Health Insurers Should Not Become Too Big to Care

This post is co-authored with Rein Halbersma and Katalin Katona, who are economic policy advisors at the Netherlands Healthcare Authority and affiliated with Tilburg University, the Netherlands.

A recent Economix blog article in the New York Times (“Health Insurance Exchanges MayBe Too Small to Succeed”), raises the concern that encouraging competition in health insurance exchanges could lead to health insurers that are too small to succeed. It is clear that the bargaining leverage of insurers, which is determined by their size and the presence of alternative insurers, lowers provider prices, and that high provider prices are a serious problem. However, there are several important arguments against letting health insurance markets gravitate towards higher levels of concentration.

First, allowing insurer market power only makes a bad problem worse. Insurer market power often has the political repercussion of leading to a cry for even more “countervailing power” by lobbying health care providers. The end result of such a process can be the worst possible outcome for consumers: market power for both providers and insurers. This process occurred in the U.S. during the 1990s in what was called the “Managed Care Backlash”, and the phenomenon has also occurred in other countries with private health insurers, such as the Netherlands.

Second, if providers have too much market power, that problem is best dealt with directly. Encouraging insurer market power is not an efficient policy for dealing with antitrust issues in provider markets. Provider market power is best dealt with through vigorous antitrust enforcement. The Federal Trade Commission and the Antitrust Division of the Department  of Justice  have renewed their efforts in this area in recent years.

Third, allowing insurer concentration can lead to too much insurer market power and substantially higher premiums. The economic reasoning is that insurer market power limits the incentives to pass on to consumers the discounts they obtain via their buyer power. In extreme cases of insurer monopoly power, the generated savings on provider prices can be more than offset by dramatically higher  premiums.

Fourth, the consequences of too much insurer market power are worse than the consequences of too little. Once insurers have obtained market power, the situation is typically irreversible. Small insurers may always decide to merge –subject to antitrust control-, but “unscrambling the eggs” is impossible in practice.

As the New York Times article rightly points out, one may worry whether some health insurers are too small to succeed against powerful providers. And excessively high prices set by powerful health care providers are a serious problem for health policy. However, when it comes to passing on provider discounts to consumers, we should also ask whether allowing insurer market power simply makes them too big to care.

Health Care Competition Saves Lives

Evidence has been mounting on the impacts of health care competition on the quality of care. The vast majority of these studies look at hospital competition and use mortality risk as a measure of the quality of care. Two recent studies I've done with colleagues analyze the impact of reforms in the English NHS designed to promote competition among hospitals.

In one study, Rodrigo Moreno-Serra, Carol Propper and I examine the impact of these reforms on mortality for heart attack patients and overall mortality. We find that mortality declined substantially more after the reforms for hospitals facing more potential competition than for those that did not. Specifically, we estimate that the reforms led to a 0.3% drop in the mortality rate for heart attack victims, saving nearly 1,000 lives per year. A recent article in Vox (an online economic policy journal) summarizes the results.

In a followup study, Carol Propper, Stephan Seiler and I analyze the impact of the NHS reforms on patient choice of hospitals for heart bypass surgery (CABG). This is summarized in a recent Vox article. We find that NHS patients are much more responsive to quality differences across hospitals (measured as risk-adjusted mortality rates) after the reforms. As a consequence, hospitals are driven to be responsive to patients and compete on the basis of the quality of care. We find that the reform reduced mortality for bypass surgery patients by 3%, via patients choosing better quality hospitals.

While there is still a lot of work to do to better understand the nature of competition in health care markets and impacts on quality, these two studies do add to a growing body of evidence on the topic. The weight of the evidence, in my opinion, is showing that health care competition saves lives. For more general overviews on the evidence, see a recent synthesis piece on hospital consolidation that Robert Town and I wrote for the Robert Wood Johnson Foundation, an earlier synthesis piece by Town and William B. Vogt, a chapter that Town and I wrote for the Handbook of Health Economics , and a recent survey piece on hospital competition under fixed prices by Hugh Gravelle, Rita Santos, Luigi Siciliani, and Rosalind Goudie.

Nothing Focuses the Mind Like a Fiscal Cliff

The Federal government is facing a self imposed deadline to reduce the budget deficit or face a mandated combination of large tax increases or budget cuts. Everyone agrees that allowing the mandated cuts to occur could cause serious harm to the economy, so the White House and Congress will have to come to some agreement (soon) to avoid driving the economy off the fiscal cliff.

The process of confronting this problem provides an opportunity to reform the U.S. tax code. No one likes our current income tax system -- there are a bewildering array of deductions, exclusions, and loopholes. This not only makes it hard for people to complete their income tax forms, it leads to serious distortions in incentives -- costing our economy billions of dollars.

A straightforward solution is to simply eliminate all exclusions, deductions, and loopholes. Under this reformed tax code all income will be taxed -- period. Both earned (wages and salaries) and unearned (capital gains) income will be taxed at the same rate.  Higher incomes will be taxed at higher rates. This will be a truly progressive income tax because individuals with high incomes won't be able to avoid taxes via the shelters and loopholes that are present in the current tax system.  Further, resources will flow to their highest valued use, rather than those that allow the avoidance of taxes.

