THE BASICS
The
basics
Health
insurance
As
with other markets, the existence of uncertainty and risk in the health care
market has led to the development of insurance. Insurance allows people to
reduce the impact that uncertainty has in their lives. People pay a fee to an
insurer in exchange for the insurer's promise to pay them a certain amount of
money if a specified event occurs. By purchasing medical insurance, people can
lessen the financial cost to them of, say, suffering an unexpected heart attack
or getting injured in an accident. In a setting where people attempt to maximize
their happiness and are averse to taking risks, the purchase of an insurance
policy improves their welfare, i.e. they are better off with the policy than
they would be without it (Arrow 1963). As well, there is a social gain. Society
as a whole benefits from the availability of insurance because risks are pooled
or shared by many people, so that if a certain catastrophic event occurs, an
individual is compensated for his or her loss out of the fees paid to the
insurer by all of the people who insured themselves against this risk.4 In
addition to the benefits of pooling risk, the general interest in health
insurance carries a moral aspect for many people. Individuals who do not possess
adequate insurance may not be able to afford the medical care that is needed in
an extreme situation and the end result may well be the difference between life
and death (Zeckhauser 1969).
Insurance
in general and health insurance in particular, however, can have distorting
effects. One of these effects is moral hazard: insured patients demand more
services than they would in the absence of insurance. By lowering the marginal
cost of care to the individual, health insurance encourages the use of health
care services (Pauly 1968). As well ird party--the government or a private
insurance company--covers their medical expenses), they have no incentive to
restrain their use of medical services. This situation can produce excessive
demand for care and waste resources, to the extent that the costs of producing
these services exceed what individuals would be willing to pay for them. On the
other hand, the absence of medical insurance may have the undesired effect of
encouraging patients to delay seeking care, which may be more costly and harmful
to their health than if they had received prompt treatment or medical advice.
The goal is to seek a balance between the incentives to under-use and the
incentives to over-use medical services.
The
phenomenon of moral hazard is illustrated in figure 1. The segment ab represents
the demand for medical care (D) and the supply of medical care or the cost of
producing each additional unit of medical service (the marginal cost) is
represented by the line ``supply (mc).'' Assuming that the market for medical
care is perfectly competitive (no one provider is large enough to affect average
prices) and that providers maximize their profits, individuals would choose to
consume g* units of medical care at price P0 because, at this point, their
marginal costs are equal to the quantity of medical care they wish to receive.
At any point to the left of d, the cost of additional medical service is too
great and individuals purchase less medical care than they would like. At any
point to the right of d, individuals are willing to pay more for medical care.
In economic terms, d is an equilibrium where supply equals demand; there is no
waste of resources.
However,
if individuals are fully insured so that the price or cost of their health care
is zero, they will consume b units of medical care (b > g*). They consume to
the point where the benefit they receive from the last unit of medical care
purchased is equal to the cost of consuming this last unit. Thus, with complete
health care insurance coverage, where the direct price to the consumer is zero,
resources are not efficiently allocated. Individuals are over-consuming and
under-paying for medical care services.
This
is not to say that the benefit from consuming the last unit of medical care is
negative, just that its cost is greater than its benefit. The welfare loss,
then, is the area between points bde. If the demand for medical services were
perfectly inelastic (i.e. a vertical demand curve)--if no matter what the price,
people demanded exactly the same amount of medical services--there would be no
welfare loss. The presence of elasticity in the demand curve implies that
individuals will demand more medical services when the price to them is
decreased, and vice versa. The more widespread the insurance coverage is, the
more protected people are from the true costs of medical care, the greater the
potential for over-consumption of medical services.
In
the insurance literature, moral hazard is often seen as a moral or ethical
problem. However, moral hazard is more a result of rational economic behaviour
than of lower morality (Pauly 1968). Individuals may recognize that their
excessive use of medical services will result in higher premiums or higher taxes
but their increase in benefits from over-consumption is large while the
incremental cost of their excessive use is small because it is paid by the
entire insured population.
On
the one hand, medical insurance increases social welfare because of risk-pooling
while, on the other hand, it introduces perverse incentives towards excessive
consumption of medical care. Richard Zeckhauser iterates this point well:
In
such a world [of uncertainty] you will be damned if you do not introduce a
risk-spreading procedure, but you will be damned in another way if you do.
(1969: 25)
It
is because of these two conflicting aspects of insurance (risk pooling and moral
hazard) that cost sharing has been introduced as a method of reducing the
welfare loss due to moral hazard, while preserving most of the welfare gain from
risk pooling.
Traditional
forms of cost sharing
Catastrophic
insurance
Catastrophic insurance is simply an insurance policy that has a high deductible
and covers all health care expenditures in excess of a pre-determined (high)
level. An insurance policy that has, say, a $1,000 deductible per year, would
cover all health care expenses in excess of a $1,000 per year. The insured
individual or family, however, would be responsible for all of the costs
incurred up to the $1,000 deductible amount. There are no deductibles in the
current publicly funded Canadian health care system although some private
insurance programs for services not covered by the public system make use of
deductibles.
