Health Insurance Adverse Selection Moral Hazard

FGS 8,10,11, 12 Cutler 1994

Outline

Uninsured in the US Demand for Insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problems with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts

US health insurance market a brief history

2

Uninsured

Uninsured and Underinsured

47 million people uninsured in 2006 (15 % of population)
An increase of 8.6 million from 2000 Majority are employed in small firms (<100)

16 million non-elderly adults (20%) were underinsured

High out-of-pocket health costs to income ratio

Figure 1: 47 million uninsured in 2006; Increase of 8.6 million since 2000

Number of uninsured, in millions
60 40 38 40 42 43 43 45 47

20

0 2000 2001 2002 2003 2004 2005 2006

Source: U.S. Census Bureau, March Current Population Survey, 20012007.

Percentage of uninsured workers Ages 18-64, by Firm Size (1997)

40 35 30 25 20 15 10 5 0 34.7 29.7 18.2 20.9 15.8 12.7 12.3

Total

<10

10-24

25-99

100-499 500-999

1000+

Firm Size

Who are the uninsured?

Mostly adults, not children half are childless adults. The number of uninsured children increased from 8 million (10.9 percent) in 2005 to 8.7 million (11.7 percent) in 2006 Poor and near-poor 60% have incomes above
federal poverty level

Workers and family members 80% in families with

at least 1 worker

Unskilled laborers, service workers

3 of 5 of the uninsured who work, work in firms with <100 workers

Uninsured: Why are they uninsured

Three primary reasons that workers dont have insurance:

The employer does not offer a health plan. Employer offers health plan, but employee is not eligible for the plan because of part-time status or some other rule. Employee doesnt buy plan because plan too expensive or does not perceive need for plan

Uninsured: Why are they uninsured likely to: Uninsured, more

Change jobs Work part-time Work for small firms

Small-firms pay much higher premiums because their risk is perceived to be large.

Why dont they buy private health insurance

There is no risk pooling with private health insurance and it is expensive

Average annual cost of family policy in the private market (3,330) Average annual cost an employee pays out of pocket towards group insurance (2,700)

Uninsured: Impact on health outcomes Empirical research gives mixed results

Empirically difficult to measure

Selection bias: Those who choose not to buy health insurance do so because they are healthier Endogeneity: does lack of insurance cause poor health, or does poor health decrease the probability of being insured. (cant determine direction of causality)

Despite inconclusive empirical evidence, the argument that those without insurance experience poor health is powerful. As the number of uninsured grow, policy makers will have an increasingly difficult time ignoring health consequences of the uninsured.

Do the uninsured receive necessary health care?

10

Do the uninsured receive necessary health care?

Often No compared to the insured population, the uninsured...

Have higher rates of preventable and/or untreated illness Are less likely to receive care that they feel they need Have more preventable hospitalizations Have shorter hospital stays for the same conditions Are hospitalized sicker and have poorer health outcomes (including death) 11

Do the uninsured receive necessary health care?

Are not known to be a sicker or higher-cost population. Pay higher medical fees. (NYT, 4/2/01)

A New York gynecologist says he gets $25 for a routine exam for a woman insured by group health insurance and charges $175 for the same exam for a woman without insurance.

The care of the poor once was supported by the wealthy and the insured, but now the opposite is happening.

12

Effect on employers
Rising health costs take bite out of small biz USA Today 10/5/03
Small-business profits are getting pinched because of price increases for employee health insurance. Among small companies that posted lower earnings in August vs. a year ago, 18% blamed higher insurance costs, says a survey of 544 firms by the National Federation of Independent Business trade group. In a similar survey a year ago, 11%
13

While the average health insurance premium for workers jumped 13.9% this year from 2002, the increase was bigger for small employers:
Ouch!

3-9 workers 10-24 25-49 50-199

16.6% 15.2% 14.3% 15.9%

Source: Kaiser Family Foundation

14

Outline

Uninsured in the US Demand for Insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problem with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts

US health insurance market a brief history

15

What is insurance

Meant to insure us against random uncertainty. Club of 100 members. On average, each year one member gets sick, it costs $20,000. It is random who gets sick. This is a lot of money for one person to pay.

16

What is insurance

Instead, they insure each other and each pay $200 a year. They pay this to avoid the risk of uncertainty that they will have to pay 20,000. Money put in bank to get interest, and pay out when someone gets sick. Aim of insurance is to reduce the variability in ones income by pooling risks with a large number of people.
17

What is insurance

Outlays for health may be variable for one person, they are fairly predictable for the group. Health insurance would not be necessary if everyone had average needs. But we do not it is variable. Insurance makes it possible to obtain health care without going Bankrupt (new cancer drug $100,000 a year).

18

What is insurance
Desirable characteristics for insurance: 1. The number of insured should be large, and they should be independently exposed to potential risk 2. Losses covered should be definite in time, place, and amount 3. The chance of loss should be measurable 4. The loss should be accidental from view point of person who is insured
19

Concentration of personal health expenditures, in US in 2002

All Persons (000s) Health Exp. ($ millions) Per Person 285,000 Top 1% 2,850 Middle 75% Bottom 15% 213,750 42,750 7,730

1,545,900 4,36,400 455,700

5,427

153,126

2,135

184

Source: Getzen T. Health Economics: Fundamentals and Flow of Funds,

20

Terminology
Loading Fee: general costs associated with the insurance company doing business, such as sales, advertising, or profit. Premium: When people buy insurance policies, they typically pay a given premium for a given amount of coverage should the event occur. Should cover average medical care expenses

21

Demand for health insurance

Results of uncertainly

Illness and medical expenditures are unpredictable Hospitalizations, serious injury, and rehabilitation and other advanced modern treatments can be very expensive Can save for possible medical expenditures Most households are averse to risk Dont take on risk, spread risk among many consumers

Insurance companies pool risk

What is risk aversion?