Pursuing this option will mean eliminating some tax exclusions and deductions that are popular -- the mortgage interest deduction and the tax exclusion of employer sponsored health insurance benefits for example. But not taxing these inefficiently distorts incentives and also means that income tax rates have to be higher. For example, it's estimated that these two features of the tax code alone will cost the Federal government over $1 trillion in foregone tax revenues over the next five years. Further, since the value of these features of the tax code rises with an individual's tax rate, they are regressive. High income individuals derive more benefit from these (since they avoid more tax) than do lower income individuals.

As a practical matter, it's unlikely that we'll actually eliminate all exclusions and deductions from the tax code. It may be desirable to retain some, such as deductions for charitable donations (although even that can be debated), and we'd likely gradually phase out those features to be eliminated. Of course, pursuing tax reform doesn't eliminate the need to address spending, but it can help. It's also important to point out that there still may be a need to increase tax rates, even if serious tax reform is undertaken.

I am not being particularly original or innovative in calling for this kind of tax reform. Many economists, politicians, and others have proposed this kind of tax code simplification over the years. What I do think is that our current set of fiscal challenges, not just the looming fiscal cliff, may finally provide our politicians with the stimulus they need to pursue meaningful tax reform.

While moving from our current system to a simplified tax code would be a big change, I think it's a change that most people would welcome. The current system is widely perceived as arbitrary, byzantine, and unfair. A tax code where all income is taxed would be simpler, more efficient, and fairer. The looming fiscal cliff provides our government with an opportunity for real tax reform -- one they shouldn't pass up.

Is The 716 Billionth Cut The Deepest?

One of the primary items of contention in Wednesday night's Presidential debate was the $716 billion in cuts to Medicare through the Accountable Care Act (ACA). Mitt Romney claimed that this would harm Medicare beneficiaries, while Barack Obama claimed just the opposite, that this would help them. Let's consider these claims.

First Romney's claim. First, let's be clear that there are no payment cuts to doctors included, so there should be no impact of the cuts on physician supply of services. It is possible that if Medicare spending exceeds the target growth rate that the Independent Payment Advisory Board (see nice explanation of the IPAB) could recommend payment cuts to physicians as part of its recommendations to reduce cost growth, but that is not mandated.

The main cuts are payment cuts to Medicare Advantage (MA) plans and cuts in the rate of increase to hospitals and a few other providers. It is possible that cuts in payment rates to MA plans will lead to some of those plans leaving the market. A recent paper by Austin Frakt, Steve Pizer and Roger Feldman finds large impacts of payment cuts on plan participation in MA (blog post by Austin Frakt on the findings, with link to the paper). Medicare beneficiaries who lose their MA plans could simply enroll in traditional Medicare or in another MA plan (if available), so they won't lose coverage entirely or access to services. Studies have shown, however, that beneficiaries in MA plans prefer them to traditional Medicare, so they would suffer a loss from having to switch. In a separate paper, Frakt, Pizer, and Feldman estimate that what beneficiaries lose due to the exit of their MA plan is more than outweighed by the savings from reduced MA payments (blog post on this with link to paper).

There are two main questions regarding the impacts of reductions in the growth of hospital payments. Will hospitals reduce their supply of services to Medicare beneficiaries, and will they reduce the quality of care they provide? The first question is basically about the elasticity of supply -- how responsive are hospitals to changes in Medicare reimbursements? There is surprisingly little direct evidence (so far as I'm aware) on how hospitals' supply of services to Medicare beneficiaries responds to Medicare payment levels. There is a lot of research evidence on hospitals' response to the introduction of the Prospective Payment System (PPS) in 1983, which did have impacts on payment levels. The evidence there seems to be that the PPS payment changes did affect intensity of care, but not volume. More recent work on changes in Medicare reimbursements for different DRGs also finds no volume response (but upcoding: "How Do Hospitals Respond to Price Changes?"Leemore S. Dafny, The American Economic Review , Vol. 95, No. 5, Dec., 2005, pp. 1525-1547). Deductively, we know that Medicare beneficiaries make up a large part of hospital patients. Therefore it's unlikely that hospitals could replace them with more remunerative patients or activities, even if they want to. As a consequence, it does not appear likely that hospitals respond to Medicare payment cuts by seeing fewer Medicare patients.

There is evidence, however, that hospitals do respond to Medicare payment reductions by reducing the intensity of care they provide to Medicare patients. David Cutler ("Empirical Evidence on Hospital Delivery under Prospective Payment," unpublished Paper, 1990) finds reductions in the intensity of treatment by hospitals in response to reimbursement reductions due to PPS. Vivian Wu and Yu-Chu Shen (2011) find evidence that hospitals that experienced large cuts in Medicare payment rates had increased mortality rates for heart attack patients relative to hospitals that had smaller cuts.

So it's possible that hospitals could respond to the reduced growth in their Medicare payment rates mandated by the ACA by cutting back on things that end up harming the quality of care. It is important to realize, however, that the ACA also introduces quality incentives into Medicare payments for hospitals. These are based on clinical quality measures and patient surveys, and penalties for readmissions. As a consequence, it's not clear that slower increases in payments will end up leading to lower quality.

