West European Health Care Systems

Among the various health insurance systems operating across the world, the West European models of "managed competition" tries to strike a balance between the market-driven American and the  government-run British systems. In my op-ed last week, I had indicated my preference that the West European model should form the basis for designing the national health insurance system for India. Though the Dutch, Swiss and German health insurance models have several similarities, there are also important differences. This post will critically examine these three health care systems.

Germany has a statutory health insurance system, covering nearly 87% of its population. It is financed through a payroll tax, where employers and employees contribute equal shares. The payroll tax at 15.5% of income forms the premium. Employees and pensioners pay 8.2% of their gross wages/pensions, while employers/pension funds must contribute 7.3%, for a total contribution of 15.5% of gross wages/pensions upto a maximum wage of (or pension) of 44,550 euros. Unemployment insurance pays the premiums for unemployed individuals, and pension funds share with the elderly in financing their premiums, which are set below actuarial costs for the elderly. For long-term unemployed people with a fixed low entitlement, the government employment agency pays a fixed per capita premium. A uniform contribution rate will be set by the government for all others.

Premiums for children are covered by government out of general revenues. All coverage is for the entire family. Employees/pensioners earning above 49,500 euros (in 2011) are free to opt out of the statutory system and purchase private, commercial coverage, but if they do, they cannot ever return to the statutory system unless they are paupers.

The health insurance premiums paid by Germans are collected in a national, government-run central fund that effectively performs the risk-pooling function for the entire system. This fund redistributes the collected premiums to some 200 independent, non-governmental, competing, nonprofit “sickness funds” among which Germans can choose. These sickness funds act as purchasing agents on behalf of the central fund and patients and premiums are paid based on the individual's actuarial risk calculated using over 80 variables by the administrators of the sickness fund.

In addition there are 46 private health insurers operated on commercial principles which provide comprehensive coverage to the remaining 11% of the population (including civil servants) and also top-up supplementary coverage, if demanded, to those on statutory insurance. Recent federal legislation has forced private insurers to levy on younger people higher premiums than their actuarial risk can justify to build up an old-age reserve, thus preventing premiums from climbing too rapidly with age.

The Dutch health care system consists of three parts. The first tier covers exceptional medical expenses (long-term care and high-cost treatment), the second covers a basic package of benefits, and the third forms private health insurance. The first two are mandatory, while the third is obligatory and takes care of supplementary coverage. The first is financed by income-related salary deductions, co-payment by consumers, and government grant. However, it is the second tier, which was reformed in 2006, that has been the object of much international attention.

The second tier provides a standard package of healthcare benefits to all citizens. The standard benefits package includes both primary and tertiary care. The services are intermediated by competing private and for-profit insurers through various private and public service providers. Each insurer has to offer the standard plan at a flat rate premium, irrespective of age, to all citizens. Coverage is mandatory for all citizens. Consumers can comparison shop and purchase insurance from any of the insurers.

The insurers are private sickness funds who compete with each other in attracting citizens. The premiums are not determined by the government, but by the individual sickness funds. They attract citizens by offering lower premiums on the basic coverage plan, though with conditions like co-payments and restricted provider choice. Some insurers give consumers the option of accessing service providers of their choice (other than those contracted-in by the insurer) by introducing co-payments.

Insurers also offer collective policies aimed at specific groups of people. These policies, which have lower premiums, can be purchased by employers or local governments for specific categories of people whose premiums are paid by the government. 

Insurance contributions come either as income-related (for self-employed too) salary deduction (with a maximum ceiling) and nominal flat-rate premiums. The former are deducted from the taxable income of employees or social security beneficiaries by the employer or from a share of their income by the self-employed. However, the employers reimburse this amount and employees pay tax on it. The income-related contribution is set at 6.9 percent of the first €32,369 (US$45,442) of annual taxable income.

Income-related contributions of employees come in equal parts from employers and employees. The level of contribution (or the percentage) is determined so as to ensure that atleast 50% of the total inflows into the Health Insurance Fund come from income-related contributions. The government contributes about 5% and the rest 45% is obtained from individual permium payments.

The latter are paid by all those insured or come from the tax-credits provided by government for those who cannot afford their nominal premium. The percentage of income-related deduction is set by the government, mostly nationally, while the flat rate premiums are determined by individual insurers. The insurance coverage costs of children under the age of 18 are borne by the government. All these contributions flow into the Health Insurance Fund (HIF). A process of "risk-equalization" takes place and payments are then made to insurers.

Insurers, especially the larger ones, operate at national-level and offer plans across the country. This also means that premium-setting is on a national-level. Each year, the Ministry of Health sets the standard benefits package premium, which forms the basis for tax-credit payments. The insurers set their respective individual premiums around this rate. It is also mandated that if the real average of the premiums offered by the health insurers differs by more than Euros 25 from the standard premium, the government must adjust the latter.

In this model, the insurers cannot make profits on their basic plan coverage. Insurers offer lower premiums and differentiate themselves only to attract more citizens so as to capture their supplemental coverage.

Switzerland too has a mandatory coverage health insurance system. The coverage includes all regular illness and related primary and tertiary care, in the form of a standard benefits package based insurance plan.

Private and non-profit insurers compete, at the canton level, to provide this standard insurance plan. The premium charged by an insurer for this plan should be the same for all adults, irrespective of age and pre-existing health conditions. Unlike the Dutch model, plans operate and set premiums at canton level. Therefore premiums vary considerably across regions. Though individual insurers determine their own premiums, they are not allowed to profit from the mandated benefits package. They should make their profits from supplemental coverage.

The insurers are allowed to charge a minimum deductible and even coinsurance on the standard benefits plan. Insurers differentiate themselves to attract consumers by offering lower premium plans which have higher deductibles. Consumers who cannot afford the premiums and the taxes are subsidized by government. Patients have choice of doctors and service providers within each canton.

This health insurance system is financed through a mixture of income contributions, deductibles and some government contribution. There are no employer-sponsored or government-run insurance plans and everyone buys insurance from the private insurers. Consumers pay the insurance premium for the basic plan up to 8% of their personal income. However, if the premium is higher than this, then the government gives the insured a cash subsidy to pay for any additional premium.

Service providers prices are set annually through negotiations held between associations of insurers and associations of service providers at canton level. The Swiss model is praised by conservatives who are attracted by the fact that consumers are forced to individually choose their insurers. This is in contrast to employer or government-chosen insurance plans.

See this excellent comparative study of Dutch and Swiss health insurance systems. This is another very good comparison of various health insurance models.

A National Health Insurance System

I have an op-ed in today's Mint on the principles of a national health insurance scheme for India.

Fee-per-service Vs bundled payments

One of the biggest challenges with cost-control in health insurance is with the payment model for health services delivery.

The prevailing fee-per-service model disaggregates services into doctor consultation, diagnostic services, and surgical treatments. Individual payments are made accordingly for each service. This naturally distorts incentives, in so far as it encourages each service provider to over-diagnose or over-treat, so as to maximize their revenues. Since many doctors also have their own diagnostic equipments, it is natural for them to prescribe the full range of diagnostic tests.

