Saturday, February 27, 2010

Designing a High Deductible Plan

I am increasingly gratified to see more economists and politicians coming out in favor of high deductible health insurance. The positive effects of such plans would be both direct and indirect. I am actually more excited by some of the indirect, subtle effects that I think would happen as more people moved into high deductible plans, especially in regard to demanding more price information.

Here are my thoughts on how one would go about thinking about designing a high deductible plan for a self-insuring employer. There are lots of details that I won't get into, and most important, to make real progress I would need historical data on the distribution of health expenses in the employee base. But I think I can illustrate some of the key ideas.

The data that I would start with would be the percentage of employees with yearly expenses falling in different ranges, like this:

Health Care Expenses, % of Employees

0 - 2500, 10%

2500- 5000, 15%

5000 - 7500, 25%

7500 - 10000, 20%

10000 - 12500, 10%

Greater than 12500, 20%

If I had this data for an employer, I would start with it to get a feel for where a reasonable initial deductible might be. I want a deductible high enough so that I capture a reasonable number of employees with total expenses under that amount. At the same time, I don't want a deductible that is going to be unreasonably high. What's reasonable? Well, for the number of employees, I think we would want to catch something like 25%-50% of the base with total expenses under the deductible, at least. My thinking here is that the deductible is set to capture expenses for which true insurance makes sense, and if something is occurring more than 75% of the time, or even up to 50% of the time, it sounds too common to be reasonably covered by insurance. But on the other hand, I don't think a deductible that is too high is going to be acceptable to people who are used to "insurance" paying the bills.

Since I don't have that detailed of data at hand right now, let me proceed by assuming that what I do know is that 1/2 of the employees have total yearly expenses under $7500, and that the overall average expenses are $18,000 per year. For a family, that is a reasonable number. Given these two assumptions, we can infer that the other 1/2 of the people have expenses that are on average $32,250 per year (with some no doubt having very high expenses!)

With average expenses of $18,000 per year over all employees, we know that "fair" insurance would be priced at $18,000. (Apologies again to Sec. Sebelius for using such a blasphemous phrase as "fair insurance. What I mean by fair here is just that if the employer charged $18,000 for the insurance, with no deductible, it would come out, on average, just even.) I do recognize that the data we observe will be influenced by the deductible in place during the data collection period.

Now what would happen if we put a $7500 deductible in place? Well, everyone with expenses less than $7500 would pay all their health expenses themselves. That is 1/2 of the people. The other half would pay their deductible, and the employer would pick up the rest.

If expenses in the upper half of the distribution (greater than $7500) stayed the same -- I will return to this point -- then the employer's expected expenses look like this:

Employer's Expected Expense = .5(0) + .5($32,250 - $7500)
= $12,375

That would be the "fair" price of the insurance plan with a $7500 deductible. Note that the fair price of the plan with a deductible is not just the average expenses less the deductible -- that is, the fair price is not $18,000 less $7500 = $11,500.

So, there is our comparison: Insurance that covers everything for $18,000, or a $7500 deductible policy that would cost only $12,375.

Importantly, as a consumer, I could buy the cheaper policy and put the difference in prices, $18,000- $12,375 = $5625 into an account, which we might as well call a Medical Savings Account. On average, that amount of money will cover my out-of-pocket medical expenses (1/2 of the time my expenses will be less than $7500, or $3750 on average; and half of the time my expenses will be the deductible, $7500.) I am not dealing with taxes here, but if that MSA better be tax deductible if the cost of insurance is, or this will never work. Also, the MSA cannot be "use it or lose it."

That gives an idea of some of the thinking that would go into the design of high deductible plan. Next would come some more subtle, yet important, issues. One, what would happen to the expenses of those folks who used to have expenses greater than $7500. I would expect them to come down, for several reasons: One, the employees would simply not incur as many expenses, partly because they would decide to forego some expensive but optional services. Two, because they would be more careful about their health to begin with. Three, because they would put some pressure on health care providers to cut their prices. These effects would be the cost-control measures that we so desperately need, and they would allow for a DECREASE in the price of insurance as time went on. Can you imagine that??