22

Risk aversion
Consider the gambling game:

Zan and Forest flip a coin. If it comes up heads, Zan wins a dollar and Forest nothing. If it comes up tails, Forest wills a dollar and Zan nothing. How much should they each be willing to pay to play this game?

Expected Return for Zan: P(head)*$2 + P(tails)*0=$1

Willing to pay $1 cents

23

Risk aversion

Would you be willing to play this game for $5 get $10 if win, for $10,000 get $20,000 if win? The fact that you are less willing to play at larger amounts shows you are risk averse

24

Risk aversion

A simple test to see if you are risk adverse. Which would you select?

Your pay check, OR Double your pay check for correctly picking one coin flip.

Equal expected values; most of us are risk adverse and select the certain option. Risk aversion: - the degree to which a certain income is preferred to a risky alternative with the same expected income.
25

Risk aversion
Expected Value: E [income if heads]=Prb(H)*$2+Prb(T)*0=1 Actuarially fair gamble: is one in which the amount you pay for the gamble is equal to the expected value of the gamble.

You paid a $1 to play, and the expected value of the game was $1.

26

Risk aversion

If price of gamble (amount pay to play game) is equal to the expected return, then the gamble is actuarially fair. In health, if expected benefit payment is equal to premiums, the insurance policy is actuarially fair. Now suppose the gamble was instead for $5,000, would you want to play the game?

If not you are defined as being risk averse, because you do not want to take the actuarially fair gamble.

27

Risk aversion
Reflected by the diminishing marginal utility of income/wealth. A > B. Utility lost when lose a dollar is larger than utility gained by winning a dollar
Utility

B A

1 2 3

Income

28

Risk aversion

Presence of aversion makes consumers willing to pay to spread risk with others. Insurance companies specialize in pricing risks, not in taking risks. Lesson from the theory of insurance: the losses that are insured are: large, infrequent, random, and not associated with a large moral hazard.
29

Demand for insurance

See notes from black board Factors affecting demand for health insurance:
1. 2. 3. 4. 5.

Probability of illness Loading fee Magnitude of loss relative to income (cost of illness) Degree of risk aversion Price: Higher price reduces likelihood that an
individual will insure against a given event
30

Demand for insurance

Probability of Illness -- evidence

Increases with age

Affected by availability of public health insurance programs (Medicare) Result of women responsible for child birth Affected by availability of public health insurance program targeting pregnant women Chronic vs. acute vs. preventive

Differs by gender

Differs by type of care needed

Elasticity of demand will differ

31

Uninsured by age, 2005

Source: ASPE tabulations of the 2005 Current Population Survey

32

Uninsured by income

Source: ASPE tabulations of the 2005 Current Population Survey

33

Percentage of Population Without Health Insurance, by 19.5 Gender, Jan-June 2003

MALE

FEMALE

34

Outline

Uninsured in the US Demand for insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problems with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts

US health insurance market a brief history

35

Problems in demand for insurance

Two main problems with demand for insurance 1. Moral hazard: The disincentives created by insurance for individuals to take measures that would reduce the amount of care demanded. OR, additional quantity of health care demanded, resulting from a decrease in the net price of health care attributable to insurance

36

Problems in demand for insurance

2. Adverse selection: A situation often resulting from asymmetric information in which individuals are able to purchase insurance at rates that are below actuarially fair rates plus loading costs - alternatively: occurs when high-risk consumers, who know more about their own health status than insurers do, subcribe to an insured group composed of lower-risk individuals to secure low premiums.
37

Moral hazard

What are the effects of the new price system (with insurance) on demand for insurance. Buying insurance lowers the price per unit of health care service at time it is bought. Person with health insurance is more likely to go to the doctor for a small problem than someone without health insurance

Likely to affect good with higher elasticity of demand such as preventive care.
38

Moral hazard
Moral Hazard: refers to the increased usage of services when the pooling of risks lead to decreased marginal costs for services. (i.e. the price is reduced). It is also used to refer to how one changes behavior when they are insured.

We may take more risks, which could have health care implications when insured rather than not insured.

Learning snow boarding (lot of people break their arms). May not learn if dont have health insurance.
39

Moral hazard

Five sources of Moral Hazard

1. Quantity demanded of medical care greater than

2.

3.

4. 5.

amount consumer would purchase if he/she paid full cost Individual less likely to engage in preventive behavior and/or more likely to engage in unhealthy behavior Individual demands higher quality/more costly types of care than he/she would in the absence of insurance Individuals incentives to monitor health care providers lower than in absence of insurance Individuals incentive to search for lower prices lower in than in the absence of insurance 40

Moral hazard
Price Price without insurance Price with insurance

Po P1 Dead weight Lost (DWL)

Qo

Q1

Quantity

Moral Hazard increase in consumption due to insurance

41

Moral hazard
Price Price without insurance Price with insurance

Po P1 Dead weight Lost (DWL)

Qo

Q1

Quantity

Moral Hazard increase in consumption due to insurance

42

Moral hazard
Price Price without insurance Price with insurance D1 D2 Moral Hazard: decreases when the price becomes more elastic. (i.e. for those goods you want no matter the price. DWL

Po P1

QoQ2

Q1

Quantity

43

Moral hazard

For services that are not very price sensitive, insurance will not cause them to purchase more services.

E.g. purchase of insulin for diabetics.

For those that are price sensitive (cosmetic surgery not from accidents), insurance may encourage one to buy more.

