EC  426    

Topic:  Policy  Design:  Health  Insurance  and  Adverse  Selection  

Question  4  

Shruti Lakhtakia

Is  the  increase  in  healthcare  spending  a  problem?  Discuss  some  of  the  factors  driving  the  increase  in  spending  according  to  Newhouse  (1992)  and  how  these  affect  your  view?

Magnitude  and  Rate  of  Growth • Both  the  magnitude  as  well  as  rate  of  growth  of  public  expenditure  per  capita  on  healthcare  are  seen  to  be  a  cause  of  worry. • Expenditure  on  healthcare  in  the  US  rose  from  4%  of  GDP  in  1990  to  15%  of  GDP  in  2003,  and  I  expected  to  go  up  to  38%  of  GDP  in  2075.

• Real  medical  care  expenditure  per  capita  has  been  growing  at  around  4  percent  per  year  for  five  decades.

Role  of  Excessive  Health  Insurance • Some  models  of  the  economy  view  this  increase  as  a  problem,  mainly  due  to  the  role  of  moral  hazard,  whereby  spending  on  medical  care  is  increasing  even  though  the  additional  gains  from  such  spending  are  very  low:  “Flat  of  the  curve”  Medicine  (Alain  Enthoven)

• The  exclusion  of  employer-­‐‑paid  premiums  from  taxable  income  exacerbates  the  situation  by  leading  to  excessive  health  insurance.

Elastic  demand  for  Services • The  price  elasticity  of  demand  is  not  zero.  Manning  et  al.  found  that  a  fully  insured  population  spends  about  40-­‐‑50  percent  more  on  healthcare  than  a  population  with  a  large  deductible,  and  their  health  status  is  not  measurably  improved  by  the  additional  services.

One-­‐‑Period  Models • These  are  typically  one-­‐‑period  models  that  take  technology  as  given,  and  focus  on  the  trade-­‐‑off  between  moral  hazard  and  risk  sharing.

However, Newhouse believes that the increase in health expenditure is not necessarily a cause of worry, and may represent the occurring of mutually advantageous exchanges between consumers and providers of healthcare. To see this, it is necessary to move beyond the one-period model and look at the role of technology in accounting for the increase in medical expenditure over time.

Discuss  some  of  the  factors  driving  the  increase  in  spending  according  to  

Newhouse  (1992)  and  how  these  affect  your  view?  

 Accounting  for  Increases  in  

Medical  Expenditure Factors  affecting  Demand

Aging

Increased  Insurance

Increased  Income

Factors  affecting  Supply

Supplier  Induced  Demand

Factor  Productivity

Demand  Side  Factor:  Aging

Explanation • An  increase  in  the  proportion  of  elderly  people  in  the  population  increasing  demand  of  healthcare  services.

Measuring  the  Effect • Newhouse  calculates  the  increase  in  expenditure  due  to  the  increase  in  this  proportion,  keeping  average  expenditure  per  person  in  each  age  group  fixed  over  time,  and  finds  that  it  amounts  to  an  increase  of  15  percent  in  total  expenditure.

Demand  Side  Factor:  Increased  Insurance

Explanation • The  spread  of  insurance  has  reduced  price  to  the  consumer  and  increased  demand  for  medical  services,  resulting  in  a  steady  increase  in  expenditure

Measuring  the  Effect • The  effect  is  measured  using  a  linear  function  to  relate  demand  to  the  average  coinsurance  rate.  A  40  percentage  point  drop  in  the  coinsurance  rate  is  supposed  to  lead  to  an  estimated  50  percent  increase  in  demand.

Criticism • The  largest  single  component  of  the  increase  in  real  medical  expenditure  per  person  has  been  in  the  hospital  sector,  yet  the  average  coinsurance  rate  for  hospital  services  remained  unchanged  during  this  time.

Demand  Side  Factor:  Increased  Income

Explanation • Medical  care  is  a  normal  good,  with  an  income  elasticity  of  around  0.2-­‐‑0.4.

Measuring  the  Effect • Between  1940  and  1990,  real  GNP  per  capita  increased  by  180  percent.  Using  the  above  estimate  of  elasticity,  we  see  that  income  growth  accounts  for  around  a  35-­‐‑70  percent  increase  in  expenditure.  

Alternative • The  elasticity  of  0.2-­‐‑0.4  is  calculated  using  cross-­‐‑sectional  household  observations,  which  may  distort  elasticity  due  to  the  endogeneity  of  income  at  the  household  level.  It  may  be  more  appropriate  to  use  an  international  cross  section  of  data  instead,  which  would  result  in  a  higher  elasticity  of  demand.

