1. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 1 of 35 15.4 Conclusion Health Insurance I: Health Economics and Private Health Insurance 15.3 How Generous Should Insurance Be to Medical Providers? 15.2 How Generous Should Insurance Be to Patients? 15.1 An Overview of Health Care in the United States Chapter 15 Despite the huge benefits reaped from the U.S. health care system, all is not completely well. First, there are enormous disparities in medical outcomes. Second, the United States is the only major industrialized nation that does not endeavor to provide universal access to health care for its citizens.

2. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 2 of 35 An Overview of Health Care in the United States 15. 1

3. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 3 of 35 An Overview of Health Care in the United States 15. 1

4. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 4 of 35 An Overview of Health Care in the United States 15. 1 How Health Insurance Works: The Basics Individuals, or firms on their behalf, pay monthly premiums to insurance companies. In return, the insurance companies pay the providers of medical goods and services for most of the cost of goods and services used by the individual. There are three types of patient payments:  Deductibles.  Copayment.  Coinsurance.

5. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 5 of 35 An Overview of Health Care in the United States 15. 1 Private Insurance nongroup insurance market The market through which individuals or families buy insurance directly rather than through a group, such as the workplace.

6. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 6 of 35 An Overview of Health Care in the United States 15. 1 Private Insurance risk pool The group of individuals who enroll in an insurance plan. Why Employers Provide Private Insurance, Part I: Risk Pooling The goal of all insurers is to create large insurance pools with a predictable distribution of medical risk. The statistical law of large numbers states that as the size of the pool grows, the odds that the insurer will be unable to predict the average health outcome of the pool falls.

7. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 7 of 35 An Overview of Health Care in the United States 15. 1 Private Insurance tax subsidy to employer-provided health insurance Workers are taxed on their wage compensation but not on compensation in the form of health insurance, leading to a subsidy to health insurance provided through employers. Why Employers Provide Private Insurance, Part II: The Tax Subsidy

8. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 8 of 35 An Overview of Health Care in the United States 15. 1 Private Insurance Why Employers Provide Private Insurance, Part II: The Tax Subsidy The subsidy to employer-provided health insurance is generally not well understood. This is not a subsidy to employers but rather a subsidy to employees for insurance purchased in the employment setting. From the employer’s perspective, whether she pays you in wages or health insurance is irrelevant; either way, a dollar of employer spending has the same effect on the firm’s bottom line (since any type of employee compensation is deductible from corporate taxation). From the worker’s perspective, however, there is a large difference: by being paid in health insurance rather than wages, the worker reduces her tax payments. If the government wanted to end the tax subsidy, it would not do so by increasing the corporate tax paid by the firm; it would instead include employer spending on health insurance as part of an employee’s taxable income.

9. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 9 of 35 An Overview of Health Care in the United States 15. 1 Private Insurance The Other Alternative: Nongroup Insurance The nongroup insurance market is not a well-functioning market. Nongroup insurance is not always available. Those in the worst health are often unable to obtain coverage (or obtain it only at an incredibly high price).

10. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 10 of 35 An Overview of Health Care in the United States 15. 1 Medicare Medicare A federal program that provides health insurance to all people over age 65 and disabled persons under age 65. Every citizen who has worked for ten years in Medicare-covered employment (and their spouse) is eligible for Medicare at age 65.

11. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 11 of 35 An Overview of Health Care in the United States 15. 1 Medicaid Medicaid A federal and state program that provides health care for the poor. Medicaid benefits are targeted at several groups:  Those who qualify for cash welfare programs.  Most low-income children in the United States.  Most low-income pregnant women.  The low-income elderly and disabled.

12. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 12 of 35 An Overview of Health Care in the United States 15. 1 TRICARE/CHAMPVA TRICARE is a program administered by the Department of Defense for military retirees and the families of active-duty, retired, or deceased service members. CHAMPVA, the Civilian Health and Medical Program for the Department of Veterans Affairs, is a health care benefits program for disabled dependents of veterans and certain survivors of veterans.

13. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 13 of 35 An Overview of Health Care in the United States 15. 1 The Uninsured Who are they?  The uninsured have lower-than-average incomes.  In 2004, almost 70% of the uninsured came from families where one or more members were full-term workers.  Over one-fifth of the uninsured are children.

14. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 14 of 35 An Overview of Health Care in the United States 15. 1 The Uninsured Why Care About the Uninsured? First, there are physical externalities associated with communicable diseases. Second, there is a significant financial externality imposed by the uninsured on the insured. uncompensated care The costs of delivering health care for which providers are not reimbursed. The third reason we might care whether individuals are uninsured is that care is not delivered appropriately to the uninsured.

15. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 15 of 35 An Overview of Health Care in the United States 15. 1 The Uninsured Why Care About the Uninsured? Fourth, there are paternalism and equity motivations for caring about the uninsured. The final reason for caring about the uninsured is that becoming uninsured is a concern for millions of individuals who currently have insurance. job lock The unwillingness to move to a better job for fear of losing health insurance. Health insurance availability may inhibit productivity increasing job switches.

16. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 16 of 35 HEALTH INSURANCE AND MOBILITY Is job lock an important problem in reality? Initially, a large literature compared the mobility rate of those who have and do not have health insurance. A more sophisticated literature in the 1990s surmounted this problem in two different ways. First, studies used a difference-in-difference strategy that compared a treatment group of those who valued health insurance particularly highly with a control group of those who did not. Second, studies examined the impact of state laws that allowed workers to continue to purchase their employer-provided health insurance for some period of time after leaving their jobs. The results from these studies support the notion that job lock is quantitatively important. E M P I R I C A L E V I D E N C E

17. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 17 of 35 How Generous Should Insurance Be to Patients? 15. 2 The generosity of health insurance is measured along two dimensions. The first is generosity to patients. first-dollar coverage Insurance plans that cover all medical spending, with little or no patient payment. The second dimension of insurance generosity is generosity to providers.

18. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 18 of 35 How Generous Should Insurance Be to Patients? 15. 2 The consumption-smoothing benefit from first-dollar coverage of minor and predictable medical events is small for two reasons. First, risk-averse individuals gain little utility from insuring a small risk. The second reason that the consumption-smoothing benefits of first-dollar coverage are small when medical spending is small and predictable is that individuals are much more able to self- insure such spending than to self-insure large and unpredictable medical events. Consumption-Smoothing Benefits of Health Insurance for Patients

19. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 19 of 35 How Generous Should Insurance Be to Patients? 15. 2 Moral Hazard Costs of Health Insurance for Patients

20. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 20 of 35 How Generous Should Insurance Be to Patients? 15. 2 Moral Hazard Costs of Health Insurance for Patients The “Flat of the Curve”

21. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 21 of 35 How Generous Should Insurance Be to Patients? 15. 2 Moral Hazard Costs of Health Insurance for Patients The “Flat of the Curve”

22. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 22 of 35 How Generous Should Insurance Be to Patients? 15. 2 How Elastic Is the Demand for Medical Care? The RAND Health Insurance Experiment The best evidence on the elasticity of demand for medical care comes from one of the most ambitious social experiments in U.S. history: the RAND Health Insurance Experiment (HIE). The findings of the HIE were striking. First, medical care demand is price sensitive: individuals who were in the free care plan used about one-third more care than those paying 95% of their medical costs. Second, those who used more health care due to the lower price did not, on average, see a significant improvement in their health. Third, for those who are chronically ill and don’t have sufficient income to easily cover copayments, there was some deterioration in health.

23. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 23 of 35 ESTIMATING THE ELASTICITY OF DEMAND FOR MEDICAL CARE Initial research on the elasticity of demand for medical care proceeded by comparing individuals in different types of health plans. It is likely that these earlier studies were seriously biased. The RAND HIE was designed to address this shortcoming. Because of random assignment, we can use the data from the HIE to assess the causal impact of coinsurance on utilization by comparing individuals in different plans. Recent studies have used quasi-experimental approaches to estimate the price elasticity of medical demand. These studies confirm the RAND HIE conclusion that higher copayments reduce care, particularly for prescription drugs, although, they find that the reduction in care has deleterious effects on health for the chronically ill. E M P I R I C A L E V I D E N C E

24. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 24 of 35 How Generous Should Insurance Be to Patients? 15. 2 Optimal Health Insurance An optimal health insurance policy is one in which individuals bear a large share of medical costs within some affordable range, and are only fully insured when costs become unaffordable.

25. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 25 of 35 How Generous Should Insurance Be to Patients? 15. 2 Why Is Insurance So Generous in the United States?

26. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 26 of 35 How Generous Should Insurance Be to Patients? 15. 2 Why Is Insurance So Generous in the United States? The mystery is: Why the jump? There are three possible reasons. The Tax Subsidy Health insurance expenditures by employers are tax subsidized: payments to employees in the form of wages are taxed, while payments in the form of health insurance are not. This is a major reason health insurance is offered through firms.

27. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 27 of 35 Health Savings Accounts  A P P L I C A T I O N Removing or capping the tax subsidy to employer-provided health insurance is a straightforward means of addressing overinsurance, but would be politically difficult because it would be attacked as a large tax increase on workers. health savings account (HSA) A type of insurance arrangement whereby patients face large deductibles, and they put money aside on a tax- free basis to prepay these deductibles. Unfortunately, HSAs have a number of disadvantages as well. First, this new tax break will be expensive in terms of foregone tax revenue. Second, a flat deductible alone is not the right structure for encouraging the proper use of medical care. Finally, if the right way to address overinsurance is to limit the employer exclusion, then HSAs represent the wrong direction for tax policy.

28. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 28 of 35 How Generous Should Insurance Be to Patients? 15. 2 Why Is Insurance So Generous in the United States? The Access Motive A second reason why insurance may be so generous is that the traditional analysis overstates the costs of moral hazard. Moral hazard is measured only by the substitution effect of social insurance programs. The income effect of social insurance programs, the extent to which you change behavior because you are richer, is not moral hazard. Psychological Motivations Finally, the third reason why insurance may be so generous is that there may be motivations for holding insurance that go beyond the simple expected utility model.

29. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 29 of 35 How Generous Should Insurance Be to Medical Providers? 15. 3 retrospective reimbursement Reimbursing physicians for the costs they have already incurred.

30. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 30 of 35 How Generous Should Insurance Be to Medical Providers? 15. 3 managed care An approach to controlling medical costs using supply-side restrictions such as limited choice of medical provider. Managed Care and Prospective Reimbursement Preferred Provider Organizations One fundamental failure in medical markets is that it is very difficult to shop for a medical provider. preferred provider organization (PPO) A health care organization that lowers care costs by shopping for health care providers on behalf of the insured.

31. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 31 of 35 How Generous Should Insurance Be to Medical Providers? 15. 3 health maintenance organization (HMO) A health care organization that integrates insurance and delivery of care by, for example, paying its own doctors and hospitals a salary independent of the amount of care they deliver. Managed Care and Prospective Reimbursement Health Maintenance Organizations In the classic staff model, HMOs hire their own physicians and may have their own hospitals. prospective reimbursement The practice of paying providers based on what treating patients should cost, not on what the provider spends.

32. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 32 of 35 How Generous Should Insurance Be to Medical Providers? 15. 3 The Impacts of Managed Care Spending The consistent finding of a very large literature in health economics is that HMOs spend much less per enrollee than do traditional retrospective reimbursement plans. Quality Do HMOs underprovide, or do they simply serve to correct some of the natural excesses of retrospective reimbursement? There is now an enormous literature on the impact of HMOs on patient treatment, and the answer is a definite maybe.

33. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 33 of 35 How Generous Should Insurance Be to Medical Providers? 15. 3 How Should Providers Be Reimbursed? The advent of managed care has clearly lowered reimbursement to providers, but it has not measurably lowered the quality of care those providers deliver. The key question for the future is whether additional “tightening” of the prospective reimbursement system is needed.

34. Chapter 15 Health Insurance I: Health Economics and Private Health Insurance © 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 34 of 35 Conclusion 15. 4 Most individuals have private health insurance, and that for those employed by large firms this is a well-functioning insurance market. For small firms and individuals there are more failures in the insurance market, one possible reason that almost 46 million Americans are uninsured. Risk-averse individuals greatly value the consumption-smoothing benefits of having their medical bills paid. There are clear moral hazard costs as well, both on the patient and provider side. Some cost sharing has been used to address moral hazard on the patient side, and managed care has arisen as a means of addressing moral hazard on the provider side. The success or failure of these approaches is not yet fully apparent.