Health Care Costs

It seems everyone understands that when you buy a drink in a hotel bar there will be a huge markup. My students came up with that example in class without my prompt. The economic explanation is called “local monopoly.” Some patrons have decided they don’t want to leave the hotel and among those some want a drink. Those customers are captured, so sock it to them. The same economics explains how some hotels (in my experience, the more expensive ones) price Internet access. Airports used to do the same sort of thing. They’d offer up the food service concession to a single vendor. Food would be very pricey and of poor quality. At least the hotels don’t appear to have watered down the drinks.

Somewhere along the line municipalities seemed to figure out that making weary travelers experience mediocre food at high prices wasn’t the best way to market their town. Now virtually every airport of size has a variety of food vendors from familiar national chains. Their pricing and food quality is comparable to what you’d see from a non-airport location in the chain. I don’t really remember when this transition took place, but in my thinking as an economist the timing must have coincided more or less with airline deregulation and the rise of the hub and spoke system. Airports generate much of their income form the airlines in the form of gate fees. Airlines that dominate an entire airport (or an entire terminal at the airport) would prefer the food to be decent and priced reasonably. So airports could make more in gate fees if they altered the way they did their food franchise was done.

Let me get to a different sort of example before addressing the issues of this post. This is part of a scene from a West Wing Episode called Process Stories:

DONNA: Five hundred dollar screwdrivers is why you didn't vote for the President?

JACK: I work for the President, that's a lot.

DONNA: It's wasteful spending.

JACK: Not it's not.

DONNA: A four hundred dollar ashtray?

JACK: (sighs) (hits ashtray)

DONNA: What was that?

JACK: A four hundred dollar ashtray. It's off the USS Greeneville, a nuclear attack submarine and a likely target for a torpedo. And when you get hit with one you've got enough problems without glass flying into the eyes of the navigator and the Officer of the deck. The one's built to break into three dull pieces. We lead a slightly different life out there and it costs a little more money.

I confronted this issue when as a campus administrator the “smart classrooms” were under my purview. The particular issue was what type of combo vcr/dvd players to buy. The home versions of these units were relatively inexpensive. The industrial version much more pricey. But the industrial version wouldn’t break down nearly as much, and every technology person will tell you that you have to look at total cost of ownership, not simply purchase price, to determine which choice is really cost effective. With the staff time that provided support of the classrooms very scarce, buying the industrial versions made sense, even if it rubbed the wrong way outsiders who would look at this spending and see it as too expensive. They simply hadn’t thought through the total cost of ownership issue.

* * * * *

Everyone at Illinois has healthcare on their minds now. We are in the midst of the Benefits Choice Period and unlike in the past where no choice simply defaulted to the plan we had the previous year, now the plans that most of us had in the past will no longer be available. The State went through an RFP process, one for Health Maintenance Organization (HMO) provision, another for Open Access Provider (OAP) provision. My current provider is HealthAlliance HMO. It was one of the bidders in the RFP, but it was not selected. Blue Cross/Blue Shield won in the HMO category. Alas, they are not available in my geographic area. And even if they were, it is unclear that we could stay with our current doctors. So we must move to an OAP, and so must others at Illinois. Further, the OAPs that are available are Tier II, meaning they feature a 10% deductible on services rendered.

Let me spend a moment simply on the RFP process. Since I’ve been involved in procurement elsewhere that has been through an RFP (for the Campus learning management system) the purpose is to produce the “best package” by going through a competitive bidding process, under the belief that such competition elicits the best packages. But then an odd thing happened with this particular RFP. We still get a variety of providers to choose from rather than just one.

