July 2006

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Is Price Inflation Different for the Elderly?

July 31, 2006 in Pharmaceuticals, Social Security | Permalink

One Social Security reform often suggested is to change the indexation of benefits from a wage inflation measure to a price inflation measure, such as the Consumer Price Index (CPI).  Critics argue that the price of healthcare has increased more than overall CPI and since the elderly spend a higher percentage of their income on healthcare, the CPI may not accurately reflect their annual cost of living increase.  This is certainly true.  According to the Bureau of Labor Statistics website, during the last 20 years overall prices have increased 85.3%, but medical care prices have increased 176.3% and medical care service prices have increased 188.6%.

This phenomenon was the inspiration for a Berndt, Cockburn, Cocks, Epstein and Griliches (1998) study on pharmaceutical price inflation for the elderly.  The authors wanted to test whether or not price inflation for pharmaceuticals is different for the elderly as compared to the non-elderly. 

The authors constructed an elderly and non-elderly aggregate pharmaceutical price index and find that elderly drug prices increased 33.1% over 6 years (1990-1996) while non-elderly drug prices increased 32.9% in the same period, an insignificant difference.  The authors also look at 3 types of medications in more detail: antibiotics, antidepressants and calcium channel blockers.  They find that when the elderly proportionally use more generics (as in the case of anti-depressants) the elderly price inflation is lower than that of the non-elderly; when the elderly use more branded medicines (as in the case of antibiotics), then elderly price inflation is higher than that of the non-elderly.  Their paper suggests no persistently higher rate of price increase for the pharmaceutical products used by the elderly as opposed to the non-elderly; the only differences in price inflation are due to the frequency of generic drug usage.

The technology of birth: Is it worth it?

July 28, 2006 in Academic Articles | Permalink

Life expectancy for low-birthweight babies has increased dramatically in the later half of the 20th century, mostly due to improved medical technology.  Prolific use of complex medical equipment and techniques–such as phototherapy, intravenous hyperalimentation, CT scans, etc.–during premature births has increased the average lifetime spending on low-birthdweight babies $39,000 between 1950 and 1990.  Is this added cost worthwhile to society?

This is the question David Cutler and Ellen Meara (2000) wish to answer in their study in the Forum for Health Economics & Policy.  The authors find that birthdweight is the most important statistic to determine newborn survival rates.  By conditioning on the child’s birthweight, the authors attribute all increased survival rates over time to better technology.  Below, I will discuss two of the measures used to evaluate whether the neo-natal technological advances are worth the cost.

Cost-Effectiveness = ch(QALY)/ch(med. spending)

  • The authors assume that the value of one year of perfect health is $100,000.  The QALY measures the benefit of a medical intervention on a scale where 1.0 is perfect health and 0.0 is death.  In the paper, low birthweight children with severe disabilities have a QALY of 0.65, those with moderate disabilities have a QALY of 0.75 and those with no disabilities have a QALY of 1.  The medical spending term takes into account only the medical cost of the birth and disregards subsequent medical complications.
  • The authors find a cost-effectiveness measure of $3,726 per QALY.  This is less effective than influenza vaccines ($1,700/QALY) or prenatal care, but is more effective than regular Pap smears ($17,000/QALY) or bypass surgery ($34,000-$48000/QALY). 

Rate of Return =  Sum_t {b^t*(V q_t)} / Sum_t {b^t*(M_t + L_t- w_t)}

  • The numerator is the discounted value of the child’s QALY.  The discount rate is ‘b‘, the value of a year of perfect health (‘V‘) is set to $100,000 and ‘q_t‘ is the QALY each year of their life.  The denominator is the discounted costs of the child’s lifetime.  The medical costs for each year of the child’s life (including neonatal care as well as subsequent medical spending) are included in ‘M_t’.  L_t is the lifetime cost of living and w_t is lifetime wages.  The authors assume this term is 0 for healthy babies (since most people consume all their income over their lifetimes), but is positive for disabled babies since over their lifetimes they will be a net receiver of society’s generosity.  These costs to society include Social Security disability payments ($4,167/year), Medicaid payments ($6,594/year) and special education costs ($4,728/year while of school age). 
  • The authors find an extremely high rate of return.  Using a discount rate of 3% (b=0.03), the authors find a rate of return to advance neonatal care of 510%.  Using 10% discount rate still gives a rate of return of over 46%.