44

Question: If you designed a health care plan

Hospital Care Surgical & in-hosp medical Outpatient doctor Dental exams/cleaning Mental health Over the counter drugs Flu shots

45

Patterns of Insurance Type of Health Variance of Demand CoverageFinancial Elasticity Care

Risk (RHIE) -0.15 -0.15 -0.3 -0.4 Hospital Care Surgical & inhosp medical Outpatient doctor Dental Highest High Medium Low

% of People Under 65 Insured 80 78 40-50 40

The losses that are insured are: large, infrequent, random, and not associated with a 46

Typical solutions to the moral hazard cost sharing Increase

Could do this through co-payments or deductibles Reduce the quantity demanded by increasing price consumer faces Increases preventive behavior/reduces unhealthy behavior since consumer faces part of costs from these behaviors Increases the likelihood of consumer choosing less expensive types of medical care
47

Typical solutions to the moral hazard

Raises the likelihood that consumer better monitors provider behavior Increases likelihood that consumer shops around for less expensive sources of care

Offer less generous insurance for specific services with more elastic demand (e.g., mental health coverage, preventive care)

48

Problems with solutions

Assumes you will decrease unnecessary care

People dont know which care is unnecessary so may decrease necessary and unnecessary care

Some health services which are elastic have long-term health gains which may not be realized by consumer

Externalities argument Preventive care and chronic disease management will lead to better health in the future and can lead to lower health costs in the future These models dont take the long-term effects of not receiving care into consideration. Increasing price may decrease demand in the short49 run but increase it in the long-run

Other solution to moral hazard

Instead of rationing on price, ration on need

Dont use price mechanism to say how much care you should or should not get

Managed Care or many universal care countries

Utilization review Gatekeepers Provider guidelines Provider networks

50

Quantity of all Other Goods

Moral hazard revisited/criticisms

U1 U2 U3 As price of X falls from 3 to 2 to 1 dollar, more of X is consumed Budget lines

0 PX $3 $2 $1

10

18 24

X=Quantity of Health care services Demand curve shows the willingness to pay (reflects marginal utility) of a particular purchase.

10

18 24

X (units)

51

Moral hazard revisited

Assumption on consumer preferences that must hold for demand to represent willingness to pay. 1. Consumers must be rational.

More of a good always makes them better off. Preferences must exhibit transitivity
If there are 3 bundles A, B, C A preferred to B, and B preferred to C
Then A must be preferred to C and not the other way round.

Consumers must be able to rank any bundle, so which is preferred to which.

52

Moral hazard revisited

2. They must have sufficient information to make good choices.
3. They must know what the result of their

consumption decisions will be If these assumptions hold the demand curve shows the willingness to pay for an additional unit of health services

53

Moral hazard revisited

Do we meet these assumption? 1. Are consumers rational?

Consumers do not have information on prices and quality to be able to rank/choose different health bundles.

You can pay a lower price for a health plan but it is not the same product. Do we really know all the differences? Do people understand the difference between feefor-service and managed care and how the type of payment system might affect care? Are they just picking the least costs without recognizing the potential quality or service differences.
54

Moral hazard revisited

Infection or complication rates are not provided by hospitals

We have to choose health plans, this is very hard to do when you cant get information on quality and pricing.

How much you are reimbursed if you have to seek healthcare outside the network when traveling.

Is more health care better?

Or are you going to get more services because quality is poor and they cant figure out the problem.

55

Moral hazard revisited

2. Do consumers know what is best for them?

People can make the wrong tradeoffs. Can be due to need to show-off or due to time preferences. E.g, young tend to think they are invincible

Who has done things where they think they were lucky? Who has friends that were not so lucky? Wearing helmet when riding bike. Would think differently about the decision if you had an accident and were hurt.

56

Moral hazard revisited

3. Do consumers know the result of their consumption decision? Do we know what would have happened if we had not been treated? The counterfactual. Would the result have been the same if I saw a different doctor? We often do not know if we made the right decision.

E.g. after head injury begin a series of acupuncture. It takes a number of session for acupuncture to work so takes time. Time also helps your head heal. So after a month and a half of acupuncture you feel better. Was it the acupuncture or was it time that healed you?

57

Moral hazard revisited

Who said the prices reflect the cost of making the good

With monopolies that prices may be too high so we are under consuming care E.g. prices of the drug for cancer going to go from $20,000 to $100,000

58

Moral hazard revisited Do costs outweigh benefits

D2 D1

MC = P

G 50 150

If a person has health insurance and pays nothing, they will increase demand from point A to point B and their accrued benefits will be the triangle ABG since the demand curve

59

Moral hazard revisited Welfare loss from moral hazard

Used results from the RAND health insurance experiment (see handout) Found those who paid 95% coinsurance compared to those who paid 0%, had annual expenditures that were 28% less Those who faced a 25% coinsurance spent 18% less than those who faced 0% Willard Manning used these results to show that total welfare loss from moral hazard is between $37 and 60 billion. (represents between 19 and 30 percent of total national health expenditure 60

Moral hazard revisited The problem with welfare calculations These calculations are based on the
assumption that the demand curves show the marginal utility a person derives from an additional service. Assumed that the services that were not consumed (when price rose) must have been those that gave them the lowest marginal utility (least effective). Hard to figure out marginal utility consumers receive from different services.
61

Moral hazard revisited The problem with welfare calculations

RAND studied grouped services received into categories based on medical effectiveness. Found that cost-sharing was just as likely to lower use of highly effective care as rarely effective care. Cost sharing did not lead to rates of care seeking that were more appropriate from a clinic standpoint.
62

Moral hazard revisited

When people try to measure moral hazard they are likely over estimating it.

Forget to take into account the utility you get from health insurance (that you are risk adverse)

You also have to ask if consuming more health care is a bad thing?

