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How insurance affects the demand for medical care

Richard Hirth

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Ideal health insurance structure

• Insurer observes health state• Cash payment based on health state

– Set to equate marginal utility of income across all possible health states; thus, large payments made (income transfers) for health states in which expensive care is highly productive

– Insured can spend the payment on whatever they please; thus, no distortion of prices

• Not feasible because health state cannot be perfectly observed; thus, insurance contracts “pay off” by lowering price of care and dollar value of the pay off depends on amount of care

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How insurance affects the demand for medical care

Demand is influenced by incentives created by the insurance-induced reduction in the price of care to the consumer

“Traditional” FFS insurance:

Can impose cost-sharing

Does not directly “manage” care (UR, selective contracting, provider incentives)

Examining the potential and limitations of traditional insurance helps clarify the rationalefor managed care

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Enrollees pay a fraction of the price of care

Encourages some cost-sensitivity when seekingcare or choosing a provider

Higher copayment more incentive to remaincost-conscious, but more financial risk. Thus,the fundamental trade-off in traditional insuranceis incentives versus risk sharing.

A. Many HI plans (both traditional and managed) employ copayments (coinsurance)

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Patient pays cpm for a unit of care

Insurer pays (1-c) pm

Slides the consumer down her demand curve fromA to B. Consumer behaves as if the price of carehad fallen to cpm.

For coinsurance rate c:

P

Pm

cPm

•

•

A

B

Q

D

Figure 1

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1) Start with the no insurance D curve. This shows whichP (actually paid by the consumer) leads to any particular Q.

2) For each Q, find the P where out-of-pocket price withinsurance = P on the no insurance D curve

Uninsured consumer buys Q=10 units at P=$20 If C=.2, she would buy Q=10 at P=$100 This is one point on the insured D curve

3) Connect the “with insurance” Ps and Qs to get the “withinsurance” D curve

Translating “sliding down” the uninsured D curveinto a “with insurance” D curve:

7Figure 2

P

$100

$20

•

•

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D with insurance

D no insurance

Translating “sliding down” the uninsured D curveinto a “with insurance” D curve (cont’d.):

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An alternative way of translating an uninsuredD curve to an insured D curve:

Uninsured D curve represents 100% coinsurance (c=1)

With full insurance (c=0), demand for care would beperfectly price inelastic (vertical)

D curves with 0<c<1 can be determined by rotating theno insurance D curve around the Q intercept towardsthe full insurance D curve. Insured D curve becomessteeper (less P elastic) as the copayment falls.

If health care markets are not perfectly competitive, how will insurance influence prices and profits?

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Creating a “with insurance” D curve

P

$100

$20

•

•

10

Dc = .2

D no insurance

D full insurance

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A

Figure 3

Q

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B. Indemnity insurance pays a fixed $ amount perunit of care

To see the effect on the D curve:• Suppose an uninsured consumer buys 10 units of care

at p=$40

• Indemnity pays $80 per unit regardless of the price of care

• If p=$120, consumer faces out-of-pocket p=$40 anddemands Q=10;

• Insured D curve shifts up by the amount of theindemnity payment

How do incentives to “price shop” differ under an indemnityPolicy vs. a policy with coinsurance?

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B. Indemnity insurance pays a fixed $ amount perunit of care (cont’d):

P

$100

$20

10

D no insurance

Figure 4

$120

$40

D indemnity

Q20

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C. Deductibles imply that the consumer facesdifferent prices at different quantities:

e.g., $500 deductible and 20% coinsurance; p=$100

Effects of deductible depend on the level of illness:

• For minor illness, deductible > expenditures, so theconsumer faces the full price of $100

• For serious illness, expenditure > deductible, so theprice of the marginal unit of care is only $20

Effects of deductibles also depend on time (January 1vs. December 31) and health status

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C. Deductibles imply that the consumer facesdifferent prices at different quantities (cont’d.):

P

$100

$20

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Figure 5Q

D Minor illness

D Severe illness

Out-of-pocket price

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D. Maximum payment provisions are the opposite of deductibles

If policy limits coverage to $100,000 (or to 30 days of inpatient care), I face a low price for small amounts of care, but a high price for high levels of care

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Why should we care about the demand forMedical care? (or “Demand” vs. “Need”)

If we’re concerned about utilization by a population, it is important to understand how demand is determined

A policy analysis based on the concept of ‘demand” canyield different results than one based on the concept of“need” (“need” = amount of care that “experts” believesome person or population should have)

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Several policies have been shaped by need-based analyses:

1) Hill-Burton Act

Subsidies for hospital construction predicated on a standard of 4.5 beds per 1000 population

Since “need” is independent of price, it is represented by the vertical line at 4.5 beds/1000

Residents of an area with D1 would have to be paidto consume as much inpatient care as they “need;”subsidies to build capacity to 4.5/1000 would bewasted

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Hill-Burton Act (cont’d.)

Residents of an area with D2 would only consume whatthey “need” at a price of p*

P*

Figure 6

“need”

D1 D2

4.5 beds/1000 pop.

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2) Health workforce policies

Step 1: Forecasts of physicians needed to serve the population (based on expected #s of people withvarious diseases and assumptions about optimal care)

Step 2: Compare to actual # of physicians (given existingtrends) to calculate future surplus or shortage

These forecasts were important determinants ofpolicies such as subsidization of medical schools

In response to errors generated by a need-basedapproach, recent workforce forecasts have beenbased at least partly on the concept of demand

Hill-Burton Act (cont’d.)

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The moral of the story:

Even if you believe that people’s preferences(as expressed through D curves) should be over-ridden in favor of expert opinion about “need,” you’ll still need to know about the determinantsof D to get them to consume what you thinkthey need

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Empirical studies of the demand for medical care

P elasticity of D for medical care determines how insuranceaffects the quantity of care demanded:

Price faced by the consumer is pc = pm*c

1% increase in either pm or c results in a 1% increase inout-of-pocket price

Many attempts to estimate the price elasticity of D:

• Estimates all over the place (0 to -3)

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Methodological limitations:

Need to observe consumers who face different Ps

• Same person, P changes over time• Different people facing different Ps at one point

in time

Studies often use insurance coverage as the source ofP variation

Biased elasticity estimates (people who expect to consume more medical care enroll in more generoushealth plans, causing the observed relationship between insurance coverage and utilization to includeboth the pure response to price and a “selection effect”)

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RAND Health Insurance Experiment (HIE)

Patients randomly assigned to different levels of coverageto allow estimation of the pure price effect

6 sites including one with a staff model HMO

Enrollment 1974-77; 3-5 year follow-up

C varied from 0 to 0.95, $1000 out-of-pocket maximum

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RAND HIE: Key results (see handout for details):

Cost-sharing matters (expenses fell 30% when c wentfrom 0 to 0.95)

Few health consequences of marginal utilization

P elasticity of demand overall in the range of -0.1 to -0.2

Income elasticity 0.2 for outpatient, 0 for inpatient

Cost-sharing reduced utilization of care deemed “effective”as much as care deemed “ineffective;” are patientsgood rationers?