Medical Wealth Effects

Imagine being a cash-poor college student who likes expensive sports cars. While you intend to buy one someday, for now you focus on paying for tuition, books, etc. Then your rich uncle dies and, knowing your car passion, leaves you a sports car in his will. While you might sell it to pay off $30,000 in students loans, you might also keep it – you are now richer, and can perhaps afford this luxury.

Does this mean that it is usually economically efficient for college students to buy expensive sports cars? No – the fact that students would not ordinarily take out a loan to buy a sports car strongly suggests such cars are not worth the price. The fact that they might buy one later when they are richer does not change that conclusion.

Oddly, some people think differently about medicine. When people have more medical insurance, they consume more medicine. And many attribute this to the fact that insured folks don’t pay the full price of their medicine. But John Nyman argues that if medical insurance were to pay out in cash like auto insurance does now, so that patients had the option to take cash instead of treatment, up to 70% of the extra medicine that insured folks consume, beyond what uninsured folks consume, would still be chosen by patients. Nyman thinks this implies that such treatment is economically efficient, and Austin Frakt and Mark Thoma agree.

Arnold Kling is skeptical:

If Nyman were to debate Robin Hanson on the empirical realism of this, my money would be on Hanson.

My argument, however, is mostly theoretical. If uninsured patients and their families would not be willing to take out loans, or sell valued possessions, to pay for some expensive treatment, that strongly suggests they don’t see such treatment as worth its price. Yes, before a problem arises people might want to arrange to make themselves financially richer in the states of the world where problems arise. And yes, market failures might prevent people from borrowing or selling quickly and efficiently. But these don’t seem to be the main effects here.

It bugs me that even economists mostly consider alternate more efficient institutions as ways to argue for their favored versions of our inefficient institutions. I say let’s try to actually give patients the choice to take cash instead of treatment. Even Nyman should agree that would reduce waste.  And if you think market failures in borrowing really prevent folks from buying good medicine, why not push for government loans to help the uninsured pay for medicine, instead of forcing everyone to be insured? If you worry that hospitals price discriminate against folks who show up without insurance at the last minute, why not help them pre-negotiate for lower prices?  Could it be that some folks don’t actually want more economically efficient medicine?

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  • Martin

    Isn’t the entire problem why mandatory insurance is beneficial due to the elimination of the adverse selection problem that would otherwise be driving up price? This brings up the question which cash-benefit people should receive. The post-mandatory insurance price or the pre-mandatory insurance price?

  • nazgulnarsil

    loss aversion means people overvalue things already in their possession though. or was that part of the point?

    • This was my first thought too, but I think we’re supposed to ignore that effect for the purposes of this post.

      • Eliezer Yudkowsky

        I don’t see why we should ignore loss effects or mental accounting (the money goes in a “health bin” and is then spent on health instead of being treated as fungible wealth). That just obviously seems to be what’s going on here and it torpedoes the whole original argument.

  • Jeffrey Soreff

    If you worry that hospitals price discriminate against folks who show up without insurance at the last minute, why not help them pre-negotiate for lower prices?

    I’m not sure whether you are intending this to apply only to “last minute” health care purchases, or also other price discriminations. There are huge price differences between what hospitals “bill” for services and what they actually accept as full payment from insurance companies. This doesn’t have anything to do with “last minute” purchases. For instance, when my wife had a knee operation, which was planned in advance, the “billed” “cost” was $15,000, and the insurance paid $4,000, which was accepted as payment in full. I don’t know why the insurance had so much bargaining power – but the vast bulk of the financial benefit to us was from this bargaining power, not from the final payout from the insurance. If we had been forced to accept the $4,000 in cash from the insurance company and then been forced to purchase the operation at its stated billing cost of $15,000 we’d have been throughly screwed.

    • Jeffrey Soreff

      To put it another way: Talking about the “market price” of health care is itself very misleading. Insurance companies and individuals are charged vastly (300%) different prices for the same service.