Comes back to a value judgment.

Much of health care are private goods. Consuming more preventative care to avoid later large costs would be good thing for society. Yet preventative care is often something an insurance company doesnt cover (elastic demand more moral hazard).

e.g. article on providing preventative care for diabetes patients in NY times.

63

Impact of RAND health experiment Increased cost-sharing in private insurance plans

% of plans requiring deductible for hospital costs rose from 30% in 1982 to 63% in 1984

Significant drop in admissions down 34% ages 1-44; down 28% ages 45-64

% of plans with annual deductible of $200 rose from 4% in 1982 to 21% in 1984 % of plans with cap on out-of-pocket expenses rose from 78% in 1980 to 98% in 1984

Contributes to increase in cost per admission

Increased interest in/adoption of managed care plans

64

Adverse selection

This theoretical idea comes from Arrows 1963 article. Risk pooling works because everyone in the group is at risk and therefore has an interest in making sure that solid insurance benefits are provided. Suppose the risk was not random, you knew:

You had a higher chance of lung cancer because smoked all your life insure You never smoked, eat well, do exercise, so think there is a low chance of getting sick would not want to pay a lot for health insurance.

65

Adverse selection

Adverse selection occurs when some factors are known to the insured (i.e. you) by not to the insurer.

i.e. there is asymmetric information Two types of consumers:

Result of asymmetric information

relatively healthy, with low risk of illness (p L) relatively unhealthy, with high risk of illness (p H)

Insurance company observes overall risk in the market not the actual risk for each individual:

p = f(p H)+ (1-f) (p L); p is probability of illness

Sets premium based on observed average risk, you decide to take up health care or not based on your actual risk. Those who are healthier or less risk adverse are more likely to under insure or not insure and those who are sicker and risk adverse will insure 66

Adverse selection

Example: suppose have n people all with the same demographic characteristics.

Each person knows what they will probably have to pay

So know where they are on the horizontal axis of the next graph.

Insurance company knows distribution of health expenditures by person but not which person pays what. People know exactly what they will have to pay. How much should insurance company charge?

67

Adverse selection

Probability

1/n

1/4M 1/2M 3/4M 1M

Health Expenditures ($)

68

People know how much they have to pay

Adverse selection

Suppose set price of insurance at $0

Everyone will sign up. Insurance company expects to pay out $1/2M so would be losing money,

69

Adverse selection

So suppose try to set the price of insurance at $1/2M

Those who know their expenditures are less than 1/2M will choose to self-insure and will not sign up for the program. Once they leave the market, the expected amount insurance company will have to pay is $3/4M, so premium will need to be this much. But then others will drop out of the market. In fact, if adverse selection is very bad, there may be no health insurance offered!

70

Adverse selection

People select into insurance based on their own risk of sickness Adverse selection into the health insurance market will be a problem if insurance companies only know the average risk of the population . To try to mitigate the problem of adverse selection insurance companies need to figure out each persons actual probability of illness
71

Possible solutions to adverse selection Waiting periods

Pre-existing condition exclusions Risk rating (underwriting)

If the high risks are something the insurance company can observe in advance, they can adjust premiums up or down to account for varying risk.

Adjust insurance based on age, gender, behaviors (how much you smoke or drink), BMI, your cholesterol, blood pressure
72

Possible solutions to adverse selection

Insurance that precludes individual selection according to subscribers perceptions of their own risk

Mandate that everyone must purchase health insurance Universal health insurance

73

Adverse selection
Alternatively, there are:

Group or Community Ratings: Premiums are based on the average characteristics of a group or community rather than your individual characteristics.

Old and young in a group pay the same amount. Those with and without chronic conditions pay the same amount

74

Adverse selection

Problems for companies in US: Compare Google to Ford

Google is full of young workers so insurance premiums and what the company has to pay might be quite low. Ford has older workers so their insurance premiums and what the company might pay will be quite high.

Still can be adverse selection, young workers may not want to buy insurance

Google is probably happier than Ford with group ratings used by private health care. Health care unaffordable for some companies

75

Health insurance premiums by age, 2004

$8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 < 18 18- 25- 30- 35- 40- 45- 50- 55- 6024 29 34 39 44 49 54 59 64 Single Family

Source: Americas Health Insurance Plans, 2008. Individual Health Insurance: A Comprehensive Survey of Affordability, Access, and Benefits

76

Adverse selection: Harvard University Problem:

1994, Harvard University was facing a substantial deficit in the employee benefits budget. Offered both HMO plans and a more expensive PPO health insurance plan. Harvard generously subsidized the more expensive, high-option PPO plans for employees. Needed to determine how to reduce employee benefits
77

Adverse selection: Harvard University

Strategy:

1995, Harvard decide to contribute the same amount to employee plans regardless of which type they chose Employee contributions increased for both the HMO and PPO plans, but more severely in the more expensive PPO plans.

78

Adverse selection: Harvard University

Premium $2,733 $1,980 $6,238 Employee Pays: Old New
$555 $277 $1,248 $776 $1,152 $421 $2,208 $1,191
79

Individual PPO Flex Individual HMO Family PPO Flex

Family HMO $5,395

Adverse selection: Harvard Universitythe more generous, more Enrollment in

expensive PPO plans decreased.

What would you predict about the characteristics of those employees who switched?

Those employees who switched tended to be younger and had spent less on medical care the previous year.

80

Adverse selection: Harvard University

Due to decreased enrollment, premiums for the high option PPO plans increased, making the PPO option even more expensive => More employees were (voluntarily) pushed out of the expensive PPO plans => By 1997, the PPO plan was discontinued, completing the adverse selection death spiral in just three years.

