The Incidental Economist

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.

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.

Since seeing Joe Newhouse’s suggestion of an all-payer health system and recalling Uwe Reinhardt’s advocacy and Maryland’s implementation of one, I’ve been trying to figure out what “all-payer” really means. What are the variations in all-payer systems? How do they work? To what extent do they reduce costs, enhance access, affect quality, etc.? In recent days, I’ve found answers to some of those questions.

From a 2009 Health Affairs article by Robert Murray, it’s clear that one Maryland-style all-payer system is an administrative pricing one. Regulators pour over hospital cost reports and, based on them, set prices. But the implication of Newhouse’s brief mention of all-payer is that he preferred it to a single-payer system because it included price signals. So there must be more to it!

A very old, 1992 Health Affairs paper by Paul Ginsburg and Ken Thorpe does reveal a little more. It’s about how to make the difficult transition from the current price-discriminatory system to an all-payer one, while maintaining price competition. There seem to be two key elements. One is that prices still vary across hospitals. So there’s a little price competition in that sense. However, a single hospital cannot vary its price for a given service across payers. That’s what all-payer means.

Ginsburg and Thorpe also suggest the possibility of insurers negotiating discounts from an administratively set cap on a given service. That permits competition and is a big price signal, but doesn’t sound like it belongs in the all-payer category. It’s just price caps. Maybe I misunderstand their ideas.

This brings me to Reinhardt’s 2009 Health Affairs blog post on the subject. (Aside: I overlooked this initially because Health Affairs blog posts don’t show up in database searches of the academic literature, or not prominently anyway, since they don’t get cited in other papers. This strikes me as a real problem for the research blog model that Health Affairs is promoting. I think they should consider bundling  a subset of their blog posts–maybe the ones with the most links, tweets, and comments–into occasional or periodic special issues.)

For starters, one could use the diagnosis-related groups (DRGs) and resource-based relative value scale (RBRVS) now used by Medicare as the first-stage relative value scales, which could be refined over time on the basis of either cost or imputed value.

If price competition among providers were desired, one would allow each individual provider to set their own monetary conversion factor for their relative value scale and compete on that simple, one-dimensional price indicator. …

One could also, however, have these conversion factors negotiated between associations of providers and associations of insurers with a region (e.g. a state) and make them binding on all providers and insurers in the region, as is now done in some European countries — notably Germany — which operate all-payer systems within regions.

Thus, to do away with the unwieldy and unseemly price discrimination now prevalent in American health care, a physician or a hospital would charge all insurance carriers or patients the same price for identical procedures. The system would work best if there were not a large number of uninsured people and if the public insurance programs — Medicare, Medicaid, and the Children’s Health Insurance Program, or CHIP — were part of the arrangement.

Very clear! I get it now. I can see the dimensions in which an all-payer system can vary to build in price competition. In the rest of Reinhardt’s post he describes the various benefits of an all-payer system and how it can serve as a transition to bundled payments.

One should not be too optimistic about what an all-payer system can do. It’s principally a system for purging price discrimination from the system, which would also eliminate cost shifting, to the extent it exists. Beyond that it would aid in the goal of price transparency, a necessary condition for a well- functioning market, and it would enormously simplify billing and reimbursement. All good stuff.

But will all-payer bend the cost curve? I think one can’t be certain without pinning down the details. With prices that are administered in some fashion, the curve can be bent by fiat. Under a competitive model, the curve does whatever the market allows. As I like to say, “The market does what the market is.”

Finally, since price discrimination currently exists between public and private payers–the former pay far less than the later, per admission or service–movement to an all-payer system means higher prices for Medicare and Medicaid. Isn’t that a problem for federal and state budgets? That’s got to be addressed before policymakers can really get behind this idea.