This paper reassures us that neonatal interventions have been welfare improving for society.  

Medicare’s (true) Administrative Costs

July 27, 2006 in Medicaid/Medicare | 13 comments

A common justification for Medicare is that the public health insurance system has an overhead cost which is about 2% of claims, while the private sector has administrative costs between 20%-25% of claims.  This tells us that Medicare is the best system for America…right?

Merrill Mathew’s of the Council for Affordable Health Insurance (CAFI) summarizes the findings of Mark Litow’s paper “Medicare’s Hidden Administrative Costs.”  Litow finds that taking into account extra legal costs from Medicare adjudication and CMS salaries, the administrative cost ratio increases to 5.2%. 

Private Insurance on average has administrative costs of 16.7% (varying between 30% for individual policies to 12.5% for large group policies).  Yet these figures are inflated.  If we exclude taxes and profits, as well as sales commissions, then the total administrative costs decrease to 8.9% overall and 8.0% for large group policies.  I do not agree that commissions should be deducted from this this figure but profits and taxes certainly should.  Medicare does not pay taxes and does not make a profit so any fair comparison should exclude these items.  Further, tax revenue from insurance companies adds to the public’s coffers; profits should be seen as a cost of capital. 

Even with Litow’s manipulation of the numbers, Medicare seems like a better deal.  Let’s see why:

  • Economies of scale: There are large economies of scale in the insurance business; however ,large insurance companies can certainly replicate the majority of the scale economies Medicare enjoys.
  • Cost of Capital: Medicare incorrectly counts its cost of capital as 0.  The true cost would take into account the direct cost of hiring IRS workers to collect the taxes which pay for Medicare as well as taking into account the distortionary effects of income taxation on workers labor supply decisions.  For the private sector, the costs of capital is transparent: it is simply the interest rate. 
  • Demographics: Medicare serves the elderly population and thus has a high cost per enrollee.  In 2003, the average medical cost for Medicare was $6,600 per person per year, while the same figure for private insurance was $2,700.  Thus, if public and private health insurance had the same administrative cost per person, Medicare would still be seen as ‘more efficient’ since Medicare’s administrative cost ratio would be less than half the size of the private insurance’s cost ratio.

Finally, we need to realize that administrative costs are like people: some are good, and some are bad.  What if a private insurance company raised its administrative costs by 1% , but was able to reduce fraudulent claims by 10% and reduce the premium charged to customers by 8%.  This is an example of how an increase in the administrative cost ratio can add value.  It is likely that private companies try to avoid paying for unnecessary medical treatment and are more vigilant to detect fraudulent claims then Medicare. 

Nearest doc: 200 miles

July 26, 2006 in Healthcare IT | Permalink

A very interesting book I recently came across is Arctic Village by Robert Marshall.  The book recounts the author’s two year stay in Wiseman, Alaska during the 1930s.  Wiseman is a town (if you could call it that) located above the arctic circle and is made up of less than 200 people.  The book details the economic, communal, sexual, and recreational life of its residents in detail and is packed with informative statistics and photographs of daily life.  I certainly recommend it for those who want a taste of life on the frontier.

The book’s section on health care is especially interesting.  The only means to get to an actual doctor or hospital is to fly over 200 miles to Fairbanks.  Home remedies and pseudo doctors are the major means of treatment on the frontier, but the general store does contain some basic household medical items such as gauze, peroxide, iodine, etc.).  Epidemic diseases, however, are generally not a problem in Wiseman since for 8 months of the year the temperature is below freezing. 