Supply  Side  Factor:  Supplier  Induced  Demand

Explanation

• Due  to  asymmetric  information  in  healthcare,  physicians  have  considerable  discretion  in  treating  patients,  and  may  induce  demand  to  protect  their  own  incomes  as  the  supply  of  physicians  increases  over  time.

• There  is  also  a  strand  of  reasoning  that  focuses  on  “defensive  medicine”  -­‐‑  the  prescription  of  tests  and  procedures  by  physicians  to  minimize  the  chances  of  being  sued  under  malpractice  suits.

Measuring  the  Effect

• The  paper  quotes  estimates  from  other  sources  to  estimate  the  contribution  of  these  effects  and  concludes  that  they  both  account  for  a  trivial  fraction  of  the  increase  in  expenditure.

Supply  Side  Factor:  Factor  Productivity

Explanation • Argument  by  Baumol:  If  productivity  gains  are  lower  for  services  like  medical  care  than  in  the  rest  of  the  economy,  then  relative  medical  prices  would  rise  over  time.  Because  demand  is  inelastic,  expenditures  would  also  rise.

Measuring  the  Effect • The  excess  of  medical  price  inflation  over  the  general  consumer  price  index  offers  some  support  to  this  idea  of  the  lagging  productivity  growth  in  medical  care.  However,  because  of  the  problems  listed  below,  the  impact  on  expenditure  is  not  estimated.

Criticisms • The  consumer  price  index  for  medical  care  has  several  severe  measurement  problems.  It  focuses  on  the  costs  of  physician  visits  and  days  in  hospital,  rather  than  the  cost  of  treatment.  It  makes  no  adjustment  for  quality  change.  The  weights  on  different  components  of  the  price  index  and  the  insurance  coverage  of  the  different  components  differ.

Growth  Accounting  Framework

Increase  in  Total  

Spending  on  Healthcare  =  

780%

Aging  =  15%

Increased  Insurance  =  

50%

Increased  Income  =  35-­‐‑70%

Supplier  Induced  Demand  =  Negligible

Factor  Productivity  =  Cannot  be  easily  

estimated  empirically

Role  of  Technological  Change

•  All the factors mentioned above, not including technological change, account for well under half – perhaps even under a fourth – of the fifty year increase in medical care expenditure.

•  According to Newhouse, the bulk of the residual increase is attributable to technological change.

Evidence  for  the  Role  of  Technology

Duration  of  Stay  versus  Rise  in  Costs

• The  length  of  stay  at  the  hospital  has  fallen,  while  the  real  cost  of  a  day  of  stay  has  increased  by  a  factor  of  4.  As  Newhouse  puts  it,  “what  is  being  done  to  and  for  people  who  are  in  the  hospital  is  affecting  hospital  costs,  not  an  increased  number  of  people  at  the  hospital.”

Comparing  Health  Maintenance  Organizations  and  fee-­‐‑for-­‐‑service  organizations • Different  payment  mechanisms,  but  a  similar  rate  of  increase  in  costs,  pointing  towards  common  rises  in  factor  prices  and  changes  in  technologies  available.

Comparing  International  Healthcare  Systems

• There  has  been  a  strikingly  similar  increase  in  spending  across  differently  arranged  healthcare  systems    across  the  world,  pointing  towards  the  role  of  technology  in  affecting  the  real  rate  of  growth.  

Conclusion •  We see that the real rate of increase in costs is similar across

countries with different institutional setups and decision-making regimes.

•  Further, HMOs offer consumers the option of availing cheaper

medical care using a lower level of technology, but given that HMOs are seeing a similar rate of increase in costs as the overall medical sector, by revealed preferences, it could be concluded that consumers prefer the existing state of affairs.

•  Thus, there is evidence that consumers are willing to pay for the

new technology, beyond simply demanding it as a result of increased insurance coverage or other factors.

•  Hence, imposing a ceiling on costs may actually lead to a welfare loss, by preventing medical care consumers and providers from engaging in mutually advantageous exchanges.

Class  Discussion •  Increased insurance, though it explains only 1/8th of

the total change, may be related to moral hazard problems. If indeed it is this factor that has led to an increase in healthcare expenditure, the increased expenditure may be inefficient.

•  More generally, Newhouse’s growth accounting

framework assumes perfect competition, which reflects a broader failure to consider questions of industrial organization.