In contrast, in countries like India, treatment of a medical condition is the basis for insurance payments. In other words, payments are bundled into a package and the insurer makes the payment to the service provider. The service provider is generally a hospital which either has all these facilities in-house or has a contract with various other external service providers for delivery of integrated services for that particular treatment. This is a much more desirable model since it mitigates and eliminates many of the incentive distortions associated with fee-per-service models.

However, a more ideal payment model for insurers would be diagnosis based bundled payment. A typical diagnosis can have multiple treatment options, based on prior medical history, clinical judgement of the doctors, and so on. This has the potential to create incentive distortions, in so far as it can encourage doctors to prescribe surgery and other invasive treatment intensive treatment regimes where they stand to benefit. A diagnosis based payment model, wherein all treatments in a Diagnosis Related Group (DRG) are covered by a flat fee, can align the incentives of all sides to optimize among treatment alternatives.

Interestingly, the bundled payment regime in India, followed by many state and private insurance programs in the country, is a consequence of the nature of the Indian health care market. In US, Canada, and especially Western Europe, individual medical practitioners and diagnostic testing centers maintain their separate identitities from clinics and hospitals, thereby forcing insurers to deal with them separately. However, in India, the larger integrated specialty hospitals have come to dominate the formal health care market. Insurers therefore deal with them directly or with hospitals who in turn contract with certain diagnostic testing centers and specialists elsewhere. Bundled payments therefore become possible.  

Any universal health insurance scheme for India should have bundled payments as one of its pillars.

Health care graphics

I am copying these excellent graphics from Derek Thompson on the challenges facing health care sector in the US. They are representative of the problems faced by health care sector across many countries.

Health care is most cost-effective in Western Europe and East Asia. The contrast with the hugely expensive and relatively ineffective American health care system is stark.



America's health care inflation over the past 30 years trumps that in all other major economies.



Contrary to conventional wisdom, health care costs are not dominated by insurer profits and transaction costs, but by hospital and physician costs and pharmaceuticals.



Slowing the growth of health care spending would require squeezing many of these slices of the pie at the same time by, for example, increasing the payoff of investments, making hospitals more efficient, reducing doctor pay, and making prescription drugs less expensive.


The top 5% of spenders account for almost half of all health care spending.



The top 1% spends $90,000 per person on health care, 381 times more than the bottom 50%. This also means that certain categories of consumers soak up a major share of the health care spending. This also means that the focus of cost-cutting should be focussed on them.



The 1% of health care spenders are much, much sicker than the rest of the country. But almost half of them are in good, very good, or excellent health. Is there a window for cost cutting there?



But of the top 1% of health care spenders who make up 20% of all health care spending, 2/3rds are older than 55.



America's long-term budget crisis is nearly entirely a crisis of government health care spending, which is overwhelmingly in Medicare and Medicaid.



Thanks to incredible advances in heart surgery and medicine, the cardiovascular related deaths per capita have declined by 80 percent since 1950.

The distortions caused by "preventive care"

Is over-diagnosis and over-treatment the logical corollary to preventive care? It increasingly appears so, atleast if America is any yardstick for such assessment.

Over the past couple of decades, as health care budgets started ballooning, successive American governments have started focusing attention on preventive care so as to do early diagnosis and limit health care expenditures. Simultaneously, as health care costs started rising, private insurers too faced the same incentives.

An excellent article in the Times points attention to the increasing trend of conducting recurrent diagnostic screening on healthy individuals for various medical conditions. In the United States, healthy men are regularly screened for prostate cancer and healthy women for breast and cervical cancer.

In the past, doctors made diagnoses and initiated therapy only in patients who were experiencing problems... But increasingly we also operate under the early diagnosis precept: seeking diagnosis and initiating therapy in people who are not experiencing problems. That’s a huge change in approach, from one that focused on the sick to one that focuses on the well... in the past, you went to the doctor because you had a problem and you wanted to learn what to do about it. Now you go to the doctor because you want to stay well and you learn instead that you have a problem.

The article highlights the negative effects of such screenings and claims that it results in needless appointments, needless tests, needless drugs and needless operations,

This process doesn’t promote health; it promotes disease. People suffer from more anxiety about their health, from drug side effects, from complications of surgery. A few die. And remember: these people felt fine when they entered the health care system.

In the past, doctors used their clinical skills extensively to make diagnosis. However, for a variety of reasons, doctors today prefer to exercise their clinical skills only after examining the results of an array of diagnostic tests. This elevation of evidence from diagnostic tests to clinical acumen has, apart from dramatically increasing medical care costs, generated several incentive distortions in a market already riddled with information asymmetry and moral hazard.

I am inclined to believe that there are broadly three factors which have contributed towards this trend towards over-treatment and over-diagnosis. One, diagnostic and treatment technologies have improved dramatically over the past two decades thereby enhancing the possibility of successful detection and cure. Second, faced with the increasing prospect of malpractice litigation and patient demand to undergo all diagnostic tests, doctors prefer the easier way out and prescribe the full range of diagnostic screening before their diagnosis. Finally, as I have blogged earlier, the nature of medical insurance has eliminated any incentive among both doctors and patients to optimize diagnostic testing.

Cost of medical care - pricing failure

The Wonkblog has an excellent interactive graphic that captures the average cost of different types of surgical procedures. Two things stand out. One, United States is a consistent outlier in the high cost of treatment. Two, India stands at the other extreme, offering the cheapest procedures.



Conventional wisdom would have it that the higher cost of medical care in the US is because Americans use more health care services, see doctors more frequently and stay in hospitals longer. However, as Ezra Klein highlights by pointing to this 2003 paper by Uwe Reinhardt and Co, the reality opposite on all these counts. The real reason for the higher cost of medical care in the US, as the graphic makes amply clear, is due to higher prices.

The higher prices in the US health care market is yet another illustration of the failure of price signals in ensuring economic and allocative efficiency. In the United States, outside of the government run Medicaid and Medicare, prices are negotiated in a free-market between insurers and service providers. As Uwe Reinhardt has shown here and here, providers largely charge what they can get away with, often offering different prices to different insurers, and an even higher price to the uninsured.



Prof Reinhardt writes,

On average, the prices for health care goods and services negotiated by private health insurers in the United States tend to higher — about double or more — than prices for identical services and goods in other countries of the Organization of Economic Cooperation and Development. It is in good part so because insurers do not seem to have sufficient market power, especially vis à vis hospitals, to resist very rapid price increases.The varying degrees of market power among private insurers in the United States have led to pervasive price discrimination among payers, with prices for identical goods or services varying among payers by factors as high as 10.

In contrast, health care prices in the other countries is regulated, with the result that prices are considerably lower. Ezra Klein writes,

Other countries negotiate very aggressively with the providers and set rates that are much lower than we do... They do this in one of two ways. In countries such as Canada and Britain, prices are set by the government. In others, such as Germany and Japan, they’re set by providers and insurers sitting in a room and coming to an agreement, with the government stepping in to set prices if they fail.

