The elderly are the most intensive consumers of health care in the United States today. Individuals over age 65 consume 36 percent of health care in the US, despite representing only 13 percent of the population (Centers for Medicaid and Medicare Services 2005
). The Medicare program that insures the nation's elderly (as well as the disabled) is the thirt largest expenditure item for the federal government, and is projected to exceed Social Security by 2024 (Centers for Medicaid and Medicare Services 2005a). This rapid growth in program expenditures was reinforced by the recent introduction of Medicare Part D, a new plan providing coverage for the outpatient prescription drugs used by Medicare beneficiaries.
The federal government has undertaken a variety of strategies to control Medicare program growth on the supply side, from the introduction of prospective reimbursement for hospitals to reductions in provider reimbursement rates. Yet Medicare spending growth has continued unabated. Recently, therefore, there has been a growing interest in demand-side approaches to controlling system costs, through higher patient costs which would induce more price sensitivity in medical spending.
Demand-side approaches, however, are complicated by the fact that Medicare beneficiaries are often covered by multiple insurers at once. Because Medicare already has quite substantial cost sharing, most enrollees have some form of supplemental coverage for their medical spending, provided by an employer, purchased on their own, or provided through state Medicaid programs. The incentives of the supplemental insurer and Medicare are not necessarily readily aligned. Indeed, there are long-standing concerns about the fiscal externality on Medicare from supplemental coverage: by insulating beneficiaries from costs, the policies increase utilization, thereby raising costs to Medicare (Adam Atherly 2001
). In this paper, we focus on an additional, offsetting effect of supplemental coverage: if the additional utilization induced by supplemental insurance coverage prevents subsequent hospitalizations, then the net external cost of supplemental insurance is smaller than previously believed.
A necessary condition for such an externality is that changes in cost sharing affect individual utilization of health care. For the nonelderly, the question of the sensitivity of medical consumption to its price was addressed by the famous RAND Health Insurance Experiment (HIE), one of the most important pieces of social policy research of the postwar period. The RAND HIE randomized individuals across health insurance plans of differing generosity with respect to patient costs, and the results showed that higher patient payments significantly reduced medical care utilization, without any adverse health outcomes on average (Willard G. Manning et al. 1987
; Joseph P. Newhouse 1993
). However, the RAND HIE evidence is nearly 30 years old and may not be germane to Medicare because the elderly were excluded from this experiment. Therefore, our paper begins by analyzing the price sensitivity of medical care decisions among the elderly.
We next examine whether increased cost sharing for the elderly causes an “offset” in the form of medical costs elsewhere in the system. Such offsets may arise, for example, if patients respond to copayment increases by cutting back on maintenance drugs for chronic illness and, consequently, need to be hospitalized later. The HIE did test this “offset effect” for the nonelderly and found no evidence, for example, that higher outpatient cost sharing led to more use of inpatient services. But, as we noted, the HIE excluded the elderly, did not analyze prescription drug use.1
We examine policy changes put in place by the California Public Employees Retirement System (CalPERS) Board. Facing mounting fiscal pressure from health plan cost increases, CalPERS enacted a staggered set of copayment changes that allow us to carefully evaluate their impact on the medical care utilization of the elderly. To evaluate these policy changes, we have compiled (with the assistance of CalPERS) a comprehensive database of all medical utilization data2
for those enrolled continuously in several of the CalPERS plans from January 2000 through September 2003.
First, we find that both physician office visits and prescription drug utilization are modestly price sensitive among the elderly, with implied arc-elasticities that are similar to those found in the HIE for the nonelderly. Second, unlike the HIE, we find significant “offset” effects in terms of increased hospital utilization in response to the combination of higher copayments for physicians and prescription drugs. These offset effects are concentrated in the most ill populations. While our dataset precedes the implementation of Medicare Part D for prescription coverage, this finding has implications for the design of Medicare Part D, which currently includes 100 percent coinsurance (the so-called “donut hole”) for beneficiaries with relatively high levels of spending—who are likely to be similar to the chronically ill enrollees who experienced disproportionate offsets in our analysis.
Finally, we find evidence of a fiscal externality from increased cost sharing: the savings from increased cost sharing accrue mostly to the supplemental insurer, while the costs of increased hospitalization accrue mostly to Medicare. Similar incentive problems are likely to arise in an intertemporal setting, when different insurers are responsible for an individual's medical costs at different ages, as highlighted by Hanming Fang and Alessandro Gavazza (2007)
Our paper proceeds as follows. Section I provides some background on previous work in this area and on the policy change we are studying. Section II describes the data and empirical strategy. Section III presents our basic set of results on price sensitivity. Section IV presents evidence on the offset effect and then extends the results in a variety of directions. Section V concludes.