Code Red: Two Economists Examine the U.S. Healthcare System

May 27, 2014

Is there a just price for pharmaceuticals?

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 6:17 am

In America’s ongoing efforts to address the rate of health care spending, there has been a renewed focus on the prices paid for pharmaceuticals.  The poster child is Gilead’s Sovaldi, a once-a-day oral treatment that represents the first real cure for hepatitis C – a condition affecting over 3 million Americans.  Prior to Sovaldi, treatment for this condition required a painful course of Interferon which had many side effects and was ineffective for many people.  No one doubts that Sovaldi is a breakthrough product, the type of innovation that clearly increases welfare.  In addition, everyone seems to agree that the current cost of Sovaldi – approximately $84,000 for a 12 week course of treatment – is unreasonable and potentially crippling to the nation.  Even the well-known “champion” of price controls and improved access to medical services at low prices, the insurance industry’s trade association America’s Health Insurance Plans (AHIP), has come out against the “unsustainable” price of this medication.

While seemingly everyone agrees with AHIP, don’t count us in.  The pricing of pharmaceuticals is a very difficult economic question and we would like a little bit more caution in the attacks against innovative pharmaceutical firms.  We can all agree that firms developing products that simply imitate existing products are primarily rent seekers (ironically this activity, while decried by many, likely lowers prices for consumers).  We don’t think that we need high prices to reward this behavior. But this clearly is not the case with Sovaldi.  Everyone agrees that this drug is both a true scientific advancement and an expansion of available treatments for a chronic, extremely unpleasant, and potentially contagious medical condition – a combination that almost unequivocally benefits shareholders and patients.  These are the very products we want more of in the future.

So let’s stop patting ourselves on the back for attacking the evil pharmaceutical firms and their high drug prices and instead ask a deceptively simple question:  Why is the price for Sovaldi (and other recent lifesaving treatments) so high in the first place?  While there are many factors, two predominate.  First, these branded drugs are provided by firms that have monopoly production rights as a result of their patent protection.  Second, these drugs provide what most people value more than anything else – healthier and longer lives.  Even more so than prior blockbuster drugs like the statin Lipitor, there is a direct connection between the latest generation of expensive products like Sovaldi, and the substantial health benefits they deliver.

Okay, so these drugs save lives and are therefore incredibly valuable.  Why do we allow pharma companies to extract so much of this value, in the form of patents?  For one thing, patents do not last forever, as the effective patent lives of most new drugs is only about 8-10 years.  After that, these innovations become available to all, forever, at a fraction of the original price.  If we take the long view, the innovators reap just a small portion of the benefits they deliver.  But much more importantly, the patent system promotes innovation.  Take away monopoly pricing, and you take away the profits that motivate research.  (Even this statement, which appears to come straight from the PR department of a pharmaceutical firm, has important limits and nuances that we discuss below.)

Let us be clear, patents create a trade-off between different inefficiencies: one static and another dynamic.  Patents create a static inefficiency because they allow firms to charge monopoly prices and therefore an inefficiently low quantity is sold in the current time period.  We can easily solve that problem by instituting price controls or allowing the government to use its monopsony power to bid down prices – as they do in Europe and Canada where the same drugs are often sold at less than half the U.S. price.  However, this “solution” creates its own inefficiency – a low quantity of products developed for the future.   Here is another way of looking at it: Someone who is sick with something for which there is a cure today would naturally be a proponent of price controls.  But someone with an untreatable condition might want to be a bit circumspect about the long arm of government in this setting.  And the same is true for anyone who might, in the future, develop an untreatable condition.  And that means all of us!

If innovation is so great, then perhaps we should support price increases.  Let Gilead double its price! Triple it!  We could have every scientist in the world working on the next $300,000 pill.   Without trying to be stereotypical economists, it isn’t at all clear that drug prices are too low, and this is not what we are claiming.  Here we make two points.  First, we note that Gilead has not been granted the power to just arbitrarily pick a price out of the air.  If that were the case they, they wouldn’t have stopped at $84,000.  Instead, Gilead gets to pick the profit maximizing price for a monopolist.  Second, we are not claiming that any price is justified just that mandated price reductions may lead us down a slippery and dangerous slope.  Certainly, a “modest” reduction in pharmaceutical prices will not stop all lifesaving treatments from coming to market.  We will have new research coming out addressing this point in the coming weeks.  But much like Justice Potters Stewart’s difficulty with pornography, the definition of a “modest price decrease” is hard to pin down.  And here is the point:  We do not have faith that government bureaucrats can appropriately account for the variety of incentives necessary if they were in charge of either setting prices by fiat or effectively setting prices by exploiting their monopsony power.  It is indeed a slippery slope, and we fear the consequences if we take the first step.

Isn’t it unfair that drugs are so much less expensive in other nations?  Certainly!  But as we tell our children and MBA students, life isn’t fair. If prices were higher in Western Europe and Canada, the case for reducing prices in the U.S. would be more compelling.  There would still be enough of a profit incentive to motivate R&D.   But we shouldn’t hold our breath waiting for others to raise prices.  Americans are stuck in a bad equilibrium in which we have to choose among two options: subsidizing innovation for the citizens of the world, or allowing innovation to grind to a halt?  While our cold economist hearts give a resounding slow clap to the free riding strategy of the Europeans, given the wide range of conditions for which we still lack effective treatments, we would rather err on the side of caution – even if it means that American consumers must serve as the greater fool. 

We should also caution that even a limited attempt at setting prices for drugs like Sovaldi might have a chilling effect across the market.  Firms will make their investment decisions with the specter of price controls lurking overhead.  We worry about the potential long terms effects of this decision.

We finally note that this is a problem that the market appears poised to address.  AbbVie is readying a competing product to Sovaldi and Express Scripts, the nation’s largest pharmacy benefits manager is readying plans to pit these two products against each other in order to lower prices.  This seems like a much better means of achieving a lower price for Sovaldi, though we can’t help but recognize the irony that it puts the opponents of Gilead and Sovaldi in the position of rooting for “me too” products. 

May 19, 2014

If We Want Lower Health Care Spending, We Are Going to Have to Pay for It

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 7:43 am

Ultimately, spending less on health care is a relatively easy task: We either need to consume fewer services, or spend less on the services that we consume. But much like we teach our Kellogg students about maximizing profits, the devil is in the details. It’s certainly tempting to ask the government to swoop in on a white stallion and solve the all our problems by fiat. For example, we could have the government simply exploit its monopsony power and set prices, but an artificially low price will lead to an inefficiently low quantity of services and future innovation (stay tuned, we will have more to say about this next week). Similarly, we could explicitly ration quantities (as opposed to implicitly doing it through a large uninsured population). But how could we hope to determine the right level of care? Ultimately, if we ask the government to unilaterally fix this problem, instead of a white stallion we could behold a pale horse and all that it entails.

The good part, perhaps the best part, about the Affordable Care Act is that it attempts to address this problem using market forces. The question is whether we are ready for what these market forces will entail. We will focus today on the role of market forces in the insurance market to control prices in the newly established ACA exchanges. This month the Obama administration announced that it would allow insurers to use “reference pricing” for insurance programs in the exchanges. Under a reference pricing system, insurers set the maximum price they will pay for a specific set of services and if patients go to a facility that costs more than that amount they are required to pay the difference. This system has recently been implemented by the California Public Employee Retirement System (CalPERS) and there were two main effects: (1) surgical volumes decreased at high price facilities and increased at low price facilities, and (2) the prices paid by individuals covered by CalPERS decreased at high price facilities but were essentially unchanged at low price facilities. While this is only one study for a single insurance system, it does provide the pattern that we would expect following a reference pricing system and is therefore provides encouragement.

