Code Red: Two Economists Examine the U.S. Healthcare System

June 26, 2015

For SCOTUS and Both Political Parties, the Ends Justify the Means

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 9:57 am

Yesterday’s Supreme Court ruling was a decisive, and perhaps the decisive, victory for the Affordable Care Act (ACA).  Legal opponents of the law are likely hamstrung for the foreseeable future (forever?) while supporters are giddy about the future prospects of the law. We note that there were two components to the ruling, only one of which was necessary to save the ACA in the near term. The first component was the decision that the wording of the law is ambiguous. This normally would have entitled the Executive Branch, in this case the Internal Revenue Service, to apply its own interpretation of the term “established by the state.” (Of course, Justice Scalia found nothing ambiguous in the wording, but we are not here to debate that point.) This is precisely what had been occurring, and the Court could have ruled that in the context of the bill the wording was unclear so we can continue on with business as usual.

The second component is more troubling. It appears (to our admittedly untrained legal minds) that Chief Justice Roberts has claimed new powers for the Supreme Court, entitling it, and not the executive branch, to interpret ambiguously worded laws.  While we are not legal scholars, the majority opinion does feel like an exercise in tortured logic where the end goal is clear and the writer is just trying to find a way to get there. We understand perhaps some reason for this attempt.  An important implication of the ruling is that the IRS may no longer apply its own interpretation of the term “established by the state.” This is vitally important to supporters of the ACA, because it prevents a future IRS, under a Republican administration, from finding its own meaning and effectively shutting down the federally-operated exchanges.

We are reminded of the earlier Supreme Court decision where Roberts dug deep to equate penalties and taxes to save the ACA. Except in that case he was going against the very logic of Congress and the President, both of which plainly said while the law was being debated that it did not involve any new taxes. If anything, this time he has dug even deeper. We are not sure why the context of the entire bill and Congress’ intent was so unimportant in the first decision but critical to the second. Just as economists might agree that a mandate is a tax, political scientists would agree that a state is not the federal government. While we agree that the context is critical for understanding the law, we would hope that the proverbial rules of the game remain constant rather than morph to fit the goal.

The Republicans have offered two primary critiques of the Supreme Court decision. The first is the obvious semantic one.  The second is a response to the Chicken Little warnings issued by Democrats who worried that if King v. Burwell had gone the other way, federal exchanges would fall apart and millions would lose coverage. Republicans countered that the law was worded as it was in order to push states to operate their own exchanges.  We are highly suspicious of this argument, for two reasons.  First, following Scott Brown’s surprise victory to replace Senator Ted Kennedy, when Democrats no longer had a filibuster-proof majority in the Senate, the final version of the ACA was rushed through without the usual reconciliation between House and Senate versions. (The Senate needed the legislation to be treated as a budget bill, which would limit filibuster.) In the commotion surrounding this legislative sleight of hand, we suspect that those four crucial words were anything but deliberate.

We should also take a minute to realize that the laws problematic and “inartful” language, is likely a direct result of this attempt to circumvent the normal process for passing rules in the Senate. In their attempt to pass the law as quickly as possible, and without a conference committee, the Democrats caused this problem. Normally, Congress would pass additional legislation as a technical correction, but in this case who would blame the Republicans for refusing to help fix a bill that was passed through extraordinary measures (though we note that we oppose most of the other refusals of both parties to come together and work on legislation over the past several years).

As far as what would have happened if the decision had gone the other way?  Some argue that states would step in if the federal exchanges fell apart.  While some states may have done this, we doubt that the majority would. We agree it would be the rational thing to do, and we want to believe in the relative wisdom of state lawmakers, but in our heart of hearts we simply cannot.  After all, we only need to look to the 21 states that have not expanded Medicaid to see examples of lawmakers turning down billions of dollars in federal subsidies while simultaneously leaving hundreds of thousands of local residents without health insurance coverage?   Never before had so many noses been cut off to spite so few faces. We are not sure what appendages would be cut off this time, but we can only imagine the indignation emanating from the mouths of Bobby Jindal, Rick Perry, and the rest as they refuse to organize state exchanges in the name of opposing “socialized medicine.”  Please.  As we’ve detailed before, the exchanges (in concept) represent a conservative, market-based approach to expanding health insurance coverage and freeing the economy of employer-provided health insurance. Republicans should support them. Since Republicans insist on placing political interests above ideological interests, Chicken Little may have a point.

While we agree that there are many changes we would like to see to exchanges, we also see them as a vital and now permanent part of the American health insurance system.  Republicans should stop focusing on foolhardy efforts at repeal and instead concentrate on what is necessary to make the current system work better.

June 18, 2015

Uber and the 1950s Logic of the Affordable Care Act’s Employer Mandate

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 9:39 am

We have recently blogged about what is perhaps the best feature of the Affordable Care Act – the individual insurance exchanges. These exchanges have the potential to create one of the first well-functioning individual insurance markets in the United States. In addition, they are an implicit recognition of the nature of the contemporary American economy – one where workers frequently move employers and are increasingly serving as independent contractors for multiple firms.

However, a recent ruling by the California Labor Commission reminds us of what must be one of the worst features – the requirement that large employers provide health insurance to all employees working more than 30 hours per week.  This mandate is a remnant of a 1950s economy where workers remained employed at the same firm for decades and the Internet was just a series of tubes that existed in our dreams.  Ironically, the ACA insurance exchanges not only make the employer mandate obsolete, but the mandate actually weakens the viability of the exchanges by locking a large portion of the healthy population into the employer provided insurance market.

In the ruling in question, the Commission declared that Uber drivers in California are employees, and not independent contractors. Data show that 15 percent of UberX drivers work more than 35 hours per week, and 40 percent of UberBlack drivers work more than that amount.  Another 30 percent of UberX drivers average 16-34 hours per week. Under the ACA, these hours statistics mean that a national interpretation of the California ruling would affect tens of thousands of people who contract as drivers with Uber, none of whom will be better off for it.

