MA Cuts: Now with Economic Wonkery
Commenters all over the blogosphere are not understanding consumer surplus and how it relates to my finding (again, with Steve Pizer and Roger Feldman) on Medicare Advantage (MA). So, let me explain it.
I stated that, according to our work, the increase in benefits from MA plans since 2003 is valued by beneficiaries at 14 cents per federal dollar spent on them. Then I said the other 86 cents in part pays for the cost of those benefits. Some people have claimed this is a contradiction. It is not.
The 14 cents is consumer surplus (which is explained elsewhere on this blog). There are two interpretations that may help:
- Beneficiaries would be no worse off receiving the 14 cents in cash instead of the extra MA benefits.
- Beneficiaries would be willing to spend only 14 cents for the extra MA benefits they receive. (In both cases “extra” here means beyond those provided in 2003.)
Meanwhile it really does cost the government $1. That other 86 cents is not a benefit, in the consumer surplus sense.
This is straight forward, standard, well established, vetted, and accepted economics. It could not have been published in the journal in which it appeared if this were not the case.
Things to Learn
Below is a list of topic areas and questions of interest to me and about which I’d like to learn more. Do you have thoughts or reading suggestions? Please send them my way.
New-Media Culture. I’m intrigued by new-media social interaction (blogs, chat rooms, e-mail, forums, Facebook, Twitter, wikis, etc.). How does cyber-culture develop? In what ways does it differ from traditional cultural? How is culture and communication shaped by the platforms on which they manifest themselves? (Related reading: The Tipping Point (Gladwell), Create Your Own Economy (Cowen).)
Inescapable You. Years ago I watched a little bit of reality TV (The Real World, The Apprentice). What interested me was the gradual revelation of participants’ true selves. At first, each would behave a particular way to win friends, gain an upper hand, appear cool, or whatever. But, in time, each gradually fell back into his or her natural pattern of behavior (or so it seemed to me). I took this as evidence that one can’t escape one’s true personality, even with cameras rolling and fame and fortune on the line. Where else but in reality shows is this demonstrated or dissected? How can we reconcile the notions of personal development and change with the idea of a “true” fundamental self? Is one or another of these concepts more or less valid in any sense?
Notation and Thought. Certain areas of science and mathematics seem especially aided by good mathematical notation. For example, linear algebra and scientific study upon which it is based is dramatically easier to understand and manipulate in matrix/vector notation than with summation notation. No doubt the ease of use and comprehension provided by good notation propels scientific inquiry. Maxwell’s equations are a particularly beautiful example of good notation. Is there research on the relationship between mathematical notation and language and the scientific insights it reveals and permits? This would be the analog to literature on the relation between language and thought.
Bias. Why is it so hard to argue something on its merits alone? Does everyone have a bias about everything? From my very limited knowledge of neurobiology and psychology I suspect the answer is “yes.” Yet it feels like it should be possible to be unbiased about something. Why? What does that even mean? Is it necessary, important, or revealing to contemplate the bias of the presenter? Or does that just get in the way of good, honest dialog and debate? (Related reading: my post Is Political Commentary Ever Unbiased?)
This Week’s Best Posts on Health Reform
The title is a triple inside joke, and I’m about to let you in on it (them). First of all, I don’t post lists of “best posts” or “interesting stuff I found on the web.” That’s what my News & Links feed is for (see far right sidebar; subscribe to it if it interests you).
Second, it is only Tuesday, a rather odd day to list this week’s best.
Third, I declare these the best posts because they’re the best posts about me, or rather, my work pertaining to Medicare Advantage with colleagues Steve Pizer and Roger Feldman. They’re by bloggers I read regularly to keep up to date on health reform. If you read them too you already know about the following:
- Who benefits from Medicare Advantage? — Kevin Drum at Mother Jones, 9/28/09.
- Is Medicare Advantage Worth It? — Ezra Klein at The Washington Post, 9/29/09.
- 14 Cents on the Dollar — Andrew Sullivan at The Daily Dish, The Atlantic, 9/30/09.
You’ve got to admit, those are darn good blog posts, no? As long as Drum, Klein, and Sullivan keep putting out posts just like these they’re sure to make all of my “best of” posts.
