Health insurance and the tragedy of the common risk pool (Doc Holliday) 1:58 AM

In my earlier posting (8 October 2009) I discussed the adverse effects of community rating on the efficiency of health insurance markets, and put forward a case for a modified voucher system for health care (which in the Australian context, I will call Medicare Savings Accounts or MSAs). In this posting I examine the tensions between health insurers and medical care, and propose some policy solutions.

A heated point of discussion in the health insurance debate is how to reimburse (that is, pay) doctors and hospitals. The traditional method of payment is the ‘fee for service’ – in which a doctor and a hospital is paid for the services they render. To an economist, this model appears to be fairly obvious – as a fee for service is basically the price of providing a service. Yet in the context of health care it has created all sorts of strange notions and policy prescriptions which are ultimately ill-conceived and self defeating.

The case against fee for service is that, put simply, doctors have an incentive to over-service their patients. The economics of this incentive is rarely put forward with any clarity by its proponents. They generally appeal to notions of ‘information asymmetries’ and ‘market power’. But none of these are adequate explanations. For example, market power assumes that doctors reduce their supply of services - but this is the opposite of what has been observed. Similarly, information asymmetries lead to adverse selection (Akerlof’s lemons problem), something which the medical colleges seem to adequately addressed.

The only explanation that makes sense to me is that over servicing is part of the wider problem of contractual enforcement - doctors have an incentive to charge and serve ‘that little bit more’ because insurers are unable to closely monitor doctors’ actions. Another way of looking at it is to think of pooled insurance being a 'tragedy of the commons'. The insurance pool is a common resource which doctors do not have any incentive in preserving. Rather, they have an incentive to encourage consultations and prescriptions believing that they are acting in the interest of their patient.

This problem is not unique to health insurance and examples can be found in other insurance markets. Consider the analogy of an automotive panel beater. I have lost count of how many times I’ve approached a panel beater and asked him to give me two quotes for the same job – a cash job and an insurance job. The quote for the insurance job is always more costly and extensive (in terms of work undertaken). The same logic applies in medicine. This phenomenon is analogous to moral hazard, but whereas moral hazard is normally associated as the patient's response to imperfect contractual arrrangements, this squarely puts it in the lap of suppliers.

One obvious implication is that free-riding on the insurance pool will give each patient additional care, but it is not clear whether the additional services necessarily lead to valuye-for-money. Another implication is that the logic of the tragedy of the commons applies to both private health insurance and to single-payer government fund insurance schemes.

My observations are not in any way new. Commentators have long observed the expansion in supply, and it has been dubbed as 'supplier-induced demand'. However, this explanation seems to have the best ring of truth to it.

But if fee for service in a pooled insurance setting leads to free-riding / supplier-induced demand (these terms should be used interchangeably), what have been the policy responses? In Europe, the United Kingdom and the United States, supplier-induced demand has led to the changes in the reimbursement of doctors and an increased monitoring of doctors' practices. In the United States where fee for service arrangements are commonplace, health management organisations (HMOs) have emerged. HMOs enter into contractual relationships with patients and doctors alike, and set limits on the practices of doctors. They can, for example, refuse to fund a course of treatment if it believes is not fiscally responsible. In the UK, the National Health Service has long salaried doctors in hospitals and has recently been changing the reimbursement of GPs. Now, doctors are reimbursed in terms of the number of patients on their books not how frequently they see their patients. In Europe, mutual sick funds have long operated their own hospitals and salaried doctors, and have closely monitored the prescribing behaviour of doctors.

There are similar pressures in Australia. Public hospitals in Australia have traditionally been funded on a capped budget basis, and doctors in public hospitals are salaried. Though some jurisdictions have increasingly adopted casemix funding of hospitals (such as Victoria) (which is essentially a fee for service arrangement) to improve productivity, in NSW at least, a public hospital is now funded according to how many people there are in its catchment area.

However, these policy prescriptions have two obvious deleterious effects. First, the close monitoring of the practices of doctors is in effect equivalent to regulating doctor behaviour. While it might be argued that it is welfare enhancing (relative to free-riding) it is not a first-best policy solution. Telling a doctor he can not give medicine x to a patient with condition y is a blunt (inefficient) instrument and misses the point that patients are highly individual and what might be an appropriate course of treatment for one patient may not be effective for another.

