David BoddySenior Research Assistant, The Hamilton Project
David BoddySenior Research Assistant, The Hamilton Project
Through reforms to cost-containment and expanded access to health insurance plans, the Patient Protection and Affordable Care Act of 2010 (ACA) has begun to shape the delivery and cost of health-care services to Americans. Many of these reforms are still taking hold, and it is too soon to completely know how they are affecting the health-care system. But looking beyond these considerations, it appears that many enduring economic challenges persist in the markets that provide health care and health insurance to consumers.
Indeed, many of these ongoing challenges center on three areas:
In the years to come, confronting these enduring challenges will be critical to helping Americans achieve long-term prosperity. A fundamental tenet of The Hamilton Project’s economic strategy is that long-term prosperity is best achieved by policies that foster sustainable economic growth and that enhance individual economic security. Improving access to health care, reducing waste in the delivery of high-quality care, and effectively directing technological innovation toward productive medical treatments would work toward achieving these goals.
In this spirit, The Hamilton Project offers six economic facts that highlight continuing challenges and complexities in health care and health insurance markets on which the policy debate should focus. Chapter 1 reviews health-care spending in the United States, focusing on the differences in spending across regions and recent trends in spending. Chapter 2 describes consumers’ health-care spending and highlights their financial vulnerability when selecting an insurance plan. Chapter 3 examines the choices consumers make with employer-sponsored insurance plans—an important source of access to health insurance in the United States.
Health-care spending varies widely across the country and has grown steadily over the past five decades. Americans now spend nearly one in five dollars on health care. However, the pace of growth in health-care spending has been falling, on balance, since the 1980s due to changes in insurance plans, provider payment methods, and public sector programs.
Spending on health care varies dramatically across the United States. For example, figure 1 shows Medicare spending for the average enrollee in the program after adjusting for prices and demographics for each hospital referral region—areas where people tend to receive medical care from similar providers (Dartmouth Institute for Health Policy and Clinical Practice 2015). Darker regions correspond to higher levels of per enrollee Medicare spending, which is a proxy for other types of health-care spending. Importantly, because these estimates already reflect adjustments for the age, sex, and race characteristics of the regions, as well as cost-of-living differences that contribute to variation in the cost of health care, the regional differences in spending seen in the figure also reflect differences in the use of healthcare services. In 2012 spending for the price- and characteristic-adjusted average Medicare enrollee in Miami (the region with the highest spending) was $13,596, whereas spending for an enrollee in Minneapolis (one of the regions with the lowest spending) was $7,998—a difference of 70 percent.
Health-care experts debate why regional differences in utilization and spending arise, even after adjusting for the prices and demographics of hospital referral regions (Skinner 2011). One explanation is that areas that tend to have patients with poorer health may use more, or more-costly, care (Chandra and Staiger 2007; Sheiner 2014). Higher spending might also arise in places where patients have stronger preferences for more-expensive treatments. However, it may also be that regional variation in spending arises from differences in the way medicine is practiced, reflecting the incentives that doctors face and the market structure of hospitals (e.g., Cutler et al. 2013; Sutherland, Fisher, and Skinner 2009). In one study, Finkelstein, Gentzkow, and Williams (2014) find roles for both patient and provider explanations, with practice styles and other location-specific factors accounting for roughly half of the regional differences in utilization.
Because there are many reasons why health-care spending and utilization differ across the United States—some of which remain unresolved—policy solutions to address high levels of spending must balance a number of considerations. If patient characteristics were to account for all of the observed variation, changes to practice
styles would do little to alter health-care spending. However, if they do not account for all of the observed variation, there may be room to reduce spending by increasing the health benefits produced by a given level of inputs, including medical equipment, hospital beds, physicians, and nurses. By the same token, increasing the productivity of health-care inputs will not equalize health-care spending across the United States due to the variation in patient health and preferences, which suggests that policy interventions to achieve such equalization would be misguided.