Another subtle issue would be self-selection if we made two plans, the high deductible and the no deductible, both available. Then we would get folks taking the no deductible plan who expected to incur large expenses, and vice versa for the low deductible plan. That would allow the high deductible plan to be priced even lower, and would force a higher price on the no deductible plan. This is essentially what we see happening to individual insurance prices in the California market, and it should not be viewed as a bad thing.

Thursday, February 25, 2010

Other Economists Supporting Reasonable Health Care Proposals

Two editorials by some very smart people that are very similar to my proposals for health care changes -- a focus on incentives for individuals, and changes in the tax treatment of health care.

First, one by Cliff Asness: "Don't Ask" is No Way to Run Health Care" The basic message here is that we are "insuring" way too much -- small health care expenses instead of focusing on catastrophic expenses. Large events are what insurance was created for. I like to ask people if they have insurance for new tires on their car every couple years?

Second good editorial is by three economists, John Cogan, Glenn Hubbard and Daniel Kessler, "A Better Way to Reform Health Care." These guys also stress the need to make individuals bear the true cost of their health care. High deductible policies and elimination of tax deductions for health spending would effect that.

Nice to see a little press on these very common sense changes to our messed up system.

Saturday, February 20, 2010

Price Increases on Individual Health Plans: Deductible Leveraging

I was intrigued by the mention of "deductible leveraging" in Wellpoint's response to criticisms of their on-average 25% premium increases for individual customers in the California market.

How important an effect might this leveraging idea be? Well, pretty significant. The basic idea is that as underlying expenses increase, the company bears a larger portion of the total expense, so long as the deductible remains fixed. This increase in cost is going to be reflected in premiums. Here's the simple math.

Let x, a random variable, be an individual's actual health care expenses for a year. Let the deductible be D and we will call the premium P. All these will be annual amounts.

Then the expected value of the individual's insurance expenses are E(x) and the insurance company's portion of that would be:

I = insurance company's costs = E(x) - D

since the individual pays the deductible first. I am ignoring any coinsurance.

With fair insurance (I wonder if Sec. Sebelius can imagine such a concept!) the premium would be set at:

P = I = E(x) - D

Now let's just see what happens to P when we experience inflation at the rate of "i" in underlying insurance expenses.

Expenses will become (1+i)x, and therefore the insurance company's costs become (1+i)E(x) - D. This means that the premium increases to

P' = (1+i)E(x) - D

Then the percentage increase in the premium is

P'/P = {(1+i)E(x) - D}/{E(x) - D}

= {E(x)-D}/{E(x)-D} + {iE(x)/(E(x)-D)}

= 1 + i{E(x)/(E(x)-D)}

Note that the term multiplying the inflation rate is greater than 1, since the denominator is smaller than the numerator. There is the basic leveraging effect.

Let's use some numbers to see how it might work out. Suppose underlying inflation in health costs to be 10%, and let's take a policy with a $2500 deductible with a premium of $3600 per year. This implies, from the above equation, that total expected costs must be $6100.

Using that last equation up above, it follows that the rate of increase in the premium will not be 10% but instead 16.9%. Using the kind of rhetoric that Sec. Sebelius (fast becoming my least favorite person in Washington), the premium increases 1.69 times faster than the underlying rate of inflation.

As will be obvious from the last equation, this leveraging effect is greater for higher deductible policies.

Note that while the individual feels a 16.9% increase in their premium, their total expected cost still only increases by the rate of inflation, that is, 10%. This is a trivial point, but one that not a single reporter or story has made.

There are many problems in the individual health insurance market that need fixing and that can be fixed. I just wish that Obama, and the Republicans too, would hold true to their pledges to stop the rhetoric and focus on the real issues. Blaming the insurance companies and their "excess profits" as dear Sec. Sebelius has been doing, is shameful.

Saturday, February 13, 2010

High Deductible Health Plans: Difficulties With

Like at many other institutions, I expect to see significant increases in my health insurance costs purchased through my employer in 2011. I have often advocated for high deductible plans -- catastrophic coverage, essentially -- as a good direction to go in health insurance. Such plans would potentially:

-- Make consumers internalize the true cost of health care and make efficient decisions concerning purchases
-- Create conditions for more price transparency. I expect that more consumers would start asking their providers what procedures will cost.
-- Make consumers realize that much of the problem with health care cost is not with the insurance companies but with high prices from providers.