Deductibles
affect individuals' behaviour in two ways. First, requiring people to pay for
the first $x of their medical care, creates a financial incentive to restrain
medical-care consumption. In other words, deductibles should diminish an
individual's use of medical services because medical care is now more expensive
as they have to pay for it out-of-pocket (price effect). Furthermore, as
individuals spend more on medical services, they have less income to spend on
other goods, including medical services (income effect). However, deductibles
and catastrophic insurance also provide the conflicting incentive not to
restrain health care consumption because expenses toward a deductible accumulate
over time. If a person's first medical expense does not reach the deductible,
his or her second medical expense need not be as large in order to reach the
deductible. In other words, any medical expenses that do not reach the
deductible have the effect of reducing the remaining deductible and thus
diminishing the expected cost of medical consumption.
The
rationale behind catastrophic insurance is threefold. (1) For individuals who
are averse to risk, the greater the probability that they will incur a loss of
some sort, the greater the benefits will be to them of having insurance against
this potential loss. (2) Insuring against the probability of an unlikely
occurrence yields larger benefits than insuring against high-probability events
(Evans 1984: 32-33). Less technically, relatively few individuals or families
experience significantly large medical expenses in any year and, therefore,
providing catastrophic insurance publicly need not be very costly. (3)
Catastrophic insurance is an insurance policy with a high deductible and
deductibles, high or low, exhibit three advantageous characteristics. First,
since there seems to be little, if any, relationship between the size of an
insurance claim and its administrative cost, higher deductibles can reduce the
administrative costs of medical insurance. Second, the moral hazard of insurance
may be less for larger claims than for smaller ones--i.e. as larger claims tend
to involve more serious health conditions and treatments (such as a bypass
operation after heart attack)--as there are fewer effective treatment options.
There is, therefore, less incentive for patients to use more health care than is
necessary (Keeler et al. 1977). Third, if individuals are averse to risk and
want to maximize their overall happiness and wealth, they will choose an
insurance policy that covers 100 percent of their medical expenses above a
certain deductible if the insurer offers medical insurance at an actuarially
fair premium (Arrow 1963).6
Martin
Feldstein (1971a) was one of the first to propose a scheme of medical insurance
that combined a high deductible with comprehensive insurance. Although he refers
to it as major risk insurance (MRI), it is identical to the catastrophic
insurance defined earlier. In Feldstein's proposal, the deductible increases
with family income up to a maximum. Feldstein analyzes the potential benefits
and costs of his proposal using six criteria: deprivation of care, financial
hardship, cost inflation, tax burden, administrative simplicity, and general
acceptability.7
Feldstein
argued in the early 1970s that moving from the prevailing system in the United
States to a system of high-deductible catastrophic insurance would reintroduce
cost consciousness and provide individuals with incentives to use medical
resources efficiently. This would occur because fewer individuals would be
covered by extensive medical insurance. Thus, individuals would have a vested
interest in shopping around for better prices and consuming medical care only to
the point where incremental benefit equaled incremental cost. This, in turn,
would apply downward pressure on medical-care inflation. The problem of moral
hazard is reduced but not completely eliminated. Once the deductible has been
used up, medical care becomes virtually free. At this point, incentives are once
again distorted, though use may be restrained even if the deductible has been
used up because the existence of a deductible reduces an individual's income (Pauly
1968).
Feldstein
acknowledged that the introduction of catastrophic insurance, if provided by the
government, would require that a fair amount of tax be collected. An increase in
taxation is never without significant hidden cost but the welfare loss of
increased taxes would be partially offset by the benefits of a less complex tax
code (fewer income tax deductions) and smaller transfers towards the (American)
national health programs of Medicare for seniors, and Medicaid for low income
individuals and families. As well, with catastrophic insurance, only families
which have exceeded the high deductible would make claims and, as a result,
there would be fewer small claims and considerable administrative savings. It is
also possible, however, that relating the size of the deductible to income would
create an administrative nightmare (Newhouse 1993).
High
deductibles can adversely affect the poor, who typically cannot afford much cost
sharing. High deductibles may prevent or limit access to medical care and may,
therefore, lead to the degradation of health for the poor. There is a valid
argument for subsidizing the poor's consumption of medical care and it has been
argued that more wealthy individuals may be willing to pay a portion, if not
all, of the poor's medical expenses if wealthier individuals benefit from the
subsidization for altruistic or paternalistic reasons or from reduced incidence
of infectious disease.8 It follows that the optimal deductible faced by the poor
may be lower than that of other individuals, even zero.
As
well, adjustments can be made to the size of the deductible faced by chronically
ill individuals as the presence of a deductible potentially renders medical
insurance pointless if one suffers from a chronic illness: the chronically ill
end up paying the deductible every year for as long as they live (Arrow 1963).
If a chronically ill person reaches the catastrophic insurance in some number of
successive years, the deductible can be reduced or eliminated (Newhouse 1995).