Second, paying doctors and hospitals fixed amounts reduces their productivity. As a community, you want doctors and hospitals to be as productive as possible (technically efficient) as they are very scarce and valuable resources. Yet paying a doctor on an hourly-basis will yield lower levels of productivity than if you were to pay them on a piece-work basis. Consider for example asking two house painters to give you a quote to paint the house: the one that gives you a fixed price quote will get the job done quicker than the one that quotes you an hourly rate. If doctors in public hospitals work long hours, it may not be because of the excessive workload they face, but because of the internal inefficiencies of the hospital caused by the financial incentives the hospital and doctors face.

This is not to say that regulating doctor behaviour and paying doctors on a salaried basis (or funding hospitals with fixed budgets) has no role in the community. But these are at best second-best solutions.

What then is the first-best policy solution? If it is the case that supplier-induced demand is simply free riding by another name, the answer is to ensure that the financial implications (market failure) of doctor behaviour are fully internalised. There are two complementary solutions to this. The first is to empower patients to resist over servicing. In my previous posting I put forward the case of governments creating Medicare Savings Accounts, abolishing community rating and making governments pay the actuarial risk premia to patients into MSAs. Under these reforms, patients will directly directly face the costs of their own health insurance, and will have a strong incentive in protecting their portion of the insurance pool. Doctors will not over service if the patient believes that the additional activity will not yield any additional benefits.

The second approach is not to employ and salary doctors but for them to own the health insurance business. Once doctors own the health insurance arm, they in effect internalise the costs of their own tendency to over service. Indeed, not only do patients have an incentive to look after their own health, but doctors will change their own behaviour away from simply disease treatment to disease prevention.

There is nothing in legislation or regulation that prevents doctors from starting their insurance fund, so in principle, it is possible. In Australia, however, there are a number of financial disincentives that inhibit such an institutional arrangement from arising. Two come to mind. First, there is little incentive for new businesses to enter into the health insurance industry. The presence of Medicare alone has severely curtailed the profitability (and degree of competition) among health insurers. When was the last time you read in the news of the start up of a new health insurer in Australia?

Second, since Medicare arrangements provide doctors with a nice little earner there is no incentive for them to champion a new world order of competition. You can bet your pretty penny that the Australian Medical Association will resist any attempts to reform Medicare. Replacing Medicare with MSAs implies greater competition for health insurance, which of course, doctors will not necessarily support.

This is not to say that doctor-owned insurance businesses do not exist. One standout example is the famous Kaiser Permanente of California. But a case study of Kaiser Permanente is for another posting.

regards

Doc Holliday

Insurance, the Market and those pesky wowsers (Doc Holliday) 3:19 AM

Now that my work has lightened up, I too will part a few shots at government and wowsers.

Health care puts forward a number of dilemmas for economists and policy makers. In this posting, I will consider the incentives and distortions that have arisen from government intervention in the provision of health insurance. I will also put forward a solution.

In any laissez faire insurance market, insurers charge insurance premiums that reflect the risk that people impose on the pool of insurance premiums. This is true for all insurance markets that I can think of - cars, houses, luxury boats, personal property. If you are 18 years old and park your Subaru WRX in Broadmeadows overnight, you pay the price!

Unfortunately, this doesn't occur in health. Instead, in every developed country that I can think of, everyone pays the average (pool) price - not the marginal cost. This is not because of a decision by health insurances but because of government regulation. The objective of community rating regulation as it is called, is to ensure that even the poorest can access affordable health care. Its effect is to smear insurance costs so that the rich and healthy subsidise the poor and the sick.

Community rating regulation appeared first in countries where private health insurance was the norm. But it also operates in the government-run single payer schemes (consider the National Health Service in the UK, Medicare in Australia and Canada). In these schemes, the costs of health insurance are smeared across tax-payers, not those seeking insurance. (The medicare levy surcharge is an exception, but this is only effective when we consider the role of Australia's Lifetime health cover rating system).

However, this has some rather unintended consequences (hello hello!). One is that it removes any incentive for individuals to adopt healthy life-styles. Why drink green tea and ride a bike to work if you know that someone else is paying for your healthcare?

