Why the government should do cost-effectiveness analysis in a health insurance market

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1 Government Why the government should do cost-effectiveness analysis in a health insurance market TILEC, Tilburg University April 17, 2012

2 Government Outline 1 Motivation Government 5 6

3 Government Rising health care costs In all OECD countries health care spending grows faster than the economy This is at least partly due to the introduction of new technologies To the extent that these technologies add value, this is fine However, if money is spent on treatments that are not worth it, welfare could be raised by excluding these technologies This is what cost-effectiveness (CE) analysis tries to do is done by the government in countries where there is (also) a public system Well known institute is NICE in the UK

4 Government Rising health care costs (cont.) Private insurers can use as well to determine coverage (formulary in case of drugs) Is there a role for the government to do in an insurance market? Economies of scale ( is a public good) can be one reason We focus on market imperfections as a reason for by the government Further, the government should then impose that treatments with low value added cannot be covered by health insurance

5 Government Health insurance is the problem? Some people argue that rising health care costs are caused by health insurance Health insurance causes moral hazard and overconsumption However, this leads to a high level of spending; not to a high growth rate Others focus on the combination of health insurance and new technologies because new technologies are covered by health insurance, I will use them although the benefit does not outweigh the cost ex post this is correct: if it is covered by my health insurance, I will use the treatment even if the benefits are small but, ex ante, why do I buy coverage of treatments that are not worth it?

6 Government Health insurance is the problem? (cont.) e.g. me too drugs: mimic existing treatments but consumers value them a lot Hence they are sold for a high price Consumers have no clue about the value of treatments when buying insurance then the market can never work and government intervention is needed not likely: the private market in the US has no government intervention of this sort and has not done too badly (Cutler and McClellan (2001), Cutler, Rosen and Vijan (2006) and Cutler (2007)) Although consumers may not know the value of new treatments, their insurers do and they select for them (formulary)

7 Government Health insurance is the problem? (cont.) Main point of the paper: this does not work (well): consumer perception determines the value of a treatment suppose consumers incorrectly believe that treatment j is very valuable insurer I a knows it is not and excludes it from coverage however, I b does offer coverage of j consumers prefer I b over I a

8 Government Contribution of the paper When buying insurance, consumers do not know the value of each treatment individually Consumers partition set of treatments (say, into eye treatments using laser technology, cholesterol reducing drugs); they know the average value of treatments in the partition We model the bargaining between insurers and research labs and derive labs incentives to invest in R&D Government intervention by excluding low value treatments from coverage raises R&D and welfare (unless consumers are perfectly rational : partition into singletons) Market cannot replicate the government outcome

9 Government Related literature Recent literature on balancing static and dynamic efficiency for treatments that are insured: Garber, Jones and Romer (2006): health insurance subsidizes demand for treatments; therefore limits on patent duration and price caps may be called for to get dynamic efficiency Jena and Philipson (2008): CE threshold determines price that manufacturers charge the government; co-insurance rate determines price faced by consumers; both should be used to balance static and dynamic efficiency Lakdawalla and Sood (2009): public health insurance decouples consumer prices from manufacturer prices; this allows the government to balance static and dynamic efficiency

10 Government Related literature (cont.) literature on contracting with externalities: e.g. Hart and Tirole (1990), McAfee and Schwartz (1994), Segal (1999), Rey and Verge (2004)

11 Government How does work? is usually presented as a method to allocate scarce resources (budget in public system) in a way that yields the greatest health benefit is used to determine which treatments should be covered by health insurance Benefits of treatments can be measured using QALYs (Quality Adjusted Life Year) ranks treatments in terms of effectiveness (highest gain per unit of budget spent) Then starting from the highest treatments, treatments are covered until the budget is spent

12 Government How does work? (cont.) Alternatively, one specifies a price per QALY Treatments are covered where the cost per QALY is below the benchmark price per QALY; budget/spending is endogenous I will take a simplistic view of that makes it equivalent to cost-benefit analysis In the model production costs of treatments are normalized to 0; hence the value added of a treatment equals its utility/quality Government policy proposed is that the government sets a benchmark quality level Only treatments with quality above the benchmark are allowed to be covered by health insurance in the market

