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Health Reform without Side Effects

by Mark V. Pauly
John A. Nyman University of Minnesota American Enterprise Institute Washington, DC April 1, 2010

Review of

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Nyman University of Minnesota

Many Areas of Agreement

Improvements to current system

Importance of guaranteed renewability (GR) Not requiring community rating, but subsidizing highrisk Subsidies for the low-income A mandate (with penalties) for the high income Some provision for dealing with those who become sick and uninsured

A few areas of disagreement

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Nyman University of Minnesota

Value of Insurance

Consumers purchase insurance because they prefer a sure loss (paying the premium) to an uncertain loss (the medical expenditure if ill) of the same expected magnitude Insurance distorts the price of healthcare causing consumers to purchase care that costs more than it is valuedmoral hazard The additional care is welfare decreasing and requires cost-sharing to increase prices of medical care and reduce welfare loss Thus, the value of insurance is financial only, and the additional care is not worth its costs

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Nyman University of Minnesota

Value of Insurance

Health insurance is contract where the consumer pays a premium in exchange for an (actuarially equivalent) amount of additional income if ill This additional income allows the consumer to purchase more healthcare than without insurance Contracts that actually pay off with a lump-sum income transfer when ill are impractical, so insurance pays off by paying for the ill persons healthcare The access that insurance provides to additional healthcare when ill is the main value of insurance

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Nyman University of Minnesota

Liver Transplant Example

Liver transplants cost about $300,000 They occur in about 1 of every 75,000 people annually in the US Actuarially fair insurance premium for coverage of this procedure alone is $300,000/75,000 = $4 The payoff if ill is $300,000 in income The amount of income that would be transferred to person who is insured and whose liver failed is $300,000 - $4 = $299,996
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Efficient and Inefficient Moral Hazard

An insured person purchases a $300,000 liver transplant that he would not have purchased if uninsured, so the transplant is moral hazard To determine whether the moral hazard (liver transplant) is efficient, it would be necessary to give the ill person $300,000 in cash and observe what he does If he uses this income to purchase the liver transplant, then the transplant is efficient moral hazard If not, then it is inefficient moral hazard
Nyman, The Theory of Demand for Health Insurance, Stanford U Press, 2003

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Nyman University of Minnesota

Median Financial Assets and Net Worth, By Income and Insurance Status, Among Nonelderly Families, Pooled Sample for 2002 and 2003, For Those In the Individual Insurance Market* Income Quartile Financial assets
Privately insured Quartile 1 Inc<$9,203 Quartile 2 $9,203-19,429 $200 ($178) $1,527 ($1,769) Uninsured $0 ($6) $0 ($5)

Net worth
Privately insured $11,235 ($10,174) $21,293 ($7,122) Uninsured -$7 ($5) $2,009 ($303)

Quartile 3 $19,429-36,330 Quartile 4 Inc>$36,330

$4,912 (4,321) $23,700 ($4,469)

$97 ($37) $1,808 ($315)

$88,474 ($16,617) $175,684 ($19,896)

$5,787 ($580) $50,963 ($5,921)

*Bernard DM, Banthin JS, Encinosa WE. Wealth, Income, and the Affordability
of Health Insurance, Health Affairs 28(5), May/June 2009, pp. 887-96.
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Why Insurance is Not Purchased

High loading fees, primarily high selling and administrative costs Not high profits

High prices of medical care in the US causing premiums to be high Reliance on other government programs like Medicaid, and charity (bad debts)

Pauly and Nyman

Myopia and not understanding the need for insurance

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Spending, Doctor Visits and Hospital Days for G7 Countries, 2006*

Canada Spending per capita Physician visits per capita Hospital discharges per 100 population Average hospital LOS (days) $3,696 France $3,423 Germany $3,464 Italy $2,673 Japan $2,581 UK $2,885 Avg $3,120 7.6 visits 16.0 stays 9.0 days US $6,933 3.8 visits 12.6 stays 5.6 days



















Hospital days per 144.00 70.56 61.32 153.36 173.80 93.13 203.52 94.50 100 days days population *Organization for Economic Cooperation and Development website, OECD Health Data 2009Selected Data,, accessed March 30, 2009 **2005 data
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Some Anecdotal Evidence

Reimbursement price of an MRI (2004)

US: $1,057 Germany: $216 Japan: $122

Reimbursement price of a CT scan (2004)

US: $616 Germany: $146 Japan: $62

Farrell D, Jensen E, Kocher B, Lovegrove N, Melhem F, Mendonca L, Parish B. Accounting for the Cost of US

Health Care: A New Look at Why Americans Spend More.

McKinsey Global Institute, December 2008, p. 50.
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High Provider Prices in the US

Many sources of market power for healthcare providers

Asymmetry of information Lack of competition by other specialists, hospitals, etc. Monopolies on certain tasks
surgery prescribing drugs admitting to hospital

Price discrimination Limits on admissions to medical schools Certificate-of-need laws Gaming the patent system Lack of enforcement of anti-trust laws Etc., etc., etc.
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Final Issues
Do exchanges actually work to increase the number of insured and also lower premiums? How do you evaluate whether profits of health insurers are high or low?

Percentage of premiums? Percentage of value of equity? Percentage of the loading?

Is the RAND Health Insurance Experiment really the best information we have about the impact of cost sharing on health?
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Attrition Bias in the RAND HIE Points

The data from the Health Insurance Experiment indicate that individuals who dropped out behaved differentlythan those who stayed to the end of the study. Thus, past inferences based largely on stayers are biased. For outpatient care, the bias was quite small. But for inpatient care, there was a moderate bias
Manning WG, Duan N, Keeler EB. Attrition Bias in a Randomized Trial of Health Insurance. Unpublished manuscript. Minneapolis: University of Minnesota, 1993, pp. 15-16.

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Nyman University of Minnesota