I have blogged earlier highlighting the market failure problems associated with purchasing and pricing health insurance service.

Lessons from the German Health Insurance Model

Uwe Reinhardt has an excellent summary of the oldest national health insurance system in the world. Germany has a statutory, mandatory, community rated health insurance system which provides a prescribed basic package of benefits to nearly 88% of population through 154 private, non-profit, sickness funds. In addition there are 46 private health insurers operated on commercial principles which provide comprehensive coverage to the remaining 11% of the population (including civil servants) and also top-up supplementary coverage, if demanded, to those on statutory insurance.

Employees and pensioners pay 8.2% of their gross wages/pensions, while employers/pension funds must contribute 7.3%, for a total contribution of 15.5% of gross wages/pensions upto a maximum wage of (or pension) of 44,550 euros. Unemployed people pay premiums in proportion to their unemployment compensation, and for the long-term unemployed the government pays the sickness fund a fixed per-capita payment. The coverage is for the entire family. Insurance is tax-financed for children. Employees/pensioners earning above 49,500 euros (in 2011) are free to opt out of the statutory system and purchase private, commercial coverage, but if they do, they cannot ever return to the statutory system unless they are paupers.



In order to equalize actuarial risk among the competing sickness funds, all premium payments go into a national risk-equalization fund, from where a capitation (that is risk-adjusted for the employee/pensioner and dependents) is paid out to chosen sickness fund of the employee/pensioner. Recent federal legislation has forced private insurers to levy on younger people higher premiums than their actuarial risk can justify to build up an old-age reserve, thus preventing premiums from climbing too rapidly with age.

In countries like India, where health insurance market is in its nascent stages and state and central governments have been experimenting with various models, the German model is instructive. The most important attraction of the German model is its offering of community-rated universal coverage for a basic prescribed package of benefits. This arrangement minimizes actuarial risks and keeps down both premiums for the insured and administration costs for the insurers.

Currently in India a number of states and the Union Government are rolling out independent insurance schemes, each for different categories of citizens within the same geographic area. Such fragmented schemes, by concentrating risks, run contrary to the principles of optimal risk management and increases the costs for all sides. Since most of those covered in such schemes are subsidized, the governments end up paying the higher premiums. Insurers hedge for both the higher risk and the actuarial uncertainties associated with such specific and concentrated risk pools by demanding higher premiums.

An ideal system would be for the Government of India to bring together all state governments on board in a national health insurance scheme which is universal for a basic package of benefits. The scheme should be community rated and opened to all insurers, public and private. An Aadhaar-complaint database can be maintained to administer this scheme and subsidize premiums for certain categories of citizens. All citizens should be mandatorily covered under the scheme, and those requiring additional coverage be permitted to buy supplementary insurance (additional benefits) from the market.

See this excellent comparison of health insurance systems from fourteen countries.

Update 1 (9/3/2012)

Conservatives in the US have for long advocated consumer-driven health plans (CDHPs) which combine high-deductible health plans (HDHPs) with Health Savings Accounts (HSA). The HDHP's have low premiums, out-of-pocket payment caps, no co-payments, but high deductibles. The consumer desposits a fixed amount each year into the HSA, which is tax-deductible and gets carried forward, and which can be used for regular out-patient medical expenses and for payment of deductibles.

It is argued that since consumers make the payments (of deductibles and other regular medical expenditures) directly and are therefore responsible for their health care purchase decisions, they are more likely to optimize on their treatment options. In regular health insurance models, the consumer is completely divorced from the payment decisions, thereby generating several incentive distortions.

Critics see this as part of efforts to introduce more private participation into health insurance and make consumers responsible for their health care plans. They also see this, along with the Republican supported plans to replace Medicare with vouchers that can be used to purchase health insurance plans from private insurers. The rising health care costs, asymmetric information problems in health care, and the lack of expertise in consumers to shop for the best possible insurance alternative, and so on make such consumer-choice plans inefficient and burdensome for consumers. See Paul Krugman's critique here.

See this Youtube video on CDHPs. See this excellent paper comparing helth insurance systems from across the world. See this account of the Swiss health insurance model.

Limits to outsourcing in health insurance

Third Party Administrators (TPAs) are the preferred means of claims settlement for health insurers across the world. In simple terms, the insurers outsource the claims settlement activity to these TPAs so as to save costs as well as time and help insurers focus on their core business.

So it comes as a big surprise that many insurers in India are cancelling TPA contracts due to customer dis-satisfaction due to health cards not reaching in time, and delays in pre-authorization, cashless issuance and processing of payment claims. A Businessline report says,

"Insurance companies also say that the claims can also be settled faster if done in-house. The claims settlement time has gone down by 50-70 per cent (depending on case to case) for ICICI Lombard since it shifted the process in-house in 2008... For Future Generali, customer complaints have gone done by 80 per cent after they moved to in-house claim settlement models in November 2010...

In-house claims settlement is faster as there is no loop in between the customer and the insurer. The industry benchmark is about 6-8 hours to approve a cashless request, whereas the approval from... in-house claims settlement team takes only 40 minutes due to... image-based process."

Is this another example of how transaction costs associated with outsourcing exceeds the efficiency benefits of specialized treatment screening and claims processing? See earlier posts here, here, and here.

Purchasing and pricing health insurance

As health insurance assumes centerstage in health policy debates in India, it is critical that we make informed decisions on the two critical factors in any health insurance model - purchase and pricing of medical care services.

In this debate there are two issues - how care is purchased and how much is paid for that service. There are two conventional approaches to purchasing medical services. Insurers can pay the service providers a specific amount for each discrete service (fee-per-service model) or make bundled payment for all of the care a patient needs over the course of a defined clinical episode.

The former is the prevailing purchase model across countries and has its set of inefficiencies. The biggest problem with this approach is that it becomes difficult to manage the incentive of doctors and hospitals to prescribe more diagnostics and treatments than is required. Insurers manage this problem by increasing the effectiveness of their pre-authorization and/or with conditions like prohibiting payments for certain basic tests. In contrast, the later approach effectively addresses this incentive problem. However, it fails with implementation problems.

Regarding the pricing of these services, different insurers can either individually negotiate with the service providers and arrive at their different price schedules or they could collectively bargain and fix standardized prices for all insurers. The US health insurance market is a classic example of such price differentiated market and its inefficiencies are well documented. Government-run health insurance systems undertake collective bargaining and fix standardized prices for each service.

Uwe Reinhardt summarizes the merits and demerits of both approaches and advocates the All-payer model,

"In developed nations that rely on multiple, competing health insurers — for example, Switzerland and Germany — the prices for health care services and products are subject to uniform price schedules that are either set by government or negotiated on a regional basis between associations of health insurers and associations of providers of health care. In the United States, some states — notably Maryland — have used such all-payer systems for hospitals only. Elsewhere in the United States, prices are negotiated between individual payers and providers. This situation has resulted in an opaque system in which payers with market power force weaker payers to cover disproportionate shares of providers’ fixed costs—a phenomenon sometimes termed cost shifting—or providers simply succeed in charging higher prices when they can. In this article I propose that this price-discriminatory system be replaced over time by an all-payer system as a means to better control costs and ensure equitable payment."

