The Effect of Health Insurance Cost Sharing within Episodes of Medical Care

Moral Hazard Control It has long been recognized that health insurance can inflate medical care expenditures by introducing moral hazard into the medical care consumption decision (Pauly, 1968; Feldstein, 1971; Feldstein, 1977). By forcing consumers to share in the marginal cost of care, health insurance deductibles and copayments are conventionally considered an effective means of combating moral hazard (see Rejda, 1989, pp. 84-87). However, the effectiveness of consumer cost sharing may be limited to controlling the frequency of a consumer's contact with the medical care system and, possibly, the frequency of hospitalization (Manning et al., 1987; Keeler and Rolph, 1988). The consumer seemingly controls the initial contact with the medical care system. Hence, deductibles and copayments would be expected to influence the likelihood of a patient contacting a physician and, thus, affect overall expenditures. For example, Lohr, et al. (1986) find that patients subject to cost sharing under their insurance contracts are less likely to make contact with the medical care system than patients with full insurance coverage. Choices regarding hospitalization generally fall into two categories: those involving elective procedures, where the decision to be hospitalized is the consumer's, and those involving serious illness, where the decision regarding hospitalization is the physician's. One would expect, then, that the effectiveness of consumer cost sharing in controlling inpatient expenditures would depend upon the type of hospitalization involved. Presumably, some degree of discretion exists regarding outpatient treatment at the margin (e.g., performing an additional lab test, increasing a prescription dosage). The extent of consumer control over such marginal outpatient expenditures is not clear. If physicians match particular treatments to particular health states without regard for the consumer's tastes for the intensity of treatment or the consumer's ability to pay and if consumers acquiesce to the treatments prescribed, deductibles and copayments will not be effective at influencing outpatient expenditures within an episode of care. An episode of care is defined as all treatment for a particular condition or symptom arising out of an initial contact with the medical care system (see Keeler and Rolph, 1988, for example). Fee-for-service (FFS) physicians generally have marginal revenue greater than or equal to zero for each additional service performed. Health maintenance organization (HMO) physicians generally have marginal revenue less than or equal to zero for each additional service performed. As long as the value of the physician's time is greater than zero, expenditure of additional time without additional marginal revenue is costly to the physician. The HMO delivery system, in effect, imposes cost sharing on the physician. HMOs have been advocated as a means of controlling consumer moral hazard. Several studies have shown HMOs to have lower expenses than FFS care, primarily because of reduced hospitalization rates (see, for example, Luft, 1981; Manning et al., 1984). One would also expect the financial incentives associated with HMOs to affect the delivery of outpatient care. This study tests the influence of cost sharing on marginal outpatient expenditures within individual episodes of medical care. The empirical tests go beyond previous work by comparing expenditures for consumers with the same diagnosed condition in both FFS and HMO contexts. (1) The effects of physician compensation systems and consumer characteristics, including insurance coverage, upon outpatient expenditures of individuals over the age of 14 are compared across 39 diagnoses. (2) The Data and Empirical Design Data The data set used in this analysis is from the Rand Health Insurance Experiment (RHIE), conducted by the Rand Corporation from 1974 to 1982. The experiment was a controlled trial in health care financing funded by the U. …