Cost sharing

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Do higher copayments decrease health care costs?

January 20, 2010 in Health Insurance | No comments

Merrill Goozner of GoozNews writes the following:

The share of health care costs borne by individuals has remained fairly steady over the past several decades, and that is the prime argument behind conservative and economist claims that making patients have “more skin in the game” will drive health care costs lower. That ignores the fact that most people (except those in some union plans) have experienced fast rising co-pays and deductibles for years. As health care inflation skyrocketed, employer-paid premiums skyrocketed. But so did individual payments in equal proportion. Where’s the evidence that the skyrocketing co-payments of the past decade held down health care costs?

Do higher copayments hold down health care costs?  In general, the answer is YES.  As Mr. Goozner has mentioned, there has been much evidence by economists that when patients pay more money out of their own pocket, they consume less medical care.  The RAND health insurance experiment finds this to be true in the strongest terms.

However, there are exceptions. For instance, higher co-payments on pharmaceuticals will decrease drug use, but lower pharmaceutical adherence may increase hospitalization rates thus increasing healthcare spending. This is a problem of how to design the insurance contract, not a violation of the central tenet of moral hazard (i.e., when someone else pays for a good, you will consume more of it).  In fact, I have written extensively on the issue of moral hazard.

Additionally, on a macro level, the majority of health care costs come from serious, end-of-life care. In these situations, the physician has much more control over the services provided than the patient.  Further, once a person has reached this stage, the copayments are likely small as the deductible has already been met.

The major problem with Mr. Goozner’s argument is that he does not distinguish between correlation and causation.  In recent history, copayments have increased and so have costs, but this does not mean that higher copayments caused the increased costs or even that they did little to stem the tide of cost increases.  Health care has changed on many dimensions including medical technology, how doctors treat patients, hospital and provider consolidation, etc.  The counterfactual against which one should measure the impact of higher copayments is the following scenario: what if all the exact same changes took place in recent history but copayments did not change over time.  How different would costs be from our current state?  Likely, healthcare care costs would have risen even faster than without the increased copayments.  Nevertheless, since one can never redo the past, this exercise is simply a thought experiment.

Logically, however, it makes sense that higher copayments and deductibles decrease medical costs.  If you go to the dentist and they want you to pay a few hundred dollars for an x-ray, you will be much more likely to acquiesce if your insurance is paying for the x-ray rather than it is coming out of your own pocket.

Higher copayments do decrease medical utilization, but they are just one of many factors that influence aggregate healthcare costs.

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Value-Based Cost Sharing

February 4, 2009 in Asymmetric Information, Health Insurance, Optimal Ins (Theory) | No comments

Many policy experts have been proponents of value-based cost sharing.  Under value-based cost sharing, medical care that is seen to provide a higher marginal benefit to the patient will have lower coinsurance rates than medical care with lower marginal benefits.  If value-based cost sharing would be implemented, preventive care should have low coinsurance rates because of the subsequent health benefit.

This seems like a very attractive way to design health insurance benefits, but a paper by Pauly and Blavin (JHE 2008) asks if value-based cost sharing is truly a novel concept.

First, under perfect information, there is no reason to have value-based cost sharing.  In this case, patients should internalize the marginal benefits–now and in the future.  ”When all agents have perfect knowledge of patient illness states and benefits of care, optimal coinsurance should be zero; insurance should take the form of a fixed dollar (indemnity) payment to cover the full cost of care when care is cost-effective, and should pay nothing in circumstances in which care has benefits that fall short of cost.”

Under asymmetric information, however, patients may make naive decisions.  For instance, patients may decide to forgo preventive care because the do not realize its long-term health benefits.  Coinsurance rates must still be designed to balance the twin goals of risk sharing and averting moral hazard.  Lower coninsurance rates will incentivize patients to get needed care.  However, designing coinsurance rates solely based on the marginal benefit of the procedure may not be optimal once we take into account that patient moral hazard may increase medical care above optimal levels.  

Pauly and Blavin also note that under asymmetric information, “it may now be the more price responsive service that should get the cost reduction, since lowering its cost sharing will have a larger effect in terms of moving it closer to the ideal level than would be the case for a less responsively demanded service.  That is, if patient ignorance resulting in underestimation of benefits from care in a given setting is severe enough, the direct relationship between price responsiveness and optimal cost sharing should be reversed.”

