DEMAND RESPONSE TO COST SHARING UNDER MANAGED HEALTH CARE

I. INTRODUCTION Demand response is one of the most venerable topics in health economics. Zeckhauser (1970) related demand response to optimal (second-best) health insurance showing that a greater demand response implied less coverage. That is, when cost-sharing provisions are the only instruments for controlling use of care, control of moral hazard requires reduced coverage. Zeckhauser's work set out the theoretical foundation for the largest economics research project of the 1970s and 1980s, the RAND Health Insurance Experiment (New-house and the Insurance Experiment Group, 1993). With the ascendance of managed care in 1990s, empirical research on demand response declined. This was due in part to great reliance on provider payment incentives and administrative processes to control use of health care. In this way, controlling costs could be done without shifting financial risk to consumers, seemingly rendering demand side cost sharing--the portion of the bill the patient pays--obsolete. Ma and McGuire (1997) generalized Zeckhauser's model to both supply-side cost sharing which imposes financial penalties on doctors for using referred services and demand-side cost sharing, demonstrating the superiority of supply-side instruments for controlling quantity while allowing for expansion of insurance coverage to protect against risk. In line with this idea, consumers' out-of-pocket burden for health-care cost fell in real terms during the 1990s and fell greatly in relation to total health-care costs. According to Health United States published by National Center for Health Statistics (2003), in 1990, the inflation adjusted (year 2000 dollars) personal out-of-pocket expenditures were $224.1 billion. By 2000, they had decreased to $194.1 billion. Out-of-pocket expenditures declined as a percent of total personal health-care expenditures from 22.5% in 1990 to 17.1% in 2000. Since the mid-1990s, the percentage of workers enrolled in some kind of managed care plans (MC) has increased from 77% in 1996 to 93% in 2006 (The Kaiser Family Foundation and Health Research and Education Trust 1998, 2006). Coincident with this growth in managed care enrollment was the so-called "backlash" against managed care's rationing methods. Providers resented being told what services were appropriate and patients disliked the bureaucracy of seeking permission from specific types of care. The negative reaction to restricted choice of provider and stringent approval processes manifests in the market and through the political process. Private and public policy makers have loosened administrative controls of health-care utilization and are returning to reliance on demand-side cost sharing to ration health-care services. Nevertheless, these cost-sharing arrangements are being implemented in the context of a health-care delivery system that still relies heavily on payments arrangements that reward provider for doing less administrative mechanisms and capacity constraints to ration care. In considering policies such as high-deductible health plans that aim to use demand prices to ration services, it once again becomes important to understand demand response. However, because the basic institutions that insure and pay for health care have changed since the 1980s, new research is necessary to quantify the magnitude of demand response within managed health-care plans (Health Maintenance Organizations [HMOs], Preferred Provider Organizations [PPOs], and Point of Service plans). Expectations about the ability of new forms of cost-sharing arrangements to save money and steer care toward more efficient types of care depends critically on demand response. The Congressional Budget Office and some actuaries continue to rely on the results of the RAND Health Insurance Experiment to project response to high-deductible health plans or to various cost-sharing arrangements. This article seeks to provide estimates of demand response to cost-sharing arrangements within the context of recent institutions that pay for and manage health care for the vast majority (93%) of privately insured Americans (Employer Health Benefits 2006). …