If all Uber drivers are considered employees, this ruling means that Uber must either provide health insurance to its drivers, pay a penalty, or limit the hours of all of their employees. It is unlikely that Uber will pay the penalty. If it provides insurance, it would want to lower compensation to offset the expense, but this would be practically impossible for Uber. The reason is that Uber has a “per ride” compensation system, so it would have to reduce compensation across the board, including drivers who work less than 30 hours weekly. It seems that the only viable option for Uber is to cap all drivers at 29 hours per week – something that would great limit the flexibility of Uber drivers.  Note that in a survey of Uber drivers, 74 percent said that they value the ability of Uber to smooth their income. In weeks where their other jobs (over 60 percent of Uber drivers have another income source) don’t provide enough income they can increase their hours with Uber to make up the shortfall. Given the liquidity constrained nature of many individuals, we should applaud the ability of firms like Uber to help the meet temporary income shortfalls through increased labor supply rather than more dubious means such as pay-day lenders.

The exchanges represent the first viable substitute for an employer mandate, and we should make every effort to support this policy. Without exchanges, many would-be self-employed workers would be hard pressed to find affordable health insurance and, if they could, they would be one illness away from reclassification into a much higher premium category. This would naturally drive many workers to choose a large company offering health benefits (even without the employer mandate, around 99 percent of large companies offer health insurance to their workers). Of course, the companies offering benefits reduce their wages to cover the cost.  But most workers don’t mind this – the cost of obtaining individual coverage was, before the ACA, was so much higher than the decreased wages from their employer.

But what a silly way to organize contemporary labor markets – i.e. forcing people to work for large companies in order to have insurance coverage. This shoehorns people into jobs that are often sub-optimal or in the case of the recent Uber ruling may constrain them from getting the most out of existing employment opportunities. It also provides an artificial competitive advantage to large firms over small firms and new entrants – which often have to pay much higher rates for health insurance and therefore face higher labor costs.

We support the ACA exchanges because they eliminate this folly. But it is equally foolish and shockingly counterproductive to also require firms to provide insurance.  If it were not for this mandate, all firms could offer their workers higher wages and let them find the coverage they want on the exchange. This would level the playing field for small firms and give peace of mind to the self-employed.  It would also deepen the risk pool in the exchanges, which is essential to their long term success.

In other words, if we get rid of the mandate, we sever the artificial relationship between health insurance and labor markets.  But the mandate, and the antiquated economic logic it represents, keeps this artifice intact.  Many companies have already redesigned their jobs to skirt the 30 hour rule.  Uber will soon join their ranks.  It is the height of folly.

June 1, 2015

Nudging Our Way Past Inertia in the Health Insurance Exchanges

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 7:31 am

Two weeks ago we received our first signs that all may not be well in the land of milk, honey, and low priced insurance, i.e. the ACA insurance exchanges.  Many insurers, including some of the largest in each state, have requested double digit rate increases, with some asking for raises that exceed 30 percent. A casual review of these requests suggests that the increases are largest in areas where the premiums were initially lowest. If these increases are approved, it will mean dramatically higher payments for enrollees, and escalating tax bills for the rest of us.  This is particularly true when the premium hikes affect the lowest priced “silver” plans available in the market (as the subsidies are tied to premiums for the second cheapest silver plan). Of course, the premium increases might backfire on insurers, but only if enrollees opt to switch to cheaper plans.

However, we have grave doubts about whether this will be the case. If participants in the exchanges behave like enrollees in employer-sponsored plans, then it seems unlikely that there will be much switching out of plan. This is a natural consequence of the way the exchanges work, combined with well documented inertia on the part of health insurance enrollees.

What is this inertia?  Academic research performed here at Northwestern University and elsewhere convincingly shows that employees are reluctant to switch health plans, even if they stand to save $2000 or more without sacrificing quality or access.  In addition, a pair of studies of Medicare Part D prescription drug plans also demonstrate that consumers switch plans infrequently and those that switch do those mostly in response to changes in the design of their own plan (i.e., are their preferred drugs on formulary) rather than in response to the relative financial attractiveness of theirs versus competing plans.

The broad reason behind this behavior is something that we can all relate to – most of us would rather avoid the unpleasant task of comparing health plans.  The architects of the ACA exchanges understood how difficult it is to shop around for insurance and wrote some rules to simplify the task. All plans have the same minimum benefits, and plans are shown in “medal” tiers (bronze, silver, etc.). But we question whether this is enough to get individuals to reconsider their health plan choices. Consider that the plans in the Northwestern study were practically identical except for premiums, deductibles and cost sharing provisions whereas the exchanges plans are far more heterogeneous.

Exchange rules can catalyze this inertia (now there is an oxymoron!).  Most exchanges automatically reenroll participants in the same plan they had in the previous year.  We suspect that the first time that many enrollees will find out about their premium spikes will be when they get their first bill.  Consider that recent survey evidence shows that 70 percent of enrollees in ACA compliant plans didn’t shop around before renewing their coverage.  And by the time they truly digest their new expenses, it may be too late to switch. (Of course, the poorest enrollees in the cheapest plans may have no premium sharing regardless, but that is another story for another blog).

We are tempted to hector the American consumer into becoming better shoppers by reminding them that they spend more on health care than they do on cars, yet they spend infinitely more time shopping for the latter than the former.  But we are reminded that driving a car can be fun, while engaging with health insurers is, shall we say, less fun (and that’s coming from two health economists, imagine how real people feel!).   So rather than browbeat consumers into paying attention to prices, we think it better to find other ways to “nudge” them to shop around.  We also note that if this was solely about what consumers pay for health insurance we might be less concerned, in a free society people will make mistakes.  However, a large fraction of these costs are borne by taxpayers and thus we care quite a bit more about the outcome of these mistakes.

When it comes to first time buyers, the exchanges do a great job. In this case, “inertia” means going without insurance and paying a penalty. First time buyers have to shop around and the websites are designed to facilitate comparison shopping. The standardized plans and medal tiers, combined with links to network providers, make the process for first time buyers relatively pain free. Though we do note that this requires these websites to have up-to-date and accurate information about these networks (again, a topic for another day). But reenrollment is another story. No one wants to shop for health insurance a second time, so most of us are happy to reenroll in the same plan.  Even if this is not a conscious choice and however irrational it may seem, the trials and tribulations of everyday life seem to make it hard to take the time to concentrate on the long term planning of health insurance compared to the short term difficulties of work, kids, and other tasks.  The rule makers have indulged our lassitude by making this reenrollment automatic and painless, or at least painless until the bills come in the first month.