More recently, Matt Berman and Andrea Fenaughty (2004) have conducted a study looking at how healthcare quality in western Alaska can improve through telemedicine.  Most individuals only have access to a Community Health Practitioner (CHP) who have significantly less training than even a nurse practitioner or physician assistant.  Patients who need specialty care are flown to Anchorage.  The telemedicine technology allows doctors in Anchorage and CHPs to view pictures of an injury or a part of the body and simultaneously discuss treatment over the phone.  The doctor in Anchorage can make a more accurate diagnosis than if the consult was simply over the phone, and this may reduce the need to fly from the rural area to the city for treatment. 

The authors analyze the compensating variation (CV) of a visit to the CHP clinic and a physician visit in Anchorage.  The CV measures the change in utility for each type of visit after the telemedicine implementation for the area.  The authors find a CV increase of $41.30 at the CHP clinic after the telemedicine implementation, and a CV decrease of $8.70 for the physician visit.  This makes perfect sense.  Telemedicine makes the CHP more valuable since they now have better access to medical expertise from the city; as the value of the CHP visit increases, its substitutes (the physician visit) falls in value.  In Wiseman in the 1930s, the only means of communication was via telephone; giving far-away doctors access to photos greatly increases the quality of care these frontiersmen (and frontierswomen) receive. 

Berman, Fenaughty (2006); “Technology and managed care: patient benefits of telemedecine in a rural health care network,” Health Economics, Vol 14, pp. 559-579.

1.5 million harmed annually by preventable drug errors

July 25, 2006 in Healthcare IT | Permalink

MedPage Today reports that the National Academy’s Institute of Medicine (IOM) claims that preventable drug errors are widespread in the U.S.  It is estimated that 1.5 million American are harmed each year from preventable drug errors; the treatment of these cases adds $3.5 billion of yearly cost.  How can we fix this problem?  The authors suggest the following:

“…consumers should maintain careful records of their medications, providers should review a patient’s list of medications at each encounter and at times of transition between care settings (for example, hospital to outpatient care), and the federal government should seek ways to improve the quality of pharmacy leaflets and medication-related information on the Internet for consumers.”

On May 10th this site ran a post on this issue and I suggested that information technology could improve the error rate.  The authors of the article agree with me, but are skeptical of the progress which has been made:

“But as Daniel R. Longo, Sc.D., and colleagues, of the University of Missouri-Columbia reported last December in the Journal of the American Medical Association, while 74% of hospitals surveyed have implemented a written patient safety plan, nearly 9% have no such plan.

Furthermore, while nearly all hospitals have systems in place to reduce medication errors, only 34% of hospitals reported full implementation of computerized physician-order entry systems for medications, Dr. Longo and colleagues said.”

Big day of healthcare news

July 24, 2006 in Current Events | Permalink

Today was a big day for news in the healthcare industry.  First, a private equity group agreed to buy HCA (Hospital Corporation of America) in a leveraged buyout deal valued at $21 billion (plus the assumption of $11.7 billion of debt).  The Chicago Tribune (“HCA agrees…“) looked to Darren Lehrich of Deutche Bank for analysis:

This gives a company like HCA the ability to duck in the hole, so to speak, in a difficult time for industry fundamentals… It takes a little bit of the quarter-to-quarter pressure off the management team and has a much longer term view in this environment, where we’ve witnessed soft volumes and deteriorating bad-debt trends for the better part of three years. 

In a second big news story, The International Herald Tribune reports that FDA may alter its drug-advisory rules.  The FDA’s deputy commissioner said that the reforms will “make sure that the current system is rigorous, consistent, and transparent.”  The article continues:

The agency has been criticized by members of Congress and public interest groups for appointing doctors and scientists who have financial or other relationships with the companies whose products they are asked to consider. 