Co-insurance
Co-insurance
is commonly used, as are deductibles and user fees, to control the moral hazard
of health insurance. Co-insurance requires individuals to pay some fraction of
each dollar of cost (usually set as a percentage). For example, a
health-insurance plan with 25 percent co-insurance rate requires individuals to
pay for a quarter of all their medical care expenses. Similarly, an insurance
plan with zero percent co-insurance is equivalent to a free health care plan.
With co-insurance, consumers of medical services pay a price for medical
services but that price is lower than the market price.
Co-insurance
can reduce the moral hazard associated with medical insurance though it does not
completely eliminate the associated welfare loss. Individuals with a 25 percent
co-insurance rate will increase their consumption of medical services until the
last dollar spent on their medical care brings them a benefit of 25 cents. A 25
percent co-insurance rate decreases the welfare loss but since the cost of
providing the last dollar of medical services is a dollar, the loss still
amounts to 75 percent of the last dollar spent (Feldstein and Gruber 1994).
Figure
2 illustrates the impact of co-insurance on the size of the welfare loss. As
seen earlier, with full insurance coverage, individuals will choose to consume b
quantity of medical care with an associated welfare loss of the area within bde.
If a positive co-insurance rate is introduced, individuals are faced with an
effective price Pi, where Pi is less than P0 but greater than zero. They will
consume g* units of medical care, which is more than they would if there were no
insurance and individuals faced the higher price of P0. The welfare loss with
co-insurance is now the area enclosed by dcf. The welfare loss due to excessive
insurance coverage has been reduced by the area bfce.
Mark
V. Pauly (1968) argues that there is an optimal co-insurance rate for each
individual, where the welfare gain from additional coverage equals the loss in
welfare from higher premiums. Pauly, however, does not believe there is one
single co-insurance rate that is optimal or ``more efficient'' for a whole
population with diverse tastes. As well, the effectiveness of the co-insurance
rate at reducing the consumption of medical services is directly related to the
price elasticity of demand. The smaller the price elasticity of demand, the less
responsive individuals are to changes in the price of a good or service. As a
result, the effect of co-insurance will be smaller and, hence, welfare loss will
also be smaller. It is also important to recognize that as the co-insurance rate
increases, the amount of risk borne by individuals increases because the
potential out-of-pocket costs increase with the co-insurance rate (Feldstein
& Gruber 1994).
It
is possible to combine deductibles with co-insurance. Feldstein (1971a) argues
that high-deductible catastrophic insurance can be improved by introducing a
co-insurance feature above the deductible. For example, you could have a basic
deductible of 5 percent of income followed by a 50 percent co-insurance rate for
an additional 10 percent of income. With such a scheme, it is possible to
introduce co-insurance while keeping the maximum dollar expenditure of each
family at the same level as it would be under the catastrophic insurance plan.
Essentially, Feldstein's proposal attempts to find a compromise between the
benefits of risk-spreading and the moral hazard of comprehensive medical
insurance coverage. As with deductibles, the poor may not be able to afford a
positive co-insurance rate but the co-insurance rate can be linked to income or
the poor and the chronically ill can be made exempt from any cost sharing.
User
fees
Opponents
of cost sharing often use the literature on user fees to make a case against all
forms of cost sharing (Evans 1993). User fees are a form of deductible applied
to a given service--a payment, for example, of $5 for every visit to the
emergency room or physician. The actual cost of the care given is greater than
$5 but patients would pay the cost up to the $5 deductible while the additional
care would be ``free.'' In Canada, user fees are prohibited by the 1984 Canada
Health Act.
Proponents
of charging user fees for selected services argue that such fees increase
efficiency in the health care sector and thus reduce costs: if required to bear
a portion of their health care costs, individuals will curb their consumption of
medical care and medical services of lesser value eventually will be eliminated.
Thus, the welfare loss from insurance should shrink. As well, they contend that
user fees can reduce the tax burden of Canadians because they redirect health
care financing from taxpayers to users. Lastly, they believe that if the health
care system is more efficient and more funding comes directly from users rather
than from taxpayers in general, then governments will be able to increase the
size of their health care budget.9
Opponents
of user fees usually stress three drawbacks. First, user fees may increase
administrative costs significantly because more human and capital resources will
have to be devoted to their collection. Second, user fees erect a barrier to
care that can have serious adverse health effects. Third, user fees may
disproportionately shift the cost burden onto lower income individuals. This
latter point will be examined in more detail in the following section.
Deficiencies
with traditional
forms of cost sharing
The
main argument against the traditional forms of cost sharing is their
distributional consequences.10 Evans (1993) argues that the principal effect of
introducing cost sharing in a tax-financed health care system like the Canadian
system is cost shifting. If cost sharing reduces public expenditures on health
care and the savings are used to reduce taxes, then it follows that taxpayers
will pay less and users of health care will pay more in the form of deductibles,
co-insurance, or user charges.
Evans
believes that, as wealthier individuals tend to pay more taxes and less h l,
since income and health tend to be closely related, this positive correlation
reinforces the intensity of the cost shifting.