In many ways, reference pricing is a close cousin of the narrow network systems that we previously described. Under narrow networks, insurance companies choose a limited set of facilities that are willing to accept their prices. Patients who want more choices can pay higher premiums for plans with wider networks. Under reference pricing, patients can go to a wider range of providers but they bear more of the cost of these choices. The organizing principal is the same for both systems: if patients want choice they are going to have to pay for the privilege.

The theory behind reference pricing is fairly clear. But will it work in practice? That is less clear. There are two main threats that we can see: (1) poor implementation and (2) political backlash. When it comes to implementation there are several important points to consider. Perhaps most important, reference pricing is not a panacea. It is most applicable for encounters with the medical system which involve a defined episode with relatively easy to understand quality measures. Think knee replacements and MRIs and not the management of Type II diabetes. This system is not well suited for managing chronic conditions. In addition, reference pricing is only as effective as the level of competition in the marketplace. Without a robust and competitive local provider market, patients lack sufficient options to shop around and this system won’t lead to reduced prices. Finally, price competition in the absence of good information about quality can create a race to the bottom, in which providers skimp on quality (e.g., reduced staffing and training, shorter therapy sessions, etc.) in order to drive down costs and, as a result, compete better on price. Patients must have sufficient information to make choices across providers based on price and quality. Obviously the first step here is some form of price transparency – a feature that is generally absent from today’s health care system. A recently announced partnership between major health insurers and the independent Health Care Cost Institute could go far to fix this problem. Perhaps more difficult is that reference pricing requires readily identifiable quality metrics (that can’t be easily gamed by providers or lead to perverse outcomes) that can be easily communicated to patients. For this, we need to think beyond standard outcomes like infection rates and incorporate important patient reported measures of quality such as pain reduction, ability to perform activities of daily living, and perhaps some measure of customer service. Given the experiences on the exchanges, where narrow network plans have been unable to accurately communicate information on which providers are in their networks, we have some fears as to whether these firms are ready to provide this type of critical quality information. Without a good quality reporting system, patients might end up choosing solely on price – an outcome that few would herald as a success.

Beyond the potential problems of implementation, we fear that the bigger threat to reference pricing will ultimately be politics. We first note that these systems are very similar to the HMO systems of the 1990s, which appeared to limit the growth of health spending before they were stamped out by a combination of a consumer protests and political handcuffs. Much like the backlash to HMOs and the more recent narrow network plans, it will only take a few patients being “forced” to pay high bills in order to get access to their preferred provider before the complaints will surface. Or perhaps it will happen before the first bill is even sent. Expect that the nation’s priciest providers will band together and speak out on “behalf” of consumers. Either way, it will take some national courage to stand up to these august providers and their feigned concerns for consumer welfare.

In the end it boils down to the proverbial lack of free lunches. It we want to lower health care spending we have to give up something. If we don’t accept some market based solutions, we will find a lunch menu filled with far worse options.

April 18, 2014

Is Higher Spending Truly Wasteful?

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:56 am

Two weeks ago, the Kellogg School of Management was privileged to host Joe Doyle, an outstanding economist from MIT. In a broad research portfolio, Joe has focused on the effects from differing intensity of medical treatments. This research is shattering some long held beliefs about the relationship between health spending and outcomes. We think that Joe’s work is not known widely enough outside of the academic community, so we are using our blog to let you know what you have been missing and, in the process, perhaps change the way you think about healthcare spending.

It is well known that the U.S. far outspends other nations on healthcare, yet the outcomes for Americans (in terms of coarse aggregate measures such as life expectancy, infant mortality, and other dimensions) are quite average. Of course, these outcomes are not the only things that we value in health care. A lot of our spending is on drugs and medical services that improve our quality of life and won’t show up in these aggregate outcomes. For example, more effective pain management can decrease pain and improve quality of life – often with important economic benefits. Despite this fact, most health policy analysts have concluded that we can cut back on health spending, without harming quality on any dimension. This is not a new idea, of course. In a famous 1978 New England Journal article, Alain Enthoven coined the term “flat of the curve medicine” to describe how the U.S. had reached the point of diminishing returns in health spending. And for nearly 30 years the Dartmouth Atlas has documented how health spending dramatically varies across communities without any apparent correlation with outcomes.

The question has always been, what health spending to cut? Garthwaite’s previous work has shown that broad regulations requiring longer hospital stays for new mothers and their babies have provided only limited benefits and that more targeted rules could save money without sacrificing quality. Beyond some wasteful regulations, we can always point to gross examples of overspending such as the rapid proliferation of proton beam treatments, beyond those clear examples how can one identify what is waste and what is medically necessary?

In two important papers, Joe Doyle and co-authors ask a more fundamental question – is the often cited broad variation in health spending actually wasteful at all? They find that even in healthcare, there really is no such thing as a free lunch. His work should be mandatory reading for everyone who believes that broad spending cuts will have no adverse consequences. For those who lack the time to read these papers, we provide the “Cliff’s Notes” versions.

The settings for Joe’s two studies are broadly similar. He compares the outcomes for patients who receive emergency treatment at different hospitals, some of which are much more costly than others. Getting unbiased results from such a comparison is not as simple as it seems. At the aggregate level, hospitals with more spending may simply be systematically treating sicker patients. This will tend to make the outcomes look worse for the patients at high cost hospitals. Of course, this says nothing about efficiency or whether these sick patients would have fared as well had they been treated at low cost hospitals. Any fair comparison of hospitals must control for severity of illness in order to avoid what statisticians call “omitted variable bias.” Unfortunately, the available data is not usually up to this task, so prior to Joe’s work, nearly all studies that compare costs and outcomes have been subject to this bias. (This is certainly true for cross-nation studies.)

From a research perspective, the best way to remove omitted variable bias is to conduct an experiment in which patients are randomly assigned to hospitals with different costs. For pragmatic and ethical reasons, researchers are unable to perform such experiments. Therefore, Joe has identified situations in the real world that meet the statistical requirements for random assignment – statisticians call these “natural experiments.” Through these natural experiments, Joe removes omitted variable bias and provides compelling evidence that contradicts the conventional wisdom that variations in health spending are pure waste.

In one study, Joe examined what happened to individuals who had medical emergencies while vacationing in Florida. Joe argues (quite plausibly) that when individuals choose a vacation spot, they give little thought to the potential for a medical emergency and the relative quality of healthcare providers in their chosen destination. (That is, visitors to Florida choose Orlando over Fort Lauderdale because they love Mickey Mouse and not because they are worried about having a heart attack and perceive that Orlando hospitals have better emergency medical services.) If one believes this argument, then vacationers who are treated in high cost areas of Florida will be no more or less sick than vacationers who are treated in low cost areas – Joe provides convincing evidence to bolster this claim. What does he find? Vacationers who have medical emergencies in high cost areas in Florida have better outcomes than vacationers who have emergencies in low cost areas. The effect is not subtle. On average, additional spending of $50,000 (in billed charges) is associated with saving one year of life. This falls well within the range used by stingy governments in Europe when determining whether to allocate additional money towards healthcare.

In a second study, Joe (working with John Graves and Jon Gruber) exploits an institutional feature of New York State’s ambulance service, namely, that most communities have several competing ambulance services. A central dispatcher who receives an emergency call examines availability before assigning an ambulance from a particular company. This creates an effective random assignment of patients to ambulances. As Joe and his coauthors discovered, each company tends to take their patients to different hospitals, which introduces an effectively random assignment of patients to hospitals. They develop a statistical method that teases out the purely random part and then compare outcomes for patients who, due to purely random chance, are taken to low cost versus high cost hospitals. Once again, they find that emergency patients do better when they are taken to higher cost hospitals, and once again the effects are not subtle. For every 10 percent increase in spending at the high cost hospitals, there is a 4 percent reduction in the one year mortality rate. Importantly, these differences in outcomes cannot be accounted for with standard measures of hospital quality such as indicators for the use of “appropriate care” after a heart attack.