Unfortunately the path to high deductible plans that would lead to such effects is not easy. There are a lot of behavioral and institutional issues that need to be corrected, and at least one major tax issue. Let me elaborate a bit by using Dartmouth's prices for insurance as an example.

My choices in health insurance are three-fold: a "high" deductible indemnity plan, a "zero" deductible PPO (preferred provider organization) plan, and a "zero" deductible POS (point of service) plan. I put quotes around the deductible amounts since they are fuzzy -- depending on what kind of provider you use, the deductible might or might not apply.

But let's try to keep it easy and focus on the two plans I paid attention to. The indemnity plan has a $3000 per year family deductible, while the PPO plan has a $750 family deductible so long as I stay in the network of preferred providers, which I normally would do. The PPO deductible only applies to some things, like hospital stays, outpatient services, physician services. Routine exams and things like xrays are either covered in full or for a nominal amount ($15).

The high deductible indemnity plan would cost $19,800 per year while the low deductible PPO costs $18,635. Thanks to misguided tax policy, all of this is paid for with pre-tax dollars.

Already you can see how tough this choice is going to be. This is not like comparing what kind of beer to buy, for sure. Not even like auto or home insurance.

But let's try to cut to the chase. If I buy the high deductible plan, I save $1165 per year. For that, I risk paying an additional $2250 or even $3000 in my own health costs. If I can put money into a health savings account, then I can keep the comparison in pretax dollars, but the problem with our health savings account is that if I don't use all the money in a year, I lose it. So I have to estimate what I will spend, and put only that much in. If I underestimate, then I will end up paying the deductible with post-tax dollars, which really hurts.

So if I expect my health care costs to be less than $1165 for the year, I would be better off with the high deductible plan -- the savings in plan price exceeds what I will pay out of pocket for costs. (I am assuming here that the effective deductible on the PPO plan is zero, as most of my expenses are in the zero deductible category.) More than $1165, and I should take the low deductible plan. And in doing these calculations, I should anticipate that my pattern of health care consumption should be different depending on what plan I have (since in one plan I pay for each service and in the other plan I do not).

This is a tough call. The biggest problem for me is that there is simply not much to be gained one way or the other. The dollar amounts are just not that large. And then there are other differences that our dear benefits providers have thrown in to make the choice even more complicated: the plans differ in mental health services, eye care, drug coverage, and even reimbursement for health care membership.

Faced with the choice, most people, I believe, opt for the PPO plan. Yes, it costs a bit more, but it is easy to understand. I think the College probably feels this is good, that most people opt for the PPO, as it discriminates against out-of-network providers. So employees use the low-cost preferred providers.

The problem of course is that now I have a zero deductible on all kinds of services and a low deductible on a lot of other things. So many consumers get into a situation where the marginal price of health care for them is zero. That causes consumption of services to be too high, and creates a situation where consumers don't know what things cost. Not even doctors and hospitals know what things cost, because nobody has an incentive to ask. And, consumers, when they see increases each year in their health care plans, blame the only entity for which they see a meaningful price that they pay -- in this case, Anthem. (Interesting, the payment for a doctor visit under the PPO plan is $15, probably leading many consumers to think that doctor's can't be charging too much!)

In my opinion, the design and pricing of these plans is very poor. If they are designed to get folks into a PPO so they select in-network providers, that can be accomplished another way. What they plans are not doing is getting people to take high deductible plans and have proper incentives.

Could better plans be designed? Of course. In my next post, I will work out some more details. However, the key elements are going to be: First, there has to be a really high deductible plan, something in the $5,000 range. Otherwise there just won't be enough potential savings to play around with. Second, with such a high deductible, the medical reimbursement account will have to have a corresponding high limit, and, CRITICALLY, the "use it or lose it" aspect will have to disappear. If you put $5,000 into an account for medical costs, and use only $1,000, then next year you should be able to roll that entire amount forward. Essentially we should be able to self-insure our medical expenses with pretax dollars over time.

