The Incidental Economist

In a Kaiser Health News column today, James Capretta misunderstands my prior critique of Medicare Advantage (MA), a critique that I believe applies to Rep. Paul Ryan’s voucher plan (which his own staff has admitted to me). Capretta wrote,

Critics say Medicare Advantage plans — the private insurance options offered to beneficiaries — are inefficient and costly. But those same critics oppose vouchers for Medicare — even though that would set up a direct competition between the private plans and the traditional fee-for-service program. …

After all, if the case critics (see Austin Frakt’s August 19 KHN column) make is correct and private insurers simply can’t do the hard work of cost control as well as the government, then Medicare’s “public option” would presumably win this contest.

Kinda makes it sound like I’m one of those critics, that I think private insurers are incapable of reducing costs. Where did I write that? What I really wrote was this,

The politics of Medicare are such that Ryan’s idea, paying for care entirely through private plans, costs more. That’s not due to a market failure, but a political one. Congress likes to spend money; insurers, providers and beneficiaries like to receive it. Congress spends even more when it can satisfy those interests under the guise of a seemingly pro-market, pro-competitive program.

MA plans have a political problem. They are paid above FFS cost whether they can achieve below-FFS cost or not. The same political problem would befall Rep. Ryan’s voucher program because under his plan the HHS secretary has the discretion to set voucher levels. We can do better than that.

In a post on August 23 I followed up on this idea and described a voucher plan that does not suffer this problem. If an independent body, shielded from politics, is in control of voucher levels and other conditions described in that post are met, I would support a voucher plan. Moreover, I am in favor of a competitive bidding system (I’ve written about it in many posts going back a year or more) with a level playing field, as described in my August 24 post. I’ll describe it more fully next week.

Capretta clearly didn’t read all my writing on this topic. He just presumed I was anti-private plan. I never wrote that. I hope he’ll read my post next week on competitive bidding and be in touch if there is any uncertainty about my position.

On my commute home I struck up a conversation with a stranger about the approaching hurricane. “I wish it would hit during the week. Then I would have an excuse not to go to work,” she said.

“Oh, I wouldn’t like that. I love to go to work. I really enjoy what I do,” was my response.

“What do you do?”

Simplifying, a lot, I just said that I’m a professor and I like to do research.

“Yeah, you get to sit back and relax while your students take exams. That’s easy,” she said.

“Well, no. I don’t give exams. I don’t teach. Even if I did, I would still not enjoy sitting and watching students take tests. I like to do research. I like to be at my computer, analyzing data, writing papers, thinking.”

Not yet convinced that this could be why I love my job, she said, “You get school vacations! Long summer vacations! You must love that.”

“Um, no, I don’t get long vacations. But I really do like the actual work. I love my job.”

We had reached our destination. Exiting the train and walking away she just shook her head and muttered, “Professors …”

Austin and I have been up and back this morning on the odd ways people have misinterpreted this post.  Avik Roy weighs in by talking about the fact that while health care is different from other markets, in that it does involve life-or-death decisions, that those aren’t as common as we think:

It turns out that the true range of life or death decisions in health care is rather narrow. If a poor woman gets hit by a bus and is sent to the ER, we all agree that America should come together and pay for that woman’s care: and, in fact, we do pay for it. If a physician makes a mistake, causing a patient to die or suffer disability, we have malpractice litigation for that—i.e., this is a problem upon which government-subsidized health care has no impact.

It would benefit those who believe that health care is incompatible with the free market to refine their arguments. A stronger liberal argument for socialized medicine would be: let’s let the free market reign in those areas of health care that are most like the rest of the market economy (i.e., non-catastrophic and elective care), and instead focus on socializing the aspects of the system that are most unlike the rest of the economy (i.e., catastrophic care).

I don’t disagree on his initial point – as a pediatrician I rarely have to deal with life-or-death decisions with my patients.  I do, however, need to deal with significant quality-of-life issues.  All the time.