Evans
contends that this pattern of income redistribution from the sick to the wealthy
is true for all forms of cost sharing, even if some proposals exclude the very
poor and the very sick. If cost sharing is linked with income, then the cost
shifting is mitigated but does not disappear. If some segment of the population
(such as those individuals below a certain income level) is exempted from cost
sharing, cost shifting will still occur among the non-exempt population.
The
argument that the wealthy and healthy benefit from cost sharing at the expense
of the poor and sickly relies on the assumption that more cost sharing will
result in lower taxes, which benefits the wealthy. It is not a certainty,
however, that taxes will be reduced. Even if they were, the marginal tax rate of
low income individuals could be reduced, and certain consumption taxes could be
diminished. As well, any savings from greater efficiencies in the health care
sector could be reinvested into the health care system or other social programs.
Or, any savings could be left in the pockets of Canadians to spend as they wish
on what they wish. Moreover, it is not clear that lower income and less healthy
individuals lose more if cost sharing is introduced and taxes are reduced
accordingly, since it is often 00the wealthier people in society who benefit
more from social programs such as education and health care (Le Grand 1982;
Horry and Walker 1994).
Evans'
argument depends upon three assumptions: (1) wealthier individuals tend, on
average, to be healthier than poorer individuals; (2) the sick use more health
care, and (3) wealthier individuals pay more taxes than poorer individuals. With
these assumptions, it seems reasonable that cost sharing would transfer income
from the sick (and poor) to the healthy (and wealthy). However, this assertion
may not be correct. The ``sick'' are not a homogenous group, and the income
transfer is from the sick to the healthy (i.e. from the ill-poor and ill-wealthy
to the healthy-poor and healthy-wealthy). Since the sick-poor outnumber the
sick-wealthy, there could be a transfer from those with lower incomes to those
with higher incomes. However, use of health care services tends to increase with
income, not decrease. Individuals, sick or healthy, use more health care
services as their income increases. This means that cost sharing does not
necessarily mean cost shifting.
Consumer
ignorance and
supplier-induced demand
Opponents
of cost sharing also point out that, because of ignorance, individuals may delay
seeking care or forgo efficacious preventive care when faced with medical
expenditures (i.e. when medical care is not free). This may subsequently result
in higher medical expenditures if, for example, the illness has reached a more
advanced stage (Roemer et al. 1975). As well, it is often argued that, due to
the consumers' ignorance, physicians (suppliers) are able to induce demand
(SID). For these reasons, they argue, publicly funded health care and government
intervention in the market are not only justifiable but necessary. However, the
hypothesis that suppliers of medical care control the demand for health care is
a controversial topic in the literature about health economics.
The
importance of supplier-induced demand (SID) stems from the fact that even if
cost sharing reduces the demand for health care and decreases expenditures at
the individual level, it may not result in an aggregate reduction in use and
costs. When physicians and other health care professionals see their revenue
dwindle because of the introduction of cost sharing (or MSAs), they will have an
incentive to induce demand to restore their previous levels of income. In other
words, the effects of cost sharing will be offset by SID. There is little doubt
that the health care market is characterized by conditions conducive to SID.
However, the relevant question is not whether the necessary conditions for SID
are present but whether SID does occur in the health care market, and there is
great uncertainty whether SID is a large problem in the health care sector.11
Those
who believe that SID is problematic contend that the market for medical care is
intrinsically different from other markets, and that medical services are unlike
other commodities. To a certain extent, this is true. The medical market is
different from the perfectly competitive model often used in economic theory,
where every participant in the market is well-informed, there are many providers
and consumers, and no one supplier can influence the average price of services.
In the market for medical service, however, there is, first, a considerable
amount of uncertainty about the effects of medical services upon health. Medical
care is only one of several determinants of health and it is not at all clear
how significant a role it plays (McKeown 1979). Second, there is the factor of
consumer ignorance. It is often difficult for one who is sick to evaluate
accurately the cause of the pain, or to determine how best to treat the pain,
especially when information about treatment is scarce. Patients and physicians
are not on equal footing when it comes to choosing an effective treatment.12
Finally, risk is an important factor in the demand for medical care as most
demand for health care is not predictable and the satisfaction one gets from
medical care is not always easy to measure. As well, even if people are not
completely satisfied with the care they receive, there are few, if any, relevant
substitutes for medical care.
However,
uncertainty and risk are not unique to the medical care market; it can be
observed in many other areas of the economy such as automobile repairs and law.
In addition, SID theorists generally assume that informed consumers (patients)
would not be willing to pay for these supplier-induced services (Newhouse 1993),
and that the induced services are less beneficial than the services that were
foregone (because of the financial incentives of cost sharing to restrain total
health care use). Neither assumption is necessarily valid (Newhouse 1993).
Newhouse points out that if, for example, physicians induce demand by spending
more time with their patients and billing for longer visits, it does not
necessarily follow that patients will be worse off; they might well prefer it.