Next post will take some imaginary data and play around with a couple plans that could get a larger portion of employees into a high-deductible plan.

More on the Health Insurance Price Hikes in CA

Both the facts and the reporting of the facts interest me in this story about Anthem/Wellpoint's price increases for individual health insurance in California.

After some searching I found the five-page response letter from Wellpoint -- why don't virtually any of the stories reporting on the increases link to Wellpoint's response, which is available here?

The letter gives some information, but it is not perfect. Brian Sassi, CEO of the Wellpoint Consumer Business Unit makes some good points. He notes that the 39% increase reported is one of the largest increases, not the average. He points out that many increases are related to insured consumers getting older and moving into higher priced tiers. He makes an interesting argument, which is that if insurance has a fixed deductible, and health care costs increase, then there is a phenomenon that he calls "deductible leveraging." This is true; with a fixed deductible and an x% increase in underlying health care costs, the premium will have to increase by more than x% to maintain fair insurance. Why deductibles are not indexed is an interesting question.

He also argues that adverse selection is working powerfully in the individual market. This is probably true.

He argues that many individuals can and do move into lower cost policies (with higher deductible) both before and after price increases. He cited one fact, that a 40 year old woman in LA can obtain a $1500 deductible policy for as low as $156 a month.

What he doesn't do, unfortunately, is give us data on the actual age-constant policy premium increases. Why beat around the bush so badly? Come on, 'fess up and spit it out for crying out loud!

So, a big question here is: Why would Anthem institute rather large price increases in the individual market at a time when such an announcement is sure to cause a huge ruckus?

Theories, with my probabilities:

1. A lower level manager made the moves without thinking about the effect and without alerting upper management. Now the company is in defensive mode. (10%)

2. Upper management made the decision on the basis of sound business analysis, understood the implications, and decided that business trumps politics and they would just deal with the outrage. (35%)

3. Upper management made the decision on the basis of sound business analysis, understood the implications, and decided that it would actually be good to stimulate some debate, since much of the increase follows from the bad state of current policy. (50%)

4. The price changes were not entirely based on sound business analysis, but upper management decided to announce them purposely to stimulate debate. (5%)

Note that the letter from Wellpoint does devote a fair amount to current policy problems, and why the proposals in Congress will not solve these problems:
Unfortunately, the proposed personal coverage requirements in the health care reform legislation passed by both houses of Congress failed all three requirements by (1) exempting tens of millions of Americans from the requirement, (2) using the tax filing process as the only checkpoint which misses tens of millions of Americans who do not file taxes, and (3) including penalties that are a small fraction of the cost of coverage. Under this framework, it is only logical that many individuals— primarily those who are healthy—would have not been captured by the mandate or would have made the logical choice to pay the penalty unless services were needed.

Friday, February 12, 2010

And Now for Some GOOD Republican Ideas

George Will, in a column titled Charting a Simple Road to Government Solvency lays out the proposals of Paul Ryan, Congressman from Wisconsin (with help, it seems, from Republican representatives Devin Nunes of CA and Jeb Hensarling of TX). The full proposals are available here.

First, on health care: refundable tax credits for purchasing portable coverage in any state, with the link to employment clearly severed. Quoting from Ryan's proposal:
Yet health coverage is currently linked to employment by the individual income tax exclusion for employer-sponsored health care. This tax treatment effectively discriminates against workers and families who do not have employer-sponsored health insurance. Compounding the problem, the number of employers providing health insurance has dropped 69 percent since 2000; and this alarming trend is continuing.

Equalizing the tax treatment of health care and coverage will give workers and families much more freedom to acquire a plan that best suits their needs. Making health insurance portable means an individual no longer will live in fear of losing his or her health care along with a job. As the marketplace begins to respond to this new patient-centered control, the resulting increase in competition will improve the quality of services and provide more options to meet the diverse needs of Americans, while lowering costs.

In addition, Medical Savings Accounts would be strengthened. Medicare would be grandfathered in for older people but younger people would enter a new program that would give them vouchers to buy insurance.