Yet just because value-based cost sharing can work does not mean that is the only solution.  Instead of spending money to reduce coinsurance rates, insurance companies or policymakers could spend money to inform consumers of the true benefits and costs of different types of medical care.  This is especially true of medical services that are not price responsive; where the only way to convince patients to undergo these potentially uncomfortable procedures is to increase information dissemination.  For instance, most people would prefer not to undergo a colonoscopy even at a price of 0.  The only way to convince patients that the procedure is needed is by information dissemination.

Value-based cost sharing is not a magic bullet, but may be a useful technique in the presence of asymmetric information.

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Physician Reimbursement and Technology adoption

December 3, 2007 in Academic Articles, Physician Compensation | Permalink

Economists and health researchers have generally shown that when doctors are paid on a fee-for-service basis, they will advice the patient to undergo more medical procedures than when the doctor is paid on a capitation or salaried basis (see my own paper: “Operating on Commission“). Which payment method maximizes welfare has not been proven and is likely to vary based on the medical procedure in question.

To add to the confusion, Astrid Selder writes in “Physician Reimbursement and Technology Adoption” that physician reimbursement mechanism may also affect the rate at which new technologies are adopted.

Selder lays out the following simple theoretical structure in which the social planner maximizes the following:

  • (1-π)U(Y-P)+πU(Y-P-acm-ε +G(m) -nm)
  • s.t.: P + πacm-%pi;R=πpm>=0
  • s.t.: R + (p-c)m>=0
  • s.t.: m<=B

The first constraints represent the zero-profit conditions for the insurer and the physician respectively and the third is a technology constraint. The probability of falling ill is π. Individuals have income Y, an insurance premium of P, and a coinsurance rate of a to may for the marginal cost, c, of a given level of medical treatment, m. Non monetary treatment costs (e.g.: side effects, time costs) are represented by the parameter n, while the benefits of the treatment are represented by the function G(m). The doctor receives a capitation payment of R and a marginal revenue amount given by p-c. B represents the technology constraint.

It seems obvious, but Selder shows that an increase in monetary medical costs (c) or non-medical costs (n) are welfare destroying. Technological innovations, represented as an increase in B are welfare improving if the technological constraint is binding or have no impact on welfare is the technological constraint is not binding. This results is intuitive: higher costs are bad, technological innovation is good.

This result, however, only holds when there is perfect information. With asymmetrical information, technological innovations may be welfare enhancing or welfare destroying. The welfare enhancing argument is similar to above: better technology leads to better medical care. If there is a moral hazard problem, however, using more basic technologies may actually help to counteract the tendency to over-consume medical care in the presence of insurance. Also, in the presence of moral hazard, technological innovations will cause insurance companies to charge higher premiums in order to cover the additional cost of this care.

How does the technological constraint, B, affect welfare in different physician compensation schemes?

  • “If B is a binding constraint and increases in B are welfare enhancing then a fee-for-service system should be used. Increases in B and reductions in [monetary medical costs] c are induced all of which are welfare improvements. Incentives with respect to [non-monetary costs] n cannot be improved upon.
  • If B is a binding constraint and increases in B are welfare reducing then a system of cost sharing [e.g.: capitation] should be implemented which induces reductions in B and c and gives no clearcut incentives with respect to n. Incentives with respect to B and c are thus optimal, and incentives with respect to n cannot be improved upon.
  • If B is not binding the optimal reimbursement system depends on the demand elasticities with respect to costs.”

In words:

“It has turned out that the state should classify diseases or treatments into subgroups which are reimbursed differently in order to achieve the desired welfare effects in each subgroup. Especially for the case of extremely severe illness shocks the introduction of a fee-for-service system may be socially desirable. It is these very severe diseases where the capitation system seems to induce negative welfare effects with respect to the technologically feasible boundary of treatment. Cost sharing/capitation systems are most suitable for treatments where a reduction of the amount of health care consumed is desirable.”

While the solution Selder proposes is logical, it does not take into account the cost to the state to collect information regarding these disease classes. Lobbying will likely influence whether a given treatment falls into the fee-for-service or cost-sharing grouping. Nevertheless, Selder’s general findings seems reasonable and applicable to the medical care finance design in the real world.

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