1. Chapter 3 Demand for Health Care Services

2. Outline Introduction of health insurance
Theoretical model of health insurance
Empirical estimates of demand from the literature
Practice problems
The RAND Health Insurance Experiment
Example: Interpreting results from a regression on abortion demand

3. Why Health Insurance? Medical expenditure is extreme volatile
1% use 25% exp
5% use 50% exp
20% use 75% exp
Difficult to self-insured because some people are sicker than others
Health insurance is relatively new (at the end of 19th century) since treatment was not very effective before

13. Insurance with Fixed Spending
One person:
U(x, h)
U’>0, U’’<0
One illness
sick with probability p
fixed treatment cost: m
H(h, m)=H(1, m)=H(0,0)
Two states
Sick (s): U(y-m, H(1,m))
Health (m): U(y, H(0,0))

14. Without insurance

15. With insurance
Fair insurance: π= pm

16. Comparing With and Without Insurance
Taking Taylor’s expansion, we have

18. The insurance plan specifies the amount of money transferred to the bad state

19. Problem with Fixed Spending
Complete information
All the sicknesses known
All the treatment known
No wasted resources in the policy
The insurance specifies the amount of money being transferred during the sickness (contingency plan)
The policy completely insures the health, but s it possible to insure someone’s health?

20. Estimating Demand for Medical Care
Quantity demanded = f( … )
out-of-pocket price
real income
time costs
prices of substitutes and complements
tastes and preferences
profile
state of health
quality of care

21. Empirical Evidence
Demand for primary care services (prevention, early detection, & treatment of disease) has been found to be price inelastic
Estimates tend to be in the -.1 to -.7 range
A 10%  in the out-of-pocket price of hospital or physician services leads to a 1 to 7% decrease in quantity demanded
Ceteris paribus, total expenditures on hospital and physician services increase with a greater out-of-pocket price

22. Empirical Evidence (cont.)
Demand for other types of medical care is slightly more price elastic than demand for primary care
Consumers should be more price sensitive as the portion of the bill paid out of pocket increases

23. Out-of-Pocket Payments in the U.S.
Hypothesis: Consumers are more price sensitive if they pay a larger % of the health care bill
The fall in the % of out-of-pocket payments may explain the rapid rise in health care costs

24. Out-of-Pocket Payments in the U.S.
Total Expenditures and % Paid Out-of-Pocket, 2007
Hypothesis: Consumers are more price sensitive if they pay a larger % of the health care bill
Higher hospital and physician expenditures may be due to the low % paid out-of-pocket

25. Out-of-Pocket Payments in the U.S. (cont.)
The previous 2 slides argue that:
 insurance coverage   expenditures
But it may be the opposite:
 expenditures   insurance coverage.
We cannot identify a causal effect using just this data

26. Empirical Evidence (cont.)
Studies which have examined price and quantity variation within service types have found that:
The price elasticity of demand for dental services for females is -.5 to -.7
The own-price elasticity of demand for nursing home services is between -.73 and -2.4

27. Empirical Evidence (cont.)
At the individual level, the income elasticity of demand for medical services is below +1.0
The travel time elasticity of demand is almost as large as the own-price elasticity of demand
Little consensus on whether hospital care and ambulatory physician services are substitutes or complements

28. International Estimates of Income Elasticity
Are health care expenditures destined to consume a larger portion of GDP as GDP grows?
Regression Analysis
Sample - developed countries
Ln(Real per capita Ln(Real per
= a + b e
health expenditures) capita income)
Estimates of b range between 1.13 and 1.31

29. Applying Demand Theory to Real Data
Demand analyses in health care must take insurance into account
Demand analyses are critical in shaping managerial and public policy decisions

30. The Rand Health Insurance Experiment (HIE)
Research issues:
How does cost sharing affect demand for personal health care services?
How does cost sharing affect demand for particular services, e.g., hospital care, dental services?
Does use of personal health care services improve health?
How does a change from fee-for-service payment to capitation affect demand for personal health care services?
Rationale for studying HIE 30+ years after HIE completed