These are significant changes. Intellectually exciting, with the potential to really change the system as we know it (which makes any scoring by the CBO virtually meaningless, as they cannot take account of behavioral changes.)

But Ryan doesn't stop at health care -- he has changes for the tax code and Social Security as well.

As for taxes, he opts for simplicity and incentives: a broad base (no deductions other than the health care credit) and two rates, 10% up to $100,000 and 25% beyond that. Beautiful. (It also solves a problem that a colleague was really harping on the other day to me: that the majority of Americans now pay NO income taxes. What kind of "skin in the game" is that?)

And Social Security, like Medicare, gets grandfathered in for older people but younger people get the option of Personal Retirement Accounts for up to 1/3 of their Social Security taxes.

Nobody can say that the Republicans do not have any ideas. This set of ideas is radical, but based on sound economics and conservative principles (as in, individual responsibility and small government). They could ensure that the US economy would be the most dynamic wealth-producing economy in the world for decades to come.

In fact, these ideas are enough to make me want to join Mr. Ryan and his colleagues.

Gingrich and Goodman's Semi-Lame Ideas

The Republicans have some pressure now to show that they are skilled at more than just blocking the Democrats. They need to come up with some ideas of their own. In two posts, I give two examples: First, a set of ideas for health care reform that don't really excite me, from Newt Gingrich and John Goodman, as they wrote in an editorial in the WSJ.

Gingrich and Goodman start out with a couple OK ideas. Give consumers the choice of either a tax credit or a deduction for health insurance, and have it be a fixed dollar amount regardless of how much insurance one purchases. Make insurance portable they say. (But they don't say clearly if they mean to sever the link of tax credits/deductions to employment. Just saying that "Employers should be encouraged to provide employees with insurance that travels with them from job to job..." Why not take the big step and make the tax credit/deduction separate from employment?)

After the first couple points that could have some effect if they were made a little more powerful, the two Republicans end up with a list of rather minor and vague points: "Allow doctors and patients to control costs." "Don't cut Medicare." "Inform consumers."

I almost fell asleep reading it. Zero intellectual excitement.

On to a better version in the next post.

Thursday, February 11, 2010

Individual Health Insurance Prices/Adverse Selection Spiral?

Many are reporting on Anthem of California's large price increases in the individual health insurance market -- see here for instance.

Be careful, of course, because all we really know is that
Anthem Blue Cross has unveiled rate increases of up to 39 percent for its 800,000 individual policyholders in California.

And of course there are the stories of individuals reporting their own personal increases.

What we don't know from the stories is what the average increase for the entire pool is.

However, some of the explanations are reasonable -- that some insured people are dropping out of the pool, leaving only the most costly remaining. As prices go up, this will of course only get worse: those who think they are healthy will take their chances, and drop out. This is the adverse selection death spiral.

I am, however, skeptical -- as usual. Skeptical that the anecdotes don't represent the average. And, if indeed the average is going up anything close to 39%, skeptical on why Anthem would be stimulating the debate on health care in such an aggravated fashion.

I will be keeping my eyes open for more information on this important development.

Yale University Announces: We'll Eat our Seed Corn

In a letter to the faculty and staff of Yale, President Richard Levin announced that he was seeking $150 million of savings in order to balance their budget. Among other cost reductions, he said that the number of new students admitted into the Graduate School will be reduced by 10-15%.

No detail was given on what schools would see the reductions, but this is depressing. In my world at least, great PhDs are in extremely short supply, and we should be increasing the numbers.

Levin attempts to temper the news by saying that the number of graduate students will be no lower than a decade ago.

So...a decade of no growth in Yale graduate students. Did the population of the world not grow in the last decade? Did the world's demands for doctorates stay level?

This cut in graduate school admissions needs to be put into the context of flat undergraduate admissions at the nation's top colleges, especially the Ivy League. When these schools were flush with cash, instead of admitting more students, they gave away more financial aid to the existing students and put up nice new buildings. The choke point at the top of the pyramid just got tighter and tighter: a larger US population, more global applicants, yet the same number of students being let through the doors of opportunity.