For much of the past five decades, growth in spending on health care has been faster than economic growth in the economy as a whole. As shown by the purple line in figure 2, healthcare expenditures in 2014 accounted for an estimated 18 percent of GDP—a marked increase from 6 percent of GDP in 1965 (Centers for Medicare & Medicaid Services [CMS] 2015). However, from 2009 to 2014 total health-care expenditures as a share of GDP have been virtually constant.
The increase in nominal health spending has not been uniform across payers. The public sector’s health expenditures have grown more quickly, mainly through Medicare, the federal government’s health insurance program for individuals over age sixty-five and younger individuals with disabilities; and Medicaid, the public sector’s health insurance program for families with low income and resources. The share of spending by these two programs (not shown) increased from 7 percent of total health spending in 1966 to 36 percent in 2014 (CMS 2015). Patients’ direct payments to health-care providers, also known as out-of-pocket spending, have grown less quickly. As shown by the blue line, out-of-pocket spending (which includes outlays for deductibles, copayments, and coinsurance) as a share of health spending has been trending down, on balance, from 44 percent in 1965 to 11 percent in 2014 (CMS 2015).
Several factors account for the growth in health-care expenditures and the tilt in spending toward Medicare and Medicaid. First, the growing share of Americans over the age of sixty-five has increased enrollment in Medicare and has helped push up health spending because per capita medical costs are higher for those sixty-five and older than they are for younger individuals. Meanwhile, the aging of the population as well as coverage expansions in Medicare and Medicaid have led public sector enrollments to increase at a faster clip than enrollments for private insurance. Second, rising incomes over the past half-century have also led to higher per capita health spending (Smith, Newhouse, and Freeland 2009). Third, despite gradual changes in the way public and private insurers reimburse providers (i.e., physicians, hospitals, and drug companies), the prevalence of the fee-for-service payment model—where insurers reimburse providers based on the number and type of treatments—continues to drive spending growth by rewarding the quantity, but not necessarily the quality, of care provided.
Finally, and most importantly, experts point to the adoption of ever-more-sophisticated—and often very expensive—medical technologies as an important source of growth in health-care spending (Chandra and Skinner 2012). Generally speaking, technological advances have led to productivity gains and improvements in quality in the health-care sector, which have contributed to better health and well-being (Cutler 2004). However, among the many challenges with health-care technology, unlike in other sectors, the users of new treatments (e.g., patients, physicians, and hospitals) face just a fraction of the new treatments’ costs while private insurance companies and taxpayers supporting Medicare and Medicaid—who do not directly use the technology—pay the remaining costs. As a result, the U.S. health-care system often pays for new, moreexpensive therapies that might not be any more effective than those already in use (Chandra and Skinner 2012). Indeed, private insurers rarely make an explicit comparison between the costs and expected health benefits of new procedures and devices (Skinner 2013), and instead cover treatments that are termed “medically necessary,” where such a designation is determined in part through judicial adjudication.
Even with insurance, many households still remain vulnerable to depleting their savings in the event that they experience a major illness or injury. Exacerbating this vulnerability, much evidence shows that Americans often choose plans for themselves that lead them to pay more for prescription drug coverage or health insurance than they otherwise need to.
In 2013 approximately 80 percent of households with health insurance through an employer faced an average annual (family) deductible of roughly $2,500 for nonpreventive care (U.S. Department of Health and Human Services [DHHS] 2014b, 2014c). In the event of a large medical expense, the average household would have had to pay this deductible before plan coverage began. As seen in figure 3, more than one in three nonelderly households with employer-sponsored insurance did not have enough liquid assets—funds in checking, savings, or money market accounts—to meet this average deductible. One in five did not have enough cash on hand to pay a smaller deductible of $1,000. Furthermore, 25 percent of families reported in 2012 that medical care imposed a financial burden (Cohen and Kirzinger 2014).