One of the FDA’s critics is the Public Citizen organization.  The non-profit recently completed a report cited a variety of financial conflicts of interest at the FDA.  The study found that ”at 73% of the meetings, at least one conflict of interest was declared for at least 1 advisory committee member or voting consultant,” and of the total of 1556 conflicts, only 573 of the conflicts reported were any details given.   

Solving the Dividend Puzzle

July 21, 2006 in Taxes | Permalink

For most individuals, dividend taxation is higher than capital gains taxation.  In theory, one would believe that corporations would thus elect to hold all their profits as retained earnings (or repurchase outstanding shares) in order to increase the price of the stock as opposed to paying out the profits as dividends, since the tax treatment of capital gains is more favorable for investors.  If there were no problems of asymmetric information, the stock price would rise more than the the value of the dividend because of the tax rules.

In the data, however, most firms do pay dividends, despite the tax disadvantage.  This is the ‘Dividend Puzzle.’

In their 2006 NBER paper (“Dividends and Taxes“), Roger Gordon and Martin Dietz offer three traditional theories to explain this phenomenon.  I will briefly review each model.

  • “New View”: The new view assumes that share repurchases are not allowed.  This is not a very reasonable assumption, but share repurchases are outlawed in the UK, and in the US periodic share repurchases are treated as dividends for tax purposes.  The theory says that if an individual has potential projects whose rate of return is high, then Tobin’s q will be greater than 1.  The firm should then sell new shares to finance these high-return projects until q=1. If future projects have a lower return, then the firm should pay out profits as dividends.
  • Agency Model: Shareholders face a tradeoff.  If they choose to keep profits within the firm in the form of retained earnings, managers may be tempted to use the money on projects with a sub-optimal rate of return.  It is assumed that managers (like bureaucrats) are empire builders and wish to increase the portion of the company over which they have control.  Investors are assumed to have less than full knowledge of the profitability of a project and thus must to some degree rely on the manager’s judgement.  In order to limit the capital available to the managers so they will only be able to finance high return projects, investors elect to have a constant stream of dividend payouts.  The drawback to this is that managers who find high-return projects are capital constrained and must go to the capital markets for more funds, which are generally more costly than procuring funds from within.  The tradeoff where dividends limit the capital available to empire-building managers but also increase the cost of financing future investment is the essence of this model.
  • Signaling: In the signaling model, the manager cares about the share price of the firm as well as its true value.  We are no longer in an empire-building set-up.  Investors are not certain whether or not a firm is a high or low value firm, but managers do know the true value of the company.  Dividends are costly, so highly profitable firms will be able to finance paying a constant stream of dividends.  The dividend stream is a signal to the market that this firm is profitable one.

This theories aim to explain some stylized facts that we see in the data.  Let’s see how they do:

  • Dividends are often positive, and stable over time.  The new view would not predict this.  Dividends should vary according to changes in profitability.  The Agency and Signalling models would both display this phenomenon as described above.
  • New Share offerings are seen concurrently with dividend payouts: The New View and the Signaling models make it seem non-sensical to raise capital by increasing the number of shares, but decrease capital through dividend payouts.  The agency theory would support this since a steady stream of dividends over time would limit capital, but occasional needs for the financing of lucrative projects would lead occasional share offerings.
  • Dividend Tax rate changes: The new view would hold that there is no change in efficiency.  The firm pays out its profits through dividends if possible, so an increase in the dividend tax lowers firm value, but does not change efficiency.  In the agency cost model, an increase in the dividend tax lowers efficiency.  Lowering the dividend tax will lead to decreased dividend payments and more retained earnings; but this leaves more cash in the hands of empire-building managers.  The signaling model would predict an efficiency improvement.  Since dividends payouts are more expensive, a lower level signal would be needed to communicate to investors that the firm is high quality.