There
are few economists and health-policy analysts willing to take the stand that the
medical market is no different from other markets. Even the conservative British
economic magazine, The Economist, acknowledges that the health care market is
very complex:
In
some respect, admittedly, health is a more difficult and complicated issue than
education. People have to rely on doctors to tell them what medical services
they need, so it is harder for them to act as informed buyers. Health care is
also an insurance product. (1997: 30)
Robert
Evans (1984), among others, argues that the health care market is different from
other markets because of the severity of market failures: uncertainty of
incidence of illness, economies of scale, insufficient information for
rate-making, adverse selection, and moral hazard. For the discussion of public
policy, however, ``market failure'' is better used to describe instances in
which the government can improve welfare in a way that the market cannot
(Kennedy 1995): ``the role for government intervention must be argued on the
grounds of comparative institutional advantage over the market. The mere
existence of externalities, market power and asymmetric information is not
enough to justify government intervention.''13
From
traditional cost sharing
to medical savings accounts
Traditional
forms of cost sharing--deductibles, co-insurance and user fees--are used in the
health-insurance market to alleviate moral hazard and thus diminish its welfare
loss. As well, cost sharing is conducive to competition and should result in a
more efficient health care system. However, cost sharing may entail regressive
redistribution of income from the poor and sick to the wealthy and healthy, or
it may impose a barrier to care that potentially endangers individuals' health
status. Advocates of cost sharing have proposed ways to mitigate the effect of
cost sharing on the poor but none seems to please its opponents. Advocates of
medical savings accounts (MSAs) believe that MSAs can reduce the welfare loss of
health insurance and induce competition in the medical market place without
creating financial barriers to care.
Medical
Savings Accounts
Medical
savings accounts (MSAs) first emerged in the early 1990s during the national
debate on health care in the United States. MSAs were initially proposed by the
National Center for Policy Analysis (NCPA) and since have been embraced by many
different organizations such as the Council for Affordable Health Insurance (Bunce
1996), the American Medical Association (1994), and the Family Research Council
(Deeds 1995). As well, many research organizations such as the American Academy
of Actuaries (1995), the National Bureau of Economic Research (Eichner, Wise and
McClellan 1996), and the RAND Corporation (Keeler et al. 1996) have analyzed
medical savings accounts as a measure for controlling health care expenditures.
What
are MSAs?
Medical
savings accounts (MSAs) are health accounts that are established in conjunction
with catastrophic health insurance. They can be set up by individuals, by
employers or by the government. The most common type is the American
employer-funded MSA. In this type of plan, employers purchase a catastrophic
insurance policy for their employees, which is much cheaper than a traditional
insurance package. Employers then deposit a portion of the funds saved into MSAs
for the employees, who are responsible for topping up their MSAs to the amount
at which the catastrophic insurance begins, if they spend all the funds
contributed by the employer. The MSA funds, including any funds remaining in the
account after a specified period (usually a year), belong to the employee,
although some restrictions may be placed on when and how the funds can be
withdrawn and used.
Governments
could easily take on the role played by these employers, providing individuals
with catastrophic insurance and depositing funds into MSAs.14 Depending upon the
health status, age, and income level of those insured, the size of the
government contribution could be all or a fraction of the MSA, that is, of the
catastrophic insurance policy's deductible. Keeping government's health
expenditures constant, all else being equal, the government contribution would
be equal to the difference between the cost of an individual's or family's
high-deductible catastrophic insurance policy and the cost of their current
health plan.
The
introduction of MSAs would encourage the consumer to enter the health care
market as an active payer (American Academy of Actuaries 1995) and, it is hoped,
provide sufficient incentives to motivate health care consumers to play a more
prominent role in their consumption of medical care services and in their
over-all health status. The promising characteristic of MSAs is that individuals
purchase medical services with money they can otherwise keep because any funds
remaining in the account at year end are the property of the individual. In
effect, MSAs can indirectly establish a cost-sharing device without infringing
on the most important philosophical cornerstones on which the Canadian health
care system is built: universality, accessibility, portability and
comprehensiveness.
Table
1 shows how a typical American employer-funded MSA can be seen as a combination
of three different health insurance plans. First, individuals purchase medical
services with funds made available by their employers (up to $857 in the
individual coverage example). The first dollars of coverage are virtually free15
since they are paid by the employers and not by the individuals. However,
individuals have an incentive to use medical services prudently because every
dollar not spent will eventually come back to them. Second, when the employer's
contribution has been exhausted, individuals are responsible for the payment of
medical care up to the cap where the catastrophic insurance kicks in (the next
$643 in the example). This can be seen as equivalent to the deductible outlined
earlier, with one important distinction; unlike regular deductibles, it comes
into effect only after $857 has been spent (i.e. after the employer's
contribution has been exhausted). Finally, once the insurance threshold ($1,500)
has been reached, health care is free at the point of service for the
individual.
MSAs
can be set up like a registered retirement savings plan (RRSP). They can be
maintained administratively by the employer, a benefits administrator, a bank,
or the government. During the first year, funds should be invested in low-risk,
very liquid financial instruments so that funds that are meant to be available
for medical care services are not quickly lost through risky speculation on the
stock market. However, at the end of the year, individuals should be given more
freedom to invest unspent funds in riskier instruments such as mutual funds,
stocks, or bonds. This allows for capitalization in the health care market. Any
funds invested today gain interest and can be used in the future for the more
expensive care most individuals will need when they are older. This is contrary
to the current system in which the tax dollars of today pay for people's health
care today; because health care funds are spent immediately, there is no
opportunity for them to be invested and to grow.