Joe Doyle will be the first to admit to the limitations in his work. He only studies emergency patients and does not compare across states. But the results in Joe’s studies did not have to come out as they did. If the conventional wisdom was unconditionally correct, then Joe would have found no relationship between spending and outcomes. Joe has produced two studies, free of omitted variable bias, that show conditions where the conventional wisdom fails.

A hallmark of excellent economic research is the ability to provide bias-free estimates of relationships of great social importance. It has been our pleasure to introduce you to Joe Doyle and his excellent work.

March 31, 2014

Taking Stock of the ACA

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 11:09 am

With the ACA exchange enrollment deadline behind us, this is a good time to take a look at the big picture. Three years after the first baby steps of implementation, what has the ACA accomplished?

When we consider the ACA, we can think of two broad goals. The “easy” goal was expanding coverage to the uninsured. We say “easy” because regulators should be able to succeed by simply throwing money at the problem, and that is a task our elected officials seem particularly adept at accomplishing. The “hard” goal was bringing down the rate of growth in health care spending. This has proven to be a difficult task for policy makers, who have been trying (and failing) for decades and have often done more harm than good.

We first consider the goal of expanding coverage to the uninsured. From its onset, the ACA chalked up a small victory by requiring plans to continue coverage for dependents under age 26. This provided coverage to as many as three million uninsured, albeit the healthiest members of the population. The lion’s share of the reduction in the numbers of uninsured was supposed to come from Medicaid expansions and private exchanges. And here is where the problems emerge.

Medicaid ranks have swelled in the 27 states (including DC) that have chosen to expand the program. Republican leadership in other states continue to assert they will not expand Medicaid, but given the exceptionally generous federal funding for this expansion, we find it hard to believe that most of these states won’t soon join the expansion. After all, even Louisiana eventually raised its drinking age to 21 to get its share of federal highway funding. Similarly, we can’t imagine that the red states will turn down billions of dollars in federal funds.

Even with half the states sitting out Medicaid expansion, as many as nine million Americans could be added to Medicaid rolls, half of whom reside in California, Illinois, and New York. While this seems like a sizeable percentage of the nearly 50 million Americans who were uninsured when the ACA was enacted, we should not celebrate too soon. If experience from previous Medicaid expansions is a guide, then most of these new enrollees previously had private health insurance. Research studies put the Medicaid crowd out rate from prior expansions at about 60 percent. If past is prologue, then perhaps only 3.6 million new Medicaid enrollees were previously uninsured. Of course the number of newly enrolled that were previously uninsured might be higher, but many of these may have already been eligible for Medicaid and simply failed to take up coverage. Tennessee’s state Medicaid system has seen a large enrollment increase even though it has yet to expand eligibility. While getting these individuals to sign up is a laudable outcome, these enrollees are covered by the less generous non-ACA matching rate and will further strain state budgets – which already unable to cope with the ever growing cost of public health insurance. Perhaps the folks boasting about the large expansion of Medicaid should wait for all the data to come in.

And that is the good news. By now most people are well-versed in the troubled roll out of the private exchanges. It is currently estimated that enrollments will top six million, although it is also estimated that less than five million of those enrollees will pay their first month’s premiums. And at least one survey suggests that only 14 percent of exchange enrollees were previously uninsured. Let’s be generous and double the McKinsey estimate. This suggests that about 1.4 million individuals who will purchase insurance through the exchanges were previously uninsured. The other 3.6 million previously footed the bill for their own insurance; now many of them are enjoying public subsidies. While these subsidies may make care more affordable, we must remember that they come at the expense of even more federal expenditures on health premiums and a growing disconnect between the cost of health care and the cost of health insurance. The cost of these subsidies could continue to rise if, as we expect, many employers scale back their offering of health insurance benefits.

By our count, the ACA has brought coverage to 8 million previously uninsured. This is somewhat smaller than the 9.5 new enrollees reported elsewhere in a study that seems to assume that all exchange enrollees will pay their premiums and does not speculate about crowd out. But both figures are low, representing less than 20 percent of the uninsured, with a large fraction of this coming from enrolling young adults on their parents plans – something that could have been accomplished by a one page regulation. So what did the remaining 2000 pages of legislation bring us? Apparently, the biggest accomplishment of the ACA is to take millions of people who were willing and able to purchase their own health insurance and place them on the public dole. While ACA supporters would say that many of these people now have “better” insurance, and they may be right, but that was certainly not how the ACA was sold. In any event, the limited data that we do have about the characteristics of new enrollees suggests that we must be careful before we state the ACA has unequivocally provided insurance to a large fraction of the uninsured.

What about the future of the exchanges? Some have argued that we have reached the number of enrollees necessary for sustainable risk pools. But, it isn’t the number of enrollees that necessarily matters here; the ultimate success of the risk pools hinges on the mix of healthy and sick enrollees. It is too soon to tell but there are certainly enough young enrollees to give hope. If insurers can make a profit off of the current pricing and enrollment mix, then premiums could remain stable and enrollments could climb. But the big problem will remain that millions of the uninsured might rather pay a modest penalty and remain uninsured than purchase subsidized insurance.

This raises a related issue. One benefit of coverage expansion is that it eases the burden on providers who must treat the uninsured regardless of their ability to pay. In many ways, these providers have served as an underfunded source of public insurance. It will be interesting to see whether those who choose not to buy insurance can continue to obtain charity care from these providers. This is particularly true given that the ACA will drastically redistribute the disproportionate share payments these facilities depend on. Ultimately, we believe that access to care, more than anything else, will determine whether the uninsured choose to remain uninsured.

Now that we’ve discussed the “easy” goal, let’s talk very briefly about the hard goal – the ACA as a blueprint for cost containment. On this dimension, casual empirical evidence was encouraging, as healthcare spending seemed to have leveled off. But there is considerable evidence that most of the slowdown in spending was due to the lingering effects of the downturn in the economy, particularly the sluggish labor market. Indeed, the most recent data reveals a sharp uptick in spending, which coincides with a rebounding economy. On the other hand, there is considerable evidence that providers are taking very seriously the challenge of cost containment. Hundreds of Accountable Care Organizations have signed up to share the financial risk of caring for Medicare and privately insured individuals. In the process, providers are organizing into large regional healthcare systems that present many promises and perils. While advocates of integration believe that this is the only way to bend the cost curve, economists who have studied the theory and evidence on integration are less sanguine. A recent Brookings Institute report notes that the benefits of integration are uncertain, but that giant systems, which are hard to undo, may obtain market power that allows them to resist market pressures for cost containment. This is ironic, as market power is completely antithetical to the purported ACA goal of achieving savings through a competitive health economy. Even more than the evidence on raising coverage, it will take many years to understand how this restructuring of our health economy will turn out. We just hope that regulators and policymakers take heed of the literature on this point.

Overall, supporters of the ACA boast how payers, providers, and even patients are actively changing the U.S. healthcare system. But coaching legend John Wooden reminded us not to confuse activity with accomplishment. On the latter score, there is less for supporters to cheer.

March 12, 2014

Finding Common Ground on Narrow Networks — Sort Of

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 9:11 am

In a recent New York Times opinion piece, Obama advisor Ezekiel Emanuel attempts to ease the minds of millions of Americans who may be selecting narrow network plans in the exchanges. In defending narrow networks, Emanuel cites the well-known example of Kaiser, which has for decades required enrollees to choose among only Kaiser-owned hospitals and Kaiser-employed physicians. He goes on to propose some “safeguards” for plans in the exchanges such as mandating that insurers disclose the criteria used to establish their network of providers and requiring that insurers pay for second opinions from elite out-of-network providers.