In particular, Prof Reinhardt points to the successful example of Maryland, which has historically deviated from other states in the US and has had an all-payer model of health services pricing. Maryland’s rate-setting system is widely believed to be one of the most enduring and successful cost containment programs in the United States. In his excellent paper, Prof Reinhardt finds evidence of price differentiation efficiencies at many levels. Private insurers pay much more for all services than public insurers, who use their larger bargaining power to lower prices.



For the same service, the variations in service fee are large in case of hospitals as against other treatment centers. There is an obvious high premium extracted by certain hospitals. The variations in payments across hospitals for the same service can be substantial.





The effectiveness of India's health insurance market will depend on it being able to get both the health service purchase and pricing model right. It is fortunate that being a nascent health insurance market, governments are not constrained by any legacy models. Since governments will be able to provide adequate health insurance to only a small proportion of the population, it is important that private health insurers too are able to keep their costs low and sell policies at affordable prices. Public policy should play a catalytic role in facilitating this.

The purchase model is more complex and not easily amenable to policy fixes. However, governments should encourage private insurers to adopt a purchase model that bundles services and makes payment for treatment of the medical condition. It is possible for governments to get health service providers as far away from the fee-per-service model of charging insurers. While it may be easier for large specialty hospitals to accept this, this model may end up excluding smaller diagnostic centers and clinics. Encouragingly, India's nascent health insurance model is, for various reasons, moving more towards the bundled purchase model than the fee-per-service model.

In case of pricing though, there is a more direct role for governments in assisting insurers arrive at standardized prices for services in all hospitals within a particular area. The model of all-payer price fixing, as is done in many continental European countries, would reduce the administrative and other transaction costs, and help keep insurance premiums at affordable levels.

In some ways, there is a free lunch here. Governments, both state and center, have an increasing leverage over private health service providers due to various newly announced state and central health insurance schemes. This strength should be used to bargain out standardized rates for services by participating hospitals within a geographical area. The private insurers could differentiate by offering variants of the basic service with top up prices.

Unfortunately, failure in this front is already evident in public health insurance. As I have blogged earlier, one of the critical failings with the Aarogyasri program was its inefficient price-fixing model. Other state governments, eager to embrace the wild populism inherent in Aarogyasri, may end up making the same mistakes.

Update 1 (3/3/2012)

Two excellent posts by Uwe Reinhardt on payment and pricing health insurance. The first dwells on the relative merits of the three purchasing models - fee for service, medical condition-based bundled payments, and capitation fee model. The second examines the three price determination models between the insurers and the insured and insurers and health care providers (doctors, clinics, hospitals etc) - free market negotiations, price-setting in quasi-markets (all payer system where the associations of health insurers within a region would negotiate with corresponding associations of hospitals, doctors etc uniform fee schedules that then would apply to all payers and providers in that region), and administrative price fixing by the government.

See also this paper by Prof Reinhardt on pricing in US hospital services.

Nudging to stay healthy!

As health care costs ratchet upwards, insurance companies have been experimenting with various strategies to keep them under control. The most interesting approaches involve the use of insights from behavioural psychology to nudge people into staying healthy so that their treatment expenditures are minimized.

The Economist points to the success of South African insurer, Discovery Group, with its "Vitality" program that applies the "air miles" model to health care. Discovery has risen from obscurity to become South Africa's largest health insurer in less than two decades.

"You earn points by exercising, buying healthy food or hitting certain targets. You rise through various levels, from blue to gold, as you accumulate points (rewards are adjusted to your starting level of fitness to give everybody a chance of making progress). And you are given a mixture of short- and long-term rewards ranging from reduced premiums to exotic holidays.

Discovery has formed alliances with a host of companies to provide rewards linked to your 'vitality level'. Pick ’n’ Pay, a South African grocery chain, provides discounts of up to 25% on 10,000 'healthy foods'. Airlines such as Kulula offer discounted flights. Discovery can measure whether people actually go to the gym, rather than just join, by swiping their membership cards. It says it has solid evidence that participation in the programme more than pays for the rewards: active participants are less likely to fall ill and, if they do, they spend a shorter time in hospital."

The "air miles" model of incentivization has been deployed in other industries, "including a credit card that offers discounts linked to well-being and car insurance that offers cheaper petrol to people who drive safely (a telemetric device installed in your car monitors aggressive driving, like harsh acceleration or sharp cornering)".

Incentive distortions in cancer treatments

I have blogged recently about market failures associated with health insurance which is a consequence of the inherent problems with health care. Nowhere is this more evident than in the case of cancer treatment.

Cancer screenings - mammograms for women and prostate cancer screening for men - have emerged as among the most controversial areas in healthcare, representative of the information asymmetry related market failures that characterize the sector. NYT writes about the difficulty of making screening calls,

"When doctors screen for early cancer, all the incentives — cultural, financial, professional and legal — line up in one direction: Don’t miss it. As a result, doctors overreact to even the tiniest abnormalities, which leads to the two basic harms of screening: false-positive tests and overdiagnoses.

False positives are really common in both breast and prostate cancer screening... Approximately 15 to 20 percent of women and men who are screened annually over a 10-year period will have to undergo at least one biopsy because of a false-positive mammogram or PSA — prostate-specific antigen — test...

Overdiagnosis is less common, but much more consequential because it leads to unnecessary treatment. Screening finds abnormalities that meet the pathological definition of cancer, yet will never go on to grow or cause any symptoms, let alone death. Sometimes patients choose to wait and see if the cancer grows, but most opt to treat it; once you’re told you have cancer, it’s difficult to wait and see what happens next.

Patients who are overdiagnosed are the big losers here. They undergo surgery, radiation and chemotherapy unnecessarily. And then there are the associated complications: chemotherapy can cause nausea and radiation can burn normal tissue; breast surgery can be disfiguring, and prostate surgery can lead to bladder and sexual dysfunction.

Doctors don’t know which patients they are treating unnecessarily, but they know how the unnecessarily treated patients got there in the first place — because they were screened for cancer.

Now let’s consider the winners — those who have avoided dying from breast or prostate cancer by getting screened. While there is some debate about whether they really exist, my reading of the data is that they do, but they are few and far between — on the order of less than 1 breast or prostate cancer death averted per 1,000 people screened over 10 years. That’s less than 0.1 percent.

Overall, in breast cancer screening, for every big winner whose life is saved, there are about 5 to 15 losers who are overdiagnosed. In prostate cancer screening, for every big winner there are about 30 to 100 losers. "

The incentives of all sides are aligned towards overtreatment. At the slightest suspicion of cancer, the patient is subjected to screening by a risk averse and liability claim fearing doctor. This impulse gets amplified if the doctors gets an incentive for every diagnostic test done, as is most often the case. The anxious patient is ever eager to get himself cleared off any suspicions and therefore willing, even demanding, that all tests be done. In any case, since he is insured, he bears no or little expenditures on those tests. The inusrers too prefer an early diagnosis, since they believe it would save them of the much greater expenses from the treatment once the case turns malignant.