Estate Planning, Part II: You’re Dead. Now What?
This is the second post in a two-post series on estate planning. In the first post I nearly covered the entire topic by cheating: I reviewed Plan Your Estate by Denis Clifford (Nolo, 2008). In this post I cover an important problem not addressed by Clifford: How would your survivors know where your assets are held, why they’re organized as they are, and how to handle them? This is a topic about which I’ve given a great deal of thought, as have others (for instance, on the blogs Bible Money Maters and Gather Little by Little). Below I describe my approach, some of which is of my own creation (though, no doubt, contemplated by others too). Some details were suggested to me by contributors to the Bogleheads Investment Forum.
For several years I’ve maintained a financial information list of every account or institution that has anything to do with my household’s finances. There is an entry in the list for all financial benefits associated with my employment (including retirement accounts and pension benefits), our attorneys (real estate and estate planning), all credit cards, utilities (phone, internet, water, gas, and electric), loans (mortgage and auto), all types of insurance, bank and investment accounts, and anything else that has to do with money.
Each entry in the financial information list includes details so my survivors can easily learn more about the institution or investment: institution name, account numbers, phone number, and web site. I also indicate how the organization communicates with me (whether by mail with paper statements or electronically). If the account draws on or deposits into some other account I also indicate the amount (or approximation thereof) and frequency of the transactions. For accounts with online access I list my user ID, but not my password (that’s the only bit of information I communicate only verbally).
Apart from a source of information for my survivors, this list is very handy for me. Every so often I need to look up an account number or contact information. Instead of digging through my files I can just pull out the financial information list.
With such a list, any of my survivors could see the structure of my household’s finances and find our assets. But that alone is not enough. Would my wife or children know what to do with the assets they inherit? Since I’m the only member of my nuclear family interested in personal finance nobody else knows very much how to manage the portfolio. Therefore, the second component of the information I leave for my survivors is a letter.
The letter explains how my survivors might go about educating themselves about our finances. It indicates where to find all important documents. It also explains that the way I manage things may not be suitable for them. I make a few suggestions as to how to simplify the portfolio. I recommend certain people they might talk to. I suggest they ask questions on the Bogleheads Investment Forum. I have not yet gone so far as to line up a financial adviser of some sort but one day I may do that. Without this letter as guidance I am not confident my survivors would know how to begin to deal with our investments. That’s why I wrote it. (Your situation may be different. If your spouse and/or children are investment savvy then you don’t have this problem.)
The final step is to put all this information in a place where my survivors will find it. That’s easy (for me). Our estate planning attorney keeps our original wills in his fire-proof filing cabinet/safe. I’ve given him a sealed envelope that includes the financial information list and the letter. I wrote on the envelop that it is to be opened by the executor of my will. The letter also indicates where else to look for a more recent version, just in case I pass before providing an update to our attorney.
I know first (well, really, second) hand how challenging it is to unwind a deceased family member’s estate. My maternal grandfather had an exceedingly simple estate. Yet it was still quite a headache for my mother to find all the pieces and to dispose of them properly. Had my grandfather made a list and written a letter of the type I just described it would have been simpler for my mother. It is so easy to do and, as I said, the master list of financial information can be of use in life, if not in death.
Medicare Advantage Cuts: Once More with Feeling
Abstracting from the economics wonkery a bit, let me put research findings on Medicare Advantage (MA) payments plainly.
Payment to MA plans has gone way up since 2003. Did the payment increase largely benefit beneficiaries or not? This is a current political and policy debate, about which much has been written in the media (both traditional and blogospheric). It turns out the answer is known and quantifiable. My work (with Steve Pizer and Roger Feldman) shows that for each additional dollar spent by the federal government (taxpayers) on the program since 2003, just $0.14 of it can be attributed to additional value (consumer surplus) to beneficiaries (see also: findings brief).
What do we make of the other $0.86? That goes to the insurance companies but doesn’t come out “the other end” in the form of value to beneficiaries. In part it is accounted for by the costs of the additional benefits and in part it is captured as additional insurer profit.
