Reconsidering the Moral Hazard Risk Aversion Tradeoff Joseph

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Reconsidering the Moral Hazard. Risk Aversion Tradeoff Joseph P. Newhouse, © 2006 Many thanks

Reconsidering the Moral Hazard. Risk Aversion Tradeoff Joseph P. Newhouse, © 2006 Many thanks to David Cutler, Richard Frank, Jon Gruber, Tom Mc. Guire, and Richard Zeckhauser for comments.

Some Prefatory Remarks l I thought about several topics for this talk u How

Some Prefatory Remarks l I thought about several topics for this talk u How and when does a subfield of economics get established? When is it recognized by the AEA classification system? When is there a field journal? A professional society? u Clear that health economics is established; JHE and HE now 1 and 2 in citation counts among all economics and policy journals taken jointly! l The questions at the top were too hard JHE and HE citation counts: Kodrzycki and Pingkang 2005, http: //www. bos. frb. org/economic/wp/wp 2005/wp 0512. pdf.

The Future l Another natural topic: the future of the field l This is

The Future l Another natural topic: the future of the field l This is something of a fool’s errand, but several factors suggest continued vitality: Technological change and cost pressures u Use of administered pricing u Off-frontier production, e. g. variations u A second-best world; few unambiguous predictions; need for empirical verification u

Cost Sharing in Health Insurance l Instead of these topics I went back to

Cost Sharing in Health Insurance l Instead of these topics I went back to what I worked on at the beginning of my career; the structure of cost sharing in health insurance For example, the size of a deductible u Although I assume a health insurance context, the issues are also relevant in a health service context u

Outline of Talk l Received theory and empirics l The context for reconsidering l

Outline of Talk l Received theory and empirics l The context for reconsidering l An elaboration of received theory l Incorporating time-inconsistent preferences

Received Theory l Cost sharing in health insurance is traditionally framed as finding the

Received Theory l Cost sharing in health insurance is traditionally framed as finding the optimal tradeoff between moral hazard and risk From Arrow (1963, 1968), Pauly (1968), Zeckhauser (1970) u This is how our textbooks present it; e. g. , Phelps, ch. 10, Feldstein, ch. 6, Zweifel and Breyer, ch. 6 u Arrow, AER, 1963, 53(5): 941 -978; 1968, 58(3): 537 -539; Pauly, AER, 1968, 58(3): 531 -537; Zeckhauser, JET, 2(1): 10 -26.

Optimal Cost Sharing? - 1 l Using the framework of trading off moral hazard

Optimal Cost Sharing? - 1 l Using the framework of trading off moral hazard and risk, the RAND Health Insurance Experiment calculated the optimal cost sharing in 1983 dollars to be a $200 individual deductible, followed by 25% coinsurance, to a $1, 500 stop loss Newhouse and the Insurance Experiment Group, Free for All? , chapter 4.

Optimal Cost Sharing? - 2 l These values were slightly above those in early

Optimal Cost Sharing? - 2 l These values were slightly above those in early 1980 s indemnity policies, but…. l The RAND calculations didn’t consider the tax subsidy to employer paid premiums nor liquidity constraints, which would have lowered the optimal cost sharing u On the other hand, the calculations assumed actuarily fair insurance

What Happened? l Instead of cost sharing escalating with medical spending, we entered the

What Happened? l Instead of cost sharing escalating with medical spending, we entered the era of managed care with lower cost sharing l Lower cost sharing was consistent with the idea that greater supply-side cost sharing had altered the moral hazard-risk tradeoff, which it probably did, but…

Two Problems Remained l Supply-side cost sharing was not well placed to affect the

Two Problems Remained l Supply-side cost sharing was not well placed to affect the decision to initiate treatment for an episode, which the RAND data suggested was the principal margin that demand-side cost sharing affected, and…

Did Supply-Side Cost Sharing Reduce Deadweight Loss? l With minimal demand-side cost sharing and

Did Supply-Side Cost Sharing Reduce Deadweight Loss? l With minimal demand-side cost sharing and reliance on supply-side cost sharing there was no mechanism to reveal willingness-topay, so that services a consumer would have been willing to pay for might have been denied l Did this play a role in the managed care backlash? Pauly and Ramsey, JHE, 1999, 18(4) 443 -458; Rosenthal and Newhouse, Jnl Hlth Care Fin, 2002, 28(4): 1 -10.

