The role of government in health care

Today: Reasons for having government-provided health care; Medicare; Medicaid; Reform efforts

Previously…

We saw that health care costs (as a percentage of GDP) have rapidly increased over the last 50 years

Health care insurance Advantages and

disadvantages

Figure 9.1: US expenditures of selected goods and services as share of Gross Domestic Product (1960-2004)

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Today

Government-provided health care Why should government provide health care?

Programs Medicare Medicaid

The government’s role in health care reform

Why should gov’t provide health care? Adverse selection Moral hazard Paternalism Income too low for some people

Adverse selection

Recall adverse selection problem (see example to the right)

The government could force everyone into the same health care plan Pro: Adverse selection

problems go away Con: Low-risk people

subsidize high-risk people

Example: 6 people at a firm Spending if sick: $10,000 3 people have a high risk of

getting sick 10% each

3 people have a low risk of getting sick 5% each

With no employer contribution, some at low risk do not buy insurance

Moral hazard

Some activities are more likely to occur to an insured person Bungee jumping Mountain climbing Skydiving Smoking? Bad eating habits?

These activities lead to inefficient outcomes

The government can intervene to try to discourage these things from occurring Anti-smoking campaigns Commercials promoting

good eating habits Prohibiting certain very

dangerous activities Withholding care due to

dangerous activities

Paternalism

A paternalist would argue that some people “don’t get it right” when it comes to health insurance

These people would say that everyone should be forced to have a minimum level of health care

Much of the 2008 presidential debate involved paternalistic arguments

Income too low for some people Some people do not

make enough money to afford health care Problem made worse by

increasing health care cost (see “Downward spiral” at right)

Young adults and noncitizens make up a substantial fraction of the uninsured in the US

Downward spiral Health care costs go up More people are unable

to afford health insurance These people must use

the Emergency room, driving up premiums for those insured

When premiums go up due to increased numbers in the Emergency room, the cycle repeats

What does the government do? The government provides over 45% of health

care funds in the United States Two main programs of government-provided

health care Medicare

People 65 and older Disabled people

Medicaid Poor people

Figure 10.2: Sources of health care funds in the United States (2004)

Private Health Insurance (35%)

Out-of-Pocket Payments (13%)Other Private

Payments (7%)

Medicare (17%)

Medicaid and SCHIP (16%)

Other Government Payments (13%)

SOURCE: Centers for Medicare and Medicaid Services [2005a].

Medicare

Enacted in 1965 Second largest domestic spending program

Funded by a 2.9 percent tax on earnings of current workers Tax split evenly between employers and employees

Provides health insurance to seniors and the disabled, primarily through the private sector Seniors must have worked and paid payroll taxes

for at least 10 years About 35 million seniors enrolled

Medicare: Overview

Figure 10.3: Medicare expenditures (1966-2004)

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SOURCE: Centers for Medicare and Medicaid Services [2005a].

Real expenditures on Medicare

Expenditures on Medicare as a Share of GDP

Different aspects of Medicare

Parts A and B of Medicare are the largest components Part A: Hospital insurance Part B: Supplementary medical insurance

New Medicare component: Part D Prescription drug benefit

Cost control measures for Medicare Before 1983, Medicare reimbursement was

retrospective for Part A Compensation is made after services are completed Little incentive to economize on costs

Since 1983, this changed to a prospective payment system (PPS) Compensation level is set before services start

500 diagnosis related groups exist for the prospective payment system

This gives incentives to economize on costs

Cost control measures for Medicare Recall DWL that occurs

when MB is low PPS appears to have

decreased DWL Average stay for

Medicare patients in short-stay hospitals decreased from 10.5 days in 1981 to 8.5 days in 1985

The decrease in stay appears to have no effect on health outcomes

Cost control measures for Medicare To keep costs down for Part B, a resource-

based relative value scale system is used Fees are set per service provided

Does not necessarily keep down number of services If fees are set too low, many medical practices will not

accept Medicare patients Medicare patients would then get low-quality care

Cost control measures for Medicare Managed-care options

Since 1985, Medicare beneficiaries could enroll in HMOs Originally, the HMO received 95% of the average

amount that the average patient would require Problem: Adverse selection… Healthier patients enrolled

in HMOs The government was overpaying the HMO

Cost control measures for Medicare Solution to adverse selection problem: Risk-

adjusted payments to HMOs Reduced HMO enrollment

New methods are being tested to try to increase HMO enrollment and decrease costs simultaneously