      • Doug

        As I mention below I posit that this is mostly due to price discrimination. Like booking an airline flight the night before, someone paying out of pocket for a procedure probably has a lot higher demand for it. Sorting out the out of pocket payers and charing them more is a way of segmenting your consumers by willingness to pay.

      • anon

        Part of the problem is that hospitals face artificially high fixed costs, such as providing emergency care to folks who are unable to pay for care. Under reasonable assumptions, fixed costs will be naturally defrayed by overcharging consumers with lower bargaining power and inelastic demand.

      • You do not need “insurance” to address your problem, a buying club will do. That is why I like very high deductible insurance over no insurance.

        Also you could have gone to Apollo health care for such a procedure and so it would be good if such alternatives were incentivized.

    • roystgnr

      This is fundamentally a legal problem. If A receives a service from B without prenegotiating the prices, what does A owe? “Whatever price B pre-published” might be a good answer. It would at least allow more price shopping, and would be a huge improvement over our current answer, “As much or as little as B thinks they can get away with squeezing out of A.”

  • Doug

    I think the biggest impediment for people going uninsured is the drastically higher rates. Being self-employed I would gladly give up all but catastrophic health insurance, except I would probably have to pay more than 3 times the rates that I do now.

    A simple legislative fix would mandate that health care providers must charge the same rate for everyone for the same procedures, regardless of medicare, private insurance or out of pocket. This would produce no efficiency loss since it’s simply reducing price discrimination. All it would do is shift producer surplus into consumer surplus.

    • Eric

      Price discrimination can sometimes improve efficiency – for example, the inefficiency created by a monopoly is eliminated if the monopolist uses perfect price discrimination (charging each customer exactly what they are willing to pay).

      • Jeffrey Soreff

        Eric, what are you talking about??? In what sense is a monopolist’s price discrimination creating improved efficiency? There is some real marginal cost to produce the good being sold (at any given time). The usual results for getting Pareto-optimal results from free markets rely on this getting matched to the price everyone sees. This can’t possibly be true if different people are getting charged different prices. They can’t all match the marginal cost of production.

      • anon

        Jeffrey, if the firm faces fixed costs which are not offset by increasing marginal costs (a reasonable assumption in many real-world situations), then marginal cost pricing is unsustainable and price needs to exceed marginal cost. It is then efficient to price-discriminate, following the Ramsey-Boiteux rule (markup is inversely proportional to the price-elasticity of demand for the good).

      • Jeffry, efficiency is the right term, if you mean efficiency at making profit, that is making the most profit by supplying the minimum of goods and services.

        Monopolies of essential services are always the most efficient at making profit because they can charge whatever the market will bear and there is no competition for customers to use instead.

        Monopolies at supplying “protection” against being shot are even more efficient. If they are well they only have to pay for bullets and guns at the beginning when they are setting up their business. Once they have “signaled” that they are serious, they usually don’t need to shoot reluctant customers any more.

      • Jeffrey Soreff

        anon, this? hmm… This seems like an odd map to the situation we are discussing. The health care providers aren’t really monopolists. The insurance companies are only indirectly consuming health care services, so I’m not quite sure what their elasticity of demand represents fundamentally… Interesting analogy though…

      • anon

        Jeffrey, bargaining power can also influence price discrimination outcomes obviously, and large insurance companies do have bargaining power. This is somewhat hard to model compared to the simple elasticity rule, but the outcomes are quite similar.

      • Jeffrey Soreff

        Anon, when you say that bargaining power can result in similar outcomes, do you just mean in terms of how the non-incremental costs ultimately get paid for, or do you mean similar outcomes with respect to the social optimality calculations also? I can see how, if there were a spectrum of individuals consuming health care, and if they had differences in their price sensitivities (ultimately reflecting differences in how much they value it), that it is reasonable for the fixed costs to get borne more heavily by those individuals that value it more highly. This doesn’t translate into having a systematic difference between the price borne by individuals and the price borne by insurance companies buying services which are ultimately consumed by similar individuals. If this is simply an artifact of the additional bargaining power insurance companies get by being bulk buyers, couldn’t we, as consumers, opt to aggregate together into a government purchaser and obtain the bargaining power that way?