And Now… l Whether because of the backlash or because supply-side cost sharing was

And Now… l Whether because of the backlash or because supply-side cost sharing was about one-off effects, or both, demand-side cost sharing is now coming back on the table l The 2003 legislation authorizing Health Savings Accounts prescribed a minimum $1, 050 deductible (individual), maximum $5, 250 stop-loss (2006 values)

HSAs and Optimal Cost Sharing l Despite product change, the HSA figures are not

HSAs and Optimal Cost Sharing l Despite product change, the HSA figures are not so far from the RAND calculations Health spending from 1983 -2006 grew by ~5 X u Ignoring the product change and using 5 X to inflate, the HSA deductible is in line u The stop loss is larger by 3. 5 X, but medical care is a larger share of income, so a less than proportional increase would be optimal u

Law Says Preventive Services Can Be Exempt l The Treasury defines preventive services as:

Law Says Preventive Services Can Be Exempt l The Treasury defines preventive services as: periodic health examinations; routine prenatal and well-child care; tobacco cessation programs; immunizations; weight loss programs; various screening programs l Importantly for my story, the Treasury excludes services that treat existing conditions; they are subject to cost sharing

Should More Services be Exempt? l In particular, should cost sharing be reduced for

Should More Services be Exempt? l In particular, should cost sharing be reduced for chronic maintenance drugs and routine maintenance visits for chronic conditions? Considerable evidence that compliance increases with less cost sharing u In some cases this may lower total lifetime cost; in others it may not, but it may improve health u

Evidence on Capped Drug Benefits - 1 l The following slides compare results from

Evidence on Capped Drug Benefits - 1 l The following slides compare results from two matched groups at Kaiser Northern California l One group had a drug benefit capped at $1, 000 of member spending (no benefits after that), and the other group had no cap u All were Medicare eligibles over 65 years of age

Evidence on Capped Drug Benefits - 2 l The comparisons are for those who

Evidence on Capped Drug Benefits - 2 l The comparisons are for those who had diabetes, hyperlipidemia, or hypertension, and who filled a prescription for an antidiabetic drug, a lipid-lowering drug, or an anti-hypertensive in the prior year l The tables show drug consumption, nonadherence, and physiologic outcomes u Adherence is having ≥ 80% of days covered

Diabetics Benefit Not Benefit Odds Ratio Capped (%) (95% C. I. ) Drug Quantity

Diabetics Benefit Not Benefit Odds Ratio Capped (%) (95% C. I. ) Drug Quantity ($) -- -- Drug Non. Adherence 21. 2 26. 2 Glycated Hg > 8% 17. 0 19. 7 0. 79 (0. 73 -0. 86) 1. 33 (1. 18 -1. 48) 1. 23 (1. 03 -1. 46) Odds ratio = capped/non-capped; Source: Hsu, et al. , NEJM, June 1, 2006 Odds Ratio results control for age, sex, race, comorbidities, office, ED copays. Physiologic odds ratio controls for initial value.

High Cholesterol Benefit Not Benefit Odds Ratio Capped (%) (95% C. I. ) Drug

High Cholesterol Benefit Not Benefit Odds Ratio Capped (%) (95% C. I. ) Drug Quantity ($) -- -- Drug Non. Adherence 26. 5 31. 4 LDL>130 mg/dl 19. 6 21. 3 0. 73 (0. 70 -0. 77) 1. 27 (1. 19 -1. 34) 1. 13 (1. 03 -1. 25) Odds ratio = capped/non-capped; Source: Hsu, et al. , NEJM, June 1, 2006 Odds Ratio results control for age, sex, race, comorbidities, office, ED copays. Physiologic odds ratio controls for initial value.

Hypertensives Benefit Not Benefit Odds Ratio Capped (%) (95% C. I. ) Drug Quantity

Hypertensives Benefit Not Benefit Odds Ratio Capped (%) (95% C. I. ) Drug Quantity ($) -- -- Drug Non. Adherence 14. 6 18. 1 SBP>140 mm Hg 38. 5 39. 5 0. 85 (0. 82 -0. 89) 1. 30 (1. 23 -1. 38) 1. 05 (1. 00 -1. 09) Odds ratio = capped/non-capped; Source: Hsu, et al. , NEJM, June 1, 2006 Odds Ratio results control for age, sex, race, comorbidities, office, ED copays. Physiologic odds ratio controls for initial value.

Use and Costs, Rate/100 Benefit Not Capped Benefit Capped Odds Ratio (95% C. I.

Use and Costs, Rate/100 Benefit Not Capped Benefit Capped Odds Ratio (95% C. I. ) ED Visits 45. 2 49. 2 Nonelective Admissions Total Cost 16. 6 18. 7 1. 09 (1. 04 -1. 14) 1. 13 (1. 05 -1. 21) -- -- 0. 99 (0. 94 -1. 04) Odds Ratio results control for age, sex, race, years of Kaiser membership, comorbidities, office, ED copays.

