusted to account for individual risk premiums – the careful, risk averse individual is taxed the same as the reckless individual. It was hoped that the new system would offer lesser costs, greater compensation certainty, and no observable differences in accident occurrence.

So how did it perform?

In terms of compensation certainty, there was a significant increase in the number of small claims for minor injury receiving compensation. A win for ACC. On the transaction costs front, overhead costs appeared to go down greatly, however the administrative costs to the government are perhaps understated. Still likely a net reduction in transaction costs. The costs of lost incentives is unclear. Health and safety spending is minimal for the NZ government, and NZ’s workplace accident rates are high on a global basis. Reporting rates for injuries have gone up though, which is perhaps a downside to ACC. Finally, ACC spends little on the collection and analysis of information due to a disproportionate emphasis placed on reducing overhead costs. This may eventually result in an inefficient no-fault system.

Ultimately, the new scheme appears to be functioning well, but it has some issues. Taxation revenue meets any shortfalls that occur within the system, and thus it is the people of New Zealand who bear the burden of extra risks and costs. As with most issues of health economics, the perfect solution to public liability insurance has not yet been discovered. Perhaps a system where tort and no-fault schemes work in tandem will be able to reduce costs and increase benefits across the board. These are the problems that health economists of the future are looking to solve. My next article will look at another interesting issue of health economics, organ donations.

Image: Pexels

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