Perhaps surprisingly given our previous commentary, we agree with the general thrust of Emanuel’s argument, which is that freedom of choice is overrated. And while we do not agree with many of his recommended safeguards, our quarrel today is not with his proposals for even more new rules and regulations. Rather, our primary quarrel is with the vast majority of the individuals who chose to comment on, and often lash out at, Emanuel’s article. These comments are emblematic of the general misunderstanding of the role of narrow network plans in controlling the future growth of health care expenditures.

In a nutshell, this is the archetypal response against Emmanuel’s claim: “Evil insurers have given us narrow networks. The government must intervene in this bloodthirsty lust for profits. Give us freedom of choice! (And preferably with the government taking over the business of insurance altogether).”

Given previous comments on this site, we suspect that many readers of our blog might share similar sentiments. So we would like to take our readers on a stroll down memory lane to explain how insurers ended up creating networks, and why we are all better off for it.

Prior to the 1980s, states forbade health insurers (who were not HMOs) from restricting provider choice. The result was disastrous. Prices rose precipitously year after year – noted antitrust economist Dennis Carlton predicted (only half facetiously) that prices would soon reach infinity. And why not. Insured patients had no reason to shop around, and so price was irrelevant. Even with today’s high deductibles, most hospital patients and many ambulatory care patients reach their deductibles and pay only a fraction of their medical bills. If patients don’t care about prices, then providers will charge what they want. Some states responded by regulating prices, but these barely put a dent in medical price inflation.

Self-insured plans were exempt from state laws governing access, and by the mid-1980s some of these plans were offering narrow networks. Providers who wanted to be included in the networks had to offer much lower prices, which ate into profits but also encouraged efficiencies. By the early 1990s all states had revised their laws to permit narrow network fully insured plans and perhaps as a result of this development, for at least five years during the 1990s, health care prices (and the premiums that we paid for our health insurance) were virtually flat. Never before had Americans enjoyed such a respite from healthcare cost inflation. And then the managed care backlash hit.

Patients complained about unpaid bills and missing referral forms. Mostly, they complained that they couldn’t see their favorite provider. And that seems to be the essence of the ongoing opposition to narrow networks. What good is a low cost insurance plan if the quality of care is compromised? Networks expanded, and healthcare inflation returned.

But here is where the critics made their (literally) fatal error. Over a decade ago, the Institutes of Medicine published two landmark studies documenting serious deficiencies in the quality of care offered by American doctors and hospitals. Most of the deficiencies result from medication errors, lack of sterility, and poor surgical technique, with a toll that could exceed 100,000 unnecessarily fatalities annually. This does not even capture all the needless pain, suffering, and death resulting from botched diagnoses. If we value our health as much as we claim, it is absolutely essential that we seek out quality providers, especially those of us with complex conditions for which skill and experience can be the difference between life and death. But when it comes to how Americans think about the quality of healthcare providers, we are reminded of humorist Garrison Keillor’s fictional Lake Woebegone, where “all of the children are above average.” In the real world of health care, only half of the doctors are above average.

We have asked hundreds of people, in all walks of life, whether they agree or disagree with the following: “My primary care physician offers higher quality care than the average PCP.” Nearly 100% agree. The truth is that about half of them are wrong. If you agreed with this statement, there is about a 50% chance that you are wrong! We have asked cardiologists whether they agree or disagree with the following: “The thoracic surgeons that I refer to offer above average quality.” They all agree, but again, about half are wrong. So are half the surgeons who agree with the statement that their hospital offers above average quality.

The fact of the matter is that we implicitly restrict our own networks and we often do a bad job of it. We choose a primary care physician recommended by a friend. We choose the specialist recommended by the PCP. We choose the hospital recommended by the specialist. Yet time and again, we make lousy choices. Seen in this light, one has to wonder if restrictions imposed by insurers would be any worse than the restrictions we impose on ourselves. In fact, the (admittedly limited) empirical evidence suggests that insurer networks tend to exclude lower quality providers. This makes sense. Low quality healthcare often leads to more complications and higher costs. Choosing a high quality provider can be a win-win for insurers and patients.

Americans who are frustrated by our high cost and complex healthcare system may get some measure of satisfaction by criticizing insurers for restricting access. But how satisfied would they be if they understood that mandating broader access will drive up costs and maybe even harm quality?

So what can be done to improve the way we select our providers? It is well-known that when it comes to medical care, experience and quality are highly correlated. So when one of us learned of a family history of a deadly condition, he sought out a provider who has extensive experience diagnosing and treating this condition. Does this guarantee a good outcome? Of course not, but it does improve the odds. We can also turn to one of the many quality report cards available on the Internet. Some report cards are better than others, and all are far from perfect. But these report cards are not useless – high ranking providers are likely to offer better quality than low ranking providers. Yet to this day, most Americans ignore this information, as if putting one’s finger in the air is a better way to find a high quality provider than checking the empirical evidence.

Until we demand and act on information about quality, it is pointless to complain about narrow insurer networks. And when the time comes that we become savvy consumers, and not just belly achers, we can start to criticize insurers whose networks really are substandard.

And, this is where we differ from Dr. Emmanuel, we can do more than criticize, we can vote with our purses and take our business elsewhere. That is how we ought to be punishing insurers whose narrow networks fail to serve our interests.

February 17, 2014

Advice that CMS Does Not Want to Hear

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 11:16 am

If there is one thing we have learned as health economists it is that whatever incentive scheme is placed in front of medical providers, some of them will find a way to game the system, making money without delivering value. We should note that this is actually not unique to health care firms, for example financial firms respond similarly to changes in financial regulations. It is only that many people cling to the belief that doctors and hospitals won’t respond to profit incentives.

The most recent, and largest, of all incentive schemes is the Medicare Accountable Care Organization (ACO) Shared Savings program. Sure enough, there is way to game this system that will result in large profits for some, without necessarily decreasing overall health care spending. It is a bit risky, and requires some careful calculation, but the payoff can be huge. So, at the risk of sounding like a late night infomercial, if you want to learn how to make a cool million bucks (or a lot more, depending on your skill and risk tolerance) and have a loose moral compass, then read on.

To explain our plan, we must first refresh your memory about the key details of the Shared Savings program. The Center for Medicare and Medicaid Services (CMS) has already approved several hundred ACOs, which come in all shapes and sizes. Some are organized by hospitals, others by multispecialty group practices, and still others simply represent loosely affiliated physicians. Importantly for our scheme, there is no regulatory hurdle that we are aware of that prevents a lay person from organizing a number of independent physicians into an ACO.
Patients are currently “assigned” to ACOs retrospectively, based on the delivery of primary care. In a nutshell, if providers in the ACO delivered at least 50 percent of the primary care services to a Medicare enrollee in the previous year, then that enrollee is assigned to the ACO for the current year. For each assigned enrollee, CMS predicts their annual health spending, using a risk prediction algorithm that accounts for the patient’s age, sex, and diagnostic conditions (based on the past year’s diagnostic codes that appear in Medicare’s billing records). If, during the current year, actual spending is less than predicted spending, CMS shares the savings with the ACO. Under current regulations, ACOs receive up to 60 percent of the savings and they are also responsible for up to 60 percent of losses if their beneficiaries end up having above average spending. The absolute magnitude of these gains and losses are capped, but the stakes are still large.

In a seemingly perpetual search for slower growth in healthcare costs, this is not the first time we have tried to introduce market incentives and reward providers who hold costs down. These shared savings are simply a variant of capitated payment systems in HMOs with two important differences. First, traditional capitated system only covered a portion of medical fees, i.e. all professional fees but not the more expensive facility fees. Second, under traditional capitation providers captured 100 percent of their savings (of an admittedly much smaller pie). Under this system it was well known that providers with relatively healthy patients stood to make a lot of money. Therefore, HMOs used proprietary risk prediction models in combination with various rules of thumb, combined with tough negotiation strategies, to set their capitated rates. Even so, many providers made a lot of money; a favorable patient mix was the provider’s best friend.