      • anon

        Jeffrey, I mean strictly how the fixed costs are paid. Bargaining would most likely be a negative-sum game under these circumstances unless hospitals have high pricing power, which seems unrealistic. Other actors in the healthcare market do have market power (doctors, nurses, pharma) but that can be fixed through simple institutional change; no need for a central government authority.

      • Jeffrey Soreff

        Anon, Many Thanks!

    • To add to what Eric said: Price discrimination can be more efficient, especially in cases where the marginal cost is less than average cost.

      • anon

        Price discrimination will actually improve efficiency under reasonable assumptions. The real problem is the high fixed costs that hospitals face, such as the requirement to provide free emergency-room care to those who are unable to pay.

  • Aram

    Giving patients the option to take cash instead of treatment has one ENORMOUS flaw. How do you decide what the proper treatment is? There are doctors who will write prescriptions for medical marijuana if you tell them your back hurts and pay them $100. Now you’ve just given doctors an enormous incentive to write prescriptions for MRIs, pacemakers, aggressive surgeries, etc so that their patients can collect cash from their insurance companies by turning down these treatments.

    Your idea makes sense only in a world of pure theory, as you seem to be saying in your second-to-last paragraph, before your last paragraph wonders why the idea isn’t more popular.

    • anon

      Perhaps Robin is being unclear, but the cash payouts would be set by the insurance company, depending on the medical diagnosis. (In principle the payout for each ailment would be spelled out in the insurance contract; in practice, reputational enforcement would likely predominate. Also, insurance companies would still want to subsidize preventive care, in order to offset moral hazard.)

      In this scenario, the goal of insurance is to “make you whole” if you get sick, rather than provide medical care directly. Hence, a rough estimate of costs would suffice for non-catastrophic ailments.

      There are some problems with this idea, though: for instance, in kind provision of medical care obviously deters fraud, since healthy folks have no need for it. Also, as mentioned above, collective bargaining by insurance companies has no direct equivalent in this alternative system.

  • DK

    I say let’s try to actually give patients the choice to take cash instead of treatment.

    What sort of dreamland are you living in? Can’t you see that every letter of the phrase “cash instead of medical treatment” is loaded with abuse?

  • David C

    “It bugs me that even economists mostly consider alternate more efficient institutions as ways to argue for their favored versions of our inefficient institutions.”

    Does anybody else besides me find it incredily difficult to decipher the full meaning behind this sentence?

  • Mary

    When people have more medical insurance, they consume more medicine.

    I question this premise. We have excellent “medical insurance” (retired military) and yet we don’t look for ways to “consume” medical care. We don’t ask the doc to run extra tests, or prescribe more meds or beg for hospital stays because beyond the fact that we don’t NEED the medical care, it is not a valued good if we are not sick. I don’t WANT to spend more time at the docs, or emergency room, or pharmacy. I’ve better things to do with my time, no matter how “cheap/free” the medical care is.

    I think that’s true for most people. There will be outliers, but for the most part, medical care is driven by NEED (illness, accident, etc) much more so than by availability or price point.

    Having said that, being able to make care choices based on cost would be very useful. We do that with our pets all the time. The scale is smaller, but the principle is the same: “Does it make sense to spend $$ to buy medical care to do YY?” The criteria, weighted differently in each instance, are costs, anticipated efficacy of care, quality of life, risks of medical treatment, risks of abstaining from treatment, etc.

  • In several states medical cannabis is legal and so such a service would also be legal.It seems to be an issue of net neutrality and free speech wherein a communications carrier such as T-Mobile makes its own moral judgments on the content it carries and censors that which doesnt meet its own moral standards. There is nothing wrong with the content being transmitted as that in itself is legal.