In a laissez faire market, there would be a variety of insurance companies each offering slightly different products. Some might offer health-management organisation type contracts: you agree to change your behaviours (eg give up smoking) in return for discount insurance. (Funnily enough, the earliest health insurance schemes (organised by many religious and charitable organisations) at the turn of the 20th century did offer just that.)

But under community regulation, no one has an incentive to change their behaviour. This is a problem for both private health insurance schemes (as in US, Switzerland and Greece) and single-payer schemes (UK, Canada and Australia). In bid to protect the insurance pool against the threat of smoking and drinking geriatrics, wowsers step up to the plate to start issuing edicts: that shalt stop drinking, smoking, and growing old etc. The number of regulations that Roy posted are indeed scary. But in a dysfunctional market without marginal prices, the number of regulations can not but grow as bureaucrats scramble to change behaviour. Any market in which there are no prices will grow increasingly dysfunctional as successive layers of regulation are introduced to control it.

Is there a role for the market? I believe there is, and Australia already gives us an example. Some years ago (in 2000 I think), Australia introduced Lifetime health cover (LHC). It was introduced by the Howard Government in response to the adverse selection taking place as healthy people opted out of private health insurance to be covered by Medicare. LHC in effect penalises people incrementally the longer they remain privately uninsured. It acts like a second-best market price for private health insurance (PHI). The older and more likely you are to get sick, the more private health insurance will cost, so join up when

you're young. It doesn't give you the same incentive to change your lifestyles as an actuarially fair premium but its close. But it did influence PHI membership dramatically. It also demonstrates that people are sensitive to market prices - even for health insurance.

Back to my dilemmas for economists and policy makers. How do we get a healthcare system that is offers all the economic efficiencies that is currently lacking yet addresses the equity concerns of providing care for the poorest in the community? The obvious response is to introduce a voucher-type system. Governments provide individuals a voucher (it may be means-tested) to be spent on health insurance. The amount given to the individual reflects their risk-rating (so high risk individuals get paid more). Individuals can get to keep some of that voucher if they can demonstrate a reduction in their risk-rating (credited back to a Medicare Savings Account for use on a rainy, sick day). Individuals can use that voucher money to purchase private health insurance from any number of competing health insurers on the market.

There is another dilemma in health care that needs addressing - market power of medical professionals (doctors and surgeons). But that is for another posting.

regards

Doc Holliday.

Deteriorating current account balance not a positive sign (Lone Ranger) 7:41 PM

The latest Balance of Payments numbers are out from the ABS and they do not tell a pretty story. The current account balance on goods and services (exports less imports) has deteriorated markedly in recent months. In of itself this is hardly a surprise, as Australia has generally had a services and goods trade deficit for decades.

Of most interest is the balance of trade for goods, which deteriorated from surpluses in the Dec '08 quarter ($3.2 billion) and Mar '09 quarter ($4 billion) to a deficit in the Jun '09 quarter (-$633 million). This is a concern because while our imports have decreased slightly from $64 billion in the Dec '08 quarter to $48 billion in the Jun '09 quarter, the value of goods exports have collapsed from $67 billion to $47 billion in the same period. While volumes have not much changed (yet), export prices for coal and minerals are way down, and this at a time where China has been stockpiling and, if anything, fuelling demand.

This begs the question - is Australia likely to have a "recovery" at a time of falling commodity prices and, potentially, export volumes if demand remains weak? These statistics are not those of an economy poised for growth and we should be alarmed about what is says about the state of our key export markets. The fun may be just beginning.

Starr quote (Lone Ranger) 10:47 PM

I have just come across an alleged quote by Ringo Starr which I thought more or less summed up everything I have been trying to articulate:

"Everything government touches turns to crap".

There really is something in this for all of us.

A further comment on arts degrees (Lone Ranger) 3:10 AM

As the holder of a Master of Arts degree, I would love to be able to refute Roy’s assessment of the modern Bachelor of Arts – but alas, I cannot fault his thinking.

Truthfully, far too many BAs in our time are complete drivel – gender, sexuality and diversity studies or white deconstructionism or media studies or peace studies or sociology and politics or whatever other rubbish the no-hopers who staff most arts faculties can invent. This is a shame as “humanities” as traditionally conceived really did look at the great questions of life – theology, history, rhetoric – and objectively tried to further the knowledge and moral stature of humanity. “Gender, sexuality and diversity studies” ain’t exactly up there with Gibbons or Aberlard. Indeed, this sort of study (aka “waste of space”) is entirely ideological, taught by losers who could never get a non-publicly funded job other than perhaps cleaning toilets, and who generally despise the following (in no particular order): the free market, capitalism, talent of any sort, freedom generally, the family, religion (especially Christianity or Judaism), people with a different point of view, national pride, patriotism, cheap consumer goods for the masses, anyone who can add up, tradition and the profit motive.