Extremely large medical expenses are rare for the typical household, but households that do face these costs without sufficient cash must turn to other means: reducing their spending on other goods and services, drawing down a retirement account, or borrowing. In some cases, the least-poor choice may be to forgo needed medical care; but in other cases patients in insured households, along with those without insurance, may have to rely on uncompensated care from hospitals. Annual outlays on uncompensated care are large: in 2012 nonprofit and for-profit hospitals provided nearly $46 billion in uncompensated care to households without the means to pay (Garthwaite, Gross, and Notowidigdo 2015). Nevertheless, many low-income individuals are still susceptible to large medical debts, suggesting that the health-care safety net could be further strengthened (Dranove, Garthwaite, and Ody 2015).
Several studies find that consumers spend more on health insurance and prescription drug plans than they need to by choosing a plan that is not well-aligned with their needs. As seen in figure 4, among elderly consumers choosing from Medicare Part D prescription plans through private insurers (shown in blue), the average enrollee’s annual spending on premiums and out-of-pocket costs is 5 to 34 percent higher than if she were to choose a lower-cost option providing the same level of coverage. For those choosing from health insurance plans offered by large employers (shown in purple), the excess amount paid by consumers for premiums and out-of-pocket costs is similarly large, ranging between 18 and 45 percent of the total cost of insurance.
This excess spending arises because, for a given level of healthcare utilization, plans differ in how much they charge in upfront premiums and in out-of-pocket costs, and consumers must choose a plan before they precisely know which (and how many) health services they will use. Research finds that many consumers do not understand the components of their plan, including what out-of-pocket costs they will face when receiving care, what medical services and prescription drugs will be covered, and which hospitals and doctors they can use (Loewenstein et al. 2013). In addition, consumers need to make a short-term forecast about the amount and type of health-care services they are likely to need, which then determines their estimated costs given their plan’s deductibles and coinsurance payments. In predicting these costs as they choose among plans, consumers can easily miscalculate their health and financial risks.
The implied costs can be substantial but experts debate why. In studies of large employer-based plans, Bhargava, Loewenstein, and Sydnor (2015) find that consumers could have saved $353 dollars each year with better-informed plan selection. Handel and Kolstad (2015) find similar evidence on the costs consumers are likely to incur from lacking information about plans’ coverage of providers and treatments. They find that the least-informed consumers pay in excess of $2,000 when choosing a plan relative to the most-informed consumers. In the Medicare Part D prescription drug market, Abaluck and Gruber (2011b) observe that consumers pay too much attention to monthly premiums compared to out-of-pocket costs, and as a result fail to match their individualized needs with the right prescription drug plan—Abaluck and Gruber (2011a) estimate that consumers incur $237 to $296 in excess annual out-ofpocket spending. By contrast, Zhou and Zhang (2012) observe
that consumers pay too much attention to out-of-pocket costs and too little attention to monthly premiums when they make their plan choices in Medicare Part D.
Moreover, studies find that consumers exhibit inertia and are slow to switch plans even when it would be financially beneficial for them to do so. In other words, once a consumer has chosen a health plan, she is not likely to switch out of it, even if her needs change over time. The reasons for this inertia range from consumers having incorrect beliefs about the potential gains from switching plans; to consumer inattention, procrastination, and the burden of learning about alternative options (see Handel 2013 for a discussion). Studying enrollment decisions among workers from one large employer, Handel (2013) estimates that inertia leads consumers to incur about $2,000 more in out-of-pocket costs than if they had switched to a plan that was better suited to their needs. Researchers find that participants choosing among Medicare Part D plans have similarly incurred excess expenses and, looking across studies, consumers could save between 5 and 34 percent of their health-care spending dollars, or $50 to roughly $500 annually (Ericson 2014; Ho, Hogan, and Scott Morton 2015; Ketcham, Lucarelli, and Powers 2015; Kling et al. 2012).