Our recommendation is simple and not unique to this setting – do not automatically reenroll individuals in the same plan. We are not suggesting that everyone has to sign up anew each year – too many who are currently enrolled will fail to do so and the number of uninsured would increase.  While we are both big believers in personal responsibility, such a proposal would be throwing the baby out with the ACA bathwater. Instead, we are suggesting that at renewal time, all individuals are asked to affirm whether they want to keep their plan, switch plans, or drop coverage.  Those who do not respond are automatically reenrolled, but are not necessarily assigned to their own plan.  There are a number of options for reassignment that would avoid financial surprises – for example enrollees could be reassigned to any plan that cost no more than the second cheapest silver plan.  In addition, they could be allocated at random to a plan that matches the distribution of people that actively re-enrolled.  There are many positive and negatives to each decision rule and we will allow rule makers to figure out the details. We should note that we are not attempting to force people into cheap plans just to minimize their expenditures. After enrollees are reassigned, they can be given additional time to accept the new plan or pick another (possibly their old plan).  What we want to avoid is that a lack of attention is costing everyone money because insurers may be gaming the design of the exchanges and consumer inertia.

Our proposal has several benefits.  First, it allows enrollees the option to affirmatively ask to reenroll.   Those who initially fail to act will be given a chance to reconsider.  Many will perk up and do some comparison shopping and those who do not will be switched into relatively cheaper plans.  We would expect that the combination of these factors will encourage insurers to redouble their efforts to hold down premiums while maintaining other elements of plan design that will attract enrollees.

Health insurance markets have never functioned perfectly and there is plenty of blame to go around for their failure.  Exchanges offer a partial solution to the problem by increasing the ability of customers to comparison shop.  While the rule makers have taken due care to assure successful competition for first time enrollees, enrollee inertia threatens to undermine the ongoing success of exchanges.  Let’s put an end to automatic reenrollment, and help assure continued vigorous competition within the exchanges.

May 26, 2015

Expect the Unexpected: Premium Increases in the Nascent Health Insurance Exchanges

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 7:44 am

As insurers begin to consider their product offerings for next year, they have had their first chance to look at a full year of data from the new customers in their ACA exchanges plans. We bet this was a sobering experience, because last week came the news that many exchange health plans are seeking double digit rate increases. Blues plans in New Mexico, Tennessee, and Maryland have all asked for increases of 30 percent or higher. The largest insurer in the Oregon exchange is asking for a 25 percent increase and many other insurers have stated that they are not far behind.

How far we’ve come from the celebratory statements from the Obama administration about the low premiums in the first year of the exchange and the recent small rate hikes for non-exchange plans. But if anything was to be expected, it is exactly this outcome:  large increases during the first years of a new insurance market. While insurance industry critics will undoubtedly blame the increases on market failures, price gouging and the rapacious greed of industry executives, the reality is that these increases demonstrate that the exchanges are functioning the way they were intended – as vibrant and competitive but still nascent marketplaces.

Like any new product marketplace, the competitors in the exchanges are still trying to figure out the value created by their product and the costs of bringing that product to market. And there are some dangers in this process – markets can be messy – but it is far too soon to give up on this most promising aspect of Obamacare. However, it is time to accept that even fairly priced health insurance is going to be expensive in a nation where health costs run so high. If anything, buying new insurance products from new exchanges only increases the volatility of insurance premiums.

When it comes to understanding the pricing of health insurance, particularly new insurance products, a little economics (and a soupcon of business strategy) goes a long way.

  1. When any business offers a new product the price they charge amounts to an educated guess. They attempt to determine demand for similar existing products, and then extrapolate from that across the different dimensions of their new offering. For traditional product markets, this involves having a really good sense of the cost of producing the product and estimated information on customer demand. The more novel the product, the less the price is educated and the more it is guess. When the new product is health insurance sold through new exchanges, the problem is magnified, because insurers don’t have a good sense of either costs or demand. Most critically, insurers had to guess about the health risks of their enrollees. The Obama administration had hoped that the ACA’s subsidies, mandates, and penalties would encourage a representative share of low risk individuals to sign up.  Evidence from enrollment in the exchanges suggests that enrollees ended up older and lower income than expected.  Insurers may not have been as optimistic as the administration, but even the most pessimistic of insurers appear to have failed to anticipate the selection in the market. Insurers who were burned by this unfavorable selection in the first year are using this opportunity to recalibrate their premiums to more appropriate (i.e. at least breakeven) levels. Megan McArdle examined the filings requesting these rate increases and found some startling losses for many insurers. For example, Moda insurance in Oregon had negative 60 percent in its first year, and they are not alone. Only now do insurers have enough data to figure out what’s driving these losses and price accordingly.
  2. Even if insurers guessed right in the first year, they know from experience that attrition in insurance markets tends to adversely affect risk pools, as the sick and old reenroll at higher rates than the healthy. This is particularly true if insurers are forced to raise prices and the marginal customers drop out of the insurance pool. This is one reason why rapid price increases are common for new insurance products outside of the exchange, and helps explain the recently discussed price hikes in the exchange.
  3. The third reason for the rate hikes combines a bit of behavioral economics with business strategy. Research shows that most health insurance enrollees who do not drop coverage display considerable inertia. That is, they often spend a lot of time when first choosing a plan, but once enrolled they tend not to switch, even if there are opportunities to save money by doing so. Some economists estimate that this inertia can cost enrollees thousands of dollars annually. Health plans that were aware of this inertia would have a big incentive to lowball premiums for their new exchange offerings. By pricing below costs in the first year they would gain valuable market share. They can then recoup any losses by increasing premiums to their “loyal” (or more accurately “passive”) enrollees in later years.
  4.  In addition, regulations contribute towards this inertia and pricing strategy.  For example, features of the law that limited the losses an insurer could face in the first few years, such as risk corridors and reinsurance, may have unknowingly contributed to this gaming behavior. In addition, low income enrollees received fixed subsidies based on premiums for the second cheapest silver plan. This would explain the pattern of low initial prices and the high increase in premiums in later year. Firms know that the plan which offers the second cheapest silver premium in the first year of an exchange likely attracts the most customers because they would be the benchmark plan used to set the subsidy. As long as all insurers begin to price at cost in the future then the market share of the originally artificially low price plan will remain high and that company profits.
  5. Last but not least, health care spending is growing, and last year may have seen a new spike, due to rising drug costs and the exercise of pricing power by concentrated providers. We will soon learn about premium increases for non-exchange plans and from this we can infer how much of the increases in the exchange reflect basic economics of the health care market – which unfortunately point to higher prices in the future.