The case for health insurance and government's role

What should be the role of government and the private sector in India's secondary and tertiary health care system, especially in taking care of those who cannot afford private health care?

Traditionalists see no or limited role for private sector and advocate that government hospitals should meet the requirements. Extreme liberals on the other hand advocate a dominant role for private sector. However, reality demands a much more nuanced appreciation of the health care market and the incentives and challenges facing its participants. This post will attempt to put these issues in some perspective. I will also attempt to outline a model health insurance market, applicable to legacy-free countries like India.

1. Fundamentally, government institutions, even if they expand exponentially, are in no position cover even a majority of those in need of such services. On all primary parameters - doctor to population, beds to population, diagnostic facilities to population, and so on - we lag way behind the requirements. This deficiency will persist well into the future.

It is therefore inevitable that if the government is committed to ensuring atleast access to secondary and tertiary care facilities to its under-privileged population, not only does the public facilities have to grow fast but also be complemented with rapidly expanding private healthcare facilities.

2. However any role for private hospitals raises important questions about the details of this involvement. Crucially, how should private hospitals be involved in the treatment of such cases for those below the poverty line? This question is important because of three reasons.

One, unlike other markets, that for selling and buying health care is rife with market failures (information asymmetry problems like moral hazard, adverse selection, over-treatment), behavioural biases (healthier/younger people prefer to stay uninsured, people prefer more diagnostic tests and invasive procedures) etc. Two, as I had blogged earlier, health care will be among the few markets where productivity imporvements will remain marginal even as technology continuously expands the treatment frontiers. Three, there will be a huge and persistent supply-demand mismatch in developing coutnries which will ensure that health care remains a sellers market for a long time to come.

The first and second factors, along with demographics, have been responsible for the rising health care costs and resultant health care mess in many developed countries. The third factor will only exacerbate the already inherent distortions of health care markets and will be an important factor in countries like India.

In view of all these, the nature of private sector's involvement in the provision of affordable health care becomes important. Experience from across the world shows that health insurance is the most effective strategy to manage these risks optimally and deliver affordable secondary and tertiary healthcare to citizens.

3. Assuming government's commitment to deliver affordable secondary and tertiary health care to all its citizens and the inevitable need for health insurance, the question then is one of ensuring how we can get care that delivers bang for the buck. In other words, how do we achieve the desired health care outcomes at the lowest cost.

This would obviously require leveraging both the government and private health care facilities. The most critical factor would be the design of the insurance model. How do we structure incentives such that the doctors and hospitals confine treatment to only the necessary diagnostic tests and procedures/medications, patients do not demand more than what is required, government hospitals and private hospitals complement each other, and the insurer's administration charges are kept at a minimum?

Here is a simple model of how this insurance can be structured. The real-world model could be some variant or other of this.

Bring all citizens of the country/state into a single risk pool. All those below the poverty line and all government employees, including their families, should be part of this risk pool. In an ideal world, it would be appropriate to include all citizens and usher in a mandatory health insurance model. Further, all the schemes offered in this market should be community rated - same insurance premiums for everyone in the same age group or no differentiation based on pre-existing medical conditions.

Finalize a basic bouquet of treatments that are covered in a universal and basic insurance package and is available to all citizens at a competitively arrived premium. There can be a single or preferably multiple insurers prioviding these schemes. Then there should be a variety of top-ups available on this basic package. Government departments can offer a menu of top-ups to their employees depending on their different levels. Similarly, private employers and individuals too can purchase insurance from this market.

The government could subsidize the premiums at varying levels depending on people's incomes. For example, the poorest could have their entire premiums subsidized. Similarly, for employees, a share of their salaries could be leveraged to complement the government's share of the premium. Employees would have the option to privately top-up on their government package.

The administration of the insurance model itself could be made more transparent and protocols based, so as to minimize excesses and distortions. The entire pre-authorization process can be done transparently and rigorously audited, so as to ensure that insurers/TPAs and service providers do not over- or under-treat patients. To a great extent, as competition increases, the presence of professional insurance agencies and TPAs should contribute towards minimizing these distortions.

A protocols-based referral system can be put in place so that atleast certain categories of those covered in the government financed health insurance model are treated only in government hospitals if facilities are available. The government could, to the extent of the packages fully or partially financed by it, control the empanelment process and negotiate bulk rates with drugs manufacturers and service providers, so as encourage the insurers to quote lower premiums. The presence of a large and vibrant set of government hopspitals will provided the much needed competition to keep private service providers honest.

An additional reason for large network of government health care facilities to exist is because for much of the foreseeable future government hospitals will be necessary to service the vast interiors of the country. Private sector will find such locations commercially unviable. Insurers could deliver their services by leveraging these public facilities in remote areas.

These schemes could be sold in newly established customer-friendly insurance exchanges. Such exchanges could helps customers easily compare across similar kinds of policies, besides making clear the fine-print of these policies. The regular private insurers, who would exist and sell their respective insurance schemes, would all be eligible to bid for offering these set of insurance services. Once the insurers are designated and premiums for the basic package for both poor and different categories of government employees defined, the top-ups may be left to the markets to decide. This will ensure that in the process of rectifying market failures, governments do not end up distorting incentives wholesale and affecting market efficiency.

If required, it may even be desirable to have a risk-equalization pool, like that in Germany and a few other European countries, which would help mitigate the actuarial risks for insurers. This will contribute towards keeping premiums down and reduce the incentive for insurers to turn away patients because of their claim ratios over-shooting. All the actual claims processed each year by all insurers can be consolidated, risk incidence measured, and some pay-outs made so as to normalize risk incidence among all insurers.

Countries like the US, which already have a legacy insurance model, will invariably find it difficult to embrace many elements of this model. But countries like India, which do not have any existing insurance model, will find it easier to embrace elements that are appropriate to its requirements. Furthermore, the favorable age profile of our population too should go a long way towards keeping premiums down if the entire population is covered.

Rising health care costs

One of the biggest challenges with health care is the consistency with which health care expenditures have been growing faster in relation to the general GDP growth across the world. The graphic below captures the rate of growth of national health expenditures in the US with respect to GDP growth rate.



When disaggregated, this rise in national healthcare expenditures is reflected in the high premiums being charged by insurers. As a recent Times article pointed out, the average health care premiums in the US has been rising faster than general price levels. Even more worryingly, the workers share of the premiums have been rising faster than the general rise in premiums.

Observations on the Aarogyasri program

Aarogyasri is a hugely popular health insurance program initiated the Government of Andhra Pradesh. Administered by a government-run Aarogyasri Trust, it covers all the below poverty line (BPL) citizens, and provides for pretty much the entire spectrum of high-value tertiary treatments. In the language of insurance, the Aarogyasri is a single-payer (government), mandatory coverage (for all BPL families), pure community rated (same insurance rate for all those covered) insurance scheme.