13 Government Framework Figure: Three sets of players and three markets

14 Government Utility T denotes the set of all (new) treatments Consumers [0, 1] have (the same) partition τ s of treatments with s S τ s = T When buying insurance, consumers know the average quality q τs of subset τ s From now on we focus on a typical element τ in this partition Probability that consumer needs treatment j τ is µ j (no co-morbidities) If consumer needs j, treatment increases utility by q j (we can ignore disutility associated with disease that requires j) Price/premium of health insurance: σ

15 Government Utility (cont.) If consumer is not insured for treatment j, it can buy j on uninsured market at price pj u When buying on uninsured market, physician helps the patient to determine q j Consumer faces budget constraint: pj u β U τ = E µ j q τ σ + max{0, q j pj u } (1) j τι j τ υ pj u β where q τ = j τ µ jq j j τ µ j (2)

16 Government Pricing games n 2 health insurers I a,..., I n Research labs L j, j τ Here we take q j as given Lab s production cost is normalized to zero Effectiveness (value added, efficiency) of treatment j is summarized by q j Contract specifies price per treatment j for insured of I i ( p ij ) and fixed part t ij that insurer pays L j Expected expenditure on j per insured for I i equals µ j p ij + t ij Contracts are options to buy for the insurer

17 Government Pricing games (cont.) L j cannot verify whether a consumer is uninsured, hence pj u p ij Offer game: Labs make simultaneously and indepedently take-it-or-leave-it private offers to insurers Bidding game: Insurers make simultaneously and indepedently take-it-or-leave-it private offers to labs If insurers cover the same treatments, they are homogeneous for consumers Insurers compete in prices (Bertrand) with interim unobservability and wary beliefs

18 Government Timing of the game 0 government sets minimimum standard q for treatments that can be insured 1 R&D labs invest to invent new treatments 2 consumers learn q τ for each subset τ in the partition of T 3 R&D labs contract privately with insurers 4 insurers decide on which treatments to cover τ ι and set σ 5 consumers decide whether to buy insurance and if so from which insurer 6 R&D labs set uninsured prices p u i 7 consumers fall ill and need treatment which is either covered by their insurance or not

19 Government Symmetric Perfect Bayesian equilibrium Consider the game from stage 3 onwards In a symmetric equilibrium of both the bidding and the offer game we have: if q τ > β: τ ι = τ π i = 0 σ = j τ µ j q τ (3) π k = µ k q τ p k = q τ t k = 0 p u k q τ (4) if q τ < β: τ ι = π i = 0 (5) π k = µ k p u k p u k = min{β, q k } (6)

20 Government Symmetric Perfect Bayesian equilibrium (cont.) If average quality in τ is high compared to consumer s budget β, all treatments in τ are covered by insurance for coverage of j, insurers raise the premium by µ j q τ : value as perceived by consumers insurers pay p j = q τ per treatment; not p j = q j (unless consumers are perfectly rational ) prices are linear labs appropriate all profits no one buys on the uninsured market as long as pj u q τ me too treatment has q j < q τ but gets paid p j = q τ : free rides on high quality treatments

21 Government Symmetric Perfect Bayesian equilibrium (cont.) there is no equilibrium with π j > µ j q τ if average quality is low compared to budget β, insurance unravels suppose that τ ι, then there is j τ ι with q j > q τι ; then it is more profitable for L j to sell on uninsured market (only) at p u j = min{β, q j } consumers understand that for each candidate set of insured treatments, highest quality treatments drop out can explain why things like soap, toothpaste, band-aid, though all important for health, are not covered by health insurance: people can afford these things without insurance

22 Government Government intervention and belief updating Suppose that the government sets q > 0 such that treatments with q j < q are not allowed to be covered by health insurance By our definition of q τ, we can write j τ q τ = ι µ j j τ j τ µ q τι + υ µ j j j τ µ q τυ (7) j Consumers learn that treatments τ υ are not allowed to be treated They can update their beliefs about q τι as follows: j τ q τι = µ j j τ q τ υ µ j E(q j q j < q) (8) j τ ι µ j j τ ι µ j