Conclusion from Kaiser Study l A drug benefit capped at $1, 000 versus no

Conclusion from Kaiser Study l A drug benefit capped at $1, 000 versus no cap led to less compliance with chronic disease regimens, poorer physiologic health, and cost increases in other medical services that about equaled the savings in drug costs u If non-compliance were to continue and physiologic health to deteriorate further, the future increase in other medical spending may exceed the decrease in drug spending

Additional Evidence - 1 l Soumerai, et al. studies on caps in two Medicaid

Additional Evidence - 1 l Soumerai, et al. studies on caps in two Medicaid populations: 3 drug/month limit saved 35% on drugs, but more than doubled nursing home admissions u Among schizophrenics: Cap on mental health drugs raised other spending by 17 times the savings on drugs Soumerai, et al. , NEJM, 1991, 325: 1072 -1077, 1994, 331: 650 -655.

Are You Saying: So What? l Did you already know that initial benefits with

Are You Saying: So What? l Did you already know that initial benefits with caps were poor economics and policy? l Then ask yourself whether an actuarily equivalent deductible with full coverage over the deductible would have yielded better or worse compliance results? l How many think better results?

Additional Evidence - 2 l In any event, if you don’t like caps, there

Additional Evidence - 2 l In any event, if you don’t like caps, there analogous findings about drug copays l Huskamp, et al. and Goldman, et al. find that increased copays decreased the use of ACE inhibitors, anti-hypertensives, antidiabetics, and statins, though they have no data on other medical costs Huskamp et al, NEJM, 2003, 349: 2224 -2232; Goldman, et al. , JAMA, 2004, 291: 2344 -2350.

Additional Evidence – 3 l Tamblyn, et al. find imposing cost sharing for drugs

Additional Evidence – 3 l Tamblyn, et al. find imposing cost sharing for drugs among the poor and the elderly in Quebec reduced drug use by 15 -22%, but led to an approximate doubling of serious adverse events, meaning death, hospitalization, or nursing home admission u No cost data, but it seems likely that total costs increased Tamblyn, et al. , JAMA, 2001, 285(4): 421 -429.

Additional Evidence - 4 l Rosen, et al. (2005) simulate that full coverage of

Additional Evidence - 4 l Rosen, et al. (2005) simulate that full coverage of ACE inhibitors for Medicare beneficiaries who are diabetic would increase QALYs and save money relative to the default cost sharing in Part D Rosen, et al. , Annals of Internal Med, 2005, 143(2): 89 -99.

An Extreme Example l With Directly Observed Therapy, tuberculosis patients are paid to be

An Extreme Example l With Directly Observed Therapy, tuberculosis patients are paid to be observed swallowing their medications u Negative cost sharing!

3 Cases to Stretch the Usual Risk -Moral Hazard Tradeoff l An easy one

3 Cases to Stretch the Usual Risk -Moral Hazard Tradeoff l An easy one to warm up l A second one that is a straightforward elaboration of received theory l A third one that ventures further afield, time -inconsistent preferences

An Easy Case l The marginal social cost of another pill is frequently negligible,

An Easy Case l The marginal social cost of another pill is frequently negligible, so any induced consumption has negligible deadweight loss l Assuming no increase in costs elsewhere, no moral hazard-risk aversion tradeoff l I assume for the remainder of the talk that marginal social cost is non-negligible u Of course, private costs of the pill are positive

Before Coming to Case 2: How Is Cost Sharing Determined? l For many cost

Before Coming to Case 2: How Is Cost Sharing Determined? l For many cost sharing is determined by employer or government choice u Even with choice among plans, employer may have standardized cost sharing l As a result: u In many cases cost sharing is exogenous u And even with choice of plan, a person’s health costs are shared with an insurance pool

The Employer’s Choice l How does an employer choose cost sharing? u Goldstein-Pauly (1976):

The Employer’s Choice l How does an employer choose cost sharing? u Goldstein-Pauly (1976): Employers minimize labor cost, look at benefit to marginal worker; unions look at benefit to median worker – u Labor cost = health care cost + productivity effects Miller (2005): Employer who minimizes cost and offers plan choice sells more generous plan as an upgrade; a lump sum subsidy to all plans is probably not optimal Goldstein-Pauly, in Role of Health Insurance in the Health Services Sector, 1976; Miller, JHE, 24(5): 931 -939.

Public Insurance l Straightforward extension of Goldstein- Pauly median employee model to median voter?

Public Insurance l Straightforward extension of Goldstein- Pauly median employee model to median voter?