Its supporters point to four features of the program as proof of its widespread appeal. One, it covers all the major medical conditions, with a generous coverage of upto Rs 2 lakh per family every year. Two, it provides un-paralleled choice to patients, giving them the freedom to choose any hospital, government or private, for their treatment. Three, it provides for completely cashless treatment in any of the empaneled hospitals. Four, the scheme incentivizes government doctors by earmarking a share of the payments recieved by their hospital for treating Aarogyasri cases to the doctors and staff.

However, it is precisely these four attractions that form the basis of concerns about its long-term sustainability.

1. The universal coverage is a red herring. In reality, the supply-side is severely constricted by the available treatment facilities. In fact, even with the spurt of private hospitals in the wake of the program, less than a quarter of patients suffering from a covered medical condition are likely to be treated under the scheme.

Herein lies one of the biggest challenge for the scheme. If the present trend continues, more private hospitals will crop up, if only to exclusively service patients covered by the scheme. This will in turn increase the available treatment facilities and thereby the actual claims processed by the insurer. It is inevitable that premiums will keep going up for years to come, merely due to the addition of new treatment facilities.

As the numbers of private hospitals increase, there will also be increased pressure to expand the pool of covered procedures. This too will drive premiums north. Adding to all this will be the universal trend of rapidly increasing medical treatment costs. Will the government budget prove deep and resilient enough to meet all these upward pressures?

2. The level of patient choice in Aarogyasri is simply unprecedented, a luxury not available to even patients in many developed economies. Given the state of government hospitals and the incentives of private and government hospitals (the former have no incentive to chase patients), patients are more or less certain to prefer the former. This would be a shame since most government secondary and tertiary care hospitals have well qualified doctors and adequate diagnostic and surgical devices, though the quality of service delivery is questionable. Questions will invariably have to be asked about whether it is possible to leverage the Aarogyasri program to improve the quality of service delivery in government hospitals.

3. Related to the previous point, the prevailing government policy on secondary and tertiary healthcare provides for no synergy between the government's own single-payer Aarogyasri health insurance program and its existing secondary and tertiary care facilities. In fact, they are each considered distinct and mutually exclusive. This is unlike the health insurance model in most western countries, where there are strict protocols for referrals, with cases being referred to private hospitals only when government hospitals are unavailable.

An application of the same model would have brought in the government hospitals as a major health service providers in the Aarogyasri scheme through a similar protocols-based sharing of cases between them and private hospitals. It would also have enabled resource-strapped Government hospitals to access payments from the Aarogyasri program. This cash flow becomes all the more important since the state government reduced its budgetary allocation to all these hospitals in lieu of the Aarogyasri allotment. In simple terms, the budgetary allocations to Aarogyasri and existing government hospitals being a near zero-sum game (net allocation being more or less the same), the private hospitals benefitted at the cost of the government hospitals.

4. Further, once the patient is admitted by the private hospital, given the pay-per-intervention payment system, their incentives are strongly aligned towards over-treatment. Since the treatment is cashless, the incentives of the patient are aligned towards accepting the "best" available treatment. Unfortunately, in the prevailing model, the incentives of the doctors are aligned towards projecting expensive invasive surgical procedures as the "best" option. For example, irrespective of the medical condition and the age profile of the patient, irradiation therapies are generally preferred (by both doctors and patients) over medication. In simple terms, the most aggressive treatments have become the standard of healthcare.

In standard insurance schemes, insurers have to keep a strict vigil on the pre-authorization process (when the tests are done and the patient is screened for a particular surgery/therapy) so as to minimize over-treatment. This is all the more so since the payments to health service providers (doctors and hospitals) are on a pay-per-procedure/intervention basis, as against the less distortionary fixed payment for treatment of a medical condition.

The Aarogyasri program too makes payments to hospitals based on a pay-per-procedure basis. In fact, the tender premiums quoted by the insurers are based on this premise. The Trust prefers this approach since it believes that its in-house pre-authorization process is rigorous enough to effectively screen patients and prevent over-treatment. In fact, effective pre-authorization is the forte of the best Third Party Administrators (TPAs) hired by the insurers. If the Aarogyasri Trust does this effectively, then it has to be counted among the most effective TPAs. In any case, as the program expands, maintaining such rigorous pre-authorization process will become difficult.

However, unless it moves away from the in-house pre-authorization process to a purer insurance model, it may not be possible to change the payment model. A medical condition based payment approach is much more complex to administer and riskier too and may not be possible with an in-house model of pre-authorization.

5. In simple terms, the incentives under the Aarogyasri scheme offered a cash reward top-up to doctors for doing much the same procedures which they were doing through their regular hospital in-patient channel. This has the potential to create a moral hazard - the doctors who internalize the incentive and do these procedures come to slowly view these incentives as entitlements.

This turn of events can damagingly distort the incentives facing doctors, especially if at some point in time the government decides to abandon Aarogyasri and decides to revert back to the old model of government institutions based health care. Further, it cannot be denied that atleast some doctors are likely to be disincentivized in taking proper care of patients not covered by Aarogyasri. Also, what about the cash incentive crowding out intrinsic motivation?

Aarogyasri incentive structuring is a powerful example of the need to exercise great caution when we introduce performance-based pay systems into government bureaucracies. Unless carefully structured, cash incentives not only distorts the current implementation, but it also generates adverse expectations which come in the way of future implementation of performance based pay. In some ways, this is similar to a situation where a doctor abruptly replaces a commonplace but effective drug with a powerful new medication against a particular virus/bacteria, only to find after some time that the second generation drug too is losing sting, leaving us with limited available options to effectively treat the microbe.

So what can be done to make the Aarogyasri program more cost-effective without radically tinkering with its existing model?

For a start, it is imperative that there be a clear protocols-based system of referrals, so that the existing government facilities are more closely integrated into the Aarogyasri scheme. The government hospitals benefit by way of accessing more funds and thereby better diagnostic and surgical facilities. It will also help the government accommodate the massive budgetary support that is inevitable in the coming years as the scheme grows.

A treatment facility wise mapping of government hospitals can help route Aarogyasri patients to those hospitals for specific medical conditions. Only those cases which cannot be treated in these hospitals (for either lack of bed space or lack of required facilities) should be referred to private hospitals. Simultaneously, there should be a vigorous campaign to improve service delivery standards in secondary and tertiary hospitals.

The incentive system for government doctors provided for under the Aarogyasri scheme has to be either dismantled or be made more nuanced. If the later is preferred, the incentives should kick-in only after a certain performance benchmark is breached.

Under the Aarogyasri scheme, the insurance premium quoted by the insurer is a function of the number of procedures/therapies covered, N, the respective price (to be paid to the hospital) fixed for each surgery/therapy (or medical condition) i, Pi, the number of empaneled hospitals (or number of available treatment beds for each surgery/therapy i), Ei, and the disease incidence risk among the population pool insured for each medical condition i, Ri.