81

Adverse selection: Harvard University

PLAN ENROLLMENT 1995 13% 87% 18% 82% 1996 8% 92% 11% 89% 1994
Individual PPO Flex Individual HMO Family PPO Flex

1997
discontinued

16% 84% 22%

100 %
discontinued

Family HMO 78%

100 %
82

Outline

Uninsured in the US Demand for Insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problem with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts

US health insurance market a brief history

83

Problems with the health insurance market (Cutler, 1994) Insurance is over experience rated

3 types of health care costs.

Those individuals can control (smoking) Costs that are not controllable but predictably related to characteristics of the group (age). Costs which are truly random factors (for unforeseen diseases or accidents).

He suggests that individual costs should be experience rated to ensure people face the true cost of their habits
84

Problems with the health insurance market (Cutler, 1994)

For predictable but uncontrollable costs it is essentially a distributional issue (should the young subsidize the old) For random costs, it is natural to pool costs.

For individual or employees of small firms their premiums are large and variable often making them unsustainable. He argues for community ratings- charge everyone the same rate based on age or location. But the bigger the pool of people the better, so why stop at community?

85

Question: why is small group health insurance so expensive? Loading cost: administrative and other costs associated
with underwriting insurance policies

Per capita loading costs decrease as firm group size increases

Loading costs = (risk premium + administrative costs + marketing costs + profits) Small group purchasers have less bargaining power Risk pool is smaller, and if a sick person less people to spread the costs Adverse selection

86

Typical loading fees by group size 80 70 As a percent of benefits 70

60 (Phelps, p. 343) Percentage 50 40 30 20 10 0 Individual 1-10 11-100 100-200 201-1000 1000+ 35 25 17.5 11.5 6.5

87

Outline

Uninsured in the US Demand for Insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problem with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts

US health insurance market a brief history

88

Health insurance features

Co-insurance

Consumer pays a fixed percent of the cost (say 20%) and the insurance company picks up the rest Patient pays a fixed amount out of pocket, then insurance company pays all additional costs Insurer covers all costs until some upper limit is reached Insurer pays fixed amount per unit of service (e.g. Physician office visit) and patient pays any additional costs
89

Deductibles

Maxiumum/limit

Indemnity (Co-pays)

Mixed

Outline

Uninsured in the US Demand for Insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problem with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts

US health insurance market a brief history

90

Demand for health care Effect of health insurance

How much you demand may depends on type of insurance. Well investigate: Co-insurance Indemnity Insurance Deductibles

91

Demand for health care Health insurance: co-insurance

Price of Physician Services

Dwo: Demand without insurance Effective Price: Amount paid out of pocket Model using DWO curve
Consumer pays without insurance

Assume: .5 co-insurance
Demand increased by one unit

50 .5*50

Consumer Pays with insurance Dwo 5 6

Quantity of Physician Services

92

Demand for health care Health insurance: co-insurance

Price of Physician Services Dwi

Dwo: Demand without insurance Dwi: Demand with insurance Model by using market price -Insurance makes her demand more health care,

50 .5*50 Dwo 5 6

-Makes demand less elastic: for the same increase in price will reduce demand less with insurance.
Quantity of Physician Services

93

Demand for health care Health insurance: indemnity

Price of Physician Services

Pay $30 instead of 60 for a doctors visit.-demand more health care - Elasticity does not change
Dwo $30 Dwi

P=60

Quantity of Physician Services

94

Demand for health care Health insurance: deductible

Purpose of deductible is to lower cost for insurance company 1. Reduce administrative costs because lower number of small claims. 2. May lower demand for medical care

Depends on cost of the medical episode Small costs small problem may not demand health care, big costs you are more likely to get the health care.
95

Demand for health care Health insurance: deductible Time cont. when medical care is demanded
If close to time when deductible is reset, may wait for care If just after deductible has started more likely to have care Probability of needing additional medical care in the remainder of the deductible period. If know definitely will meet deductible, wont wait to go to doctor.

96

Outline

Uninsured in the US Demand for Insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problem with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts

US health insurance market a brief history

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Three important insurance markets

Three important insurance types in the US are 1. Fee-for-service 2. Managed care (associated with capitation) 3. Consumer-driven health plans and health savings accounts

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Fee-For-Service
Popular system before the 1990s

Patients choose medical provider

No gatekeeper: can go to any doctor and ask for any services

Doctors are reimbursed for each service they provide by the insurance company

Physicians have a schedule of fees, and so did insurance companies and the lower of the two would be paid

Providers (doctors) had autonomy over what care to prescribe and how to practice medicine Doctors tended to have independent practices Insurer manages the financial risk and pays usual, customary, or reasonable charges
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Fee-For-Service
Problems with fee-for-service: No restraint on supply-side

With asymmetric information, problem of supplier induced demand. (over prescribing)

Doctors know more than patients so prescribe things that patient doesnt really need

No incentives to find most cost-effective way to deliver care. Saw excess supply of hospital beds, nursing staff etc

Could be so doctors had room to maximize income

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Fee-For-Service

No demand constraint

Often no co-payments Could choose what doctor, hospital, and specialists

These two problems lead to over-utilization and high health care costs Policy options

Gate keepers, must go to primary care physician before go onto specialist Second or third opinions, must seek second opinions before expensive care given (another doctor who would not have the profit motive) Co-payments Managed-care a major response in US

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Managed care
Key features: 1. Patient care is provided through a network or organization of providers (hospitals, physician, clinics etc).