This is a repost/update of my last piece on Rep. Ryan’s “Roadmap” from my old blog.  Still relevant:

Rep. Ryan is disappointing me. He has a defense of his “Roadmap” up. Specifically, he wants to talk about how his plan will affect Medicare. In his own words:

We do not have a choice as to whether Medicare will change from its current structure. It is being driven to insolvency. An honest debate requires a serious discussion of how Medicare will avert its collapse and be made sustainable. Unfortunately, but not surprisingly, the Democrats’ political machine has attacked my contribution to this debate, making the false claim that the only solution put forward to save Medicare would “end Medicare as we know it.”

The CBO has said that my reform plan, “A Roadmap for America’s Future,” would put Medicare on a sustainable path. The plan protects and preserves Medicare for those enrolled now and for those who will become eligible in the next 10 years, while reforming the program to ensure it will be there for younger generations. Future seniors would have access to the same coverage I enjoy as a congressman.

OK. First of all, no one is arguing against the fact that Medicare might have to change from its current path to be sustainable. But part of the reason that path was made worse was because of the huge unpaid for addition of Medicare Part D, which was not passed by the Democratic machine. ARGH. Look, he’s made me make a partisan argument. Unforgivable. Deep breath.

Rep. Ryan, your plan for Medicare is not crazy. It’s not corrupt. It’s not morally wrong. But I’m sorry, it absolutely would end Medicare as we know it.

Medicare right now is a defined benefit plan. Everyone knows exactly what they are going to get from the government and that’s what happens. Every year, the government (CMS) figures out how much it will cost to give those defined benefits, and it pays the bills. There are pros and cons to such a plan, but that’s Medicare as we know it.

You would like to change Medicare to a defined contribution plan. In that plan, everyone knows how much money (in a voucher) they are going to get every year, and then they go out and buy insurance. Every year, the government sets how much it is willing to pay, and gives out the vouchers.

A defined contribution plan is NOTHING like a defined benefit plan. Going to a voucher system, is a total change from Medicare. It’s the “end of Medicare as we know it”.

Medicare right now is the equivalent of Canada’s single payer health care system. You want to end that; you want to privatize it. It’s a radical change. Own it. Deal with it.

Your proposal would be a much greater disruption of Medicare than anything in passed in health care reform recently. Yet many of your colleagues have said that any cuts to Medicare would be horrible. Did you share this view with them earlier this year? I ask, because I’ve always felt that the demagoguery about cuts to Medicare was foolish. I’m not sure you’ve always been consistent. A wonk would clarify that.

The irony is that you keep talking about the CBO as if they were the gold standard of knowledge in terms of how reform will affect the budget in the future. Did you share this feeling with your colleagues when they were debating health care reform earlier this year? I ask, because I’ve always felt the CBO was credible. I’m not sure you’ve always been consistent. A wonk would clarify that.

Another irony is that what you are proposing, giving people money or vouchers to buy private insurance, sounds much like the exchanges recently passed in the PPACA. Right? How is it different? Did you share your feelings on the value of this type of setup with your colleagues when they were debating health care reform earlier this year? I ask, because I’ve always felt the exchanges seemed like something conservatives would support. I’m not sure you’ve always been consistent.

A wonk would clarify that.

UPDATE: Paul Krugman clarifies a point I’ve been trying to make.  A true conservative wonk would answer the challenge of ending Medicare as we know it with, “Yes, and we should.”  There are arguments to be made by serious people who think that a voucher/defined contribution system would be superior.  I have not yet been convinced those arguments are correct, but there are people I respect who continue to make them.  What I don’t respect are people who don’t appear to understand those arguments, and think that somehow you could take Medicare, turn it over to private insurance, give people vouchers that may not be enough to cover premiums in the future, and claim with a straight face that it’s still “Medicare as we know it.”  Come on.

Not since the RAND Health Insurance Experiment (HIE) has there been a randomized controlled experiment of the effect of insurance on health outcomes. Finally, a second one is underway, the Oregon Health Study (OHS). It’s being conducted by Heidi Allen, Katherine Baicker, Amy Finkelstein, Sarah Taubman, Bill J. Wright, and the Oregon Health Study Group who report on the study design in the most recent edition of Health Affairs.