In creating the shared savings program, CMS faces the same problem previously faced by HMOs – rewarding efficiency without encouraging risk selection – as well as many new ones. Unlike private firms, CMS cannot rely on rules of thumb, because government agencies can never be seen to make arbitrary decisions. So CMS relies on a state of the art risk prediction algorithm (albeit one whose parameters are well known). However, it is hard to predict medical spending with purely objective data in billing records and as a result even the state of the art is mediocre at best. The R-squared for a regression of actual spending on predicted spending is no higher than about 0.4. That means that the risk prediction algorithm explains no more than 40 percent of the variation in health spending. What about the remaining 60 percent? Some of it may be pure random noise – which would be impossible for CMS or any provider to predict. For example, even the healthiest woman with the best prenatal care will sometimes give birth to a child who requires costly neonatal care.

More troubling is that some of the remaining variation is likely very predictable to individuals who have more information about the patient than the statisticians performing the risk adjustment. A risk prediction model may know that a certain percentage of women of child bearing age will, in fact, have a child in the next year. Each woman likely knows this probability with far greater certainty. For most other health conditions, patients may be less well informed than the statisticians. But their doctors, well that is a horse of a different color. Physicians are likely both more informed than patients about their broad health risks and more informed about their patients than the statisticians at CMS.

Historical precedent shows that this is likely the case. For example, consider the long standing controversy about third party utilization review. Independent panels establish norms for the appropriate treatment protocols based on available statistical research. This type of research is quite similar to the process used by CMS for risk prediction. Many physicians are reluctant to strictly adhere to these norms, arguing that their specific treatment plans account for idiosyncratic differences among their patients that are not captured by the statistical models.
Want another example? Consider the objections that providers raise to the creation of report cards for physician or hospital quality. Again, these report cards are risk adjusted, but the adjustments are necessarily imperfect. Some providers treat patients who are sicker than the data indicate, and this adversely affects their rankings. This is not just a statement of physician preferences. There is considerable evidence that providers game this system by avoiding patients who are more severely ill than is suggested by the risk adjusters. (For example, see the relevant section in this lengthy review article.)

These examples strongly suggest that physicians are able to out predict statisticians. We should be clear, this is not an indictment of the quality of the statisticians but simply reflect the fact that physicians have better information about the underlying health of their patients then is available through billing records. In most settings we find this greater familiarity with our health by our physicians comforting.

Of course, physicians were also able to out predict statisticians under traditional capitation plans. But the stakes in earlier capitation programs were small in comparison to the stakes in shared savings – professional fees versus the whole medical care kit and caboodle. Under shared savings, the right patient can be worth thousands of dollars. In addition, savvy providers in the capitated world were matched in a fairer fight against profit maximizing HMOs, whereas under shared savings government regulations often force CMS to fight with at least one hand tied behind his back.

And these conditions create the million dollar opportunity.

Anyone can access and use the CMS risk adjustment model or something very close to it. A clever statistician with decent access to extensive clinical data – the kind of data that a physician can help provide — can determine whether a given physician’s patients tend to cost more or less, on average, than is predicted by the model. Or physicians might just know this information at a gut level and may be willing to bet on their own instincts. The savings could be due to the physician’s efficient decision making, but is perhaps more likely due to the patients’ good health. It really doesn’t matter. Either way, there are opportunities to profit at CMS’ expense.

If we are correct, then the following is a formula for success. First, gather together millions of dollars. Second, approach a series of physicians who likely have healthy patients. Third, gather clinical data from candidates and identify those physicians whose patients consistently cost less than predicted by the CMS algorithm. Alternatively, invite physicians to identify themselves as efficient, with the proviso that they must take an ownership stake in the ACO. Fourth, organize these physicians into an ACO, using the millions of dollars as seed money to employ the physicians (or as a cushion in case it turns out that we are full of hot air.) Finally, wait for the checks from CMS to roll in and get ready for a life on a beach filled with those drinks with the tiny little umbrellas.

You may be wondering why we don’t undertake this plan ourselves. Perhaps it is because our moral compasses are firmly pointing north. (Yes, there are Republicans with moral compasses pointing north.) The adage “it takes money to make money” also has something to do with it. Maybe it is that our tolerance for risk doesn’t extend to exposing ourselves to the capricious whims of regulatory agencies. But if any of you want to give our idea a try, you have our permission if not our blessing. And remember that Dranove loves expensive dark chocolates (no nuts please) and Garthwaite has a taste for premier cru Burgundies (red or white). Our addresses are not hard to find.

February 10, 2014

The Real Health Reform Debate Starts Here (Warning: You Still Have to Pay for Lunch)

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 9:12 am

For the past five years our political leaders have pretended to be engaged in a great debate about the U.S. healthcare system. The President offered his vision for health reform. The Republicans offered a far less ambitious alternative and otherwise attempted to block any reform. Both sides claimed that their proposals would solve the problems of access and cost containment while the other side’s approach would accomplish nothing or worse. Neither side suggested that there could be any possible downsides to their promises of rainbows and ponies for every American.

While neither of us are naïve enough to suggest that politicians should present the flaws of their plans during a legislative debate, we’ve had several years where a responsible Administration would have been clearer about the inherent tradeoffs of their ambitious health care reform. At the same time, Republicans should have opposed the ACA on its merits instead offering knee jerk ideology and platitudes. This fervent and fact based opposition would have exposed many of the “problems” that are now emerging for the ACA – allowing a more fulsome discussion of these issues before the implementation of the legislation.

As we teach our first year MBAs here at Kellogg, no matter how much you hope it will be different every major policy decision facing businesses and governments involves trade-offs, and the best decisions come when you carefully evaluate the benefits and costs of these choices. Absent a serious debate about health insurance, neither the American people nor their elected officials seem to have fully considered the actual benefits and costs of the ACA. As these costs now emerge, the public appears to be shocked at what they are finding. We thought it would be useful to try and clear the air and rise above the purely partisan rhetoric about the trade-offs dominating the recent news. In our next blog, we will discuss other tradeoffs that are equally important, but have received less attention to date.

Tradeoff #1: Eliminating the employer-based insurance system versus encouraging labor supply.

This tradeoff received front page treatment last week after the Congressional Budget Office predicted that 2.3 million people would leave the labor force as a result of the ACA. Many people, including those who frankly should have known better, appeared surprised by this estimate. But economic theory tells us that this reduction in labor supply was inevitable, because an important feature of an employer-based system is that it encourages individuals to work. One reason for this, is it is often difficult (if not impossible) to obtain insurance in the individual market (a problem resolved by the ACA). Garthwaite and his co-authors have recently published a peer reviewed empirical study documenting this effect have just published a peer reviewed empirical study confirming this theory. Beyond access to insurance, the ACA’s need-based subsidies effectively drive up marginal tax rates, and drive down labor supply, for low wage earners.

Reaction to this CBO report has served as a Rorschach test of a person’s opinion of the ACA. Ardent ACA supporters such as the President’s chief economic advisor, Jason Furman, make a classic economic “revealed preference” argument that that we should respect the choices of those who opt out of the labor market. This rests on the fact that a primary benefit of the ACA is creating a non-employer option for health insurance and therefore many Americans who were working just to receive a fair price on benefits could now re-optimize without this inefficiency.