Gordon and Dietz conclude that the Agency model best fits the data, but more investigation is required.  The do not support this conclusion with econometric proof, but simply that the Agency model best fits the stylized facts of the market.  Their paper is very theoretical and they make some assumptions of which I am uncomfortable.  They assume that firms can acquire other firms as a more efficient way to increase the share price than paying dividends which are tax disadvantaged.  But merging with another firm involves many transaction costs (lawyers, integration costs, etc.), and is likely less efficient for investors unless a smooth match is made.  I am curious on how dividend payments of firms in the same sector affect the decision of an single firm to pay dividends. More interesting papers regarding taxation are available at Roger Gordon’s homepage.

Cavalcade of Risk #4 posted

July 20, 2006 in Health Insurance | Permalink

The Cavalcade of Risk #4 is posted.  From the C or R website:

The purpose of the C of R is to offer insights into the world of risk management; generally, this will be insurance-related, but that’s not a requirement. Our goal is to help folks understand what risk is, and how to manage it. It’s about business and finance, of course, but it’s also about risks in our everyday lives and personal relationships.

Contingent Valuation Method

July 20, 2006 in Econometrics | Permalink

How much would you be willing to pay for a cancer treatment with a 2% chance of working?  How much would you be willing to spend for a new vaccine that was as effective as a prior vaccine, but was now available in chewable tablets?  One way to answer questions regarding new products or goods where markets don’t exist is to use the contingent valuation method (CVM).  In general, CVM is a survey which presents individuals with a hypothetical situation and solicits these individuals for a value of how much they would be willing to pay (WTP) for the good in question.  CVM was orginially used to value environmental laws changes as well as new urban transportation systems.  On of individuals at the forefront of this field is Richard Carson, an economist at UC-San Diego. 

In a 1999 Health Policy article, Thmoas Klose analyses CVM in the medical field.  Below are different CVM methodologies:

  • Open-Ended: Here a person is asked a general question of how much they would be willing to pay for the good.  In practice, however, these questions often lead to very inaccurate responses.
  • Take-it or Leave-it (TIOLI):  In this method, an individual is presented with an option of paying $X for the good.  The benefit here is that the survey participant is faced with a concrete decision.  On the negative side, it often takes a large sample size to achieve accurate estimates.
  • Bidding Games: Using a computer, a survey participant will be asked a question as in the TIOLI situation.  If they answer ‘yes’ to a WTP of $X, subsequent questions will ask if the individual would be willing to pay $Y for the good where Y>X.  If the answer to the TIOLI question in the first stage is ‘no’, then subsequent questions will ask the individual wold pay $Z for the good where ZStarting point bias (the amount $X may be seen as a ‘reasonable’ amount by the individual and they may offer an inaccurate WTP) can cause problems.
  • Check box: This is similar to an open ended question, but individuals get to check a box which corresponds to the maximum they would be willing to pay for the good.  This method has the problem of range bias, where respondents tend to pick values in the middle of the range of boxes.

There are two other important biases to note which I did not mention above.  The first is question order bias.  Some people will offer a high WTP when question are in a certain order, but when the order changes their WTP may also change.  There may be suggestive elements in the wording of the question which may cause a problem.  Also, response effects need to be taken into account.  Response effects occur if an individual answers a question strategically.  For instance, someone with cancer may answer ‘$10m’ to the question ‘How much would you be willing to pay for a cancer treatment with a 2% chance of working?’, because they believe this would influence drug companies to produce the treatment.

Another issue to take into account is the payment method.  Is the person paying for the treatment through a co-pay, through increases in insurance premiums in order to cover the treatment, or through increased taxes?  Also, what is the timing of the payment.  Is it ex-ante (before they get a disease), intermediate (in the diagnosis stage) or ex-post (after they already have the disease)? 

CVM is a very useful tool, but one that must be used with caution.  Careful design is imperative in order to be able to reach valid conclusions from a CVM survey. 

  • Klose (1999); “The contingent valuation method in health care” Health Policy, Vol 49, pp. 97-112.