So, it's far from clear that Mitt Romney's claim that the ACA's reductions in Medicare payments will harm Medicare beneficiaries is correct. There is some evidence that points in this direction, but my personal opinion is that it's unlikely.

What about Barack Obama's claim that the Medicare payment cuts will help beneficiaries by keeping Medicare solvent? It extends the solvency of Medicare from 2016 to 2024.  There has been some controversy about the impacts on Medicare spending and the Federal budget. Charles Blahous has claimed that extending the solvency of Medicare actually ends up increasing the government's spending and increases deficits. He assumes that benefits would be cut when the Medicare trust fund is exhausted (the law is that it can't spend more than comes in) and there would be no Medicare deficits. Therefore the Medicare savings from the ACA aren't really savings -- they wouldn't have been spent anyway.

Peter Orszag says this isn't correct -- roughly speaking, the government would have continued to pay for Medicare absent the ACA, so that's not the right basis for comparison and there are true savings. Jeff Brown does yeoman's work trying to sort out the controversy. These views lead to very different conclusions about the impacts of the ACA on Medicare and the federal deficit. My own view is that Peter Orszag is right. I seriously doubt if the government would carry out the benefit cuts that would be required.

Obama's claim about the solvency of Medicare is correct. The implications for spending and deficits are subject to some (very wonky!) debate, but I think the most likely scenario is one in which these are true savings.

We're Better Off with the ACA

In order to be completely aboveboard, I want to be clear that I support the ACA. In my opinion, we're better off with it than without it. Extending health insurance coverage to over 30 million Americans will be a major improvement for the US. That doesn't mean I think it's perfect or that I like every aspect of the ACA (I seriously doubt if anyone does), or that I don't seem problems or issues with some aspects of it. I do, and it's not how I would have done it (more on this in a post to follow). But I feel that it's a major accomplishment finally passing a health reform bill and substantially reducing the ranks of the uninsured. Imperfect as it is, that's progress, and I'll take it.

Have We Bent the Cost Curve? Not So Fast

The Health Care Cost Institute issued a new report today that shows the rate of growth of (private) health care spending trending up again after a couple of years of slower growth.   This casts some doubt on contentions that the slower growth we've seen is due to cost control efforts finally taking hold. Obviously it's too soon to know for sure, but this reversal in trend is disturbing.

What's driving the increase? Prices are the answer, as previously. We don't know what's behind the increase in prices, but there are a number of possible candidates, including increased consolidation and exercise of market power by providers, overall price increases in the economy, and the ACA 80/20 rule. Provider consolidation has been increasing, and we know that this leads to substantially higher prices. The 80/20 rule specifies that health insurers can allocate no more than 20% of their total expenses to administration; the rest has to go to medical care for beneficiaries. Obviously the intent is to moderate administrative expenses, but this regulation can be complied with either by controlling administrative spending or increasing spending on medical care. It's possible that an unintended consequence of this rule has been to drive up health care spending, although I need to be clear that this is just speculation at this point. Some careful research is necessary in order to determine what the major factors are driving these price increases.

Another important finding in this report is that spending on children's health care (age 18 and under) rose faster than for any other age group. This continues a trend that was discovered in the 2010 HCCI report. This indicates that this is not simply a one time phenomenon, but rather an ongoing trend. Obviously this is cause for concern and we need to dig in to determine what's behind this.

Everything You Need to Know About a Doctor Shortage, Medical School Debt, and Physician Payment in a Few Easy Numbers

There has been a lot of discussion recently about an impending doctor shortage, the large amounts of debt medical students are saddled with, and whether physician reimbursements (Medicare specifically) are sufficiently high.  These issues all basically revolve around whether medicine remains an attractive occupation. While it's certainly possible to subject this question to extensive empirical analysis, a few simple numbers tell the story.

First, more than twice as many people apply to medical school as are admitted. In 2011, 43,919 people applied to US medical schools, and 19,230 were accepted and matriculated -- a ratio of nearly 2.3 applicants for every person admitted (who subsequently attended). This ratio has varied over time, but the long run average is greater than two. Don't just believe me -- the Association of American Medical Colleges -- the medical school trade association, publishes these statistics.

The fact that so many people want to become physicians (and so few do) over a long period of time is prima facie evidence that medicine is an attractive occupation.  If medical school debt is so crushing, or Medicare physician reimbursements so penurious, then why do so many people desperately try to get admitted to US medical schools?

Second, physicians from other countries want to come to the US, not the other way around. Currently approximately 26% of physicians practicing in the US were trained in other countries. Some of those people of course are US citizens, but the majority are (originally) foreign nationals. There is very little flow in the other direction.

Clearly medicine remains a very attractive occupation. That's not to say that we couldn't face problems when the Accountable Care Act extends health insurance coverage to over 30 million Americans, thereby expanding the demand for medical services. But any such shortage (if it occurs) will largely be due to restrictions on entry into the profession, not because medicine has become financially unattractive.