So, do higher MA payments produce little value to beneficiaries, as Obama claims, or are the benefits they fund important to maintain, as Republicans would have us believe? The balance of the evidence is on Obama’s side. In fact, it is a landslide: for each dollar spent, 14% of the value reaches beneficiaries and 86% of it goes elsewhere (profit or cost).
Cuts to MA should be a no brainer.
The Health Care Cost Shifting Myth
This post originally appeared on The Health Care Blog on 31 August 2009.
There is a pervasive notion that providers of health care can make up for lower payments received from one set of payers (e.g. Medicare, Medicaid, uncompensated care) by increasing prices charged to other payers (e.g. private insurance companies). To the extent it occurs cost shifting offsets attempts to control overall health care costs through reduced fees paid by public insurers. It makes “bending the cost curve” harder.
However, it is a myth that providers can fully shift costs. That they could do so violates, in most cases, principles of economics. Moreover, empirical evidence suggests cost shifting, where it occurs, is done so at a minimal level: only a small fraction of decreased payments by public payers shows up as an increase in charges to private payers. Losses associated with one payer are largely not recouped from another.
Some take price discrimination as evidence of cost shifting. However, price differentials are not necessarily the recouping of losses from one payer by overcharging another. As described in the 2001 Health Affairs paper by Richard Frank “Prescription Drug Prices: Why Do Some Pay More Than Others Do?” price discrimination can be due to unequal bargaining power across classes of purchasers. In other words, in maximizing profits, providers charge different prices to different market segments. In such cases, by definition, profits cannot be further increased by cost shifting. (Uwe Reinhardt makes a similar argument on the Health Affairs Blog.)
It’s true that cost shifting could theoretically occur under specific conditions. One case is when a provider has monopoly power that it has not fully exploited, for instance charging private insurers less than it could. More fully exploiting its monopoly power with respect to those payers, such a provider can recoup losses. Still, there is a limit to how much of the lost revenue can be recouped. The monopoly profit-maximizing price level imposes a ceiling.
Another instance in which cost shifting could occur is in a more competitive market in which all providers have roughly the same level of undercompensated care. All competitors in such a market might choose to increase charges to private insurers by the same amount, maintaining their relative competitive positions. However, if one competitor elects to reduce costs or reduce its burden of undercompensated care, it might be able to charge private insurers less then others, thereby increasing its market share. So, cost shifting may not be a stable equilibrium.
The literature provides estimates of the extent of cost shifting in cases where it is theoretically possible. The March 2009 MedPAC Report to Congress: Medicare Payment Policy (Chapter 2A) includes a summary of such evidence. It concludes that the dominant dynamic in the market is that hospitals with strong market power have abundant financial resources. In turn they have a high cost structure (perhaps due to provision of relatively higher quality care) that causes lower or negative Medicare margins. In contrast, hospitals that are forced to run efficiently are adequately funded by Medicare payments. That is, Medicare payments are sufficient to cover costs but some hospitals run inefficiently and make it appear otherwise. Therefore, MedPAC has concluded that increased Medicare payments to hospitals would not reduce rates charged to private insurers. The primary effect would be to induce lower cost operations.
The MedPAC report cites mixed evidence from the literature on the level of cost shifting, as does the December 2008 CBO report Key Issues in Analyzing Major Health Insurance Proposals. A few studies from the 1980s found evidence of cost shifting at a rate of up to fifty cents on the dollar. However, conditions in the 1990s were less conducive to cost shifting and the rates were found to be on the order of a 0.4 to 1.7 percent increase in private payments in response to a 10 percent reduction in Medicare and Medicaid fees. In a 2005 study of geographic variation in health costs of the Federal Employees Health Benefits Program, the GAO concluded that the considerable variation it found was not due to variations in payments from other payers.
In conclusion, cost shifting is not as large and widespread a phenomenon as some would believe. Under some market conditions it is inconsistent with economic theory. And, while it can occur under other market conditions it is far from a dollar-for-dollar shift in costs. The most recent studies of the phenomenon find little evidence of cost shifting or very low levels of it. Claims that reductions in public payments for health care will necessarily show up as commensurate increases in private payments are unfounded.
