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Health Insurance; the Theoretical Basis By Dr. Lawumi Adekola.
Date Posted: 20/Jan/2015
Generally, Insurance is the method of protection against the consequences of financial loss by transferring the risk of loss to an insurance company. The insured (proposer) makes a small payment (called premium) to an insurer (insurance company), who in turn agrees to pay for financial loss on the occurrence of a specified event to which the insured is exposed (at risk).
The origin of health insurance can be trace to medieval Europe when labour associations and employers created guilds which pooled funds to help members in times of need on account of illness i.e. sickness and disability insurance. Later, the scope was broadened to payment of doctors to certify or provide care to members. Further development lead to the creation of earning related social health insurance systems, most of which were legislated upon; Germany (Bismarck system-1883), Austria (1887), Norway (1902), Soviet Union (Semashko system- 1918), United Kingdom (Beveridge system-1948)
Health Insurance can be classified into two broad groups;
- Income Protection Insurance: Provides recovery of income loss as a result of disability arising from illness (sickness insurance) or accident (personal accident insurance).
- Health Care Insurance: This medical expenses insurance, most often called ‘health insurance’ provides protection for health care expenses which may include hospital charges, specialist fee and other expenses e.g. ambulance fee.
Health Insurance can be defined as a system for financing medical expenses through contributions (or taxes) paid into a common fund to pay for all or part of health services specified in an insurance policy (agreement) or law. Health insurance makes it possible to substitute a small but certain cost (premium) for a large but uncertain loss (claims) under an arrangement in which contributed funds and risk of medical needs of a large number of people are pooled. In health insurance, the healthy and fortunate majority compensates for the risks and costs of the unfortunate ill minority by the principle of ‘solidarity’ or ‘cross-subsidy’. Haven been successfully applied in developed countries, health insurance could certainly be a veritable tool for sustainable health care financing in many low and middle income countries.
Principles of Health Insurance
Pooling and Prepayment: These principles are the basis for a functional health insurance system. Pooling presupposes that risks and costs are pooled for a large number of persons and prepayment means that premiums are paid in advance. The mix of both principles differentiates insurance from other methods of payment for medical care. 
Methods of payment for medical care
. Solidarity/Cross-subsidy: Cross subsidizing the health care expenditure of unhealthy members from healthy members. The solidarity principle implies that the high risk individuals receive a subsidy from the low risk individuals to increase their access to health insurance coverage. In addition to risk-solidarity, there could also be income-solidarity; cross-subsidies from the high-income individuals to the low-income individuals (e.g. social health insurance). Solidarity, in essence balances ‘means and needs,’ ensuring that people pay according to their means but access care according to their needs
. Large numbers: Also called the principle of destruction of risk.  The law of the large numbers shows that for a given probability of illness, the distribution of the average rate of illness in the groups will collapse around the probability of illness as the group size gets larger and larger. The larger the population enrolled the more the risk probability tends towards the predicted/ known value. In essence, the larger the pool of members get, the less the likelihood of market failure.
. Insurable interest: This is the legal right (of an individual or a group) to insure, arising from a financial relationship recognized by law between the insured and the subject matter of insurance. The insured must have something to benefit by the continued existence of the insurance contract and something to lose by the loss of the contract. Insurable interest is one of the foundations of insurance because in its absence, insurance would be no different from gambling and (even if legal) would not be a binding agreement. 
. Utmost Good Faith: All insurance contracts depend on mutual trust. Both parties (Insurer and Insured) must show transparency and reveal to each other details which are ‘material facts’. Material facts are information that my influence the decision of the parties to enter into the contract. In health insurance the insurer must state clearly, the term, conditions and exclusion to the policy while the proposer may be required to give information pertaining his/her medical history. 
Market Failure in Health Insurance
Market failure is usually due to certain behavioural pattern on the part of the stakeholders i.e. insured, insurer and care providers. This will usually manifest as excessive asymmetry in the pool e.g. when the total fund in the pool is overwhelmed by the cost of treatment, ultimately leading to a collapse of the insurance company. There are two main problems that can lead to market failure in health insurance and these are:
- Moral Hazard
- Selection Bias
. Moral Hazard: In general, moral hazard is indifference to loss because of the existence of insurance. In Health insurance it manifest as the use or provision of more (expensive) care because the insurer reimburses the cost. Supplier induced moral hazard is over provision of healthcare by providers due to health insurance coverage, while demand induced moral hazard  is over-utilization of healthcare by insured because insurance will pay the bill. Demand induced moral hazard could be because the insured takes less preventive care or opt for more (expensive) care than necessary.
. Selection Bias: There are of two types of selection biases. The first is ‘adverse selection’ in which the people who insure themselves are those who are increasingly certain that they will need health insurance and thus buy more insurance. It is a situation of buying of health insurance by high risk people with resultant overrepresentation of such high risk people in risk pool. The second is ‘cream selection’ which is the practice of excluding the unhealthy and sick (high risk) from the insurance coverage by insurers. 