Call it normal market forces, or call it “price gouging” if that is how you must describe firms charging a market clearing price. But the big takeaway is that in the first years of a new insurance market, we should be surprised if pricing did not follow the very pattern that we are now witnessing in the exchanges. And that may very well be good news, because the same economic forces suggest that premiums will quickly settle down, as risk pools stabilize and strategic entry pricing becomes less relevant in mature markets.
However, there is a dark side of competitive insurance markets that must be acknowledged. As insurers raise prices to cover their sick populations, we know that they may chase out the healthier enrollees. Consider again the case of Moda in Oregon, which lost 13,000 members last year when they raised prices by 10.6 percent.  What is keeping insurance executives awake at night, and what should be worrying Obamacare supporters, is the possibility that those who leave are the young and healthy enrollees that have already been far too difficult to attract. These individuals may decide that the fairly low Obamacare penalties aren’t worth the increasing premiums.  For example, in the most recent open enrollment people it is estimated that 3-6 million people were required to pay the penalty for being uninsured but less than 200,000 people took advantage of the ability to sign up for coverage upon being told of this penalty at tax time.  This suggests that these individuals are making a conscious choice. If this pattern continues and leads to an overall death spiral for the markets, it will be an unfortunate outcome for all involved.

Supporters of the ACA signed on to a plan that relies utterly on competitive insurance markets. However, some of these individuals appear to have been also believed in the fantasy they were sold that the exchange markets were the only thing standing between American citizens and low-cost health care.  That’s simply not the case. Now that they have seen exactly how these markets function, let’s hope they don’t have buyer’s remorse and attempt to enact onerous regulations that exacerbate the potential problems in these markets. Rather than bemoan market forces, let’s harness them to make the exchanges even more effective.  Over the next few weeks we will discuss plans for insurance design that will help us move towards these goals.

May 21, 2015

Competition: The Best Cure for Rising Drug Prices

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 5:23 am

Apologies for our recent hiatus from blogging.  One of us (Garthwaite) was conducting some field research in health care related to the birth of his second child.  We will now return to our semi-regular blogging schedule.

As the ACA insurance expansion begins to fully take hold, attention is returning to the seemingly ever growing cost of care in the United States.  Many voices are chiming in about the need to pay greater attention to the rising prices paid for medical services and pharmaceuticals. Last week we held Kellogg’s annual MacEachern Symposium. Featured speaker Amitabh Chandra put rising prices atop the list of reasons for healthcare cost growth. And a recent Bloomberg View editorial has called for price regulation of medical services (we should note that Chandra’s focus on prices was not a similar call for price regulation).

The central topic of this year’s MacEachern Symposium was the rising prices of specialty pharmaceutics, the poster child for which is Sovaldi, which is Gilead’s cure for hepatitis C and carries a price tag of about $84,000 for a course of treatment. These high prices have attracted a great deal of attention and led many to call for regulators to lower them by any means necessary. For example, President Obama has recently called for Medicare to be allowed to use its monopsony power to “bargain” down the price of pharmaceuticals.

It is dangerous to introduce new regulations to solve a problem without fully understanding the cause of the problem. At the most basic level, these prices are high because we grant 20 year patents to innovating firms to provide an incentive for them to make large risky investments in research and development.  If one factors in the very low probability that any patent turns into a marketable drug, the cost per new drug may be $2 billion or higher. Given the length of the regulatory process, the effective patent length results in about 12-13 years of time where the innovating firm can sort of act as a monopolist and set a profit maximizing price.  We say “sort of” because patents cannot prevent competition from different drugs that target the same diseases a feature that blunts the monopolists pricing power. As a case in point, Sovaldi already faces competition from newer drugs such as Harvoni (also developed by Gilead) and Viekira Pak (developed by Abbvie), and prices have fallen considerably.  And once patents run out, generic manufacturers can enter the market with an effectively perfect substitute for the product resulting in price decreases of approximately 70 percent.

It must also be pointed out that Gilead and the other makers of high priced drugs could never achieve such high volumes at such high prices if drugs weren’t covered so generously by health insurance.  Without insurance, very few Americans could afford the cost of Sovaldi, let alone the six figure price tags of many new cancer drugs. As a result, expansions of insurance such as those under the ACA and the creation of Medicare Part D, while laudable as goals, are part of the cause of high prices.

Taking these facts together, we note that if you want to lower drug prices you should be looking at either the current structure of the patent system or the design of the federally subsidized insurance system – both of which serve as distortions in the market. This is likely the reason for President Obama’s misguided focus on increasing Medicare’s monopsony power for drugs.  We discuss below why this would a problem and why instead, we think the President should focus on a particular feature of Part D that is likely driving higher prices for certain types of drugs.

Peter Bach of Memorial Sloan Kettering noted at the Maceachern Symposium, Medicare Part D has six “protected classes” of drugs where insurers were forced to offer coverage for every available product.  These categories are anti-cancer; anti-psychotic; anti-convulsant, anti-depressants, anti-psychotic, immuno-suppressant, and HIV and AIDS drugs. These protected classes all but assure that innovators can charge whatever they want to all insurers, not just those in part D, because private insurers that fail to follow Medicare’s lead can be sued for inadequate coverage.  A suit that would be hard to win when the poorly funded social insurance program offers coverage for the service.

With these facts in mind, we note that President Obama is upset about the monopoly prices caused by patents and his solution is to increase the market power of social insurers.  It might seem that increasing the clout of purchasers will make the drug market more competitive, but this is decidedly not the case.  The answer to having “too much” market power by one participant should not be to attempt to increase the market power of the other participants.