In other words, Premium, Pr = f(N)+g(Pi)+h(Ei)+q(Ri)

Insurers seek to ensure that their expenditure due to claims and administration costs is lower than the premiums collected.

Of these, the most important parameter is the prices of procedures. Neither the insurer nor the health service providers have an incentive to control it. The health service providers are the direct beneficiaries of higher procedure rates and therefore lobby hard for maximizing procedure prices. The insurers merely pass on these higher prices on to the consumers by way of higher premiums.

The insurer seeks to minimize his claim outgo either by limiting the number of empaneled hospitals (so that the numbers of cases that can be treated is controlled) or turning away (on some pretext or other) those who claim treatment. Both these problems can be addressed. The former can be mitigated by defining the list of empaneled hospitals in the tender itself, including those which are likley to be added each year and details of when they will become operational. Since the premiums are revised each year and it takes atleast an year for establishing any hospital, such up-front disclosure is not likely to create any problems. The later can be overcome by making it mandatory to treat all the patients pre-authorized by the Aarogyasri Trust.

Both the aforementioned conditions, coupled with upfront disclosure of number of surgeries/therapies, transparent fixation of prices for each procedure, and government-run pre-authorization can substantially align the incentives of all parties. If these conditions are fulfilled, the insurer's bid would be determined purely based on his actuarial risk calculation for the insured risk pool and their administration costs. Such bids are more likely to generate efficient outcomes, since it increases the likelihood of the successful bidder also being the most efficient insurer.

Addressing incentive distortions in health insurance

Health care abounds with information asymmetry and incentive distortions, and consequent market failures. The objective of any efficient health insurance system is to align incentives in a manner that health service providers deliver and patients demand the right amount of care, and insurers do not turn away any deserving patient. All the different models of health insurance in use across the world seek to achieve this objective.

Health insurance providers base their payments to health service providers either on the basis of fee-per-service or a single lump sum for the full treatment regime. The former aligns the incentives of health service providers towards over-treatment - they get more money for more procedures. The latter shared-savings programs, while attempting to be cost-effective, may incentivize providers to provide less care overall and channel patients towards the cheapest treatments.

Insurers have sought to address such incentive distortions with rigorous screenings and patient-side measures like co-payments and deductibles. The latter consumer-driven schemes seek to encourage patients into searching for the most cost-effective option by forcing the patient to share part of the treatment cost burden. Though there have been apprehensions that such cost-sharing would force patients to skimp on their treatment options, they have not been borne out conclusively. In fact, the Rand Health Insurance Experiment, the most comprehensive study of its kind, found that when insurers increased cost-sharing, though individuals reduced their care consumption by about 30 percent, the vast majority suffered no ill effects.

Now an interesting paper by Lorens Helmchen proposes a new cash-for-care arrangement, where "when faced with two treatments of roughly equal efficacy but dramatically different cost, the insurer would pay patients a cash fee if they chose the less expensive option". Though a form of shared savings plan, such plans differ in that unlike conventional shared savings plans which share savings exclusively with health care providers, cash for care shares savings with patients. In simple terms, cash for care gives patients a bonus to ration their own care.

Such cash for care schemes would be especially effective in end-of-life care (it accounts for a quarter of Medicare spending in the US), especially relating to cancer treatment. Treatments for the same class of cancer can range in cost from as little as $1,300 a month to more than $7,000. In such cases, the choices of the patient would be a reflection of the value attached by the patient to his/her own life.

However, from the perspective of the insurers, I am not sure whether it will be effective for end-of-life care patients. Unless it forces them to face extreme pain and other difficulties, any such patient is most likely to choose a treatment option that increases the chances of living longer. This objective is most often fulfilled by the expensive option. In any case, the success of such models can be evaluated only when actually implemented, since it would also depend on whether it causes any dramatic drop in health care outcomes for those chosing the cheaper alternative over the more expensive one.

Where health care inefficiencies lie?

It is widely known that the market for health care services is rife with several market failures. See this seminal paper by Kenneth Arrow. It is also widely accepted that the United States, with its private health insurance market, is the best representation of these failures.

The Economist has a graphic that traces the major sources of wastage and inefficiencies and an estimate of the amounts. As the article points out, the pay-per-service model of insurance creates perverse incentives - "the more services a hospital provides, the more it is paid".



Ezra Klein makes the interesting point that even in comparison to single-payer systems like Canada (government is the only insurer) and UK (the government is not only the sole insurer of note but also employs most of the doctors and nurses and runs most of the hospitals), US, with its private insurance dominated health care market, has a much larger government health care system. It also has the highest private health care spending.



Health care, especially in light of the US experience, is also a classic example of "how it can be possible for unregulated free-market health-care systems to cost more and deliver inferior care than strongly regulated systems with heavy government involvement"!

See excellent graphics from Kaiser Foundation comparing health care costs across developed economies.

Why incentives alone are not enough?

Econ 101 would have it that successful public policy is that which is designed with appropriately aligned incentives. However, the complexity of the real world means that when implemented, many of these incentives, doubtless laudable when seen in isolation, results in often undesirable outcomes. Here is one recent example.

Under the popular Arogyasri health insurance program run by the Government of Andhra Pradesh, government hospitals and its doctors are incentivized by way of cash payments for each patient treated. The presumption is that once the incentives are appropriately aligned, government hospitals would be able to attract patients under the scheme and use the incentive amounts to improve infrastructure and buy equipments.

However, it has been found that this incentive architecture has not been adequate to get government hospitals to attract patients under Arogyasri. Here are two possible reasons, which also informs us about the complexity involved in designing public policies.

1. It is an open secret that many government doctors, especially specialists, practice in private hospitals outside their regular working hours. There is evidence to suggest that these doctors are being offered much higher incentive payments by the private hospitals for every patient treated under Arogyasri. In fact, the government doctor even becomes a link to attract the patient to the private hospital. In other words, there is an unforeseen and even bigger incentive at work that nullifies the incentive structure built-into the scheme.

2. Most government hospitals do not have the required basic physical infrastructure and equipments to carry out many of the procedures. Further, even when they do have the equipments, the hospital environment is not conducive to attracting patients and for performing surgeries. Most often, the doctors in government hospitals face problems from lack of electricity or water, absent or recalcitrant nurses and attendants, equipments facing minor repairs or without consumables, and so on, all of which come in the way of their work. In contrast, in a private hospital, the doctor can merely walk into the operation theatre and carry out the surgery without any concern for managing the hoospital environment.

Therefore, despite the presence of the all facilities, patients prefer the private hospital and doctors exhibit an inertia to carry out operations. The last-mile cost imposed by the environmental challenges and the resultant behavioural inertia to do surgical procedures in the hospitals is often large enough to prevent the treatment getting carried out in the hospital despite the incentive to do so.

Both these reasons again highlight attention to the fact that while structuring incentives is necessary, it is far from adequate to ensure the achievement of public policy objectives. In this case, perversely enough, the program may have had the effect of widening the existing deep divide between government and private hospitals and creating a new divide between the good and poor government hospitals.

Why health care cannot not be rationed?

