Dr. Robert Graboyes, Mercatus scholar and expert on the Affordable Care Act, recently discussed the law’s impacts on Medicaid and challenges facing states considering Medicaid expansion on Mercatus’ Inside State and Local Policy podcast. In 20 minutes, Dr. Graboyes discusses principles legislators may consider while attempting to improve opportunities for health, strengthen the healthcare system, and why the two might not be the same mission.
A Colorado organization managed to produce ads promoting health insurance under the Affordable Care Act that are so goofy that some supporters thought they were a parody produced by over-caffeinated tea partiers. But the ads are more than just an unwitting parody. Some of them also unwittingly illustrate an economic principle that is crucial for understanding the cost of health insurance: moral hazard.
Two of the best examples are reproduced below.
Contrary to what you might think after reading the ads, “moral hazard” does not mean health insurance is hazardous to your morals. (For some commentary on what these ads say about morality, look here.)
Moral hazard refers to an insured party’s incentive to take greater risk because the insurer will pay the costs if there is a loss. The two ads above pretty clearly say, “Go ahead and engage in risky behavior, because if there’s a cost, your health insurance will take care of it.”
In the health care context, moral hazard can also involve excessive use of health care services because the insurer is paying the bill. “Excessive,” in this context, means that the patient uses a service even though its cost exceeds the value to the patient. For example, my Mercatus colleague Maurice McTigue tells me that before New Zealand reformed its health service, a lot of elderly people used to schedule monthly visits to the doctor’s office because it was free and provided a good opportunity to socialize with friends and neighbors. Visits dropped significantly after New Zealand’s health service instituted a $5 copay for doctor visits — which suggests that some of these visits were pretty unnecessary even from the patient’s perspective!
Moral hazard can have a big influence on the affordability of health insurance. Moral hazard losses in private insurance plans can equal about 10 percent of spending. Moral hazard losses in Medicare and Medicaid are much higher, equal to 28-41 percent of spending. (References for these figures are on page 8 of this paper.)
Duke University health care economist Christopher Conover and I examined the eight major regulations rushed into place in 2010 to implement the first wave of Affordable Care Act mandates. The government’s analysis accompanying these regulations failed to take moral hazard into account. In other words, federal regulators extended insurance coverage to new classes of people (such as “children” aged 21-26) and required insurance plans to offer new benefits (such as a long list of preventive services), without bothering to figure out how much of the resulting new health care expenditures would be wasted due to moral hazard.
Is it any wonder that health insurance under the Affordable Care Act has turned out to be less affordable for many people? Makes me want to do a keg stand to forget about it. After all, if I fall down and get hurt, I’m covered!
As the LA Times reports, the Obama administration has vowed not to approve any cuts to Medicaid during budget negotiations:
Preserving Medicaid funding became even more crucial to the Obama administration after the Supreme Court ruled last summer that states were not required to expand their Medicaid coverage. Administration officials are working hard to convince states to expand and do not want any federal funding cuts that could discourage governors from implementing the law.
“There is a big irony,” said Ron Pollack, executive director of Washington-based Families USA, a leading Medicaid advocate. “The fact that the Supreme Court undermined the Medicaid expansion is now resulting in greater support and a deeper commitment to making sure the program is not cut back.”
Paying for Medicaid remains a major challenge for states. The program has been jointly funded by states and the federal government since it was created. And many states, including California, Illinois and New York, have had to make painful cutbacks in recent years to balance their budgets by reducing physician fees and paring benefits, such as dental care.
However, protecting Medicaid spending — without changing incentives for the healthcare industry or patients — does not necessarily mean improved health outcomes for beneficiaries. As of 2011, nearly one-third of doctors said that they would not accept new Medicaid patients because they are losing money on those who they do see, indicating not only a lower quality of care for Medicaid patients compared to those on private insurance, but reduced access to care. Under the current Medicaid structure, states are incentivized to spend more to receive larger federal matching funds grants, but at the same time federal requirements limit opportunities to improve quality of care through innovation.
The State Health Flexibility Act proposed by Representative Todd Rokita (R-IN) proposes a way to change these incentives. Under the State Health Flexibility Act, state funding for Medicaid and the Children’s Health Insurance Program would be capped at current spending levels. At the same time, states would be released from many federal Medicaid mandates and instead would have the flexibility to determine eligibility and benefits at the state level. Rokita proposed this bill last year, and parts of the bill made it into the House budget.