Adverse selection will threaten quality of care, especially for the chronically ill and also threaten solidarity and efficiency. Cream selection will also threaten solidarity and defeats the essence of social health insurance.
Methods to counteract selection bias and moral hazard: 
- Selection biases: Compulsory universal health insurance coverage, Group insurance and Community rated premium.
- Moral Hazard: To counteract demand driven moral hazard  some insurance schemes typically require the insured to make an initial payment for care (“deductible”) before applying for benefits and many also require the patient to pay a small share of the cost of care (“co-payment”) – these two devices are intended to discourage overuse of health care services. To counteract supply side moral hazard, insurance schemes have devised several methods of risk sharing with provider of care. These risk sharing methods are embedded in their reimbursement methods.
- Others: Mandatory/compulsory health insurance, standardization of benefit and premium by the regulator, standardization of contract and enrollment procedure, and development/enforcement of ethical codes for insurers/providers.
Forms of Health Insurance
1. Private Health Insurance
2. Social/Public Health Insurance
3. Community-based (Micro) health insurance
. Private Health Insurance (PHI):
PHI is health Insurance cover provided to individuals or groups based on an assessment of the risks they carry. It differs from social health insurance because it is usually voluntary, can be very expensive and is usually not equitable. Private health care insurance confronts various problems; notably inequity, moral hazard and selection bias.
. Social Health Insurance (SHI):
Social health insurance is a method of health care financing where the society provides for health care by offering health insurance, to some significant degree, at the public’s expense. Such programs are usually mandatory and provided for through taxes or legal regulations. SHI assures universal financial access to the decent minimum and requires the healthy to share in the cost of care of the sick. The element of cross-subsidy or solidarity is essential as the premiums of the poorest can be cross subsidized by that of the rich or the government. The target of SHI is to utilize public funds to subsidize premiums for health services, thereby shifting public subsidies from supply side (infrastructure) to the demand side (service) in order to improve efficiency and quality of health care services. The problem of selection bias can be countered by making health insurance cover universal. However, some of the other problems of private insurance, notably moral hazard (explained above), will remain. 
The fifty-eight World Health Assembly in May 2005 adopted a resolution recommending SHI as an effective strategy for financing health systems. But it is difficult to have social insurance in non-industrialized countries, where many people are not formally employed. 
. Community-Based Health Insurance (CBHI):
CBHI, also referred to as Micro Health Insurance are organized under the leadership of voluntary organizations to cater for the healthcare needs of the weaker sections of the society. CBHI are more prevalent in developing countries where out-of-pocket expenditures are high and many of the people are informally employed. Several examples abound in Asian and Sub-Saharan African countries; India, Bangladesh, Rwanda and Tsonga in Kwara State, Nigeria. CBHI is usually a non-profit health insurance programme for a cohesive group of households, individuals or occupation-based groups, formed on the basis of the ethics of mutual aid and collective pooling of health risks, in which members take part in its management.
The World Health Organization in recent times has recommended that CBHI schemes are not to work in an isolated way. However, CBHI will at best perform a complementary role to other universally based health financing methods. Governments have the task to define their place within the context of a national health financing policy.
Provider reimbursement
Providers of care under a health insurance system can be reimbursed using different methods. Apart from serving as remuneration, the reimbursement method usually seek to control supplier induced market failure while improving the quality of care rendered. Four of the commonly used methods are described below.
. Salary: Payment per unit time spent rendering care (weekly or monthly), independent of the number of patient or amount of work done. It is an old method of payment that is rarely used in insurance reimbursement.
. Fee-for service (FFS): This is a payment system in which the provider of care receives a fee for each service rendered, usually retrospectively, after the services are rendered.  The services can be unbundled into consultation, investigations, treatments or procedures; hence, the provider is rewarded according to the amount of work done.
. Capitation: This system pays a fixed amount for each enrolled person assigned to a provider to cover a defined set of service, per period of time, whether or not the services are used. This method may serve as an incentive to limit care and encourage preventive care.
. Diagnosis Related Groups (DRG): DRG is reimbursement by fixed price per illness episode. It encourages limiting procedures but providers will continue to push for higher reimbursement.
Useful References/ Further Reading:
1. Dr. Sukumar Vellakkal (2012). Health Care Financing (Topic 3). People’s Open Access Education Initiative: Peoples-uni.
2. Resolutions and Decision, 58th World Health Assembly. May 2005.
3. Lawanson A.O. Health Care Financing in Nigeria: National Health Accounts Perspective. Asian Journal of Humanities and Social Studies (ISSN: 2321 – 2799) Volume 02 – Issue 02, April 2014
4. Community Based HI:
5. UHC for workers:
6. Dr Chidi Ukandu (2014). Leadership of health care systems: Understanding health insurance Pharmanews Edition: vol. 36 No. 05. Oct.2014.
7. Dr. Ladi Awosika. Health Insurance and Managed Care in Nigeria. Annals of Ibadan Postgraduate Medicine. Vol.3, No.2 December, 2005.
8. Health Financing: A guide (2006) WHO,


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