Free Personal Finance E-Books
There are many good personal finance e-books available. Two made recently available are written by bloggers I like and trust. I encourage everyone interested in sound and simple investing to download these books and distribute them widely (or simply share this post). But act quickly because these books may not be available for free for long. One of them is scheduled to disappear next week.
Investing Made Simple. Mike Piper, host of The Oblivious Investor, has made his book Investing Made Simple available electronically until 10/1/2009.
As a courtesy I asked Mike what he’d like me to do with my electronic copy after 10/1/2009. Should I share it or just keep it to myself? I expected him to ask me not to share it and to refer people to Amazon.com or his site so they would pay for his book. To my surprise, however, he was fine with the idea of sending people the electronic version for which he is not compensated. He wrote,
[H]elping Mike earn six bucks can’t compete with the importance of helping an investor avoid paying tens of thousands of dollars in pointless mutual fund fees over his or her lifetime.
Mike is a good guy! I hope he earns a lot of money on his books because he deserves it.
Roth IRAs. Blogger J.D. Roth, host of Get Rich Slowly (GRS), has posted his e-book Roth IRAs: The Get Rich Slowly Guide to Roth IRAs. By some measures GRS is the most popular personal finance website. From what I’ve read so far J.D. Roth and other GRS contributors provide sound advice, and I feel comfortable recommending their work to others.
J.D. has done the community a service by posting a summary of many other personal finance e-books, some available with no strings whatsoever and some requiring a small payment or a (free) subscription sign-up.
Happy reading.
A Funny Thing About Drug Pricing
A University of Chicago law student with a prior career in the pharmaceutical industry whom I interviewed for a job the other day shared some knowledge regarding drug pricing that I thought quite interesting. It hadn’t occurred to me, though it seems perfectly obvious, that drug companies price drugs over which they possess a patent monopoly according to the avoided costs of the next best treatment for the diseases they address. If an insurer typically has a hundred heart attacks in its risk pool every year, and a new wonder-drug will prevent fifty of them, it will pay just under its cost for treating the fifty avoided heart attacks for a supply of the drug sufficient to achieve this result.
And it turns out, according to my source, that pharmaceutical companies do typically set the unit price of non-copycat patent drugs in relation to the avoided cost for insurers for on-label use. But then a funny thing happens. The pharmaceutical manufacturer begins promoting down-label and off-label uses of the drug – i.e., use of the drug by patients who are not as at risk of the condition as those for whom the drug was approved to treat, and use of the drug to address other conditions than that for which it has been approved, respectively.
The avoided costs for treating down-label and off-label patients is typically less than for on-label patients, if it can be quantified at all. But at this point, the decision whether to administer the drug is within the hands of the doctor and the patient, and the insurer reimburses for the drug at the price that was negotiated based on the higher on-label rate of cost avoidance. Over time, the down-label and off-label use of a drug can and often does exceed the on-label use, often by a significant degree. As a result, an insurer will often find itself paying out significantly more in reimbursement for a patent drug than the cost of avoided medical treatment the drug achieves. Yet another hidden cost driver in the Freakonomics of our crazy health care system.
A comment from Austin Frakt follows.
Pharmaceutical manufacturers have so many ways to milk insurers. Co-pay rebates to policyholders being another (hat tip to recent Planet Money focus on this). These are just a few of the ways in which insurers really aren’t the big problem in health care. They’re played by providers.
Drug Discovery: U.S. vs. Europe
An interesting paper by Donald Light was posted on the Health Affairs website on 25 August 2009. “Global Drug Discovery: Europe is Ahead” aims to debunk two popular misconceptions about pharmaceutical research: (1) That the U.S. has eclipsed Europe in drug research productivity and (2) that most new drugs are therapeutically important. In summary Light’s findings are as follows.
- Using data on all 919 new chemical entities (NCEs) approved between 1982 and 2003, Light shows that Europe still leads the U.S. in percentage of NCEs discovered and percentage of NCEs deemed “global” (introduced into four or more of the G7 countries).