Instead, the President should think about doing things that increase competition among the drug makers.  First, he could think about implementing patent reform.  If what we desire is that pharmaceutical firms earn less money while their drugs are under patent then perhaps we should consider addressing the route of that alleged “problem.” Perhaps patents are too long and that should be fixed?  Or we could imagine systems that have been proposed wherein the breadth of the patent being a function of the value that the drug brings to market.  There are many reforms that we could look at if we think that the market imperfections created by patents are providing too many rents to innovating firms.

After considering patent reform, he could look into reforming the existing rules of Part D that bind that hands of insurance companies participating in that program.   If insurers can’t threaten to remove a drug from its formulary it’s very hard to effectively negotiate price discounts. And these discounts can be quite substantial.  Consider the case of Gilead’s Sovaldi.  While this drug was originally priced at $84,000, this was only the case while it was the only oral treatment that cured hepatitis C.  Less than a year later, Abbvie released Viekira Pak.  Initially, this drug was priced similar to Sovaldi.  However, as a result of competition between these products they are each now selling at a reported 40 percent discount.  Express Scripts, the nation’s largest pharmacy benefit manager, achieved this discount by removing Sovaldi from its formulary for the vast majority of its patients.  However, if Express Scripts wanted to attempt the same strategy with its equally expensive oncology products they would not be able to since CMS requires them to provide coverage for all of these products.  The best they could accomplish is to put different products on different cost sharing tiers – a far less threatening action given the cost of these drugs.

Removing protected class status would actually introduce more competition into drug pricing for Medicare.  Some people may argue that removing the drugs protected class status would deny needed pharmaceuticals to individuals, particularly those who might not respond to one therapeutic substitute compared to another.  In fact, a recent attempt by the Center for Medicare and Medicaid services to remove some of these protected classes was roundly criticized. However, it is important to realize that any attempt to lower the returns of pharmaceutical companies will, at the margin, decrease new drugs from entering the market.  Our recent research shows that many of the new drugs that are developed in response to small changes in expected returns are the very same me-too products and therapeutic substitutes that were individuals are worried about lacking coverage if the protected classes go away. While we note that our proposed solution of removing protected classes also involves lowering expected returns, we would hope that policies that remove inefficiencies in the market are superior to those that introduce even greater inefficiencies.

February 19, 2015

The Unfortunate Propaganda of “Shared Responsibility” in the Affordable Care Act

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 11:59 am

Last week we wrote that it was well past time to end the employer mandate in the Affordable Care Act.  In light of some commentary this week, we thought it best to revisit this issue in more detail.  It seems that most of the support for the employer mandate comes from a misguided understanding of why employers are currently the primary source of private health insurance.  It is explicitly not because of a sense of “responsibility” to the employee, at least not any more responsibility than they feel when they pay employee wages for their work.

Here is a basic summary of how labor markets work, based on decades of very widely accepted academic research and practical experience. Employees receive compensation from their employers in return for their work product.  In other words, employers aren’t running charities for their workers, but neither are workers volunteering their time at firms.  Each expects something from the other. Some employee compensation comes in the form of cash wages and some in the form of fringe benefits such as health insurance, pensions, free coffee, parking, etc.  Either explicitly or implicitly, employers and employees negotiate these compensation packages with employers attempting to craft the least expensive package that the employee will accept.  Firms know they can offer employees tax free income in the form of health insurance and they exploit this feature of the tax code to the benefit of both employees and employers.  And for a variety of reasons, prior to the exchanges, it was often much easier for employers to purchase insurance than it was for employees to buy it on their own.  As a result, many Americans get insurance from their employer.  As an added “benefit” of this system, the whole country likely spends more on health insurance than we otherwise would and the federal government provides more tax benefits to the rich than to the poor.

It should be clear from this point that employers are not “giving” their employees health insurance.  We know this because when health insurance gets more expensive, wages don’t grow as quickly.  This is because employers are only interested in the cost of the total compensation package, and if health costs go up, wages must go down.

Failing to understand these basic economic points leads to poor arguments and harmful policies.  For example, in a recent Viewpoint in the Journal of the American Medical Association, John McDonough and Eli Adashi make an impassioned plea in favor of keeping the Section 1513 of the ACA also known as the “Shared Responsibility for Employers.”

Congress’ decision to call the requirement of employers to provide health insurance or pay a fine as a “shared responsibility of employers” is a master stroke of propaganda to which we must tip our hats.  However, we must see through this cute turn of phrase and realize that this section of the ACA simply enshrines some of the worst aspects of our current health insurance system and actively works against many of the actual goals of the ACA.  Unfortunately, McDonough and Adashi have their blinders on.  They state, “[t]he core value undergirding the shared responsibility principle is the realization that all of the major stakeholders of the health care system must contribute something if comprehensive health care reform is to be accomplished. Stated differently, making the ACA work requires a measure of  responsibility from consumers, hospitals, physicians, insurance companies, drug makers, medical device makers, home health agencies, labor, and—because of section 1513—large employers.”  This argument amounts to a bit of a tautology.  Large employers are a stakeholder in the health care system because we mandate them to be a part of it [under section 1513] and because we mandate that they offer insurance they are a stakeholder in the health care system.  McDonough and Adashi never ask the more fundamental question:  Why should employers even be part of the health care system to begin with?  If we are trying to implement health reform, shouldn’t we be looking to end those aspects of the system the create large distortions?

They then go all in by stating that the shared responsibility is a “public good especially for employers who might otherwise be inclined to shift the cost of employer sponsored health insurance onto the federal government and thereby the taxpayers.”  Much like calling the employer mandate a “shared responsibility,” saying that this is also a public good is at best a misapplication of the term. In economics we define a public good as having two characteristics:  you cannot stop another person from using it and its value doesn’t decrease when another person does use it.  Clean air and national defense are quintessential public goods.  But health insurance?  (This is hardly the first time that JAMA has published egregiously incorrect economic arguments.  We note in passing that the American Economic Review has the good sense not to publish medical studies.)