The
unspent funds are one of the most important components of MSAs. By definition,
the MSA funds that are not used during the year by the patient belong to the
patient. Some of the options on how and when unused funds should be withdrawn
are the following.
These
are only examples of possible scenarios. There are many other possible forms
that an MSA system can take. Currently in the United States, individuals are
free to use the funds that remain at the end of the year to purchase extra
health care services (i.e. there are no extra taxes or financial penalties).
However, funds that are withdrawn to purchase other goods and services are taxed
and sometimes subject to financial penalties (Matthews 1997).
MSAs
and incentives
There
are three distinct sets of incentives at work in an MSA. First, the incentive to
restrain use. The effectiveness of this incentive depends on individuals'
perception of the employer's contribution. If individuals perceive the MSAs as
insurance, then the incentive will be trivial; if the MSAs are perceived as
potential savings, then there will be an incentive for individuals to constrain
medical care consumption (AAA 1995). Second, for the individual's contribution,
the incentive to restrain use is similar to that of a deductible except that it
comes into effect only when the contribution from government or the employer has
been exhausted. Third, once the insurance threshold, the deductible, has been
reached, the incentives are akin to that of free care; that is, there will be
little incentive to constrain use.
These
three sets of incentives do not work independently. Rather, they work in
sequence as medical expenses accumulate over the year. If a first medical
expense does not consume all of the employer-provided funds, then a second
medical expense need not be as large in order to reach the level at which the
individual's contribution must be used. Any medical expenses that use but do not
exhaust the employer's contribution have the effect of increasing the expected
cost of medical consumption, because once the employer's contribution is spent,
the individual's contribution begins. At the other end, any medical expenses
that are paid from the individual's contribution but do not reach the deductible
have the effect of reducing the expected cost of medical consumption for the
individual as the amount that is needed to reach free care is less than before
any expenses were incurred. It is also important to note that the sequence of
employer's and individual's contributions can be inverted; that is, the
individuals depicted in table 1 could be responsible for the first $643 of
medical services (as they would be if paying a regular deductible), then the MSA
funds ($857) would be used to purchase medical care.
Key
issues
Savings or insurance?
The success or
failure of an MSA as a cost-sharing instrument depends heavily on the perception
that each individual has of the funds (AAA 1995 and Keeler et al.
1996). If the MSA account is perceived as a contingency fund, then there is no
financial barrier, no financial inducement, and thus no incentive to restrain
use. Individuals who adopt this view have no incentive to change their
consumption of medical services. On the other hand, if the funds are perceived
as potential savings, then the level of cost sharing is significant and is
equivalent to a deductible. Individuals who perceive the MSAs funds as pure
savings would have a stronger incentive to diminish their consumption of medical
services. Whether an MSA balance is viewed as savings or insurance depends on
several factors such as taxes, restrictions on the account balance, and the
source of the contribution, and these factors will determine the effectiveness
of MSAs at reducing the costs of health care.
Taxes
Taxes distort
incentives and often affect certain segments of the population
disproportionately. An important question is whether contributions to MSAs by
the individuals insured should be exempt from taxes (i.e. tax deductible).
Exempting MSA contributions tends to favour individuals with higher incomes
because wealthier individuals, on average, face a higher marginal tax rate (AAA
1995). A $500 contribution would only cost $333.33 in after-tax dollars to an
individual who is facing a 33 percent marginal tax rate while it would cost $400
in after-tax dollars to a less wealthy individual who is in a 20 percent
marginal income tax bracket. This is a standard problem in public finance.
However, if MSA contributions are not exempt from taxes, there is little
incentive to contribute to them.
MSA
contributions can be compulsory. That is, individuals could be required by the
government to deposit funds into an MSA. Certain provinces such as British
Columbia and Alberta already use premiums to help finance their respective
health care systems. Monies from premiums can easily be renamed and used as
individuals' contributions. However, an alternative to compulsory contributions
is the use of tax credits instead of tax deductible expenses. Tax credits can
provide an incentive to contribute to MSAs without being regressive.
Another
question is whether interest on positive MSA balances should be taxed. There are
several possibilities: it can be taxed as ordinary income at the appropriate
marginal tax rate; it can be taxed when withdrawn at the appropriate marginal
tax rate; or taxes owed can be accumulated each year and be paid when the funds
are withdrawn (AAA 1995). With any of these scenarios, the incentives associated
with taxation of the interest on investment are simple: the smaller the
effective tax rate, the greater the incentive to have funds in the MSAs at the
end of the year, i.e. the larger the incentive to spend dollars on medical
services wisely.
Individual's contribution:
voluntary contributions or forced savings?