Patient must use the preferred providers or will pay more Organization is held clinically and fiscally responsible go the outcomes and health status of the population served

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Managed care
2. Utilization review: centralized reviews of the appropriateness of provider practices (i.e. doctor told if they are over prescribing or not using the most cost-effective care by administration)

Doctors dont like this because they cant practice how they want to integrate financing and delivery of health care Goal is to provide cost-effective and comprehensive health care

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Managed care
3. Selective contracting: payers negotiate prices and contract selectively with local providers (physicians and hospitals

Distinguishing characteristic from fee-for-service

Patient must use the preferred providers or will pay more

4. Gatekeeper: must see a primary physician who needs to prescribe any specialty services

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Managed care
5. Doctors payment:

Capitated rate per member per month

i.e. doctor paid a set amount per patient, if dont use it all keep the rest, if use more have to finance themselves Stop loss provision in contract. Specifies the total over the capitation rate per member before must be paid more. Reinsurance again large losses

Yearly salary: may be adjusted for patient load Negotiated fee-for services (for some kinds)

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Managed care
These features could lead to lower cost and better quality care Capitation:

Introduce a budget constraint onto the supply side

More volume means less profit

Creates an incentive to keep people healthy, prevention emphasized Incentive to choose most cost-effective way to provide care
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Managed care
Utilization review:

Incentive to choose most cost-effective way to provide care Incentive to provide only needed care Introduces a demand constraint May provide better quality care since better communication between different doctors looking after case

Gatekeeper:

Networks:

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Managed care
Competition among hospitals:

2004, approx. 41% of hospitals reported having revenue from capitated contracts Managed care organizations often only contract with one hospital in the area

Hospitals compete on price to get these contracts

Note the competition for fee-for-service payment to hospitals increased price as they competed on quality and number of services
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Managed care
Types of Managed Care Organizations (MCOs): 1. Health Maintenance Organizations (HMOs):

Example Kaiser Provide comprehensive health care. Usually entail few out-of-pocket expenditures. Must use services provided by the HMO doctors or network

Tend to hire all personal and have them as salaried staff. Must see primary care physician and have them authorize any care you get Choose a primary care physician and cant see others
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Primary care physician is the gatekeeper

Unauthorized care is not reimbursed

Managed care
2. Preferred Provider Organization (PPO) Consumer given two choices of plans
1. 2.

Use in-network providers and have a lower deductible and co-payment Use out of network providers but pay a higher out-of-pocket costs.
So financial incentives provided to encourage use of network providers.

Usually no gatekeeper system

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Managed care

Organization contracts with physicians and hospitals to provide services at below average cost (i.e. negotiates prices for services).

These are the people that become in-network providers Usually does not use capitation

No guarantee provider will see patients under the plan About half require a mandatory second opinion for recommended surgery. Some kind of utilization review is usually done.
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Managed care
3. Point-of-service (POS)

Hybrid of HMO and PPO Like PPO, two tier coverage

In network much cheaper than out-of-network.

Like HMO, each member is assigned to a physician gate-keeper, who must authorize innetwork care in order for the care to be covered on the in-network terms.

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Growth in managed care

Growth of managed care was slow

Historic opposition by organized medicine groups to managed care

Took away patient choice of doctor Threatened ability of doctors to earn excess profits

Under fee-for-service can price discriminate

Charge different fee for the same services

Not possible to price discriminate due to capitated or negotiated fees

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Growth in managed care

HMO Act 1973:

Enabled HMOs to become federally qualified if they provided comprehensive benefits and some other requirement Loan guarantees and grants for startup costs provided Qualified HMOs could require firms in the area with 25 or more employees to offer the HMO as an option Medicare and Medicaid switching to HMOs Number of HMOs grew from 235 in 1980 to 623 in 1986
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Still no real expansion until the 1980s

Growth in managed care

Really expanded in the 1990s

First HMOs expanded HMOs consolidated Enrollment in HMOs increased from 33 million in 1990 to 81 million in 2000 HMO enrollments decreased but PPOs are expanding rapidly Provider greater choice of doctors (more expensive than HMO)

2000s

See Figure 12-1 FGS

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Economics of managed care Figure 12-2 FSG: Changing expenditures D = Demand (fee-for-service) Price
f

Df Dm Pf Pm

Dm = Demand (managed care) Total expenditure FFS light grey Total expenditure MC - dark grey

Quantity
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Economics of managed care

Predictions using economic theory:
1. Factors leading to a decrease in price

Exerts market power to lower prices from Pf to Pm

Only possible when had been earning economic profits 1. Factors leading to the decrease in demand

Reduce inpatient care by keeping patients healthier, using alternatives which are more cost-effective Limiting length of stays Minimizing supplier induced demand Encouraging more cost-effective care though information technology and financial incentives to providers

Tradeoff
Constraint on consumer choice of doctors
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Economics of managed care

3. Amount of care provided by managed care organization may provide less care than is optimal

We want good health over our life-time HMO wants to minimize costs since receives a constant revenue per patient each year

If they believe their patients will not stay in the HMO for a long period of time

Provide cheaper care in the short-term to minimize costs, even if it mean higher long term costs May mean the other HMOs have higher long-term costs if the patient moves to a different HMO This is called a negative externality
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MR, MC

Economics of managed care Figure 12-3 FSG: Health Marginal cost externalities Marginal social cost HMO
1

(including external health effect on HMO2)

Marginal Revenue (price) Quantity of services

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Economics of managed care

4. May use less high tech care
Assume:
We split our life into two periods (period 1, and period 2). It is not certain if we will be with the same HMO in the second period. You are sick and HMO has two options which across the two period cost the same:
High-tech, possibly capital-intensive procedures leading to high period 1 costs, and zero Period 2 costs. Low-tech, les capital-intensive procedures, leading to low costs in both periods.

Given HMO does not know if you will stay with them, they will choose the less capital intensive 120 option in period 1 to minimize costs.

Managed care
Potential Problems with MCOs: 1. Dumping: refusing to treat less healthy

patients who might use services in excess of their premiums.