My own memories as an under-grad in the commerce faculty included the arrow pointing to a toilet paper dispenser in the men’s with the caption saying “arts degree”. Is it any wonder?

The arts graduates have taken over (Roy Rodgers) 6:31 AM

My apologies to all those with arts degrees. I'm sure you're living meaningful lives, contributing to society, adding value and all the rest of it.

Its just that at uni you were quite unmistakeably the butt of our jokes over in the economics and commerce faculties. I've actually forgotten how the jokes themselves went, but I remember the punch line, which was always the same and went something like this ... whats an arts degree good for ... wiping your arse. Boom Boom.

Well how wrong was I. It looks like an arts degree qualifies you for much more. In fact it appears to be a prerequisite for entry into Australia's political elite. Not just labour but liberal as well. The attached tables outline the educational qualifications of both our current cabinet and our current shadow ministry.

Over 50% of ministers and shadow ministers hold BAs including both big kev and mighty mal. Big kev holds a BA with majors in chinese language and chinese history, and no post grad. Take a second to digest that ... our prime minister has a degree in saying ni how and the decline of the ming dynasty ... he has no formal training in politics, law or economics.

Mighty mal didn't disclose what his majors were but on the up side he has done some post graduate training and is a Rhodes Scholar (the only other Rhodes Scholar in the bunch is Tony Abbott).

The second most popular degree is law, with over 56% holding some form of law qualification. You'll probably notice that quite allot of them double up on both BAs and LLBs.

There are three things that are immediately obvious to the casual observer.

1. Nearly everyone holds tertiary qualifications (all labour and most liberal). While we would expect to see high levels of tertiary qualifications, I think we should also see a number of accomplished people without quals ... such as those that have worked their way up off the factory floor or alternatively the entrepreneurs who have driven economic growth over the last couple of decades.

2. Another striking observation is the total lack of science degrees, engineering degrees or medical degrees. Where are these guys? These guys that actually know how to do complicated stuff.

3. The other thing that slaps you in the face is a lack of economics. Only approximately 20% have undergone any form of formal economics training.

I don't care what anyone says, economics is not something you pick up casually. I have never encountered anyone with a deep understanding and appreciation of economics that didn't have some formal training. To understand it requires actual study. This apparent under representation is alarming as economics is the one field that deals with allocation, of how resources should be shared and of how to maximise welfare for the community......the whole economy. And you would think that that is the core activity of governement, how to put in place and maintain a framework that allows us all the freedom to pursue our own endeavours and live by our own merits.

Given that these guys are the self proclaimed economic managers of our little slice of the world, we should all be alarmed that they are basically arts graduates or lawyers. Its like putting a cap on my 6 year olds head and telling him he's now the bus driver. Fasten your seat belts ... adjust your nappy and sit back for the ride.

It actually explains a lot. Now I know why Joe Hockey can't really engage in any deep economic argument (he's an arts grad), now I know why mighty mal asks questions like "whats marginal cost?" (he's an arts grad). It goes along way to explaining why swan thinks its a good thing to go around proclaiming 'this is a robin hood budget' (he's an arts grad) . Apart from the fact that in the analogy wayne is actually the sheriff, the contention is economically obnoxious and symptomatic of someone who is totally ignorant of the economic harm they are sowing.

This explains why as a group they are easily bamboozled by an econometric study. Why they think it's such a good idea to put price caps on natural gas. Why they think grocery markets need to be regulated. Why price caps need to be placed on petrol. Why keynesian economics actually has merit.

It explains away that embarrasing 7000 word dribble big kev coughed up for the monthly and why he seems to just not get Hayek.

This explains every thing ... they are all BLOODY ARTS GRADUATES!

I didn't include in the table their work experience prior to parliament. The following high level summaries should suffice ....