Even if individuals
have a strong tax incentive to contribute to their health account, everyone may
not choose to do so. Individuals who decide not to contribute to their MSAs will
essentially face a deductible with all its pros and cons which can create a
barrier to care (albeit not a very large one). If individuals contribute fully
to their MSAs, then there are no barriers to care, in the sense that there will
never be a time when they do not have the necessary financial resources to
purchase medical services. While voluntary contributions are preferable,
mandatory contributions would achieve many of the same objectives.
Account balance
The key issue here relates once again to how individuals will perceive the MSA
funds: as savings or insurance. The perception will depend on the availability
and accessibility of the unused funds. On the one hand, the more easily
accessible the funds are, the closer they will be to savings. If the unused
funds can be withdrawn without any penalty, then it follows that unused funds
essentially become savings at year end; once the year has elapsed, the unused
funds can be used by individuals as they wish. On the other hand, if the unused
funds revert to the government once the year is over or once individuals reach
65, then individuals will most likely see these funds as nothing more than
insurance and there will be an incentive to use all the funds available: ``use
it or lose it'' (AAA 1995). The abundance of different arrangements possible is
a strength of MSAs for it gives policy-makers more flexibility in achieving the
desired level of cost sharing (Barchet 1995).
A
major weakness of MSAs, however, is the uncertainty surrounding people's
perceptions, and evaluating their perception of MSA funds is not a trivial
exercise. In addition to the incentives already discussed in this section,
unused funds may also create a wealth effect. Individuals who accumulate a
positive balance may feel wealthier and this sense of wealth can, in turn,
increase consumption of medical services, which are, after all, normal
goods--that is, demand for them increases as an individual's income rises. As
well, if unused funds can only be withdrawn at the age of retirement,
individuals may simply reduce their contributions to a retirement plan. This
redistribution of funds indirectly makes the unused funds totally accessible,
which strengthens the incentives to shop wisely for medical services in order to
buy even more health care or to increase savings.
In
addition, the insurance threshold can be linked to the amount of the unused
funds. That is, individuals who accumulate balances in one year would see their
maximum deductible increase in subsequent years. However, this mechanism
diminishes the incentives to consume less health care use because it penalizes
individuals who do so.
Setting
a maximum permitted balance would also diminish the incentive to constrain use,
and once the maximum balance has been reached, the incentives to restrain use
are completely eliminated. Table 2 attempts to summarize some of the different
key arrangements possible in an MSA scheme and their respective incentives to
use the health care system prudently.
Other
incentives
Asymmetric information
A degree of consumer
ignorance exists in health care and patients are, therefore, dependent on their
physicians for guidance to a certain extent. In this context, MSAs may provide
physicians with financial incentives to recommend unnecessary treatments to
their patients. It has been argued that the amount of unnecessary services
provided by physicians can be significant (Winslow et al. 1988; Roos and Sharp
1989). Evans (1987:173) goes even further and states: ``Providers have ignored
or resisted the external accountability implied by evaluation (based on evidence
as opposed to professional opinion), or external comparison.''
It
has been argued by advocates of a ``one-tier'' health system that the Canadian
system needs a third-party as ``braking mechanism'' to prevent an overuse of
medical services. Neither the federal nor provincial governments have been able
to ensure appropriate use of health and medical care services. Nor have they
been able to ensure that patients who require care receive it in a timely
fashion. Given their size and distance from the interaction between provider and
patient, governments as ``braking mechanisms'' will never be able to intervene
except with heavy-handed acts such as the closing of hospitals and a resistance
to purchasing newer, more expensive medical technologies. While these measures
may decrease use of the health care system, they do not encourage more
appropriate use. One of the results expected from the use of MSAs is an
incentive for patients to take a greater interest in their health and their
consumption of medical services (Barchet 1996; McArthur et al. 1996). At the
very least, MSAs likely will stimulate demand for information and this may well
act as a ``braking mechanism'' (Barchet 1996).
Savings and intergenerational
accountability
In 1984, Singapore
introduced a new health care system based on four basic principles: (1) free
choice, (2) self-accountability and self-reliance, (3) free-market competition,
and (4) restriction of the government's role to that of provider of last resort.
With these tenets in mind, the government of Singapore implemented Medisave,
Medishield, and Medifund accounts, schemes similar to medical savings accounts.
Although some have questioned the success of MSAs in Singapore,16 it cannot be
disputed that the experience of the people of Singapore with MSAs has shown some
of the broader potential benefits of adopting MSAs. First, Medisave plans are
conducive to savings, which is favourable to economic growth and social welfare.
Second, MSA-style plans increase intergenerational accountability; that is,
individuals are required to accumulate funds in periods of low use (generally
when young) in order to be able to purchase care in periods of high use (when
older). Individuals face strong incentives to anticipate future risks and
conserve monies. In Canada and the United States, the health care systems differ
from that of Singapore in that for the most part they require younger
generations to pay for the health care expenses of older generations. The MSA-type
plans in Singapore have shown that MSAs are likely to encourage higher savings
as well as to provide individuals with incentives to be intergenerationally
accountable.
