This chapter looks at options for financing healthcare. International comparisons show significant variation in the shares of government-managed schemes, voluntary health insurance and OOP expenses in total health spending, even when removing countries in crisis (for example, because of internal unrest or war). See Chapter 5 for more details. Uncertainty in both the incidence of disease and the effectiveness of treatment as well as information asymmetry are salient features of healthcare. This uncertainty leads to different responses to facing potentially exorbitant healthcare costs. There are different non-insurance forms of paying for healthcare; however, the most widely used response to protection from financial uncertainty is health insurance. Health insurance can be set up in different forms, all of which involve pros and cons. Practical aspects of healthcare financing are covered in Chapter 17.

Uncertainty in health and healthcare

Uncertainty is a defining element of both health and healthcare. This uncertainty has several aspects: first, the underlying medical condition causing the patient's symptoms; second, the effectiveness of alternative treatments; and third, possible side-effects of treatment.

One of the problems associated with many types of healthcare is that an individual does not know with certainty when she is going to need them. For example, she does not know when she will need to visit the emergency department because she has broken her arm. Thus, her demand for emergency department care for a given time period cannot be predicted.

Generally, most people stay away from risky situations if they can or reduce their exposure to risk, if at all possible. This preference for less risky situations is known as risk aversion. Some individuals are risk loving (they gain utility from taking risks) and others are risk neutral (they have no preference either way).

To understand risk better, and in order to introduce a simple model of insurance, we need to discuss some basic theory. A probability is the likelihood that a given outcome will occur. Probability can be interpreted objectively (for example, assuming probabilities similar to those experienced in the past) or subjectively (such as feeling lucky), where the perception of risks associated with such a probability is based on the individual's experience or judgement.