[T]he Oregon Health Study [is] a randomized controlled trial that will be able to shed some light on the likely effects of [Medicaid] expansions. In 2008, Oregon randomly drew names from a waiting list for its previously closed public insurance program. Our analysis of enrollment into this program found that people who signed up for the waiting list and enrolled in the Oregon Medicaid program were likely to have worse health than those who did not. However, actual enrollment was fairly low, partly because many applicants did not meet eligibility standards.

Get excited! But don’t get too excited. The study runs through 2010 and no outcome results are available yet.

The paper includes a nice summary of observational, quasi-experimental, and experimental studies of the effects of public insurance programs on outcomes. As I’ve written before, observational studies are not of primary interest to me. There’s only been one other experimental study (RAND HIE). About the quasi-experimental studies, the authors write,

Some studies have found evidence that public health insurance reduces mortality among infants and children [8-10] and improves some outcomes—although not mortality—among the elderly. [11–14] Although they are much more persuasive than observational studies, quasi-experimental studies are not truly randomized. Thus, investigators must rely on the assumption that the people whose health insurance was affected by environmental or policy changes are otherwise identical to the people in the comparison group.

The authors’ references 8-14 are listed below. References 8 and 9 pertain to Medicaid and are on my list of papers as part of the “Medicaid-IV” project.

References

8. Currie J, Gruber J. Saving babies: the efficacy and cost of recent expansions of Medicaid eligibility for pregnant women. J Polit Econ. 1996;104(6):1263–96.

9. Currie J, Gruber J. Health insurance eligibility, utilization of medical care, and child health. Q J Econ. 1996;111(2):431–66.

10. Hanratty MJ. Canadian national health insurance and infant health. Am Econ Rev. 1996;86(1):276–84.

11. Card D, Dobkin C, Maestas N. The impact of nearly universal health care coverage on health care utilization: evidence from Medicare. Am Econ Rev. Forthcoming.

12. McWilliams JM, Meara E, Zaslavsky AM, Ayanian JZ. Health of previously uninsured adults after acquiring Medicare coverage. JAMA. 2007; 298(24):2886–94.

13. McWilliams JM, Meara E, Zaslavsky A, Ayanian JZ. Use of health services by previously uninsured Medicare beneficiaries. New Engl J Med. 2007; 357(2):143–53.

14. Finkelstein A, McKnight R.What did Medicare do? The initial impact of Medicare on mortality and out of pocket medical spending. J Public Econ. 2008;92(7):1644–69.

Two articles of interest in yesterday’s Boston Globe. I don’t have time to comment much.

Insurers hawk plans with less choice, by Reed Abelson

As the Obama administration begins to enact the new national health care law, the country’s biggest insurers are promoting affordable plans with reduced premiums that require participants to use a narrower selection of doctors or hospitals. …

The size of these networks is typically much smaller than traditional plans. In New York, for example, Aetna offers a narrow-network plan that has about half the doctors and two-thirds of the hospitals the insurer typically offers. People enrolled in this plan are covered only if they go to a doctor or hospital within the network, but insurers are also experimenting with plans where it simply costs more to go outside the network. The new health care law offers some protection against plans offering overly restrictive networks, said Nancy-Ann DeParle, head of the office of health reform for the White House. Any plan sold in the exchanges will have to meet standards to make sure patients have enough choice, she said.

This will increase price competition. But consumers will not like it, in general. In exchange for significantly lower premiums, maybe enough will.

Firms cancel health coverage, by Kay Lazar

The relentlessly rising cost of health insurance is prompting some small Massachusetts companies to drop coverage for their workers and encourage them to sign up for state-subsidized care instead, a trend that, some analysts say, could eventually weigh heavily on the state’s already-stressed budget. …

State officials said they have not seen convincing evidence that there is a trend. There has not been an unusually large spike in enrollment in Commonwealth Care, the subsidized insurance program, according to spokesman Richard Powers. And in any case, Dr. JudyAnn Bigby, secretary of health and human services, said the administration budgeted for higher health care spending because it anticipated that there would be growing numbers of long-term unemployed residents who would be signing up for coverage.