On the other hand, many opponents of the ACA have touted the CBO as a job killer. This may be a true about the law overall, but is certainly not what the CBO report says. More reasoned opponents have stated that it is disingenuous of the administration to suggest that this reduction in labor supply is a pure benefit. The CBO is clear to point out that the reduction in labor supply is also the result of negative incentives from the phase-out of means tested subsidies. This is true and also shouldn’t be surprising. Like other mean-tested transfer programs, the phase out of the ACA subsidies over time creates a disincentive for labor supply. At a minimum the ACA creates a large health insurance notch in an individual’s budget set at 400 percent of the poverty line. At this income level subsidies disappear entirely and, depending on a person’s age and location, earning a few dollars more could cost thousands of dollars in lost subsidies. This creates an artificial disincentive to supply labor and is something that everyone, including the economists at the White House, should be worried about.

Given declining trends in labor force participation, any policy that decreases labor supply should cause some concern. That being said, this is not something that is unique to the ACA. It is difficult to imagine how we can sever the link between employment and insurance through any type of insurance reform without providing tax subsidized coverage through exchanges and thereby reducing labor supply. Republicans and Democrats could have, should have, debated this issue. All Americans should have had an opportunity to weigh in. Instead, we are handed the Obama approach and told to like it.

Tradeoff #2: Lower premiums and overall health spending versus freedom of choice.

When the media weren’t concentrating on the labor supply effects of the ACA, this week also brought more stories about newly insured individuals from the exchanges realizing that their inexpensive plans had a relatively small number of providers. This is a feature of their plans – not some defect. As we have earlier blogged, most individuals could have opted for plans with broader networks, either through exchanges or the preexisting individual insurance market place, but chose instead for the low cost alternative. Perhaps some of these patients should think back to their excitement about finding a low cost plan on the exchange. This was not a gift from insurance companies, but instead is a direct result of narrow networks.

Again, the tradeoffs have been known for decades. Economists have long argued that selective contracting, and the creation of provider networks by insurers, is a powerful tool for reducing provider pricing, encouraging provider efficiency, and reducing overall health spending. Dranove has even written two books about this! Apparently the message of these books has not been fully understood by the general public or even policymakers. Selective contracting is ineffective unless insurers can credibly threaten high cost providers with exclusion from networks. Insurers first narrowed their networks in the 1990s, and health spending in the private sector moderated for the first time in decades. After the managed care backlash of the late 1990s, insurers felt compelled to offer broad networks. Unable to credibly threaten to exclude providers (especially those providers with market power), insurers could no longer extract deep discounts. Through most of the 2000s, right up until the Great Recession, health spending soared.

Once again, many insurers are offering narrow networks, and health spending seems to be trending down. Providers who have been excluded from networks are complaining and they have the ears of many politicians. There are proposals in state legislatures to compel insurers to expand their networks to include all providers willing to participate. And President Obama has floated the idea of mandating that insurers include certain designated safety net providers.

The tradeoffs here are a bit more obvious than for labor supply: If we want greater access we will have to pay for it. In most states, exchanges offer a choice of narrow and broad network plans, so patients can make their own choices. In those areas where plans don’t currently offer broad networks, if there is sufficient patient demand for these products at premium levels that are profitable, then at least one insurance company will create and offer such plans. And if no broad network plans can survive the cauldron of competition, this tells us how patients have evaluated this tradeoff.

Instead of allowing market forces to craft the types of plans that emerge, legislators are threatening to force insurers to broaden their networks. Describe as “any willing provider” legislation, these regulations are pitched as an attempt to improve access and support safety net providers. In reality, they are the camel’s nose under the tent that will destroy the potential benefits of narrow networks. If we want broad networks, we will vote with our dollars in the exchange marketplace. And we can support safety net hospitals through direct taxation and subsidies, rather than through the backdoor via insurance regulations. Unfortunately, our elected representatives seem inclined to decide on these tradeoffs for us. And as is so often the case, concentrated interest groups (namely, affected providers) are likely to sway the political debate, so that Americans are denied chance to make their own choices.

Forcing insurance companies to broaden their networks will undoubtedly increase premiums for many plans in the exchanges. Is it worth the higher cost to have broader access? Should Americans be allowed to make this choice, or are market forces too unreliable? We know how our elected officials feel about these issues, but what do the voters think? Who knows?

We are not suggesting that individuals should have a voice on technical policy decisions. But these are not obscurities we are talking about. These are fundamental questions about our healthcare system that transcend party lines. Should employers provide insurance? Should we insist on freedom of choice? It is not clear where most Americans stand on these questions and their inherent tradeoffs, because no one thought to ask. Instead, Democrats have pretended that the ACA was a magical world where we can have our cake and eat it too, while Republicans have seen their own sort of magic in market forces. Most Americans have figured out that the real world of health care is messier, with difficult tradeoffs.

Is it too much for our elected officials to treat voters with a bit of respect, stop playing partisan games with the health economy, and start talking about real issues? Sadly, we think the answer is yes.

Our elected officials have not asked voters where they stand on these issues. So we are asking. Given the inherent tradeoffs, should government do what it can to sustain employer-sponsored health insurance? Should government mandate broad access to medical providers? Tell us what you think.

February 3, 2014

One and One Half Republicans Respond to the President’s Call for Ideas

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 3:06 pm

In the State of the Union, President Obama told Republican Members of Congress to stop holding votes to repeal the ACA and start proposing propose alternative ideas for health reform. In response, House Majority Leader Eric Cantor promised a vote in the House of Representatives in 2014 on a Republican alternative to the ACA. There were few specifics about what this alternative would entail.

Both of us would have preferred for this conversation to have happened over the past three years – before the ACA exchanges had gone into effect. While we agree with the President’s sentiment that the Republican’s quixotic efforts to repeal the ACA have been, at best, a distraction, it is disingenuous to suggest that there are not many existing ideas that would greatly improve the efficacy of the Affordable Care Act. Yet Representative Cantor’s comments make us wonder if any of those ideas are forthcoming from his side of the Congressional aisle.

It is not as if Republicans lack ideas for health reform. At least one of us is a Republican (the other waffles too much) and in the past three months we have offered numerous concrete proposals. So we thought we would take this opportunity to provide a “Republican” response to the President’s call.

In their blanket criticisms, Congressional Republicans have often failed to grasp that if you distill the ACA down to its most basic elements, perhaps its most important feature is the introduction of competition in private health insurance through the creation of exchanges. This is, at its core, a Republican idea, and unfettered by additional regulations, could lead to real innovation and cost savings. But the President, like most Democrats, appears to intrinsically distrust markets, and the exchanges are burdened by too many regulations. Here is just a partial list of those regulations, followed by our proposals to improve competition in the ACA:

1) Employers are mandated to continue offering health insurance

2) There is an exceptionally rich minimum benefit package

3) The ACA prohibits catastrophic health plans for the majority of enrollees

4) The ACA continues the tax subsidy for employer provided health benefits

Proposal 1: Repeal the employer mandate

In addition to being the largest expansion to of public health insurance since the Great Society programs of Lyndon Johnson, the ACA creates a realistic alternative to the system of employer provided health insurance that has dominated the American health insurance system since the 1940’s. In a prior blog we discussed at length the problems that employer-sponsored insurance creates for workers. The ACA has new regulations governing non-group insurance that should partially reduce these problems, yet still attempts to force employers to continue to offer employer provided benefits. Why add layers of new regulations to perpetuate this system when a more obvious and simpler solution is available? Allow all employers to opt out of offering coverage if they believe it is the right business decision. In all likelihood, employers would instead offer subsidies for purchases on the exchange (either through earmarked payments or higher wages). Not only would this unburden employers of a responsibility that they should never have borne, it would also greatly expand enrollments in the exchanges, leading to more stable risk pools and more affordable premiums.

