Sunday, February 10, 2008

Health Care economics

Health care services market is different from the market for any other service in many respects. It suffers from a number of incentive distortion problems and market failures, which causes classical free markets to fail. It has been observed across the world that as real income rises, people expect more medical care. This demand is accelerated by the rapidly aging populations and the expanding list of lifestyle diseases and problems. This increasing demand, coupled with the proliferation of sophisticated technologies and advances in diagnostic tests and surgical procedures, all of which are invariably expensive, have meant that health care costs have been soaring.

For the last 30 years, health-care costs have been rising 6 percent to 8 percent a year in the US - more than double the inflation rate in the rest of the economy - because demand keeps outstripping supply. To give one example, in 2001, with prices across the US economy up less than 2 percent, hospital costs rose 8 percent, drug costs increased 16 percent, physician costs jumped 9 percent, and insurance premiums increased 10 percent.

Why health care costs are so prone to inflation? What are these incentive distortions and market failures that bedevil the health care services market? What is the influence of medical insurance on the development of the health care services market?

I have tried to list out some of the major incentive distortions and market failures that distinguish the health care market from other services.

1. Market suffers from inherent monopoly characateristics. Surgical procedures or drugs are most often unique, thereby relying on one or a few suppliers/producers. Further, the availability of specialists is also limited, thereby giving them considerable bargaining power. There are no cheaper alternatives to fall back on, if prices rise.

2. Health care services cannot be substituted. Unlike other services, health care cannot be substituted and the costs associated with not accessing it are often unacceptably high and even fatal.

3. Health care services market, especially for the emergency, life saving treatments is inelastic. In fact, in many ways, primary health care services atleast, exhibit Giffen characteristics of demand rising even as the prices rise.

4. Given the specific, skilled and doctor-centric nature of health care services, it will always experience supply side contraints. Supply side limitations by way of the numbers of doctors and specialists, and the small numbers of skilled specialists cannot be easily overcome. These constraints will get exacerbated as more an more people get covered by better medical facilities, both through rising incomes and better medical insurance cover.

5. The market suffers from an information assymetry problem. The inherently technical nature of tests and procedures, ensures that there is a heavily skewed information assymetry between the doctors and the patients. Most patients are in no position to make a choice between treatment options, and have to place their full trust on the judgement of the doctors. As we have seen, this often gets betrayed. There is a genuine difficulty in converging the faith in doctor's judgement and the patient's apprehensions in an objective, quantifiable manner.

6. Inherent difficulty in achieving convergence between the financial incentives of the sellers (doctors) and the buyers (patients). The patients want to receive health care at the lowest cost, but do not possess the technical expertise to be aware of what they need. The doctors, who know what the patient needs, is often incentivized by pharmaceutical companies and medical equipment and service providers to over treat the patient.

7. Trade off between the diagnostic optimum and doctor's experience, distorted by the potential costs of legal claims. Doctors make their diagnosis of the patients condition based on both their professional experience of similar symptoms and situations, and the results of the diagnostic tests conducted. But in view of the ever present danger of legal damages in the case of wrong or mis-diagnosis, doctors tend to become over cautious in making their diagnosis. Even for the simplest ailments, doctors insist on conducting the full protocol of medical tests before making their diagnosis and prescription. Apart from contributing to delays in delivering treatments with its attendant consequences, this also increases health care costs for little marginal benefit. An experienced doctor should be able to easily, with more or less assured certainty, make accurate diagnosis of simpler ailments and medical problems. Medical insurance only accentuates this problem, as insurance companies hedge themselves against any possible legal claims.

8. The intermediation role of diagnosis in confirming treatment options increases the costs substantially. In many ways, diagnosis form the critical determinant in deciding the treatment option, and is increasingly forming a major share of the full treatment. The scope of diagnosis has expanded over the years to include tests that not only confirm the presence of certain ailments, but also preclude the possibilty of others not always related or relevant to the ailment under treatment. This also leads to over use of medical tests and thereby increases demand.

9. Medical Insurance suffers from the moral hazard problem. With their premiums having been paid, the patients have an incentive to approach the doctor and carry out the full spectrum of medical tests and undergo all necessary and unnecessary surgical procedures, so as to reassure themselevs that they have availed off all the possible diagnostic and treatment options. The easy availability of information in media like the internet makes patients demand the maximum possible standards in their treatment. In other words, since it does not cost them any more, insured patients tend to over-use medical care even for minor complaints. It has been found that even teh use of deductibles for each treatment visit, does little to deter frivolous visits. This artificially generated demand, in turn contributes towards cost inflation, besides causing supply compression and other market distortions.

10. Unlike other services, medical insurance sellers stand to gain by selling their policies to those who need it the least and denying the service to those need it the most. This means that they go great lengths to screen the applicants, in the process sharply increasing the transaction costs. It is estimated that 19 cents in every dollar spent in medical health care in the US is taken away by transaction costs.

11. Health Insurance generates certain cognitive biases. Since people do not pay directly the premium costs, being shared with the employer and deducted from the salary, they tend to be not directly aware of the costs incurred. This is exacerbated by the tax concessions given to both employers and employees for their respective contributions.

12. Unlike other services, comparing drugs, devices and procedures are difficult. Comparative effectivenesss studies for them are very rare. Past comparative effectiveness trials have shown that older and cheaper anti-psychotic drugs are often just as good as expensive new ones. Similar comparison of two rival treatments of patients with stable coronary artery disease - a traditional combination of angioplasty and drugs versus drugs alone - measured by heart attacks and survival rates, found no difference. This difficulty to compare prevents the patients from doing any cost-benefit analysis of treatment options.

There is an excellent article in the Slate by Robert Shapiro, which brings out some of these problems.

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