One therefore has to ask, why have an RFP at all? Why not, instead, simply announce a state contribution per member for each plan and have as many plans as would like sign up with pricing accordingly, which would let the providers decide how much to charge via premiums versus how much to charge via deductibles or co-pays. Friends of mine are miffed that Heath Alliance is not available. I’m miffed too. If it were available but at a substantially higher premium than the OAPs, how would that have played out? I don’t know. But if you look at the map of provision by Illinois counties, you see the choices are non-uniform across the state. (One plan, called Quality Care Health Plan is available to all members in the state. It is plainly more expensive, but it does provide coverage for non-networked providers which can be of value if you need to see a specialist out of the area or if you need health care while traveling.) So, to justify the RFP, either you have to argue that we in the counties with fewer choices are as well off as before though we have to move to the OAP plans or you have to argue that overall across the state we are better off in aggregate because those in counties with more choices will win more than others in counties with fewer choices will lose. The latter might be true. It would require some estimate to be made about the out-of-pocket expense members will experience under these various plans. Unfortunately, such a calculation doesn’t seem to have been made and it didn’t enter into the selection process. Only premiums were used to determine the winners in the RFP.

Now let me say a word about the politics around health care for State employees. The State had been running a huge deficit and health care costs for State employees count as a big expenditure item, so it is good and correct to try to reduce that expenditure. There are two possible ways of doing this – one is to have the insurance providers receive less, the other is for the employees to pay more. My eyeballing of the outcome is that we have some of both. But that leads to a further quandary. Is this one and done or is it likely to be ongoing this way with subsequent RFPs produce winning bidders that have relatively modest premiums but higher and higher deductibles? If I were betting, I’d put my money on the latter as to where we are heading.

Now let me try to connect this health care bit with what I wrote up front about pricing in hotel bars. When you are in an HMO, you are largely oblivious to pricing. You make co-pays that don’t depend on the prices charged. And for most doctor visits, for example I took my son to see the optometrist this week to see if he needed a new prescription for his glasses, you don’t see the price of the visit. You only see the co-pay. So the insured is literally ignorant of the price the insurance company pays the medical provider. The situation is different when a surgery is performed or a non-surgical procedure is done that warrants a bill being generated. Then you get pages and pages of charges, most of which you are inclined to ignore, just as you ignore the language of the license agreement as you install new software. You only look the bottom line – how big a check you must write. That’s determined by the HMO’s co-pay. So HMOs are bad on making patients aware of what the insurance company pays the health care provider.

Let’s hold in check for a minute whether that ignorance is itself a good or bad thing. Let’s first consider the OAP approach in Tier II, where there are deductibles that are a fraction (10%) of the billed expenditure. So the amount the insured pays now varies directly with what is billed. (There is a cap on this for the full year. Once the cap is reached there is no further deductible paid.) At least for recurrently consumed medical services, under this approach there is a way for the insured to learn about the transaction prices. Armed with such knowledge, what impact would that have on behavior? If there is price variation for the same type of service within the network, conceivably the insured could do comparison shopping. In towns like Champaign, however, much of the health care is provided by either Carle Clinic or Christie Clinic, and their associated hospitals. For most services price depends on the service but not on who provides it. So shopping for the best price is not going to happen. Shopping for a preferred doctor within the network, however, will happen. Sometimes, however, given the system capacity constraints this amounts to shopping for a doctor who is available.

The other possibility that knowledge of transaction price (and incurring some share of it) will produce is that the insured will on occasion refrain from getting the service. This possibility also exists in the co-pay model. Indeed it explains why the co-pay exists. And at least with our provider, Carle, the possibility is further encouraged by providing a phone number for the Patient Advisory Nurse, who gives ready counsel and offers home treatment suggestions when that appears a sufficient alternative. The principle at play seems to be if the situation is mild then treat it at home, but if it is serious enough then come in for an office visit. In my limited experience with this some wiggle room is left to account for how the patient assesses the situation and how nervous the patient seems in the circumstance. There is a walk-in clinic for those who feel the need and can’t wait for a scheduled visit, but don’t feel the situation is serious enough to go to the emergency room. To this already somewhat complex calculus, the OAP Tier II approach lets a variable price based on the nature of the transaction come into play.

Let’s agree, because basic economics tells us that it is true, that the demand for the service will be more elastic when the patient bears some of the cost than when all the cost is borne by the insurer. So, to the extent that health care pricing is like hotel bar pricing, with very high markups built in, making the insured bear part of the cost and thereby making the demand more elastic should have a good effect on the prices that are charged. In other words this is a cost containment measure in accord with standard economic analysis.