Labour
By way of short summary. For Labour the bulk of ministers hold either a BA or LLB, all (without exception) followed the work path of uni, then union or union legal representation followed by political appointments (eg ministerial advisors). There are no ministers who don't hold degrees or have spent time working on the actual factory floor. The only exceptions are a couple of ministers who have a background in education, ie used to be teachers and an ex rock star.

Liberal
While as with labour the bulk of shadow ministers hold BAs or LLBs there is a more diverse working experience ranging from company CEOs to milkmen and real estate salesmen. A small number of shadow ministers do not hold tertiary qualifications and there is more agricultural representation.

Its worth noting that both labour and liberal hold approximately the same number of ministers (shadow ministers) with economic training.

Roy Rodgers Vs the Nursey lady from red cross 9:53 PM

Big kev has declared 2009 is the year of the blood donor. He wishes to raise awareness of the need for blood and the importance of voluntary donors.

Fantastic you may say, bloody good you may think … what possible smart arse comment could Roy Rodgers possibly impart on such a worthwhile endeavour.

Lets unpack his wishes the need for blood. I’ve got to admit that this sounds reasonable to me. Given my lack of medical training I’m more than willing to believe that modern medicine and modern treatment practices do require blood.

Wish number two is to raise awareness of the importance of voluntary donors. This is the bit that gets me. Why are volunteers so important? And by volunteers they are referring to hapless altruists with enough spare time that they can spend an hour or so freely giving their own life juice to the state or in this case the state sponsored entity.

Don’t get me wrong, there is nothing wrong with donating time or money to causes you find attractive enough to sedate whatever degree of altruism you have imbedded in your own utility function. There is nothing wrong in giving food to the homeless. I myself always throw junkies a couple of bucks whenever I see them begging. I see it as my contribution to supporting the anti prohibition movement.

The bit I query is whether this is the right approach to take to blood. The thing is, blood is not a charity, people can afford it (or most people could) so the idea that giving blood is somehow charitable is a crook.

The other worry about blood is that if its so important and if its availability literally saves lives, why in the name of the almighty are we satisfied to limit our source of supply of the stuff to a small group of altruists. Not only satitisfied but have actually provided the Red Cross with a legislative monopoly/monopsony. The absurdity of the situation is only highlighted by the apparently never ending shortage of the stuff. According to that annoying bloodhound they keep abusing in their advertising we are living in a perpetual blood drought.

I find this state of affairs so annoying, that during the recent blood drive associated with the Victorian bushfires I decided to conduct a little experiment. I thought i would try and find out how much the Red Cross values a pint of blood and by extension how much they value the life that it saves. I donned my polar fleece vest, neil diamond tshirt and a sturdy pair of Rockwell shoes (my imagined blood donor uniform) and waddled down to the donor centre.

Nursey type : do you wish to donate blood.

Roy: yes I would love to …. whats the going rate per pint?

Nursey type: (face shows confusion and a slight look of concern) there is no going rate.

Roy: okay in the absence of an observable market price ill give you a pint for 20 bucks.

Nursey type: 20 dollars? … you misunderstand we don’t pay for blood

Roy: wow, haggle hard …. Look a lobster is as low as I’m prepared to go.

Nursey type: are you serious people are dying?

Roy: ok … that’s a 50 then (thinking, nursey heres a hint, in a bargaining situation never disclose you have near perfectly inelastic demand)

Nursey type: (with an angry tone) how can you be such a tight arse, profiting off dying people …. Please leave

Roy: me tight? … hey you’re the one that wont fork out a lousy pineapple to save a life ... tell you what, Ill give you a pint for $50 and if i dont pass out, ill give you another for $45 .... and i wont avail myself of your free mouldy sandwiches.

Nursey type: please leave

Roy: hey Im only trying to save lives ..... right then, I'm off to the hospital to see if i can scalp some fresh stuff!!

Why have we not established markets in blood? It’s a basic fact that markets and prices are much better, more efficient and more fair allocative mechanisms than any centrally controlled system would be.

There is nothing about blood that makes it inherently unmarketable. There is rivalneous in consumption, there is full excludability, there are no information problems and we have quite clear frameworks for property rights. If its my juice then its mine.

If we had markets we wouldn’t have shortages.

It makes you wonder just what the human cost of this seeming aversion to the comodification of blood actually is. To my mind one life lost is one life too many, especially if that loss could have been avoided for the sake of a lousy $50.