Then there is this question of “shifting the cost” of ESI onto the government.  This notion ignores that the burden of ESI already falls on the government because these benefits are exempt from incomes taxes.  According to the White House Office of Management and Budget, in 2012 this cost the federal government approximately $170 billion.  Given the progressive nature of the United States Income Tax Code, this tax break is exceptionally regressive with an estimated five sixths of the benefits of the exemption flowing to the top half of the income distribution.  If employers stop offering health insurance, the competitive market for labor will force them to increase wages.  Because health insurance costs are roughly independent of wages, the resulting wage increase will be larger, in percentage terms, for lower income workers.  At the same time, federal tax receipts will increase and, given the progressive nature of the tax code, more of this money will come from richer Americans than from poorer Americans.  And if Congress could ever get its act together on tax reform, this could be part of a grand bargain resulting in lower overall marginal income tax rates.  This is what happens when you eliminate massive inefficiencies – everyone wins.  (Well, the bloated health sector would lose, as individuals might purchase less generous health insurance.  But isn’t the point of ongoing health policy to relieve us of this bloat?)

Firms that stop offering ESI could shift costs to the federal government to the extent that lower income individuals would now qualify for subsidies on the ACA exchanges.  We find it perplexing that ending the horizontal inequity of the ACA (i.e. the individuals with similar assets, income, and family structure face meaningfully different tax liability based on whether they get insurance from an employer vs. the exchange) would be seen as a negative.  Certainly this aspect of the ACA should be seen as a bug and not a feature.

We should also note that removing the employer mandate is not the same as ending employer provided health insurance. As noted health economist Mark Pauly has said many times, employees may value the services of their employers as a knowledge broker for insurance. In addition, firms with a high percentage of relatively well compensated employees may find it is economically advantageous to give up the subsidies on the exchange in order to retain their tax free insurance (though this seems to be more of an argument in favor of ending the tax exemption).  All we are asking for by ending the mandate is allowing the exchanges to compete on a more even footing with ESI.  Even if we do not eliminate the perversions of the current tax code, ending the mandate would benefit many employees and create a thicker and healthier market for the exchanges which should improve both the options and pricing.

February 12, 2015

Shame on Staples? No, Shame on You Mr. President. It’s Past Time to End the Employer Mandate

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 10:46 am

The New Year always brings many changes.  In addition to soon to be broken resolutions, this particular year ushered in strict mandates requiring employers with more than 100 full-time employees to either provide health insurance to those employees or pay fines of between $2000 and $3,000.  We’ve seen many firms publicly respond to this by cutting benefits to part-time workers.  Despite the criticism that often accompanies these decisions, in many, if not all, of these cases this move benefits employees. Without the offer of employer-provided insurance they get access to the ACA exchanges.

Part of the criticism stems from the implicit belief that firms “give” benefits to their employees out of some form of philanthropy.  These benefits are just a tax-preferred (though not really for low-income employees) form of compensation, and research shows that increases in benefit costs result in lower wages for employees.  The firms that have cut benefits will either increase wages or lose a lot of employees. (If they cut benefits, do not raise wages, and do not lose workers, then they must not have been profit maximizing to begin with; we highly doubt that firms like WalMart would have knowingly forsaken an opportunity to maximize profits.)

As the employer mandate has been phased in since the passage of the ACA, we have seen an increasing focus on the artificial distinction between full and part time employees.  Firms are only responsible for fines based on how many full-time employees don’t have access to insurance and a compilation of anecdotal evidence suggests that employers have responded by placing strict caps on the number of hours their employees can work.  Suggestive evidence of this being a widespread phenomenon can be seen in this analysis of CPS data, which shows an increase in the number of part-time hours working below 30 hours per week.  While there are many things that could be causing this shift, the timing strongly suggests that hand of the ACA employer mandate at work.

Most recently, news emerged that Staples has threatened to fire any part time employee that works more than 25 hours per week.  To be fair, Staples executives claim that this is simply a reiteration of a long-standing rule though the timing suggests that stricter enforcement of this regulation is likely related to the large fines that Staples would face for part-time employees that cross the artificial 30 hour barrier.  In a recent interview, President Obama was none too pleased about this announcement:

“I haven’t looked at Staples stock lately or what the compensation of the CEO is, but I suspect that they could well afford to treat their workers favorably and give them some basic financial security. It’s one thing when you’ve got a mom-and-pop store who can’t afford to provide paid sick leave or health insurance or minimum wage to workers — even though a large percentage of those small businesses do it because they know it’s the right thing to do. But when I hear large corporations that make billions of dollars in profits trying to blame our interest in providing health insurance as an excuse for cutting back workers’ wages, shame on them.”

Shame on you Mr. President. First, Staples is only doing this because of your policies.  And who can blame them for reacting like this. Staples isn’t earning “billions” in profits per year. They are competing in a world of online commerce where their competitors don’t have the same large retail workforce (though much of their business appears to be shifting out of the retail setting as they shutter hundreds of stores.) Finally, it should be noted that recent research finds that these larger employers are already offering higher wages than “mom and pop” stores.

These points aside, the President’s statement is either disingenuous or belies a willful ignorance of how and why private employers provide benefits to their employees. Benefits are not something that private firms owe to their employees, instead they are part of a compensation package that is determined in the marketplace.  These benefits are provided by employers because of the combination of a historical accident of post-WWII price controls, the tax-preferred status of these benefits, and the benefits of risk pooling in the employer setting in a world where people don’t have to purchase insurance.  Most economists believe that this employer sponsored insured (ESI) is inherently inefficient, and recent research by Garthwaite and his co-authors shows that is distorts the labor supply decisions of many Americans.

In this setting, what we are actually talking about is not just the provision of benefits but limits on how many hours employees can work because of a new explicit mandate in the ACA.  This is just further evidence that the employer mandate is causing far more harm in the labor market than good.

While we have been critical of many aspects of the ACA, one facet we clearly support is that it represents the first realistic opportunity to move away from the distortions of ESI.  By forcing people to purchase insurance and imposing an increasingly binding tax on “high dollar” benefits, the ACA limits the main benefits of ESI.  However, it then includes a counter-productive mandate that forces employers to offer benefits and distorts the number of hours that employees work.

Rather than lecturing CEOs that are acting in the fiduciary interest of their shareholders, the President should show the courage to end the employer mandate.  It will surely not be popular among many of his most liberal supporters, but it ultimately will make the ACA more effective.

