WPS3741

# Can Insurance Increase Financial Risk? The Curious Case of Health Insurance in China

## by

## Adam Wagstaff and Magnus Lindelow

The World Bank, Washington DC, USA

### **Abstract**

The most basic argument for insurance is that it reduces financial risk. But since insurance opens up new opportunities for consuming expensive high-tech care which permits health improvements that are valued by the insured, and because in many settings the provider is able and has an incentive to exploit the informational advantage she has over the patient, it is not immediately obvious that insurance will in practice reduce financial risk. We analyze the effect of insurance on the probability of an individual incurring ‘high’ annual health expenses using data from three household surveys—one a cross-section, the other two panels. All come from China, a country where providers have until recently largely been paid fee-for-service (often according to a schedule that encourages the overprovision of high-tech care and the underprovision of basic care) and who are only lightly regulated. We define annual spending as ‘high’ if it exceeds 5% of average income in the sample and as ‘catastrophic’ if it exceeds 10% of the household’s own per capita income. Our estimates of the effect of insurance on financial risk allow for the possible endogeneity of health insurance in the panel datasets by allowing for a time-invariant fixed effect capturing unobserved risk that may be correlated with insurance status, and in the cross-section dataset by using instrumental variables, where we use availability of and eligibility for health insurance as instruments. Our results suggest that during the 1990s China’s government and labor insurance schemes increased financial risk associated with household health care spending, but that the rural cooperative medical scheme significantly reduced financial risk in some areas but increased it in others (though not significantly). From our results, it appears that China’s new health insurance schemes (private schemes, including coverage of schoolchildren) have also increased the risk of high levels of out-ofpocket spending on health. Where we find evidence of health insurance increasing the risk of ‘high’ out-of-pocket expenses, the marginal effect is of the order of 15-20 percent; in the case of ‘catastrophic’ expenses, it is even larger.

**Corresponding author and contact details:** Adam Wagstaff, World Bank, 1818 H Street NW, Washington, D.C. 20433, USA.  Tel. (202) 473-0566. Fax (202)-522 1153. Email: <u>awagstaff@worldbank.org.</u>

**Keywords:** Health insurance; financial risk; China.

World Bank Policy Research Working Paper 3741, October 2005 The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org.

**Acknowledgements:** Our thanks to Agbessi Amouzou, Shengchao Yu and Lei (Lydia) Liu respectively for their help preparing the China Health and Nutrition Survey data, the Gansu Survey of Children and Families (GSCF) data, and the Health VIII baseline survey data.  Wave 1 of the GSCF was funded by The Spencer Foundation Small and Major Grants Programs, while Wave 2 was funded by grants from the Fogarty International Center at the National Institutes for Health and the World Bank Research Committee.