Medicaid: Overview

Figure 10.4: Medicaid expenditures (1966-2004)

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Medicaid eligibility

1965: Health insurance for recipients of cash welfare payments

1980s: Children of low-income two-parent families became eligible “Children” can include care to pregnant women

1997: State Children’s Health Insurance Program Allows states to get additional money from federal

government to reduce number of uninsured kids

Financing and benefits

Federal and state governments share the cost Poor states get higher matching rates than rich

states Federal government contribution comes from

general revenues States must offer major services with

Medicaid Hospital stays, physician visits, prenatal care,

vaccines for children

Financing and benefits

States have some flexibility in program administration Example: Capitation-based reimbursement is

allowed Recall that health care provider receives annual

payment per patient in their care, independent of services rendered

Some empirical evidence (Duggan 2004) shows that forcing people into managed care increased Medicaid costs Questionable if the causation implied is actually true Other relevant factors may be missing, leading to bias

Medicaid stigma

Many people do not enroll in Medicaid Guilty feelings Stigmas Uninformed about

benefits Public service

announcements help to get more eligible children on Medicaid

Does Public Insurance Crowd Out Private Insurance?

Health insurance Health insurance Health insurance

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Amount of publiclyprovided insurance

Amount of publiclyprovided insurance

Amount of publiclyprovided insurance

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Person who is uninsured before public insurance

Person who values private insurance relatively lowly

Person who values private insurance relatively highly

Are Medicaid expansions effective? Unclear for two reasons

How much is due to crowding out? Many eligible people do not enroll in Medicaid

Cutler and Gruber (1996) estimate that about half of new Medicaid enrollment previously had private insurance

Card and Shore-Sheppard (2004) estimate that crowding out occurs less than Cutler and Gruber estimate They also find that take-up rates due to expansion are low

Another issue: Job lock

Job lock If a new job does not offer insurance due to a pre-

existing condition, the worker will stay at the old job

Health Insurance Policy Portability and Accountability Act of 1996 (Kennedy-Kassenbaum Act) Provides provisions to reduce job lock Mixed success

Health care reform

Why is health care reform a hot topic? Increased costs Significant portion of population without insurance

Increases cost to others

Two parts to discuss here Some questions about possible reforms What has actually been passed?

Health care reform

Some proposals to try to solve the health care problem Mandating everyone to have insurance

Hot topic in the 2008 Presidential race Catastrophic insurance

Only provides payment when expenses become large Health Savings Accounts can be used to pay for this

type of insurance Nationalized health care… Consumer-driven health care (CDHC)

Nationalized health care reform Pros

Everybody is covered Commodity

egalitarianism No adverse selection

problems Government can use

cost-cutting measures to prevent care with low MB

Cons Predetermined budget

may lead to a suboptimal amount of health care provided

Long lines in some cases Government determines

what is “medically necessary”

New technology may not be adopted quickly

Moral hazard problems

What is CDHC?

Recall inefficiencies of providing coverage for basic services Over consumption of medical services Deadweight loss

CDHC advocates health insurance to be like other types of insurance Covers truly catastrophic events High deductibles Shoppers can shop many companies, not just

what is offered by employer

CDHC example

Recall we have seen this type of example already Provide a yearly fund to each person or family

Carries over to the following year if not used After the yearly fund is used, up to $5,000 of

expenses must be made out-of-pocket After out-of-pocket expenses are paid, 90% of

expenses are covered Insurance for years with truly high expenses

CDHC reform

Pros Reduces deadweight

loss by letting consumer pay full cost of health care

Increased competition by allowing consumers to shop around

Cons Unhealthy people could be

priced out of the market due to high risk

Most consumers are unable to make completely informed decisions about health care

Routine exams and immunizations with high levels of positive externalities may be forgone

Is there a solution?