- From results produced by the European Federation of Pharmaceutical Industries and Associations, Light shows that between 1990 and 2000 the U.S. has not increased its productivity of pharmaceutical research as measured by the percent of NCEs discovered divided by the percent of funds invested (1990 U.S. value 0.76, 2000 value 0.75). Meanwhile, Europe has increased its productivity (1990 Europe value 0.99, 2000 value 1.17).
- Finally, Light cites numerous studies that have found that about 11-15 percent of NCEs are therapeutically important and this rate has held steady for forty years. The rest are not clinically more effective than previously existing treatments.
It is well-known that we pay relatively higher prices for drugs in the U.S. than elsewhere. It is often argued that one benefit of high prices is high rates of innovation and more effective NCEs. Yet, U.S. innovation rates and rates of clinically important NCEs are not particularly high, nor are they growing. Of course, European companies benefit from high U.S. prices as much as U.S. companies do and people in the U.S. benefit from European drugs as much as Europeans do. So, despite Light’s findings it isn’t clear to me that they are in and of themselves arguments against the compensating benefits of high U.S. prices. If it were the case that U.S. purchasers only bought from U.S. firms then Light’s argument would be air tight.
If Light’s findings are accurate, what is clear is that European pharmaceutical companies are operating more efficiently than their U.S. counterparts. The obvious question is why? The answer is beyond the scope of Light’s article.
Pascal’s Wager? The Uncommon Relationship Between Drug Industry Profits and Research
Tyler Cowen has cautioned in the NY Times that cost containment measures as part of health care reform may impact the US lead in medical research and development. But how much do private sector profits contribute to the pace of medical innovation? This question is particularly salient to the US pharmaceutical industry, which is the largest private contributor to US medical R&D, and has agreed to provide up to $80 billion in cost savings over ten years in connection with comprehensive health reform. Will this modest hit to their profits detract from their investments in research and development?
The standard corporate finance answer is no. In a well established business with access to capital markets, the link between profits and investment in research development is weak. So long as a business’s expected profits from research and development exceed its cost of capital by some amount, its investment in research and development will chiefly be limited by the law of diminishing returns. An increase in profits will not spur additional R&D investment, because the business has already invested all it profitably can. A decrease in profits to some point still above its cost of capital will not decrease R&D investment, because foregoing profitable investment opportunities will not increase profits.
But it turns out this is not true for pharmaceutical companies. Pharmaceutical R&D investment does vary in close relation with profits (Scherer 2001, Health Affairs). Why? Pharmaceutical companies do not lack access to capital markets. Why do they choose to make investments in R&D out of free cash flow that they won’t make with funds from other sources?
I think the answer is this: Patent protection assures an enormous payoff to the inventor of a blockbuster drug. But the probability is remote and in any event difficult to estimate that any given research program is going to produce a blockbuster. Thus it is difficult to impossible to estimate the risk-adjusted return on investment of such a research program relative to cost of capital. So such research programs get funded cautiously if at all from the capital markets. Free cash flow, however, is close to cost-free money. Betting it on a blockbuster with free cash flow is a lot like Pascal’s wager: if you lose, you lose nothing; if you win, you win everything.
I had the discussion that led up to these thoughts with a Facebook friend of a certain free market bent whom I took to be making the generally incorrect assertion that R&D investment varies with profit. Though I took great pains to explain the text-book reasons why that is not generally the case, he remained incredulous that I could not appreciate the obvious relationship. And the thing is, it was completely intuitive to him, because he works for a company – Google – that is also a special case. Google also operates in an industry where a single success can create blockbuster returns through first mover advantages and network effects. Not surprisingly, Google plows a lot of its free cash flow back into R&D on projects whose odds of success are hard to quantify. It was completely obvious to my friend why it should do so.
The pharmaceutical R&D investment model that also applies to software has been called “virtuous rent seeking.” But the CBO, for example, has questioned whether the private incentives for such investments, in the pharmaceutical arena at least, are so strong that they produce overinvestment from the perspective of social utility. And of course, that is the tragedy of Pascal’s wager: whether or not he lost nothing on the bet, society as a whole perhaps lost a great deal when he turned his mind away from science to God. In the end, it is not clear that any diminution of investment in R&D by the pharmaceutical companies as a result of health care reform will actually be missed.
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