If this is a real trend, it could have far more to do with the economic downturn than the nature of the Massachusetts health care market. What do you expect when health care costs go up and business revenue goes down? At least there is a sensible individual market for folks to fall back on.

Katherine Ho’s paper titled “Insurer-Provider Networks in the Medical Care Market” (American Economic Review, 2009; ungated version available) models the bargaining process between insurers and hospitals. It’s fascinating, but far too mathy for a post. (If I can distill it down to something simpler I’ll write more about it later.)

The paper also includes this revealing passage:

The executive director of one hospital system described a potential outcome in such markets [in which managed care is strong and hospitals compete for contracts]: “There are examples where there were too many hospitals in an area and the plans played them off against each other to the point where the price paid was no more than marginal cost.”

The more interesting situation arises when hospitals tailor their characteristics in order to capture positive profits. Interviewees noted that the negotiations could be very different in these markets. A hospital director said the following: “In market X [where hospitals are very strong], the prices [the best hospitals] charge are based on their very high patient satisfaction results and their strong reputation. They can get high prices from any plan in the market and they don’t need them all.” The CEO of a small hospital in a different market had a similar story: “Large [hospitals] in this market can dictate whatever prices they want. The bigger names can demand the higher prices.”

Market structure matters. If we’re to rely on the market for health care the prices (premiums) we pay are a function of the balance of market power between insurers and providers. That’s not the only factor relevant to prices, but it is one driver of geographic and temporal variation in premium levels and changes.

Kaiser Health News anticipates the consolidation in insurer and provider markets due to the new health law.

Bloomberg Businessweek reports that … health insurers are “moving towards an oligopoly” accelerated by the new law. … The health-care overhaul is likely to push at least 100 insurers with 200,000 members or less out of the business ‘as the plans are increasingly unable to invest in the infrastructure and technology to effectively manage care.’ …

In the meantime, doctors are being driven together in practice by health reform and “solo practices could be on the way out,” National Journal reports. …

Doctors are increasingly looking to band together in ACOs to reduce costs and put themselves in line for the Medicare money such organizations are likely to see after health reform is implemented. “The big question now is not whether accountable care organizations are the future, but who will control that future.”

We saw this coming, right? How the money will flow from Medicare through the new provider organizations is the trillion dollar question.Whether hospitals or primary care doctors (or some other entity) controls how its distributed will determine if and how this whole experiment will work.

The other big issue is that provider integration under ACOs (or otherwise) are fine and good for Medicare, but somebody needs to think through the consequences for the private side of the market. Which way will the insurer-provider market power battle push premiums? I’ve been asking this question, reading and posting on literature relevant to it, and thinking about it for a year now.

With all that work, you’d think I’d have made some progress in addressing it. Actually, I have, but only a little. More to come.

Jenn Abelson and Todd Wallack report in today’s Boston Globe that the attempt by Massachusetts Governor Deval Patrick to hold down insurance rate increases has been overturned.

In a blow to the Patrick administration, an insurance appeals board yesterday overturned the state’s cap on health premium increases for small business and individual customers covered by Harvard Pilgrim Health Care.

The three-member administrative panel — which consists of attorneys who work for the state Division of Insurance — found that rate increases Harvard Pilgrim initially sought in April are reasonable given what it must pay to hospitals and doctors.

The administration is considering an appeal. Rulings on the rate cap for other insurers are pending.

This seems like a fight between regulators and insurers–and it is. But it’s all about hospital and doctor prices. Are they reasonable or not? An economist should be tempted to say that the market tells us what is a reasonable price. Yet this is not a competitive, efficient market. Prices are strongly related to hospital market power, which is high (recall the AG’s report). The market is broken and something must be done.