Say the organization is not equipped to treat certain patients. FFS wont do this because charge for all services given.

1. Creaming: Seeking to attract more healthy

patients who will use services costing less than their premiums

FFS may do this if reimbursement rates are not high enough

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Managed care
3. Skimping: Providing less than optimal quantity of

services for any given condition FFS wont do this because can charge for each service given pay MCO to provide preventative or quality care, since they will not reap the lower future health care costs from these efforts

3. Poor Quality: If patients dont stay in MCO long, may not

FFS may do this if reimbursement rates are not high enough On the flip side MCO may promote more preventive care than under FFS depends on how fast the rewards are reaped. FFS dont like to do it because reimbursement rates often low for preventive care.
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Impact of managed care Recap: Predictions

Theory predicts that MC compared to FFS:

Increase utilization of preventive services Reduce utilization or more costly service (partly by more preventive care) hospital care Lower health care costs Reduced quality/quantity of care:

Capitation raises some concerns

Skimming provide less than optimal care Use lower technology solutions Could result in poor health outcomes

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Impact of managed care Recap: Predictions

Adverse selection

Healthier patients select into MC given lower costs Riskier select MC due to more comprehensive benefits and community rating Healthier patients due to cream skimming and dumping by plans.

What happens in reality?

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Impact of managed care Methodological issues

Methodologically difficult to find empirical evidence

Could compare health care costs, and quality for all those who are under FFS and all those under managed care.

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Impact of managed care Methodological issues

Problem 1:

If utilization decreases is this because the managed care organization is reducing necessary care, or because the population is healthier due to more preventive care therefore not needing as much care altogether. Need to look at outcomes that will separate out these effects.

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Impact of managed care Methodological issues

Problem 2: SELECTION BIAS Do the same types of people choose FFS and managed care? No, sicker people more likely to choose FFS so health care costs for those people will be higher

Expenditure may be higher not because FFS more expensive, but because they have a sicker population May also find FFS uses more technology. Not because of incentives but because they have a sicker population and more high tech care is more likely to be needed. Very hard to control for how sick someone is. Comparing two very different populations so may not have people with the exact same types of sickness in both groups.

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Impact of managed care Methodological issues

To do analysis well really need to randomize people into FFS or managed care or to find a policy experiment where people are forced to move from one to the other due to a mandate

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Impact of managed care Empirical evidence

Selection

Evidence that the healthier select into managed care plans

10-30% lower utilization prior to switch for non-elderly population Greater differences among Medicare population

Riley et al (1994) Medicare patients entering HMO had 37 % lower than average costs while those exiting had 60% higher than average costs

Need to worry about selection bias when examining impact on costs, utilization and quality

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Managed care Empirical evidence

Utilization

Confounded by selection issues

Evidence on selection means there would be lower utilization due to healthier population in managed care Studies are confounded Lower inpatient admission rates Mixed effects on length of stay Overall lower average number of inpatient days Great likelihood of number of outpatient visits

Early studies of HMOs (reviewed by Luft, 1981)

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Managed care Empirical evidence

Rand Health Experiment (Manning et al. 1984) Randomized experiment 2,353 individuals randomly assigned to either:

FFS physician of their choice (431 people) HMO (1,149) Control group: HMO people who had been in the HMO the year before.

The FFS people where then randomized into one of four groups.

Free care Pay 25% of expenses up to max of $1,000 out of pocket Pay 95% of expenses up to max of $1,000 out of pocket 95% co-insurance on outpatient services, up to a max of $150 per person or $450 per family

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Managed care Empirical evidence

See Table 12-3 FSG for results HMO findings consistent with non-experimental findings Less inpatient hospital use More outpatient use

Costs:

Rand Health Experiment

Lower inpatient costs Higher, but not significantly, outpatient costs Overall costs 28% lower than under free care plan
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Managed care Empirical evidence

Prices

Mixed evidence

Some evidence that managed care plans effective in obtaining lower prices for care

Tied to monopsony power Depends on the market, including monopoly power of hospitals, excess or non-excess capacity of provider in the market

Other find higher prices

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Managed care Empirical evidence

Innovation/Adoption of new technology

Mixed evidence

Early studies found positive association between managed care penetration and use of new technology More recent studies find slower diffusion of new technology where managed care penetration in higher Some find no differences

Recent literature on a number of issues

Miller and Luft, 2002 Table 12-4 FSG

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Managed care Empirical evidence

Costs: 2 questions
a) Do they reduce the level of costs?

Use more cost-effective practices so as more people move to managed care the overall health care costs will go down. This is a one time cost decrease

Evidence that the overall costs are reduce (Rand health experiment)

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Managed care Empirical evidence

b) Do they reduce the growth in costs (trends)

Reduce the percent increase in costs each year.

Earlier studies found that growth in costs about the same between FFS and managed care. More recent studies find slower rates of growth under managed care plans (up to 1 percentage point a year)

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Consumer-driven health plans and New approach to health insurance health savings accounts Response to:

Renewed growth in health care costs Move in 2000s from HMOs to PPOs may be partly responsible for this Continued growth in health insurance premiums Backlash against restricted choice in managed care Growth in information technology Greater consumer control over health care spending Making consumer sensitive to cost of care Allowing consumer to choose provider, but to also pay for the differences in the costs of the providers
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Emphasizes

Consumer-driven health plans and Consumer savings accounts healthDrive Health Care: Typical package

High deductible/catastrophic health insurance plan (typically PPO type) Individual deductible may be $3,000, more for families

Must pay for all care up to $3,000 after that the insurance company will pay.

Co-insurance: in-network co-insurance much cheaper than out of network.