An Implication l Tenure in the employment group is relevant for a cost-minimizing employer;

An Implication l Tenure in the employment group is relevant for a cost-minimizing employer; ceteris paribus, firms with longer job tenure will provide insurance with less cost sharing if those services reduce future costs u I have not tested this l In Medicare life cycle costs relevant

A Note on Measuring the Risk. Moral Hazard Tradeoff l Much empirical analysis, the

A Note on Measuring the Risk. Moral Hazard Tradeoff l Much empirical analysis, the RAND HIE included, uses an annual time frame, but lifetime risk is relevant with chronic disease l Positive intertemporal correlation of health spending from chronic disease raises risk for a given level of positive cost sharing

Second Case: An Elaboration of Received Theory l Because costs are shared within a

Second Case: An Elaboration of Received Theory l Because costs are shared within a common insurance pool, less cost sharing for those services and/or individuals that lowers overall spending for the pool is the usual case of a subsidy to recognize an externality Here too no moral hazard-risk aversion tradeoff u Held-Pauly (1990) take up an analogous case, but don’t frame the issue as optimal cost sharing for all services u Held and Pauly, JHE, 1990, 9(4): 447 -461.

A Third Case: Take Your Medicine! l We surely all heard that from our

A Third Case: Take Your Medicine! l We surely all heard that from our mothers l So why as adults do some persons not take drugs that will improve their future health but may not save them money?

One Answer l They are insured for other medical services and place a low

One Answer l They are insured for other medical services and place a low value on the uninsured health costs such as pain, suffering l The second part doesn’t seem very plausible for the above cases of chronic disease l Models of time-inconsistent behavior seem relevant in this context

me-Consistent and Time-Inconsistence P l Assume a standard health economics utility function: l With

me-Consistent and Time-Inconsistence P l Assume a standard health economics utility function: l With time-consistent preferences (standard discounting), or: 0< <1 l Time-inconsistent preferences, quasi-hyperbolic discounting: 0 < β, < 1 Maximize lifetime utility s. t. lifetime budget constraint Strotz, 1956; Akerlof, 1991; Laibson, 1997; O'Donoghue and Rabin, 1999; Frederick, Loewenstein, and O'Donoghue, 2002.

Already a Health Application l Gruber-Koszegi (2001, 2004) use a model with time-inconsistent preferences

Already a Health Application l Gruber-Koszegi (2001, 2004) use a model with time-inconsistent preferences to justify much higher cigarette taxes to induce “compliance” with not smoking u With this model cigarette taxes are less regressive than usually assumed and may be progressive because “internalities” disproportionately accrue to the low income Gruber-Koszegi, QJE, 2001, 116(4), 1261 -1305; J Pub Econ, 2004, 88(9 -10): 1959 -1987.

Time-Inconsistent Preferences and Optimal Cost Sharing - 1 l Solutions in these models depend

Time-Inconsistent Preferences and Optimal Cost Sharing - 1 l Solutions in these models depend on whether the individual is aware of the timeinconsistent preferences or not u Solutions are easier if unaware (naïve case) l Also can depend on whether example is immediate reward or immediate cost u Chronic disease application is immediate cost; small difference between and β can generate large welfare losses if individual is naïve Laibson, QJE, 1997, 112(2): 443 -477; O'Donoghue and Rabin, AER, 1999, 89(1): 103 -124. .

Time-Inconsistent Preferences and Optimal Cost Sharing - 2 l In other words, with time-inconsistent

Time-Inconsistent Preferences and Optimal Cost Sharing - 2 l In other words, with time-inconsistent preferences, induced compliance can be welfare increasing, potentially by a large amount, independent of risk

Specific Subsidies l Very specific cost sharing structures such as free ACE inhibitors for

Specific Subsidies l Very specific cost sharing structures such as free ACE inhibitors for elderly diabetics are not found in the market (selection), but disease management and case management use non-price methods toward similar ends u Medicare could adopt such a structure and there could be mandates in private insurance

Conclusions: Social Perspective l Current cost sharing structure may not be optimal from society’s

Conclusions: Social Perspective l Current cost sharing structure may not be optimal from society’s perspective l Without considering risk, welfare may be improved by selectively lowering cost sharing for certain persons and/or certain services l Case 1: Negligible marginal social cost u From social perspective, negligible cost sharing

Social Perspective, cont. l Case 2: Induced greater compliance that adds cost for the

Social Perspective, cont. l Case 2: Induced greater compliance that adds cost for the specific good or service but saves overall lifetime costs u Additional subsidy; externality l Case 3: Induced greater compliance that increases value of health by more than cost Models of time-inconsistent behavior relevant? u Marginal Benefit of health = MC compliance u

Conclusions: Private Perspective l From a private perspective: u Case 1 of negligible cost

Conclusions: Private Perspective l From a private perspective: u Case 1 of negligible cost probably doesn’t exist u Cases 2, 3: Optimal subsidy will generally be less than from social perspective

Conclusions: Policy and Research l HSA legislation seems too restrictive l More generally, current

Conclusions: Policy and Research l HSA legislation seems too restrictive l More generally, current cost sharing structure seems sub-optimal, even from a private perspective l Optimal cost sharing seems like a fruitful field for future research