When Avik calls for a stronger liberal argument, he’s ignoring the fact that many have been making it for a while.  I, for instance, have no problem with using the free market for some things.  I said this just two weeks ago:

I come down somewhere in the middle.  I’d say that for the stuff we agree everyone should get, that comprises the base set of quality health care, you ignore the moral hazard.  We want people to get that, and we should make it as easy as possible.  But for stuff that is unnecessary – and there is a lot of it – we let people get additional insurance to cover that.  Or we cost-share that.  Or we make them pay for it themselves.

I don’t think, for instance, that insurance should pay for elective plastic surgery.  I don’t think it should pay for Lasik.  I don’t think it should pay for more expensive drugs when equally efficacious generics are available.  I don’t think it should pay for full body CAT scans or unnecessary screening tests.  I don’t think it has to pay for single rooms or fancy food or satellite TV.

All of those things – cost share away.  Free the markets.

But for things which do work and yet still are not life-or-death decisions, like asthma medications, diabetes check-ups, appropriately recommended colonoscopies and mammograms, and so on, I think that we should avoid the free market.  We want people to get that stuff, even need them to.  And even small increases in cost-sharing have been shown to dissuade them from it, resulting in bad outcomes and sometimes increased cost.

Avik and I don’t disagree in principle, we disagree on the details.  And I think if Avik looked closely, he would see that many people arguing the more “liberal” side have been making strong arguments in this fashion for some time.

Earlier I alluded to the cost risk allocation problem in health care. Costs are high. Who should bear the risk, individuals, insurers, physicians, the government? I suggested that the risk should be allocated differently for different populations. The elderly and ill should, perhaps, bear less risk, the young and healthy more, and so forth. ACOs are an attempt to shift risk to provider organizations. CDHPs are based on shifting more to individuals. Both models can do some good, but for different populations. That’s why I never claim that either is the solution or totally wrong. It’s more complicated than that.

Risk can be allocated differently by diagnosis or treatment too. This dimension of risk allocation is compatible with ACOs and CDHPs, or any number of other designs. The concept is value-based insurance design, something I’ve written about before. It’s a way to take the full conclusions of the RAND health insurance experiment and other, related work seriously and to fine-tune risk allocation accordingly.

From that work, we know that some people–those with chronic illnesses or the elderly–really do suffer worse outcomes when they have to pay for more of their care, while others–healthy, working-age individuals–generally do not. To the extent that a specific type of care would improve outcomes (relative to other types of care or to no care) and/or reduce future costs, that should be reflected in cost sharing. One should pay less for care that is more beneficial.

But if an individual pays less, some other entity pays more. The cost risk is shifted, but to whom? The answer is, “It depends.” Insurers can bear some risk. So can the government. What’s best can be settled via a competitive pricing system. I’ll have a lot more to say about that next week, so forgive me for just leaving it hanging there.

Rather than repeat a fuller description of value-based insurance design and some of the research relating to it, I refer interested readers to a this prior post.

I think it is worth emphasizing the key underlying idea here. The health care cost problem is a risk allocation problem. If risk is allocated optimally, costs will come down (relative to trend) with minimal reduction in (or better an increase in) quality.  To recognize that simple fact is already to admit that there is an optimum, we’re likely not at it, and that it can vary by population and even health condition. So, it is complex in detail and not amenable to a one-size-fits-all insurance design.

If past experience is any guide, some will find something to disagree with in what I’ve written above. That baffles me. Does anyone want to spend more for worse outcomes? (It seems so.) Does anyone not think financial incentives and price signals matter in health care as in all other industries? (Apparently.) That’s all I’m talking about, harnessing them to obtain far better results. Welcome to health economics.

Just getting something (else) off my chest.

True story: very early in my experience as a blogger I linked to a prominent journalist in health care, among other topics. Unknown to me at the time I violated a common courtesy in the blogosphere. With my link I was using the journalist’s credibility and freely-provided work to support my argument. That’s fine. But I didn’t actually name the individual. I think I wrote something like (though probably not exactly), “Support for this notion can be found elsewhere [link].”