One of the central themes of the debates about health insurance in the United States is the "rationing" of health care. Conservatives believe in the provision of unlimited access to all health care, irrespective of its costs and benefits, and oppose all attempts to ration health care on any cost-effectiveness criterion. On the contrary, liberals argue that the steep rise in health care costs leave governments with little choice but to restrict the types of care covered.

Governments across the world face a two-fold challenge with their health care budgets. On the one hand, a large number of public spending needs compete for scarce resources, while on the other hand aging populations and increasing cost of medical treatments put upward pressure on health care budgets. In this context, the rationing debate is all about whether governments should finance unlimited health care or should cap expenditures at some reasonable level. This essentially boils down to putting a value for human life. This value would vary, decreasing with age.

There are four fundamental challenges with health care that inevitably leads us down the path of rationing.

1. With terminal care patients, especially given the advances in medical technology, it may be possible to prolong lives, albeit at a massive treatment cost. In fact, end-of-life care is taking up an increasing share of health care budgets (approximately a quarter of the $450 billion that Medicare spent last year went to pay for care in patients’s last years of life). For example, many oncology treatments on patients with solid tumors are extremely expensive and prolong life by just a few weeks.

Should health insurance schemes cover these cases? More specifically, should government health insurance cover treatments that have no curative potential and are merely life-prolonging? Should governments refrain from aggressive therapies which have no chance for cure or recovering function? More generally, should governments cover all the possible treatment options?

The problem with rationing here is that distinguishing severely ill patients who are treatable from those who are terminal is not always simple. There is also the issue of treatments that while not curative, can improve the quality of post-treatment life.

2. The perennial problem for health insurance has been about managing the issue of over-treatment. Incentives of doctors, health service providers, and even patients are aligned to over-treat. Doctors and service providers get paid more if the patient undergoes more diagnostic tests and surgical interventions. Subjecting the patient to the full spectrum of diagnostic tests also protects doctors from expensive legal suits if something goes wrong with their treatment. And finally, patients too are comfortable and increasingly demand that all possibilities be ruled out during their treatment.

It therefore becomes critical for an insurance provider (and therefore governments which subsidizes the insurance scheme) to place restrictions that would contain over-treatment. This invariably results in some form of rationing.

3. Then there is the issue of over-diagnosis, especially for the elderly. For example, an "MRI will find nasty looking knee and spine abnormalities in many Medicare-aged patients who don’t (and won’t) suffer from serious knee or back pain. Most men over 80 have a few abnormal prostate cells that will never make them sick (and won’t be helped by treatment) but can be profitably labeled 'cancer'." Similarly, most old people will display evidence of heart disease if one looks hard enough.

Knowing when it is prudent or necessary to start treatment is also essentially a rationing decision. Insurers will have to take judgement decisions to either agree or disagree for certain treatments, though the patients may demand and doctors may want it.

4. Finally, there is the issue of ineffective treatments. The BMJ has classified more than 3000 treatments as either of unknown effectiveness (51 percent), beneficial (11 percent), likely to be beneficial (23 percent), trade-off between benefits and harms (7 percent), unlikely to be beneficial (5 percent) and likely to be ineffective or harmful (3 percent). In Britain, the National Institute for Health and Clinical Experience (NICE) is entrusted with the responsibility of studying treatments and declaring them ineffective or not and whether to be included in the NHS treatments.

Any attempt to restrict treatments whose effectiveness is largely questionable is another form of rationing. In the absence of such restrictions, pharma companies and health service providers have an incentive to push through treatments of doubtful value.

In any case, it is indeed surprising that conservatives in the US, who are all ardent free-market advocates, take umbrage at rationing of health care. After all, free-market itself is the ultimate rationing mechanism - one that rations scarce resources among competing interests in the most efficient manner. In other words, the debate should not be over whether health care should be rationed, but about how efficiently and fairly can this rationing be done.

Information over-load and health care

Standard explanations trace market failures in health care in general and health insurance in particular to information asymmetry (patients knowing more about their condition than the insurers and doctors knowing more about treatments and diagnostic procedures than patients) and its resultant adverse selection problems, and moral hazard (insured patients having no incentive to curb treatment and costs) concerns. Here are two less-discussed dimensions to this debate, both of which highlight the complexity involved in managing health care markets.

First, Tyler Cowen makes an important distinction between information asymmetry and information overload, and feels that adverse selection is less a problem. He writes,

"When it comes to the elderly, adverse selection as a problem is overstated. The real problem is usually a high degree of information about many conditions, so often insurance is difficult per se. It’s not the asymmetry of information that is the core issue, it is the existence of lots of information, and that is one of Arrow’s subtler points. That distinction matters a good deal for mechanism design.

An old person might know better his health care condition, but not know better his expected health care costs. That is a critical distinction. You can’t reach age 60 and credibly say: "I’ve been healthy so far, I guess my lifetime health care costs will be low." It’s not even clear whether the healthy or the unhealthy will have lower health care costs in their later years; the unhealthy might die rather quickly and decisively. Adverse selection on the grounds of health care costs need not be high and arguably actuaries can estimate those as well as the individual himself."

Another manifestation of information over-load involves the problem of patients being unable to effectively discriminate between multiple treatment options. For example, a patient exposed to two different sets of diagnosis, struggles to make a choice, leave alone the correct choice. Also, though the patient can avoid subjecting his/her body to all diagnostic tests if he/she can trust the doctor's clinical skills, such trust, for various reasons, is an increasingly rare commodity.

Further, most often, in their anxiety, patients end up following the herd and over-treating themselves. Unfortunately, the incentives of the doctors and the diagnostic service providers too are aligned towards leading patients down the path of the herd. In all these cases, it is not information asymmetry, but information over-load that either paralyses decision making or leads patients to make the wrong choices.

Co-payments and deductibles, while trying to incentivize patients to optimize on their treatment, does not always, atleast among those at the top half of the income ladder, curb over-treatment. Awareness campaigns and focussed information dissemination about medical conditions and treatment options can play an important role in helping patients make informed treatment choices.

In another post, Paul Krugman makes the point that health care recipients cannot be exact substitutes for "consumers" in the general marketplace. He writes,

"Medical care is an area in which crucial decisions — life and death decisions — must be made; yet making those decisions intelligently requires a vast amount of specialized knowledge; and often those decisions must also be made under conditions in which the patient is incapacitated, under severe stress, or needs action immediately, with no time for discussion, let alone comparison shopping.

That’s why we have medical ethics. That’s why doctors have traditionally both been viewed as something special and been expected to behave according to higher standards than the average professional. There’s a reason we have TV series about heroic doctors, while we don’t have TV series about heroic middle managers or heroic economists."

The term consumer-choice becomes meaningless in case of patients fighting to save their lives. The choice is mostly a fait accompli. As Krugman argues, it is indeed surprising that even forty years after Ken Arrow wrote this seminal paper distinguishing health care from other markets, the issue still evokes confused rhetoric. See also this post on the shockingly low levels of health care literacy even in the US.