Even if reach deductible, still have to pay co-insurance For individual may have a $5,000 max One pay 5,000 out-of-pocket dont need to pay anymore.

Out-of-pocket maximum

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Consumer-driven health plans and Health savings account (HSA). Personal health savings accounts savings
account used to pay for care

Only eligible for HSA if have a high deductible. Account is tax exempt. Dont pay taxed on the money you contribute and dont pay taxes when you take the money out Individual or employer may contribute up a fixed amount (e.g. 100 percent of deductible or $2,700 per individual or $5,450 per family in 2006). Cant contribute more.

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Consumer-driven health plans and Can only take out money to pay for qualified health health savings accounts else expenditures. Will pay a penalty if use it for anything

If you dont spend the money one year it stays in your account and you can grow it through money market funds, mutual funds, CDs etc. Once reach 65, individuals can make nonqualified health withdrawals and only play the appropriate tax rate without any penalties.

Problem with this is it is being used for tax evasion Used to save money tax free while pay a high tax rate. Then take money out when retired so are paying a low tax rate. Rich benefit more than poor.

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Consumer-driven health plans and Advocate argue: health more likely: savings accounts Consumers

Only get care they need since they have to pay much of the cost out-ofpocket Will choose cheaper or more cost-effective care since pay out-of-pocket Will be more likely to use cheaper drugs This will all lead to decrease in growth in health care costs. Still have incentive to managed costs once high deductible has been reached

Insurers:

Benefit people of all risk levels by imposing caps on out-of-pocket spending. More people will insure because the costs of the plans are cheaper

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Consumer-driven health plans and health savings accounts Opponents argue:

May decrease costs now but lead to higher costs later

People wont pay for necessary care that keeps them healthy in the future

May not get necessary preventive care or manage ongoing chronic conditions Leads to higher costs in the future

If can switch plan with lower out-of-pocket costs will do so. Otherwise, will be left pay high health care costs

Detracts from risk pooling (purpose of insurance)

Plan likely to attract the healthy Pay: low costs when healthy, high costs when unhealthy

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Consumer-driven health plans and health savings accounts Difficult for individual to measure quality of
care due to asymmetric information not clear how easy it is for them to make the right choices

Will not decrease the number of uninsured because they dont have enough money to pay the high deductibles so no point getting the insurance

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Consumer-driven health plans and health savings accounts

Choice of provider not really different if not rich

To keep prices down need to use in network provider

Choice of provider has not changed

Costs may go up with choice of provider

Can use out of network provided (choice) but will pay more

No negotiated prices with out of network providers so they can charge much more If insurance covering costs once the max is hit this choice of providers will cost a lot more to the health care system

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Consumer-driven health plans and health savings accounts

Early Evidence

Little use to date, but growing interest Some evidence that lower risk population more likely to choose this type of health care. This is called favorable selection (healthier choosing to insure this way) Others suggest greater appeal to high income populations Tax evasion Can choose high cost providers and still have insurance pay for it when have expensive years No trouble paying the 5,000 or more out-of-pocket Means there is may be little impact on reaching the 145 uninsured

Outline

Uninsured in the US Demand for Insurance

What is insurance risk pooling What is risk aversion Demand for insurance Factors affecting demand for insurance Moral hazard Adverse selection

Problem with demand for insurance

Problems with the health insurance market (Cutler) Health insurance features Insurance and demand for medical care Supply of insurance

Fee-for-service Managed care Consumer-driven health plans and health savings accounts
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US health insurance market a brief history

US health insurance market Brief history

Earliest health insurance dates to 1840s

Sickness insurance

Provided income during illness

Limited supply of private insurance

Some interest in public health insurance in the early 1900s

Teddy Roosevelt: Progressive party Opposed by American Medical Association and others socialized medicine

1920s/1930s see increasing demand for and supply of health insurance

Rising health care costs

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US health insurance market Brief history

1929: Modern private health insurance Dallas teachers contracted with Baylor University Hospital

$6 annual payment paid in monthly installments 21 days of hospitalization

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US health insurance market Brief history

1930s & depression Growth in similar prepaid health care plans with hospitals

Protect individuals from risk during period of low and falling incomes Guaranteed hospitals a steady income

American Hospital Association created and organized several plans, e.g. Blue Cross

Subscribers free choice of hospitals within a city Pre-paid policies covering fixed amount of hospital care with no deductible/copayments Premiums determined by community ratings Grow from 1,300 to over 3 million covered from 1929-1939
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US health insurance market Brief history

Blue Shield plans

Success of Blue Cross plans for hospital care led to the development of Blue Shield plans for physicians care.

1939: California physicians service plan

Covered all physician services

Physicians could charge patient above the amount they received from BS plan (cost-sharing)
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US health insurance market Brief history

1940s/1950s

Growth in for-profit insurance companies

Success of BC/BS Health care costs increasing Employers offering health insurance as a benefit

Govt imposed price and wage controls to curb inflation Only way employers could attract new workers was with fringe benefits. So offered private health insurance. These fringe benefits were not reported to IRS (tax-exempt) IRS eventually asked them to be included in wage bill Workers expressed alarm and congress passed the health insurance could remain tax exempt
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Use experience rating not community rating so could set lower premiums for some

US health insurance market Brief history

1960s/1970s Increase in population covered by private health insurance

Most through employers

Continued increase in comprehensiveness of policies Fueled by:

Growth in incomes Tax treatment of insurance benefits

Dont pay tax on money going to health insurance

Medicare/Medicaid introduced in mid-1960s

See rise in health care expenditures

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US health insurance market Brief history

1980/90s

Increase in managed care (HMOs) Medicare/Medicaid switching to managed care Increase in PPOs and introduction of consumer driven care and HSA

2000s

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