Individual responsibility and
preventive medicine
It is often argued
that there is not a strong correlation between health care spending and health
status (McKeown 1979; Evans 1982; McArthur et al. 1996). There is, however, one
component of medical care that has shown promising results: preventive care.
This is not to say that preventive care is the cure for all of the problems that
ail the Canadian health care system and preventive care will most likely not
reduce health care costs. It may even increase them because people will live
longer to consume more health care services (Evans 1984).
With
increasing pressures facing the Canadian health care system, legal, medical, and
economic controls such as smoking bans and alcohol taxes have been offered as
ways in which to ``promote'' healthier lifestyles, although these approaches are
often worse than the vices of which they attempt to rid us (Morrein 1995).
Irresponsible lifestyles do not justify government assault on individual
freedoms unless a person's behaviour is harming another. If the societal
objective is to promote healthier lifestyles, we must look more closely at
medical savings accounts because, with MSAs, individuals have an incentive to
give up a vice, maintain a healthy diet, use more preventive medicine, and act
more responsibly with respect to their health care since, by living a healthier
lifestyle and thus avoiding the medical care system, individuals will be able to
pocket the savings.
Some
critics have argued that MSAs may create a barrier to preventive medicine. They
claim that individuals, because they can pocket any unused MSA funds at the end
of the year, will forego preventive care. This, in turn, will have the effect of
increasing health care costs because individuals will delay seeking care until
they require very costly care. However, the RAND Health Insurance Experiment
(see below, table 11) has demonstrated that, while cost sharing does reduce the
use of medical services, including preventive care, it will not, for the most
part, affect individuals' health. As well, if indeed the use of certain
important preventive services, such as large scale immunization, is reduced by
the introduction of MSAs, these services can always be provided free of charge
to all by provincial governments or their health regions out of general revenues
from taxation.
MSAs,
the poor, and the chronically ill
Understandably,
many people feel that health care should be available on the basis of need, and
paid for on the basis of ability to pay (van Doorslaer et al. 1993). J.P.
Newhouse and his co-authors strongly reject cost sharing for the poor: ``we
start from the premise that substantial cost sharing for the poor is simply not
an option'' (Newhouse and The Insurance Experiment Group 1993: 352-53). It
follows, therefore, that a special mechanism must be in place to deal with less
wealthy individuals. MSAs can be adapted to limit the cost sharing faced by the
poor while retaining the incentives to use health care efficiently. The maximum
deductible can be set as a function of income, with lower deductibles for those
people with lower incomes. Or the poor can be subsidized directly; that is, the
government's contributions to less wealthy individuals can be increased. These
two alternatives, however, come with some problems.
The
latter option requires that the poor be identified in some manner, and this can
be difficult to do and humiliating for the specified group. As well, a cut-off
income level would have to be determined and this creates a strong incentive for
individuals not to earn any income above the cutoff level or to hide any income
above that level that they do earn. Nevertheless, MSAs allow policy makers to
limit the degree of cost sharing imposed on the poor. Setting the maximum
deductible as a function of income may be a reasonable solution although this
method may amplify the distorting effect of taxes.
Cost
sharing with MSAs would also have to be revised for those who suffer from
chronic illnesses. Imposing traditional cost sharing on the chronically-ill can
be considered as a tax on the sick (Evans 1984). Those who are chronically ill
have no other choice but to pay the cost-sharing portion of their medical bill
year after year. However, with MSAs, cost sharing can be diminished or
completely eliminated for those who suffer from specific chronic conditions or
for those who repeatedly exceed the insurance threshold because of continued ill
health.
Medical
savings accounts: just another
form of cost sharing?
Opponents
and critics of MSAs, notably those from Canada, often argue that MSAs are
nothing more than deductibles and co-insurance thinly disguised. However, there
are important differences between MSAs and more traditional cost sharing devices
such as deductibles, co-insurance, and user fees.
First,
MSAs do not have a universal, co-insurance element. At most, only those
individuals who can afford it are required to contribute to the costs of their
health care, and even they will be partially subsidized. Health care is paid
from general tax revenues for everyone once the insurance threshold has been
reached and everyone will have at least some public funds that go towards the
cost of the deductible placed in their MSAs.
Second,
MSAs do not contain any user charges and individuals do not have to pay any
extra charges when they use services. They pay the entire cost with funds from
their MSAs or from the catastrophic portion of their insurance.
Third,
the MSA maximum deductible will be equivalent to a traditional deductible only
if the funds are fully perceived as savings by individuals. This can happen if
individuals move money away from their retirement savings into their MSAs. How
far MSAs are perceived as savings rather than insurance depends heavily on how
they are designed. However, the most important difference between MSAs and
deductibles is that MSAs can eliminate barriers to care. If all individuals
contribute fully to their MSAs either because of strong tax incentives or
because contributions are made compulsory, then there are no barriers to
care--there will never be a time when individuals do not have the necessary
financial resources to purchase medical services. Funds will be available in the
MSAs, and it will be the decision of individuals if they use the funds to
purchase health care services or save these funds for later consumption on
non-medical goods and services.