Health Policy Topics for a Principles of Economics Course Tom Buchmueller University of Michigan Ross School of Business

Overview Introduction Major challenges in health policy: cost, coverage, quality How is health care different? Information issues in health care Insurance expansions under the Affordable Care Act Questions/Discussion

My Background PhD in Economics, University of Wisconsin Research in health economics – Mainly health insurance; policy-oriented Teaching in a B-school since 1992 – UC-Irvine ( ); Michigan (2006- present) : Sr. Health Economist, Council of Economic Advisers – Worked mainly on Affordable Care Act implementation

Major Challenges in Health Care Cost – Health care accounts for roughly 18% of US GDP – For decades, health spending has grown by ~ 2% more than GDP Coverage – Nearly 50 million Americans are uninsured – Lack of coverage results in inadequate care, exposure to financial risk Quality – Quality of health care provided to Americans is uneven – Safety, under-provision and over-provision are all problems

Health Care is Different Addressing these problems is difficult because of the many ways that health care markets differ from the ideal of perfect competition. From a teaching perspective, health care (and health insurance) provides a variety of opportunities to introduce concepts of market failure and for interesting philosophical discussions. I begin my health policy course by asking how well the assumptions of the model of perfect competition hold for health care.

The Textbook Model of Perfect Competition Basic Assumptions 1.Standardized product (commodity) 2.Large number of buyers and sellers (price takers) 3.Ease of entry and exit 4.No externalities 5.Good (and symmetric) information 6.Minimal concern about equity/fairness

How Well Does the Model Fit Health Care? There are few markets where the textbook model of perfect competition fits exactly. For some aspects of health care, the fit is not that much worse than for other goods where markets work fine. Other aspects are sufficiently different that a pure market solution will never be possible. Health care is also unique in the way that there are multiple deviations from the competitive ideal.

How Well Does the Model Fit Health Care? Minor Deviations from the Model 1.Standardized product (commodity) -Some care are very patient-specific (but that is true of lots of services) 2.Large number of buyers and sellers (price takers) -In many markets, providers have market power 3. Ease of entry and exit -Licensing and education requirements limit entry to health professions -Regulatory and cost factors limit entry to hospital markets -Patents limit entry to pharmaceutical and device markets  Good examples for discussing the values of competition and the competitive effects of licensing and patent protection

How Well Does the Model Fit Health Care? Moderate Deviation from the Model 4.No Externalities -Communicable diseases  Supply/demand analysis of positive externalities from immunizations

How Well Does the Model Fit Health Care? Major Deviation from the Model 5. Good (symmetric) information -Patients lack information about provider quality, benefits of treatment  Principle-agent problem with providers -Insurers lack information about consumer health risk  Adverse selection -Insurers lack information about the necappropriateness of treatment  Moral hazard 6. Equity concerns -Health care is a right (?) -This is an externality of sorts  Need for redistribution

Information Issues in Health Insurance Adverse Selection Arises when consumers choose as individuals and insurers are limited in their ability to base prices on individual risk. – Higher risks will tend to have a greater demand for insurance – If low risks drop out of the market, premiums will rise – In the extreme, markets may experience a “death spiral” Simple models predict low risks suffer most; in the real world there is a greater concern about insurer practices that disadvantage high risks (risk-rated premiums, coverage denials, pre-ex exclusions) – policies aimed at limiting these practices can make things worse

Information Issues in Health Insurance Moral Hazard General definition: when insurance changes an individual’s behavior in a way that increases the probability or magnitude of a loss. In health care, moral hazard is simply a price effect. – Insurance lowers the price of care at the time of use, inducing a movement down the demand curve

Employer-Sponsored Insurance Accounts for roughly 90% of private health insurance in the US Q: Why do so many employers provide health benefits? A: Should ask why do many workers choose to purchase health insurance through their employers (paying with reduced wages). There are 3 main advantages relative to individual insurance – Tax subsidy of ESI – Risk pooling – Economies of scale

Limitations of Employer-Sponsored Insurance Tax subsidy of ESI contributes to moral hazard Link between insurance and workplace may reduce welfare by distorting labor market decisions – “job-lock”; PT/FT; self-employment – Problems are driven by the lack of good options in individual market ESI coverage is incomplete and declining over time – Negative trend can be explained by rising health care costs combined with rising income inequality For years policy proposals differed on approach to ESI – Some aimed to expand ESI; others eliminated ESI – ACA takes a middle approach: Maintain ESI where it works well (large employers); Reform individual insurance market based on what works in ESI

The Three-Legged Stool of the Affordable Care Act Insurance Market Reforms Individual Mandate Premium Tax Credits

A Government Take-over of Health Care? Affordable Care Act is fundamentally a market-oriented policy – Rooted in proposals by conservative think tanks; tested in MA Complexity of the policy stems largely from the challenge of balancing competing goals – Market competition/consumer protections/redistribution Whether an ideal balance is achieved, remains to be seen