Proposal 2: Scale back the minimum benefit package

As we have recently written, mandating exceptionally rich and homogenous coverage across all plans limits the ability of these plans to innovate on plan design. First, it prevents individuals from opting out of coverage for certain services or to at least choosing less generous cost sharing for things such as mental health coverage. Second, it limits the ability of insurers to tailor coverage to control the costs of services that provide uncertain benefits, such as robotic surgery or proton beam therapy. These mandates come at a time when academics and practitioners alike are experimenting with Value Based Insurance Design – creative alternatives to the traditional structures of deductibles and copayments. The ACA stops such innovation in its tracks. Any realistic alternative to the ACA should begin by reducing regulatory hurdles that allow insurers to innovate on the design of benefit packages. If we are concerned about the potential for cream skimming by plans offering less generous benefits, we can modify and extend existing reinsurance programs.

Proposal 3: Repeal the prohibition on catastrophic health plans and, if proposal 4 is not feasible, provide a level tax playing field for high deductible plans

Perhaps the biggest innovation in insurance design in the last ten years has been the high deductible health plan, coupled with Health Savings Accounts. (HSAs are accounts that allow for tax-free expenditures on health services and are meant to level the tax playing field versus more expensive, traditional insurance plans.) Currently, only individuals under the age of 30 or who have a hardship exemption are allowed to purchase high deductible plans in the exchanges. However, even those who are lucky enough to be allowed to buy these plans cannot use the ACA tax subsidies for lower income individuals for their premiums. This makes absolutely no sense. We propose that individuals purchasing high deductible plans receive the same tax subsidy as individuals purchasing plans for the “Silver” tier of the exchange, with any subsidy that is greater than their premium to be placed in qualified Health Savings Account. If we are unable to repeal the tax deductibility of employer provided insurance, expenditures from this account should be tax free. However, if we do level the tax playing field expenditures from this account should be taxed but limited to medical services. After age 65, any remaining balance in this account could continue to be used for health services not covered by Medicare or converted into an annuity for retirement spending.

Proposal 4: Level the tax playing field

Nearly all economists agree that the tax subsidy for employer sponsored insurance is inefficient, because more expensive plans enjoy larger subsidies, and regressive, because it disproportionately benefits the rich. Talk about having the worst of both worlds. We realize that it is probably easier to repeal the ACA than it would be to repeal the tax subsidy – a benefit that is currently supported by both big business and organized labor. But we are compelled to renew the call; here is a chance for Republicans to prove themselves as the voices of reason on economic policy. Couple this repeal with a reduction on marginal tax rates for all Americans, and we have a win/win/win for economic growth, reducing health spending, and increasing equity. Beyond this, the ACA continues a decades-long curiosity in the tax code: employer-sponsored health insurance enjoys the full tax subsidy, but insurance purchased by individuals receives a partial subsidy at best. These parts are the ACA are fighting against each other. We should also note that this change in tax policy is really just an expansion of the “Cadillac Tax” already included in the ACA.

So you see, it is possible for Republicans to offer concrete and realistic proposals for health reform. Now if only we had the email address for the President’s Blackberry …

January 21, 2014

The ACA: When Insurance Isn’t Insurance

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:51 am

We will be blunt. Hidden under the cloak of expanding health insurance, the Affordable Care Act (ACA) has fostered a massive subsidization of healthcare goods and services. These subsidies often have little or anything to do with what economists would consider the “insurance” part of health insurance – providing protection against financial catastrophe. Perhaps more troubling, if the past is prologue these subsidies will continue to grow, transferring huge amounts of money to politically favored groups and doing very little to decrease aggregate health spending – a presumed goal of health reform.

In order to understand these claims, it is necessary to take a step back and explain why insurance (of any form) is a good thing in the first place. Simply stated, insurance provides individuals with protection against unpredictable financial hardships not of their own making. Most of us don’t like risk, and therefore we are willing to pay other people to avoid uncertain outcomes. Therefore the benefits of insurance are to protect us from uncertain events. The key here is the uncertainty. If something is not going to cause financial distress, or the expense is relatively predictable, then, by definition, the service is not insurable. A health plan could cover the service, but that is a subsidy, i.e. other people in the insurance pool or an outside actor such as the government are simply paying for your service. It is not insurance.

Sadly, most of the discussion around what constitutes “real” health insurance under the ACA bears only a passing resemblance to the protection against financial risk that is the hallmark of insurance. For example, Secretary of Health and Human Services Kathleen Sebelius said: “Some of these folks have very high catastrophic plans that don’t pay for anything unless you get hit by a bus … They’re really mortgage protection, not health insurance.” What does Secretary Sebelius think insurance is? We don’t expect auto insurance to pay for our gasoline. Indeed, we buy auto insurance precisely so that we can meet our mortgage payments (or similar vital financial obligations) in the event that our car is stolen or worse. For a Cabinet Secretary to preside over the largest expansion of insurance since Medicare and not understand or care what insurance is supposed to be for…well, frankly we are shocked (and not in a Casablanca sort of way).

Secretary Sebelius mistakenly believes that a health plan isn’t an insurance plan unless it covers things such as routine annual visits to a physician or other services that we expect will occur each year and that we can budget for in advance. These types of services (while valuable and necessary) carry little to no associated financial risk and as a result, there is little insurance benefit to forcing the coverage of these services. It should be noted, though some may not like this fact, that this is also the case for many maternity services or for contraception. These have been two of the more controversial mandated services and they are effectively uninsurable in most cases. In fact, when maternity services are covered by insurance, the payments for these services are largely a subsidy with little risk sharing benefits. Perhaps the most apparent example of this is when an individual seeks to purchase insurance when they are already pregnant. While insurance companies were castigated for considering pregnancy to be a “pre-existing condition,” they were entirely correct in their assessment. If Secretary Sebelius wishes to state, as a matter of policy, that Americans should subsidize maternity care, then she should say so. Perhaps the majority of Americans will agree. But let’s not invoke the myth that this is some sort of insurance. Furthermore, there are probably better ways to subsidize this care then forcing its coverage into the premiums of everyone on the exchanges.

Even when our health insurance plans provide protection against financial risk, this protection comes at cost known as moral hazard. Full insurance, which drives the marginal cost of a service to zero, will cause folks to buy medical goods and services even if they don’t really need it. (Either patients will demand more of it or their providers will prescribe more of it, knowing that cost is not an issue.) This drives up health spending without a commensurate increase in benefits. Moral hazard may be inconsequential for services such as open heart surgery, but it can be quite large for other services, such as many prescription drugs, eyeglasses, contraception and even mental health care. And if the latter are not too costly, or are predictable, then coverage entails a subsidy with little or no insurance benefit making the coverage mandate even more problematic.

Insurers counteract moral hazard by requiring deductibles, copayments, and coinsurance. These measures balance risk spreading benefits and moral hazard. Low income individuals may feel the bite of financial uncertainty with relatively low medical spending. But most of these individuals will be enrolled in Medicaid and not in the exchanges. Most participants in the exchanges can plan for nontrivial annual deductibles and can bear the financial uncertainty associated with nontrivial cost sharing. Many of the lower tiered plans on the exchanges have relatively large amounts of cost-sharing – which makes them more like insurance than many products offered by employers. But actual catastrophic insurance plans are primarily available (likely for a political reason such as this long being a popular policy among the Republican opponents to the ACA) to individuals who are under 30 and these plans can’t be purchased using tax subsidies from the government.

Beyond limiting access to catastrophic plans, the ACA inhibits innovation in the design of health plans by setting a fairly rich set of minimum benefits for all insurance plans in the United States. This lack of innovation in plan design may be one of the largest and under discussed long term costs of the ACA. Perhaps more galling, Congress demonstrated their infinite wisdom by deciding to use the current employer-provided health system as a model for the future of health insurance. Under the ACA, the Secretary of HHS was tasked with determining a set of essential health benefits that were similar to a “typical employer.” Yes, the ACA has decided that the structure of benefits that has led to ever increasing health spending will be codified as the definition of insurance for every American.