I’d rather see efforts to reduce hospital market power or the effects of it. If we’re going to rely on market-based health care we should insist on a market that doesn’t harm consumers. Capping insurance hikes is an indirect and short-term approach to battling hospital clout. On the other hand, there was some evidence that insurers were reacting to lower premiums by attempting to stick it to the hospitals. Would that have worked? We may not get to find out.

If we’re not willing to break up the hospitals then price regulations are the only other solution. But if regulators can’t cap insurance prices, what’s left? I can only think of one solution, which has two components: (1) capitated payments to integrated providers to cover a long duration of care (that solves the public payment side) and (2) an all-payer rate system so large hospitals can’t dominate the market (that transfers the public solution to the private side).

Nationally, and in Massachusetts, I’ve heard a lot of talk about the first part of this two-step solution. The buzzwords are “bundling” and “accountable care organizations” (ACOs). Those are fine ideas for public payers that have the force of law to set prices and contracting arrangements. Put what are private payers–that’s the rest of us non-poor working folks via our insurance carriers–to do? There’s nothing inherent in bundled payments and the ACO model that reduces provider market power. It could increase it.

That’s where all-payer rates come in. If insurers are free to collude on price they negotiate as a block. Proponents of a public option should see something to like here. Advocates of a free market need to explain how else to address the imbalance of market power that exists. This seems to me to be about as free a market as we can afford.

Readers of this blog continue to write good comments and draw my attention to good papers, which comprise some of the content of my occasional Reading List posts. Since one of the purposes of this blog is to learn things I’m grateful for such feedback. Thank you!

A recent example came by e-mail. A reader sent me the time series illustrated below. It’s a time series of the ratio of health insurers’ aggregate “load” (non-medical expenses) to premiums, computed from historical National Health Expenditure data (which I verified). The vertical scale is percentage, the horizontal is year. Subtracting the plotted ratio from one yields the medical loss ratio (MLR), the proportion of premiums spent on health costs. That’s the quantity regulated by the ACA to be 85% for the large-group market and 80% for the small- and individual-group markets.

Notice that the load/premium ratio has not exceeded about 13%, corresponding to an MLR of 87%. Thus, on average, the MLR minimums of the new health care law won’t be binding. But this masks the heterogeneity of MLR by market. In the large-group market, MLRs are already about 85%, so the new law will still not bind in that market, on average. Those products must dominate the NHE figures because the small-group and individual markets have  smaller  MLRs, closer to 75% according to one recent study. Thus, the MLR minimums, if they do anything, will have their effect in the small- and non-group markets.

Meanwhile, co-blogger Steve Pizer and I have had some discussions about what the MLR minimums might do and how they’re similar, or not, to other types of rate regulations. My thoughts ended up in a Kaiser Health News column, where I suggested MLR regulation won’t solve the cost problem. Here’s what Steve wrote about it in a recent e-mail:

MLRs are similar to rate of return regulation of monopoly utilities, as existed for phone companies. There, deregulation reduced costs, which suggests MLR minimums won’t help. But nobody is proposing to replace competitive insurance markets with regulated monopolies. The purpose of loss ratio regulation is to prevent the kind of rate hikes proposed in California this year–rate hikes without a basis in observed rising costs. Why would a carrier in a competitive market do such a thing? Because they’re anticipating a cost spike or because they just took a big hit in investment income. I think the practical effect of loss ratio regulation will be to smooth out the underwriting cycle, preventing premium spikes when investments drop but also reducing price wars when investments are doing well. This seems to me to be a reasonable goal, although the burden in red tape will be substantial. I agree with you that it does next to nothing about cost growth.

Steve’s insight that MLR minimums will help consumers by smoothing premium growth is not something I had considered. We’ll see if he’s right. Regardless, I’ve learned a lot about MLRs from readers. Score one for blogging!