But the above discussion really focuses on out-patient services only. In-patients, once at the hospital, don’t really shop for services at all. The in-patient is under the care of an attending physician who makes recommendations for xyz tests and treatments, not all of which can or should be forecast in advanced. Having the patient bear some of the cost might affect the demand elasticity for certain types of “elective” procedures, but once having elected to do the procedure the consequence of the patient bearing a fraction of the cost is simply to lessen what the insurance company pays. Thus, if there is an issue of hotel bar pricing in the health care costs of in-patients, it is far from clear that addressing the patient “moral hazard” via deductibles will do much if anything to contain costs.

This gets to the other way of thinking about cost containment for healthcare, which focuses on the total-cost-of-ownership issue – prevention and early detection. With that, consider for example that dreaded procedure the colonoscopy. Here I will speak only for myself, not the entire population. I hate going to the doctor and doing these things. The recommendation, I believe, is to have a colonoscopy for the first time when you turn 50. I had mine when I was 55. Likewise, I eschewed regular physicals and for a long time really didn’t have a primary care physician. What changed this for me? The answer in a nutshell is pain. When it hurts enough, then you go to see the doctor. Relieving the pain trumps the aversion to the doctor visit. I self-diagnosed sciatica. It proved to be arthritis and bone spurs. In the process it was learned that my blood pressure was high. So now I’m on meds for that. The colonoscopy followed as part of the bargain.

The Affordable Care Act aims to encourage better prevention and early detection. For my last physical and on several recent renewals of my meds, there was no co-pay whatsoever. But I needed somebody else to inform me that was a consequence of the act, not a decision made independently by HealthAlliance. I wouldn’t have known otherwise. Pricing that you only discover as you complete the transaction can’t really serve to guide behavior.

I’d like to make two other observations and then close. That last physical I had was done by a nurse-practitioner not my primary care doctor, though apparently they consult with one another. Since I didn’t have any new problems, this seemed ok to me. A couple of nights ago on the News Hour they had a very interesting segment on nurses as complete substitutes for primary care doctors, in low income neighborhoods where there is a shortage of doctors. The argument is that nurses could do more than we typically allow them to do and where there aren’t enough doctors it makes sense to give the nurses more responsibility. Now translate the argument to the situation I’ve been discussing. Are we likely to see pricing alternatives where, given a particular health issue, for a lower price you can see a nurse and for a higher price you can see a doctor? Economists are normally in favor of this sort of price discrimination as it leads to efficiency in allocation. But differential health care based on willingness to pay makes me queasy. Indeed, if you look at how premiums are calculated for the State of Illinois plans (page 6 of the document, page 8 of the pdf) there is a modest amount of progressivity built in; premiums rise with salary until a certain threshold. If there is progressivity in the premiums, why undo that in terms of the care provided. Deductibles that are a share of the transaction price, as distinct from co-pays that don’t vary with the transaction price, provide an incentive toward such differential care.

At the moment, I’m exempt from Medicare. Having been part of the (underfunded) State of Illinois system for a sufficiently long period my withholdings have gone to the State, not to the Feds. As a result, my healthcare plan is the same one my children are on. (They are under the age of 26.) At present I pay about $800/year in premiums for their healthcare on a per child basis. They then have the same coverage as I do. If you look at the subsequent page of the document linked to in the previous paragraph, you can see the premiums for dependent care, which don’t feature any progressivity in them. Instead, what is obvious is that the incremental cost for the second dependent is lower than the cost for the first dependent and there is zero incremental cost for dependents beyond two. So there is some cross subsidy built into the pricing. In this case large families are receiving a subsidy. To my knowledge nobody is bent out of shape on this point.

This gets you to think about other cross-subsidies in the system. As a retiree, my premiums are zero (this is akin to how Medicare functions). But otherwise premiums don’t vary by age. Nor do they vary by prior healthcare expenditure or current diagnosis. People seem to like these type of cross subsidies. High deductibles can undo the cross subsidization.

We should think about that.