February 9, 2015

The Unfortunate Return of All Payer Rate Setting

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 12:04 pm

In our ongoing attempts to reform the ACA to better address the growth of health spending, rather than simply expanding insurance, the focus is turning to prices.  Some aspects of the ACA offer promising attempts to control hospital prices.  For example, as we have blogged about before, the emergence of narrow network plans allow insurers to more effectively negotiate with hospitals by providing a credible threat the high priced hospitals will be excluded from insurance plans.

However, we are also seeing the re-emergence of some truly terrible ideas.  In a recent interview with Vox, President Obama was asked about whether private insurers should be allowed to negotiate prices as a group.  He said, “I think that moving in the direction where consumers and others can have more power in the marketplace, particularly when it comes to drugs, makes a lot of sense.”

As the writers at Vox point out, it sounds a lot like the President is talking about the return of all payer rate setting. We have been down this road before. All payer rate setting had faddish appeal in the 1970s, with New York and seven other states trying it on for size. After research (including Dranove’s) showed that rate setting barely put a dent in double digit hospital price inflation, all of the guinea pig states except for Maryland abandoned the dubious policy.  Instead of centralization, states in the 1980s opted to deregulate insurance, which opened the door to selective contracting.  Prices plummeted, which is what we would expect once market forces were unleased.  And recent research shows that in recent years, even with the growth of provider market power, hospital prices in Maryland have grown faster than in surrounding states.   It is worth noting that private insurers agreed to all-payer rate setting in the 1970s due to concerns about cost-shifting.  If all payer rate setting is reincarnated, it will not be the first time that we have introduced a cure that was worse than the disease.

However, even if rate setting did drive down prices, this would hardly be evidence that it was succeeding.  After all, monopsony is every bit the antitrust problem as monopoly.  When today’s competitive payers try to drive a hard bargain they end up with narrow networks; they would drive harder bargains still but there is a limit to how small those networks can be – a limit circumscribed by market forces.  A single monopsony payer can force such a hard bargain that providers will be forced to cut staff, hours, training, or even close – and the monopsony payer will suffer none of the consequences.  This isn’t idle speculation… New York’s rate setting program was accompanied by some inner city hospital closures.  A rate setting commission would have to perform quite the balancing act, assuring that the right hospitals are open in the right locations, offering the right services at the right quality.  President Obama might trust government to thread that needle, but we surely do not (and frankly the course of human history with respect to central planning is on our side).

Advocates of allowing collusion among payers cite the need to counteract provider market power.  We feel their pain; Dranove has played a leading role in antitrust cases that target provider mergers.  But we are reminded of our parents telling us that two wrongs don’t make a right.  Allowing both sides of the market to have monopolies does not mean that we will get to an efficient solution.  As our colleague Marty Gaynor said, “If your bike gets a flat tire, do you let the air out of the other one?”  In this case we fear that rate setting which combines government agencies and private insurers into one collusive bargaining unit means we will deflate both tires and then throw the bike off a bridge.

January 30, 2015

Where Does the ACA Go from Here?

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 11:33 am

Barring a Republican landslide in 2016, it looks like the Affordable Care Act (ACA) is here to stay.  By and large, we think that is a good thing.  While there are many things in the ACA that we would like to see changed, the law has provided needed coverage for millions of Americans that found themselves (for a variety of reasons) shut out of the health insurance market.

That being said, since its passage the ACA has evolved and the rule makers in CMS continue to tinker around the edges.  We are especially encouraged by CMS’ willingness to relax some of the restrictions on insurance design, but remain concerned about some of the rules governing employers and the definition of what is “insurance.”  In the next few blogs we will examine some of the best, and worst, of the ongoing ACA saga.

We start with one of CMS’s best moves—encouraging reference pricing.  The term reference pricing was first used in conjunction with European central government pricing of pharmaceuticals.  Germany and other countries place drugs into therapeutic categories (such as statins or antipsychotics) and announce a “reference price” which insurers (either public or, in Germany, quasi-public) that insurers will reimburse for the drug.  Patients may purchase more expensive drugs, but they were financially responsible for all costs above the references price.  Research shows that reference pricing helps reduce drug spending both by encouraging price reductions (towards the reference price) and reducing purchases of higher priced drugs within a reference category.  Other research has found suggestive evidence of similar results for reference pricing for medical services.

While the ACA does little to govern pricing in the pharma market, the concept of reference pricing can and should be extended other medical products and services.  In particular, insurers can establish reference prices for bundled episodes of illness such as joint replacement surgery.  Under the original ACA rules set forth by CMS, insurers were free to establish a fixed price for bundled episodes.  They could even require enrollees to pay the full difference between the provider’s price and the reference price.  But there was a catch. It wasn’t clear if any spending above the reference price would count to the enrollees by enrollees out of pocket limits (currently $6,600 for individual plans and $13,200 for family plans).  Obviously, allowing the out of pocket limit to bind on reference pricing would limit the effectiveness of this cost control measure.

A simple example may help. Consider knee replacement surgery for a patient who already paid $2,000 in medical costs this year.  An insurer might set a reference price of $15,000.  Then providers can charge any amount over $19,600 and the out of pocket cost to the patient would be capped at $4,600.  And if the patient had any other medical expenses that year, the out of pocket cost would be capped even lower.  This would hardly discipline providers whose prices are well above $19.600.   Considering that one study suggests there will be substantial differences between prices charged by the top and median quintile providers of bundled services, such kind of market discipline is sorely needed.

Last year the Department of Labor (DOL) solved this problem, issuing a new rule so that payments above the reference price do not count towards the out of pocket limit in large group and self-insured plans.  So now the formula for reference pricing under the ACA resembles the successful formula for reference pricing in Europe.  We would actually prefer the that the regulators go a step forward and say that spending above the reference price also cannot be counted towards the individual’s annual deductible.

But even this new rule will only go so far to introduce market discipline.  Insurers must be willing to bundle payments and this won’t happen in any big way until there are more “bundlers” – organizations capable of accepting bundled payments.  Providers need not integrate to do this; indeed, the organizational problem of paying and incentivizing individual providers (be they doctors, technicians, nurses, or therapists) remains regardless of how the bundler is organized.  But someone has to be the bundler.