Other articles of interest regarding CVM in the medical field:

  • Popper, Carol (1990); “Contingent Valuation of time spent on NHS waiting lists,” The Economic Journal, Vol 100(400), pp. 193-199.
  • Diener, O’Brien, Gafni (1998); “Health care contingent valuation studies: a review and classification of the literature,” Health Economics, Vol 7, pp. 313-326.

The Cost Effectiveness of Nurse Practitioners

July 19, 2006 in Nonphysician Clinicians | 2 comments

Many studies have claimed that Nurse Practitioners (NPs)–as well as Physician Assistants (PAs)–are adequate substitutes for primary care physicians.  Researchers claim that NPs can perform a great majority of the tasks currently carried out by primary care physicians, and should be used more frequently since NP and PA salaries are usually half of primary care physicians.  The Bureau of Labor Statistics reports that the median PA income in 2004 was $69,410, as compared to a family practice doctor with less than two years of specialization who would earn a median salary of $137,199.  

Two of the more reliable studies which analyze the cost-effectiveness of Nurse Practitioners are those of Mundinger, et al. (2000) and Ettner, et al. (2005).  In the Mundinger study, individuals were randomly assigned to one of two clinics.  The first clinic was staffed with nurse practitioners and the other clinic was staffed by primary care physicians.  Both clinics had access to the same pool of specialists, inpatient units, and emergency departments.  A follow-up survey was conducted after six months.  The study concludes that:

  • There is no significant difference in patient health status, with the exception that in patients with hypertension, the diastolic value was statistically significantly lower for NP patients.
  • There were no significant differences in utilization rates between the two clinics.
  • There were no significant differences in patients satisfaction, with the exception that after 6 months, the patients rated physicians higher (4.2 vs. 4.1 on a scale of 1-5; P=.05) in the category of provider attributes.

There were some problems with this study however.  First, the patient base was almost exclusively Dominican immigrants on Medicaid.  Thus, it would be difficult to generalize these findings (especially those on patient satisfaction) to the wider U.S. population.  Secondly, it is possible that the physicians were of superior quality, but because measuring the true value of medical inputs on patient health is difficult, this might have caused the lack of any statistically significant difference.  Otherwise, this study is fairly robust.

In Ettner, et al. (2006), the researchers divided the 5th floor of an academic medical center into two wings.  In the West wing medical personnel used a traditional style of care but in the East wing there was an intervention which “…consisted of adding a nurse practitioner (NP) to each of the 2 general medicine teams on 5E” as well as some other changes in care practices.  The authors find the following:

  •  Intervention costs were $1187 per patients but savings were $3331 per patient resulting in a net benefit per patient of $1484. 
  • Of the total savings amount ($3331), $1947 was due to reduced cost during the impatient stay and the remainder was due to decreased hospital utilization after the discharge.
  • The authors re-run the analysis to take into account the possibility of attrition bias and find that the net benefits are still $947/patient.

The biggest problem with this study is that it analyzes a Multi-Disciplinary Doctor-NP Model (MDNP) model which involves a variety of changes in how provider teams treat patients.  It is difficult to analyze how much of the net savings is from the use of a nurse practitioner and how much of the savings is through more effective management of medical personnel.  Also, one must worry that the Hawthorne effect and not MDNP may have been the cause of additional worker productivity in the East wing.  The study does use robust statistical methods and puts forth a convincing argument for the use of MDNP in more hospitals. 

Mundinger, Kane, Lenz, Totten, Tsai, Cleary, Friedewald, Siu, Shelanski (2000); “Primary care outcomes in patients treated by nurse practitioners of physicians: A randomized trial,” JAMA, Vol 283(1), pp. 59-68.

Ettner, Kotlerman, Afifi, Vazirani, Hays, Shapiro, Cowan (2006); “Reducing the costs of patient care? A controlled trial of the Multi-Disciplinary Doctor-Nurse Practitioner (MDNP) model,” Medical Decision Making, Jan-Feb; pp. 9-17.

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