The complexity of health insurance decisions—with the need to predict likely use of health care and to understand the cumulative costs for both premiums and out-of-pocket costs—means that consumers are prone to paying more for health insurance than they need to. As a result, and as described in Fact 6, some scholars have discussed the possibility of limiting consumer choice in the selection of health insurance (refer to Fact 6; also see Frank and Lamiraud 2009; Leibman and Zeckhauser 2008; Sinaiko and Hirth 2011). However, as discussed in Gaynor, Ho, and Town (2015), sometimes consumers are able to improve upon past decisions. For example, Ketcham, Lucarelli, and Powers (2015) note that Medicare Part D plan holders incurring the largest excess health insurance expenses after selecting a plan in 2006 were more likely to switch to less-expensive plans the following year. After five years of enrollment, annual out-of-pocket costs declined notably but were still about 21 percent more for these consumers than if they had instead selected the minimum-cost plan available in that year.
Through employers, private insurers offer Americans numerous health insurance options that vary in coverage and cost. Choosing the right plan entails navigating many complex dimensions of insurance plans and weighing them against the risk of needing care.
During the past twenty-five years, the types of employer-based health insurance plans covering workers have changed dramatically. Conventional plans, shown in light green (figure 5), were formerly the dominant type and covered all services and providers in exchange for a monthly premium. Today, the preferred provider organization (PPO) health insurance plan, shown in light blue, is the most commonly purchased option, covering 58 percent of eligible employees. PPO plans provide access to similar insurance coverage for services as a conventional plan but, typically, for a lower premium. In exchange, PPO plans charge beneficiaries a higher rate for services obtained from providers outside a network of preferred providers.
While PPO plans are the dominant plan today, some workers are choosing other insurance options, such as health maintenance organization (HMO) plans. These plans also feature low premiums but have more-restrictive provider networks than PPOs and account for a dwindling share of covered workers. Point-of-service (POS) plans, covering 8 percent of workers in 2014, allow patients to venture outside of the network at a higher cost, similar to a PPO. However, POS plans feature generally lower copayments, and in exchange patients must pay an annual deductible out-ofpocket before receiving coverage. High-deductible health plans with savings options (HDHP/SOs) are the newest type of plan, enrolling one in five workers in 2014. HDHP/SOs are similar to the POS model but feature even lower premiums and higher annual deductibles, often in the $2,000 to $3,000 range for single coverage (Claxton et al. 2014). In order to help consumers to pay these deductibles, HDHP/SOs are generally coupled with tax-preferred health savings options.
These changes reflect a shift in the health insurance industry toward greater cost-sharing, where patients pay for a portion of their medical bills, and a narrowing of provider networks that have led to lower negotiated provider prices. In conventional plans that were previously dominant, patients did not face any financial costs when obtaining additional treatments because their insurance provider fully covered their health services (Feldstein and Gruber 1994). To curb potentially unnecessary spending, insurance companies introduced cost-sharing mechanisms like copayments and deductibles to make beneficiaries more responsive to the price of their care. Evidence suggests that utilization of these types of consumer incentives has helped slow the growth rate of health expenditures, as discussed in Fact 2 (Chandra, Holmes, and Skinner 2013).
Of the roughly 116 million Americans working in the private sector in 2014 (DHHS 2014b), 56 percent were able to choose their health insurance plan from more than one employer-sponsored option, up from 38 percent in 1996 (DHHS 2014a). This rising trend reflects, in part, employers voluntarily offering more options and insurance companies creating more plan options.
Consumer choice in selecting health insurance plans also extends to Americans who obtain insurance outside of the employer-sponsored system. For instance, part-time workers and contractors may purchase health insurance through the federal or state health insurance marketplaces where they may choose among four tiers of plans from numerous issuers (Burke, Misra, and Sheingold 2014). Also, those receiving Medicare—the federal health insurance program for people aged sixty-five or older and younger individuals with disabilities—must choose between traditional Medicare or one of numerous Medicare-approved plans from private insurers (also known as Medicare Advantage). Medicare Part D, the prescription drug plan for elderly households, offers thirty different plans, on average, with no fewer than twentyfour plans available in each state (Hoadley et al. 2014).