To my surprise, the journalist wrote me to say that I should include his/her name if I’m going to use his/her work in my argument, even if only via a link. Just stating “elsewhere” is a bit dismissive and is poor “netiquette.” I didn’t know! But I do now. By the way, this was back when I was blogging anonymously on a personal finance blog (not this one). That the journalist bothered to contact me illustrates how seriously people take blogging ethics and norms.

Lately, I’ve begun to appreciate how that journalist may have felt. I’ve seen my work plagiarized and other more minor violations of this blog’s terms of reuse. Sometimes my words or those of co-bloggers are quoted without a link or the author’s name is misspelled (that’s just a mistake, but still bothersome). It’s really annoying! As time permits, and commensurate with the transgression and its degree of visibility, I track down bloggers and journalists and point such things out to them. Almost always they do the right thing. When they do, they are completely forgiven. I hold no grudges about honest and then corrected mistakes.

I am certain most who quote or reference this blog or its authors do not intend to irritate. The best way to demonstrate that is by a graceful recovery. I don’t mind my words being used elsewhere, nor do this blog’s other authors. That’s what they’re for. I just ask that they be done so according to the copyright to which we’re entitled (see also the footer of every page of this blog).

Enough on this. I feel better now.

Recently, I explained that there are many possible causes of high market concentration. Furthermore, its effect on consumer price and market entry is theoretically ambiguous. In principle, dominant firms in concentrated markets (such as those in many health insurance markets today) could benefit from economies of scale or scope. If the resulting cost savings are not retained by the dominant firms, consumers may benefit from lower prices. This could happen if there exists the plausible entry of a potential rival that would undercut the dominant firms if they raised their prices.

On the other hand,* if economies of scale or scope don’t exist or are not large, there may be no consumer benefit from market concentration. There only exists downside risk of higher prices, particularly in the presence of barriers to entry. An unpublished paper presented to the Chicago Fed in March 2010 by Hilliard, Ghosh, and Santerre (pdf of slides available) describes what is known about these factors with respect to health insurance, providing some useful references in the literature.

Demsetz (1973) argues that while the large firm‐sizes involved in concentrated markets may make collusion more likely, they may also allow exploitation of economies of scale and scope. Such concentrated markets may be beneficial to consumers, if the cost savings are passed on in the form of lower prices. There is little evidence, though, that scale and scope economies are important for health insurance. Engberg, et al. (2004) is the most recent study to reject the presence of scale economies in health insurance. …

The AMA suggests that exclusive control over health care provider networks acts as a sufficiently high entry barrier to prevent competitiveness. … [N]ew entry can … [also] be prevented if high concentration permits existing firms to prevent [rental] access to their networks in an effort to counter new business. Furthermore, contestability theory suggests that high sunk costs may deter entry by acting as an exit barrier (Baumol, et al. (1982)). … [I]mportant start‐up costs that are not recoverable include marketing and the cost of setting up provider networks (when renting is too expensive), which may be sufficient to deter entry. Perhaps the most significant barrier to entry, relatively unique to health insurers, is very high consumer switching costs. Samuelson and Zeckhauser (1988) show that status quo bias generates high insurance switching costs in general. This bias is amplified when most customers obtain health insurance through employer‐sponsored group plans with limited provider networks.

Not mentioned by the authors are barriers to entry associated with state regulation. If compliance with state rules about network adequacy or other properties of product offerings is challenging (perhaps due to lobbying by incumbent firms), that is a deterrence to entry as well.

*Economists always have another hand handy. Annoying, isn’t it?

References

Baumol, W. J., J. C. Panzar, and R. D. Willig, 1982, Contestable markets and the theory of industry structure (San Diego: Harcourt Brace Jovanovich).

Demsetz, H., 1973, Industry structure, market rivalry, and public policy, Journal of Law and Economics 16, 1‐9.

Engberg, J., D. Wholey, R. Feldman, and J. B. Christianson, 2004, The effect of mergers on firms’ costs: Evidence from the HMO industry, The Quarterly Review of Economics and Finance 44, 574‐600.

Samuelson, W., and R. Zeckhauser, 1988, Status quo bias in decision making, Journal of Risk and Uncertainty 1, 7‐59.