The rule making process of determining the “typical employer” actually left Secretary of HHS with a good deal of latitude about what would be covered. There was an opportunity to move towards a mandate that each American have true insurance. But given Secretary Sebelius’ twisted definition of insurance, it shouldn’t be surprising that she ended up choosing a very generous package of services as the “minimum.” And coverage for some services known to be at risk for moral hazard, such as mental health and substance abuse coverage, must be covered with the same cost sharing as other services, which as we wrote about before has its own problems.

We believe that starting with generous existing employer plans as a basis for the services that should be covered is a fundamentally flawed strategy. Many features of these plans are more about quirks in the federal tax code than optimal insurance design. Employee health benefits are not taxed as income. Purchase eyeglasses on your own, and you use after tax dollars. Buy them through employer-sponsored insurance, and you use before tax dollars. Given these tax rules, it’s no surprise that employer provided health insurance evolved into pre-paid medical services plans. Of course, taxpayers pay for a good portion of these costs – a regressive subsidy that economists have long protested (in vain, of course.)

For a long time, individual insurance policies were far less generous than employer-sponsored policies. One likely reason is that these policies did not get the same tax deduction as employer-sponsored policies. As a result, many of these policies actually looked like true insurance. Lest sound economic thinking wear out its welcome, states have mandated minimum benefits standards for individual policies. (The mandates do not apply to the self-insured plans offered by the vast majority of large employers.) Today, the average state mandates 45 benefits, ranging from asthma management, alcoholism treatment, and treatment for HIV/AIDS to acupuncture, circumcisions, and mammograms.

A small percentage of these mandates are for services that economists would describe as insurable. Politics, not economics, explains the rest. A small number of providers and patients who pool resources to lobby for their cause prosper from these mandates. Taxpayers who are too diffuse to stand in opposition bear the costs. Congress will not be immune from this simple calculus and we expect the minimum benefit package to steadily grow. The ink was barely dry on the EHB rules from HHS before groups that were not included began their lobbying campaigns to demonstrate their importance. As this occurs, the ACA will be less and less about providing Americans with health insurance, and more and more about subsidizing favored interest groups.

The President has said that his second administration is all about creating jobs. What we didn’t realize that he must have been referring to creating lobbying jobs for healthcare interest groups.

December 18, 2013

What We Don’t Know Can Hurt Us

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 1:39 pm

As the health insurance exchanges find their footing and potentially millions of Americans gain access to insurance, this may be a good time to step back and take a longer term view of the ACA. When you get down to it, expanding health insurance coverage was the easiest and least controversial part of health reform. There is no shortage of ways to expand health coverage and almost any credible health reform proposal would have done the job, provided enough money was thrown at the problem. In designing the ACA, perhaps as a result of political pressure, President Obama opted for a combination of heavily subsidized individual insurance exchanges and generous expansions of Medicaid. Freed from political constraints, he might have instead pushed for the single payer system that many of his most ardent supporters desired. Republicans inclined to expand coverage (at least one of us is proof that unlike the unicorn these do exist) might have pushed for a pure voucher program that harnessed market forces. All of these options would expand coverage to the degree that policymakers were willing to fund them. So while we congratulate the President for his political success (we doubt the other options could have made it through Congress), it is a simplistic mistake to evaluate the implementation of the ACA by counting the numbers of uninsured or waiting for the monthly updates on the enrollment figures from the exchanges website. Any regulator with a big enough purse can, in the fullness of time, expand access. Frankly, that’s the “easy” part of healthcare reform.

But what about the other elements of the so-called “triple aim” of health reform: cost and quality? You see, while we agree that liberal, moderate, and conservative health reforms can all improve coverage, they each will have very different effects on the other important outcomes. Consider for example the oft-discussed “Medicare for all”; i.e. a single payer system. This would increase access without the messiness of the exchanges. It would also allow the government to flex its monopsonistic muscles and quickly reduce costs – though likely at the expense of quality. In contrast, relying on markets may not reduce costs in the short run, and may not necessarily reward real quality (though it has a better short than single payer in this regard).

Evaluating health reform in the context of the “Triple Aim” is important, but even that approach is not nearly enough. There is a broad consensus among that technological change is the most important long run driver of cost and quality. It follows that the most important element of health reform is its impact on technological change.

To understand how technological change affects all of us, consider the profound impact of the top ten medical advances in the last ten years, as listed by CNN:

1. Sequencing the human genome
2. Stem cell research
3. HIV cocktails
4. Targeted cancer therapies.
5. Laparoscopic surgery
6. Smoke free laws
7. The HPV vaccine Gardasil
8. Face transplants
9. Drugs reducing or eliminating periods
10. Bionic limbs

Going forward, it is hard to imagine not enjoying the benefits of these advances. So we wonder which, if any, of these advances we would be enjoying today if a single payer system or even the ACA had been enacted 20 years ago. We can’t provide a precise answer to this question, but we have a strong intuition about the direction of the effect. Consider these three stylized facts:

1) Considerable private sector investments were required to translate most of the ten advances from the original basic research into viable medical treatments.
2) If researchers and private firms do not expect to cover the costs of their investments, then research will dry up as capital flows towards more productive ends.
3) In health systems that regulate prices (i.e., every industrialized country except the U.S.), governments are able to use their market power to reduce prices down close to marginal costs.

The stylized facts lead inexorably to the conclusion that medical innovation depends critically on profits reaped from American consumers. From a pure equity standpoint these facts are not great for Americans, as the rest of the world free rides off our largess. However much we lament this outcome, it is hard not to think of an even worse situation. Had the United States adopted single payer health reform in the 1980s, then by now, we would have largely solved our access problems. Unfortunately, what we might also find is that we’ve made sure that everyone has access to the essentially the level of technology available to the 1980s medical consumer, and the innovations on CNN’s list would look much different, and much less innovative. Imagine having to move forward without some of these innovations. Which would you sacrifice? Targeted cancer therapies? The HPV vaccine? Here is a situation where death is an option.

By changing the rules affecting payment rates and technology adoption, health reform affects the incentives for medical innovation. Leave the status quo, and incentives remain high. While we readily acknowledge that the current “market” based system might inappropriately reward technologies that provide few benefits, witness Da Vinci surgical robots and Proton beam therapy, it also leads to innovations like the ones on CNN’s list. We wonder how many of us would give up targeted cancer therapies and bionic limbs so as to avoid paying for Proton beam therapies. Not us. On the other hand, if we implement draconian rules, then the innovation pipeline may run dry.

Twenty years from now, some future version of CNN will publish a new list of the top medical advances. The health policy decisions that we make today will shape that list, yet no one is discussing them. How will planned reductions in Medicare payments affect innovation? Will efforts to promote pricing transparency, in the absence of comparable data on outcomes, drive consumers away from providers who use more costly technologies? Will narrow network plans be followed by narrow technology plans (that limit reimbursements for expensive technologies?) How will the newly created independent payment advisory board (IPAB) weigh the role of innovation incentives when establishing payment rates for existing technologies? Will further government encroachments into health care system, perhaps by taking a step closer to a single payer model, avoid draconian cuts in payments for technology?

In the absence of a debate about these issues, we worry that the federal government will take the politically expedient view by saving money today while sacrificing innovation in the future. After all, we will all reward politicians for the cost savings, but how can punish them for innovations that are never realized? If we implement the wrong policies, then Americans (and the rest of the world) might find themselves in a perverse version of Waiting for Godot, waiting in vain for medical advances that can only be dreamed of, because the innovators lack the financial incentives to turn dreams into reality.

As we continue to evaluate the launch of the exchanges, let us remember that expanding access is the easy part of health reform. Getting right the dynamics of technological change is much harder, and, we believe, much more important. Let’s start having that conversation before it is too late.

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