Is there a solution to the health care problems presented over the last week? There will probably never be a complete solution

Security and efficiency will be “at odds” with each other Some people will always choose NOT to have

insurance unless forced to Current trend: More middle-class Americans are

deciding to have little or no insurance This increases health care insurance premiums for those that remain insured Downward spiral

Changes coming from the 2010 Reform Law soon

Is there a solution?

What if we are willing to accept new ways for health care and insurance to be administered? We will likely be able to increase security without

giving up efficiency Catastrophic insurance may be most important at

reducing risk Higher deductibles, co-payments, and co-

insurance rates can decrease loss of efficiency

Is there a solution?

Is prevention the key? Should people be encouraged to eat healthy?

Should healthy food be subsidized? Should unhealthy food be taxed?

Are taxes on smoking and alcohol set at the optimal level?

Should some drugs be legalized, taxed, and regulated? Tax money can be used for health care costs

Some parts of the reform package… Another part of the solution: General

requirement to have health insurance Most firms must provide the option Most Americans would be required to buy

coverage “Fairness” issue: Increased pooling

Companies are prevented from denying coverage due to pre-existing conditions

What will the reforms lead to? Fewer downward spirals

Lower frequency of insured people paying uninsured’s costs Possible reduction in insurance premiums

Probable net increase in use for services Many more routine visits Fewer ER visits

What is still needed?

Ways to deal with DWL due to not paying full cost Policies to increase efficiency are needed

Figuring out how to pay for these reforms Value added tax (VAT) needed?

Dealing with the high costs of the retiring Baby Boom generation

Summary

The government provides health care insurance for millions of Americans through Medicare and Medicaid Some believe that every person should be able to access

needed health care Adverse selection and moral hazard are significant

problems Health reform efforts try to increase medical

coverage Paternalistic issues and efficiency are at odds with each

other

Next lecture

Social Security Chapter 11

Read pages 227, 231-235, and 239-250 History Current structure Long-run problems due to the graying of America How people’s decisions differ with and without

Social Security

Problem

Timothy has the following utility function U(x, y) = x + (10,000y)½ x denotes Timothy’s consumption on everything

except health care y denotes Timothy’s consumption on health care

Note: We assume no disutility from work

Problem

Timothy is currently working 1,500 hours per year Hourly wage is $10 He also receives government health care, valued

at $3,000 per year Timothy could work a second job for 700

hours per year Hourly wage is $8 With the second job, Timothy would make too

much money for government health care

Problem

What should Timothy do? We need to find Timothy’s highest possible utility

working one job …working both jobs

Problem: Working one job

Total wages: $15,000 Total government health care: $3,000 Total benefits: $18,000 How does Timothy maximize utility if he has

$18,000 in total benefits? Note that at least $3,000 must go to health care Maximize x + (10,000y)½ subject to x + y = 18,000

and y ≥ 3,000

Problem: Working one job

Maximize x + (10,000y)½ subject tox + y = 18,000 and y ≥ 3,000 For now, ignore y ≥ 3,000

Maximize x + (10,000y)½ subject tox + y = 18,000 Equivalent to Maximize 18,000 – y + (10,000y)½ First order condition

–1 + 10,000½ / 2y½ = 0 y = 2,500

Since Timothy would only want $2,500 in care, he is constrained to take at least $3,000

Utility from working one job

Utility when x = 15,000 and y = 3,000 15,000 + (10,000 * 3,000)½ = 20,477

Working two jobs

Wages $15,000 from first job $5,600 from second job $20,600 total

Working two jobs

Timothy’s maximization problem Maximize x + (10,000y)½ subject to x + y = 20,600

Notice that x and y only need to be nonnegative here Maximize 20,600 – y + (10,000y)½

First order condition is the same as with one job y = 2,500

Working two jobs

What is Timothy’s utility if he works both jobs? He spends $2,500 on health care He has $18,100 left for everything else Utility is 18,100 + (10,000 * 2,500)½ = 23,100

What should Timothy do?

Utility from one job: 20,477 Utility from both jobs: 23,100 Timothy should work the second job and give

up his government health care

Is “Big Brother” caring for you?