Choosing a health insurance plan can be complicated. Typically, enrollees are asked to consider at least four dimensions in selecting coverage: (1) premiums and expected out-of-pocket expenses, (2) coverage and benefit levels, (3) access to doctors and hospitals, and (4) the availability of health and wellness resources to help them stay healthy (United Healthcare n.d.a). For enrollees, calculating the cost they will likely face for a health plan is further complicated by the ways different plans treat premiums (monthly coverage payments), deductibles (the amount enrollees must pay before health-care providers cover the remaining costs), copayments and coinsurance (what enrollees pay every time they use a service, as a set fee or as a percent of the bill, respectively), out-of-pocket maximums, and health savings accounts (Claxton, Cox, and Rae 2015). In assessing the expected costs and benefits of each available plan, enrollees must project what their risk is of requiring medical treatment, and for families buying insurance, enrollees must undertake these complex calculations for each member (United Healthcare n.d.b).
Given the complexity of the choices, it is not surprising that many studies find consumers select plans that are not wellaligned to their expected needs and preferences (Frank and Lamiraud 2009; Leibman and Zeckhauser 2008; Sinaiko and Hirth 2011; also see figure 4). For instance, individuals who are healthier or more willing to take risks sometimes choose plans with high premiums and coverage levels, when they could choose lower-premium- and less-extensive-plans that more closely align to their risk tolerance and expected medical needs. Studies have also shown that facing too many choices can be overwhelming for consumers, reducing their ability to discern among options and causing them to make worse decisions for themselves (Cronqvist and Thaler 2004; Iyengar and Lepper 2000). Moreover, enrollees in health insurance do not change insurance plans frequently, so even if their current plan is not well-aligned with their preferences or if their expected coverage needs—and optimal insurance coverage—change, they tend not to switch. As discussed more fully in Fact 4, the cost of making these mistakes can be quite high, pointing to a role for policy interventions to aid consumer decision-making.
However, even if consumers were to choose insurance policies that are more closely aligned with their risk tolerance and expected medical needs, it might not necessarily make them better off, due to offsetting factors at work in the health insurance market, which in turn presents challenges and trade-offs for those offering and designing health insurance plans. More specifically, in health insurance markets, when consumers choose plans in their best interest, healthier individuals will opt to purchase cheaper options with less coverage while less-healthy individuals buy morecomprehensive and more-expensive plans (McGuire 2012; Rothschild and Stiglitz 1976). If this segmentation is severe enough, then adverse selection in the insurance market can lead insurers to offer only more-comprehensive plans—at higher prices—to the small group of individuals requiring more-expensive treatments, thus deterring both healthy and unhealthy individuals from purchasing insurance (Cutler and Reber 1998). Indeed, Handel (2013) provides an example of how consumers making better choices for themselves can lead to lower overall welfare due to these off-setting factors.
Figure 1. Average Medicare Reimbursements per Enrollee, by Hospital Referral Region, Adjusted for Price, Age, Sex, and Race, 2012
Source: The Dartmouth Institute for Health Policy and Clinical Practice (2015).
Note: Hospital referral regions are defined by assigning hospital service areas to the region where the greatest proportion of major cardiovascular procedures are
performed, with minor modifications to achieve geographic contiguity, a minimum population size of 120,000, and a high localization index. A hospital service area is a collection of zip codes whose residents receive most of their hospitalizations from the hospitals in that area. Medicare reimbursements shown in the figure correspond to a random sample of enrollees belonging to both the Medicare A (inpatient) and B (physician services) programs.
Figure 2. U.S. Health Care Expenditures as a Share of GDP and Out-of-Pocket Expenditures as a Share of Total Health Expenditures, 1965–2014
Source: Centers for Medicare & Medicaid Services (2015).
Note: Data are from the Centers for Medicare & Medicaid Services’ (2015) National Health Expenditure Accounts. “Out-of-pocket as a share of total” is calculated by dividing, for each year shown, nominal out-of-pocket health-care spending by total nominal health-care spending. “Total as a share of GDP” is calculated by dividing, for each year shown, total nominal health-care spending by nominal GDP.
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