Change Matters: A Dynamic Demand for Medical Care Jennifer L. Kohn Agenda: 1. Motivation 2. Literature & Contribution 3. Model 4. Empirical Tests 5. Conclusion and Future Research

Source: Kaiser Family Foundation calculations using data from the U.S. Department of Health and Human Services, Agency for Healthcare Research and Quality, Medical Expenditure Panel Survey (MEPS), > $13,000< $730 Motivation The top 5% of spenders account for nearly 50% of spending. > 65 < 65 poor health

Literature & Contribution Theoretical Literature: Willingness to Pay: Mishan (1971), Berger et.al. (1987), Murphy & Topel (2006) Human Capital: Grossman (1972), Ehrlich & Chuma (1990), Liljas (1998) Empirical Literature: Theoretical Testing: Grossman (1972), Wagstaff (1986, 1993), VanDoorslayer (1987) Health & Wealth: Viscusi & Evans (1990), Blau & Gilleskie (2006), Finkelstein et. al. (2008) Econometrics: Newhouse et. al. (1980), Deb & Trivedi (1997), Greene (2007) Empirical Contributions: 1. Multiple equation model consistent with the theory. 2. Empirical support for the significance of the change in health. 3. Empirical support for the assumption that health and wealth are complements and consumption and medical care are not separable. Theoretical Contributions: 1. An explanation for the observed pattern of medical care spending. 2. Model of health transition consistent with current accounting. 3. Testable hypotheses about the demand for medical care.

Model: Utility “Utility” = Consumption, Health, and the Change in Health today yesterday Health gets better! yesterday Health gets worse. Literature: Habit Formation -- Constantinides (1990) Adaptation -- Groot (2000), Gjerde et. al. (2005)

Model: Utility 1. Health State, not a flow of healthy days Grossman (1972), Ehrlich & Chuma (1990) Berger et. al., (1987) “…the utility individuals derive from consumption depends on their state of health.” Murphy & Topel (2006) 2. General functional form Change in Health

Model: Change in Health Change in Health = Investment - Depreciation medical care AND current health an amount NOT a rate x stock Medical literature: co-morbidities FASB # 142 (2001) Grossman (1972) Old way:New way:

Higher health, more negative the decline in health Source: NYT 7/30/06 Higher health, less negative the decline in health Model: Change in Health

Model: Change in Wealth and Endpoint Conditions Endpoint Conditions: H min and T max are exogenously fixed at the beginning of the planning horizon

Why do we demand medical care? Marginal Benefits From Health = Marginal Cost of Health Capital Marginal utility from health + Marginal income from health Marginal cost of medical care + Interest rate + rate of depreciation No inevitable disequilibrium + Marginal utility from the change in health x Marginal productivity of health to investment - Marginal productivity of health to investment Inevitable disequilibrium! Larger disequilibrium the lower the state of health Larger disequilibrium the greater the decline in health

Marginal benefits of longevity decrease over the lifecycle Grossman (1972): “…even though Health capital falls over the life cycle, gross investment might increase, remain constant or decrease.” Why do we demand more medical care? Marginal utility from the change in health and marginal productivity of health keep benefits high. t↓Tt↓T

RAND (2003) Why do we demand more medical care at the end of life? Ehrlich & Chuma (1990) g(T)

Time Path of Medical Care Demand

Time Path for Consumption The demands for consumption and medical care are not separable. The sign of the relationship between health and consumption, and between the demands for medical care and consumption are empirical questions.

Summary of Theoretical Implications 1. Change matters: the change in health is a significant factor in an individual’s demand for medical care. 5. Health and wealth: health and consumption and consumption and medical care demands are not separable. 2. Price matters less over the lifecycle. 3. Quality of life matters more than longevity at the end of life. 4. The advance of medical technology increases the demand for medical care over time.

Empirical Issues 1. Consistency with the theory Gilleskie (1998) Joint estimation of the demands for medical care and consumption Consistency with economic restrictions 2. Unobservable health and price for medical care Single or multiple indicator, Self-assessed health MIMIC Van der Gaag and Wolfe (1982), Ersblad et. al. (1995) Latent Variable Bound (1999), Disney et. al. (2006) MCA Greenacre (2002) Hadley and Weidman (2006) 3. Discrete counts and unobservable heterogeneity Negative binomial, finite mixture Deb and Trivedi (1997), HHG (1984) Incidental parameters problem Greene (2007) Initial conditions problem Wooldridge (2005)

Non-linear system of equations (NLSUR) Empirical Specification j = hospital days (H), tests & services (TS), and general practitioner visits (GP) Controls = marital status and education Errors clustered by individual and correlated across equations Economic Restrictions: 1.Negative own-price effects (negative semi-definite Slutsky matrix) 2.Symmetry in cross-price effects The greater the decline in health, the higher the demand for medical care. Hypotheses: The demands for health and consumption are not independent. The demands for medical care and consumption are not separable.

Data Data: 14 waves (1991 – 2005) of the British Household Panel Survey FULL sample: 119,970 person-year observations OSM balanced panel of 40,896 observations (3,145 individuals) Distribution of the Change in Health Self-reported health 1 = good Health Index Self-reported Health and the Health Index Health Index: MCA using all available data for each wave. If the change in health matters, we should be able to see it!

Empirical Results FULL Sample, P-values reported < 0> 0

Robustness Results Signs, significance and magnitudes consistent across specifications

consumption Utility Health Higher Health Lower Health Z(H) Z(High) Z(Low) A decline in health is associated with an increase in the marginal utility of consumption. Health & Wealth Implications Holding price constant, consumption declines

Value of a “Life Year” Murphy & Topel (2006) Value of a Life Year IncomeConsumption

Source: Kaiser Family Foundation calculations using data from the U.S. Department of Health and Human Services, Agency for Healthcare Research and Quality, Medical Expenditure Panel Survey (MEPS), > $13,000< $730 Conclusion Change Matters! We make trade-offs between health and consumption. Econometric issues for better fit to data Do people stay in the top 5% over time? How are the top 5% affected by price? What is the trade-off between quality and quantity of life? What is the effect of medical technology?

The Wall Street Journal, December 12, Dr. Kishnani, who led the second clinical trial, says, "What I learned from these trials is that each family has to decide when enough is enough." How do we design a health care financing system where every family gets to make this choice? Future Research