More pragmatically, there are only so many conditions that lend themselves to bundling.  The study of price variation that we mentioned earlier covered most of the high priced conditions for which bundling is popular – joint replacements, CABG surgery, and back surgery.  Unfortunately, these represent just a small fraction of total health spending.  It is difficult if not impossible to delineate the boundaries of chronic care for diabetes, cancer, asthma, and many other high cost conditions.  One solution is to capitate providers, but many providers and their patients will object to this complete reversal of economics.  Shared savings under ACA is the half-hearted version of capitation.   But there is a way to incentivize patients to be more cost conscious.

The key is to recognize that deductibles might be a good way to get healthy people to pay attention to prices, but the U.S. health spending crisis is not driven by profligate healthy people. It is driven by the 18 percent of us, mainly with chronic conditions, who spend 80 percent of our health dollars. But patients with chronic conditions routinely blow through their deductibles.  So the increased reliance on first dollar deductibles seems woefully misplaced. CMS can and should allow insurers to creatively redesign cost sharing so as to increase the price sensitivity of chronically ill patients, without increasing overall financial risk.

For example, consider a typical plan with, say, a first dollar deductible of $5000, and a coinsurance rate of 10%. A diabetes patient will spend $5000 in just a few months, and the savvy diabetes patient will realize that the marginal price of all spending throughout the year is just 10 percent of the full price. This hardly encourages price sensitivity. Here is an alternative plan that the ACA should allow. Insurance covers the first $20,000 of medical bills.  Beyond that, the patient pays 33 percent of the next $20,000, up to their $6600 out of pocket limit.   (Of course, the exact thresholds would depend on the predicted medical needs of the patient.)  The patient faces less financial risk than previously, yet is faces higher marginal prices. It is a win-win. The point is that it is always possible in this way to encourage patients to be more responsible without increasing their total out of pocket burden.

Admittedly, this plan may force CMS to redouble its efforts to limit insurer cream skimming.  For certain this plan won’t do such a good job of encouraging price sensitivity among the healthy. But that is a feature and not a bug of our proposal. Instead of imposing costs on the low spending individuals who are not causing the run-up in health spending, we prefer to follow the advice of great sage Willie Sutton and concentrate our efforts on “where the money is” not where it isn’t.

November 21, 2014

Now who’s being stupid (and it’s not Jon Gruber)?

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 10:14 am

To date, we’ve consciously chosen not to blog about the recent controversy surrounding our colleague Jon Gruber.  This is not because we lack opinions on the issue, but mainly because as economists we didn’t think we had anything of value to contribute to the discussion, which was largely about scoring political points.  However, recent attempts to stop grant support for Jon’s academic research have drawn our attention and we think it is important to highlight some important issues.  Beyond being the “architect of the ACA,” Jon is one of the most prolific and influential economists in academia.  His academic research is exactly what we should be supporting with grants regardless of any regrettable comments he made.

Since these videos emerged online, Jon has been subject to a wide range of attacks on both his personal character and his intellect (though we note that in a battle of the brains between David Axelrod and Jon Gruber, we’re taking Gruber every day and twice on Sunday).  We are not naïve, and understand that some of this is just part of the overly political nature of the debate over the ACA, in which the videos of Jon’s various comments are just another pawn.  Academics who choose to become involved in the political process must play by a different set of rules – and in the age of social media these rules are different even from what they were 10 years ago.  Though we would also note that the clutching of pearls by various members of each political party about the content of Jon’s statements does make use think we are watching the audition tapes for Casablanca’s Captain Renault.

We should note from the outset, that any casual reader of this blog realizes that we sincerely disagree with Jon on many political issues, particularly those related to the design and implementation of the ACA.  In addition, neither of us was pleased with the manner in which the ACA was debated, designed, or passed.  That being said, in the past couple of days, Republican lawmakers sent a letter to the National Institutes of Health asking them to review one of Gruber’s recent grants.  This is simply a bridge too far, going well beyond the bounds of reasonable and fair outcomes from this kerfuffle.

Perhaps a little context will make clear why this is the case.

Throughout his career Jon has written on a wide variety of topics ranging from the crowd-out of public health insurance, supplier induced demand and the effect of health insurance as precautionary savings (and these are just his health care papers).  In more recent years, Jon has focused a lot of his work on understanding the decision making of enrollees in Medicare Part D (i.e. the prescription drug benefit available to seniors as of 2005).

As we all know, choosing the right health insurance plan is really hard.  Consumers have to consider premiums, deductibles, copayments, coverage limits, networks…it is extremely challenging.  (To be fair, making the right choice for purchasing a variety of good is hard but insurance is just far more complicated).   We know from personal experience how hard this can be.  A few years ago, our employer offered a menu of health plans and learned, after the fact, that the cost sharing provisions assured that one of the options was worse for all employees, regardless of their health needs.  Even so, this was one of the most popular choices, and one of us made the mistake of choosing this plan!  I don’t think we are being presumptuous to say that if consumers with PhDs have a hard time making sense of plan options, others are also likely to struggle.  Indeed, Jon’s research (with various coauthors) confirms that seniors have potentially been making systematic errors with their initial plan selections.  For example, in peer reviewed work he has shown that seniors appear to use premiums rather than out of pocket costs when choosing their insurance plans, even though this decision rule often leads to worse financial decisions.

Jon’s  work is important for understanding how to shape the options available to seniors under Medicare Part D.  But it also suggests that all consumers may face challenges when choosing plans in the ACA exchanges and helps explain some of the rules governing plan offerings, such as the classification into “medal” categories that greatly facilitate comparison shopping.  In addition, several private companies are now providing information to consumers trying to sort through their plan offerings.  Jon’s research, which has been instrumental in these important developments, represents the very type of work that the NIH should be funding.  Thanks to his work, we have made important progress in designing exchanges that promote efficient choices of insurance plans.

Beyond this particular topic it’s important that we avoid the blatant politicization of the grant making process.  While we understand how some people could be offended by the comments that Jon made, and we remain unimpressed with the debate over the ACA, this shouldn’t spill over to the academic side of this conversation. Even throughout this entire process, no one has questioned the quality of Jon’s work or analysis.  He is one of the best economists of his generation and someone whose research should be supported. Ultimately, we all need to realize that stopping support for Jon’s research in order to score political points is, well, just plain stupid.

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