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.