31. The Rand Health Insurance Experiment
A large, social science experiment to study individuals’ medical care under insurance
A large sample of families were provided differing levels of health insurance coverage
Researchers then studied their subsequent health care use

32. The Sample 5,809 individuals, under 65 6 sites 1974 – 1977
Dayton OH, Seattle WA, Fitchburg MA,
Charlston SC, Georgetown County SC, Franklin County MA
1974 – 1977
Cost : $80 million

33. Insurance Plans in the Experiment
Families randomly assigned to 1 of 14 insurance plans differing in cost sharing rates and in maximum dollar expenditures per year (MDE or stop loss)
Free fee-for-service (FFS).- i.e., no coinsurance
25% copayment per physician visit
50% copayment per physician visit
95% copayment per physician visit

34. Insurance Plans in the Experiment
Individual deductible
- $150 deductible for physician visits; all subsequent visits free
HMO
- Not the same as free fee-for-service
- Since HMO receives a fixed annual fee, it seeks to limit physician visits

35. Table 3.3. Sample Means for Annual Use of Medical Services per Capita
Plans*
Face-to-Face Visits
Outpatient Expenses (1984 $)
Inpatient Dollars (1984 $)
Total Expenses (1984 $)
Probability Using Any Medical Service
Free
4.55
340
409
749
86.8
25%
3.33
260
373
634
78.8
50%
3.03
224
450
674
77.2
95%
2.73
203
315
518
67.7
individual deductible
3.02
235
608
72.3
* The chi-square test was used to test the null hypothesis of no difference among the five plan means. In each instance, the chi-square statistic was significant to at least 5 percent level. The only exception was for inpatient dollars
Source : Willard G. Manning et al. “Health Insurance and the Demand for Medical Care : Evidence from a Randomized Experiment,” American Economic Review 77 (June 1987), Table 2

36. Results (cont.)
No statistically significant difference in inpatient (hospital) expenses by insurance type
Does NOT necessarily imply inelastic demand for hospital services
Experiment included $1,000 cap on out-of-pocket medical expenses; 70% of hospital admissions costs $1,000 +
As coinsurance ↑‘s, probability of ANY use ↓‘s

38. Own Price Elasticity of Demand
Results (cont.)
As consumers’ copayments drop, demand for medical care becomes more price inelastic
The data confirms the theory
Own Price Elasticity of Demand
All Care
Outpatient Care
Copay 0-25%
-0.10
-0.13
Copay 25-95%
-0.14
-0.21

39. Results (cont.) Free fee-for-service (FFS) versus HMO coverage
No difference in physician visits found
But only 7.1% of HMO patients admitted to hospital, versus 11.2% of FFS patients
HMO patients cost 30% less than FFS patients on average
HMO’s do save money relative to FFS

40. Health Implications
The experiment verifies that ↑coinsurance → ↓demand for medical care
What are the implications for health outcomes?
i.e restraining medical care expenditures is not the only objective we care about, especially for the poor

41. Health Implications (cont.)
Poor adults (lowest 20% of income distribution) with high blood pressure experienced clinically significant improvement under free FFS plan, but not in cost sharing plan
Similar findings for myopia, dental health
Free FFS only improves health outcomes in 3 specific cases versus cost-sharing
If want to restrain costs and maintain health, targeted programs at these 3 health problems is more cost-effective than free care for all services

42. Was it worth it? Rand Health Insurance Experiment cost $80 million
Initial results published in 1981
In the next 2 years, # of insurance companies with first-dollar coinsurance for hospital care increased from 30% to 63%
# of insurance companies w/ annual deductible of $200 + per person ‘d from 4% to 21%
Estimated cost saving from ‘d demand for medical care = $7 billion
Government sponsored studies often yield important knowledge for business

43. Conclusions
Our economic model of demand provides hypotheses that we can test with real data
Although it is difficult to measure the quantity of medical services demanded and economic variables, both price and income effects are important determinants of the demand for medical care