23 Government Government intervention and belief updating (cont.) Hence for a covered treatment j, it is now the case that d p j dq j = µ j j τ ι µ j (9) As q is increased, the set τ ι shrinks, free riding is reduced and d p j /dq j is increased This effect raises the labs incentives to invest in R&D

24 Government R&D investments max Normalize q [0, 1] Firms invest R&D effort e at cost c(e) with c(0) = c (0) = 0, c (e), c (e) > 0 and lim e 1 c(e), c (e) = +. (10) Given e, quality level q has distribution function G(q, e) with G e (q, e) < 0 for each q [0, 1 L j s optimization problem is given by e j π j (q j, q j, q)g(q 1, e 1 ) g(q τ, e τ )dq 1 dq τ c(e j ) (11)

25 Government R&D investments (cont.) First order condition for e j can be written as dπ j (q j, q j, q) g(q 1, e 1 ) ( G e (q j, e j )) g(q dq τ, e τ )dq 1 dq τ j (12) For given e j, the higher is dπ j /dq j = µ j dp j /dq j, the higher is L j s incentive to invest in R&D If free riding by me too treatments is reduced, incentive to invest in R&D is increased

26 Government Comparing q < β with q = β cases q < β q = β q k < q dp k dp dq k = 1 k dq k = 1 q k q dp, β and q τι < β k dp dq k = 1 k dq k = 1 q k q dp, β and q τι > β k dq k = µ k dp k j τ ι µ j dq k = 1 dp q k > β and q τι < β k dp dq k = 0 k dp q k > β and q τι > β k dp k dq k = µ k j τ ι µ j dq k = µ k j τι µ j dq k = µ k j τι µ j µ k j τ ι µ j

27 Government Comparing q < β with q = β (cont.) Government should forbid insurance companies to cover treatments that consumers can afford themselves (without insurance) This raises R&D and also total welfare (because of the free riding there is underinvestment in R&D)

28 Government Why can t the market achieve this? Consider the use of exclusionary clauses in the contracts between insurers and labs in stage 3 of the game Insurers only cover a subset of the treatments in τ (formulary) Insurers and labs can agree that only treatments with q j > q can be covered by insurance Specifically, L j with q j > q only sells to I i at p ij if I i does not cover treatments with q k < q Can this achieve the same increase in R&D as government intervention? How would this work?

29 Government Why can t the market achieve this? (cont.) Assume that q j {q l, q h } with q l < β < q h and µ j = µ for each j τ Consumers know q τ and hence can deduce the number ν of high quality treatments Consumers have the following beliefs: if ν or less treatments are covered in the market, then only q h treatments are covered in equilibrium This can indeed be an equilibrium in the bidding game However, an insurer has the outside option of selling q l treatments that consumers value at q τ q l -labs are willing to sell at p = q l + ε

30 Government Why can t the market achieve this? (cont.) Hence insurers can make a profit by deviating and covering l-treatments To prevent such a deviation, h-labs need to leave insurers a rent and hence π h < µq h while π l µq l If the government sets q = β, we find π h = µq h, π l = µq l Lab solves max e {eµq h + (1 e)µq l c(e)} Welfare maximizing planner solves the same problem

31 Government Extensions Concave utility function β distributed on [β, β] Co-morbidity: µ i + µ j

32 Government Conclusion with the following features: if consumers are perfectly rational, no need for government intervention if consumers only know average quality per subset of treatments, government can raise R&D and welfare by setting a minimum standard q for treatments that are allowed to be covered by insurance market is not as effective in enforcing the exclusion of low quality ( me too ) treatments When buying insurance, consumers do not know the value of each treatment exactly Hence they think that some treatments have great value, while actually they do not

33 Government Conclusion (cont.) This cannot be solved by insurers using formularies, as insurance contracts need to be sold to consumers A government run institute like NICE in the UK is also valuable in a private health insurance system Government then forbids the coverage of low quality treatments by health insurance

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