While this bill seems unlikely to make any progress under the current administration, it mirrors reforms proposed by at least one democratic state governor. Oregon’s Governor John Kitzhaber, a former emergency room doctor, received a Medicaid waiver in 2011 to receive a one-time $1.9 billion payment from the federal government to close the state’s Medicaid funding gap. In exchange, he promised to repay this money if the state failed to keep Medicaid costs growth at a rate two-percent below the rest of the country. Kitzhaber sought to achieve this by allowing local knowledge to guide cost savings. The Washington Post reports:
Oregon divided the state into 15 region and gave each one a set amount to care for each patient. These regions can divvy their dollars however they please, so long as patients hit certain quality metrics, like ensuring that adolescents get well-care visits and that steps are taken to control high blood pressure.
The hope is that each of the 15 regions, known as coordinated care organizations, will invest only in the most cost-effective health care. A behavioral health worker who can prevent emergency admissions becomes a lot more valuable, the thinking goes, when Medicaid funding is limited.
While the Oregon plan is not a block grant — the federal government has not capped the amount that it will provide to the state — it does share some similarities with the State Health Flexibility Act. The state and its designated regions have a strong incentive to provide their Medicaid recipients better health outcomes at lower costs because if they fail the state will have to repay $1.9 billion to the federal government. Additionally, the state and the regions have the freedom to find cost savings at the level of patients and hospitals, which isn’t possible under federal requirements.
Today, the Mercatus Cetner released a new policy brief by Tami Gurley-Calvez on Medicaid reforms implemented in West Virginia, based on a working paper she wrote this fall. In 2007 the state enacted a Medicaid redesign with one objective being to reduce the rate at which Medicaid patients visited emergency rooms for non-emergencies. Additionally, the plan, called Mountain Health Choices, was intended to incentivize healthy behaviors among Medicaid recipients.
The “choice” in the new plan was an option for women and children to opt into an enhanced plan or default into a basic plan. The enhanced plan offered greater benefits but required participants to agree to “doing [their] best to stay healthy’ and to agree to visit their primary care physician for non-emergency treatment. The objective of reducing ER visits was to both reduce healthcare costs for state taxpayers and to improve healthcare outcomes.
Gurley-Calvez finds that with the Mountain Health Choices reforms, patients on this enhanced plan did visit the emergency room at lower rates. However, patients who defaulted into the basic plan began to visit the emergency room at a higher rate, potentially because they were not eligible for treatment for some illnesses with a primary care doctor. She explains:
Based on this research, states should consider whether they can create a greater connection between health providers and members’ involvement in their own health care. However, policymakers must be cognizant of what drives member decision making in their policy designs. In the West Virginia case, a majority of members did not enroll in the enhanced plan in the short term despite additional health coverage and no direct monetary costs to enrollment. Further, states should consider the possible costs, both near term and future, of restricting treatment options by limiting coverage levels.
This case of attempted cost savings by changing incentives represents an ever-present challenge in public policy. Predicting how people will react to new policies in a changing world is difficult, and policymakers should not be overly confident that the incentives that they design will result in the outcomes that they anticipate.
The recession of 2008 pulled the mask off of state budget pathologies that had been identified as institutional weaknesses in the decades leading to the crisis.
The “new normal” for state and local governments does not look like the booming 1980s and 1990s but in fact is riddled with many fiscal challenges. Revenues aren’t what they were before 2008 though they are expected to reach pre-recession levels in FY 2013. The Medicaid and employee benefits bill is rising. The stimulus pushed forward budgetary reforms. These are some of the findings of the Ravitch-Volker Report, an effort of the State Budget Crisis Task Force which assembled in 2010-2012 to diagnose the major problems facing six states: California, Illinois, New Jersey, New York, Texas and Virginia.
Much of the analysis is non-controversial: Medicaid is eating up budgets, as are pensions costs and health care benefits.
Medicaid, currently at 24 percent of state spending, will continue to increase as enrollment, medical inflation and the increasing caseloads that come with higher unemployment increase costs. This is not a surprise. What is new is that the federal government is making it harder for cost-saving measure to be enacted, and “entrenched provider groups in each state resist reductions in Medicaid provider rates….” I do not believe this is the intention of the authors of the report but the diagnosis of Medicaid’s future highlights the dysfunctional aspects of this federal-state pact which has led to the creation of special interests that benefit from inflating costs.
On the pension front the Ravitch-Volker report points to the the role discount rates have played in the pension funding problems facing the state and local governments, in particular in New Jersey. And they also note the reliance on budgetary gimmicks that may even result in a kind of budgetary “cynicism.” A point I have made in the past.
But the report also makes a few assumptions about the interplay of federal, state and local spending that I think could benefit from an expanded debate. The authors warn that cuts in federal discretionary spending will doom subsidiary governments. On the surface, that’s true. Cuts in aid mean less money in state coffers for education, transportation and other areas. But the larger question is what are the fiscal effects of grants-in-aid between governments? There is the public choice literature to consider on the role of fiscal illusion in finances. And further, does the current model of delivering these services actually work as intended?
Their recommendations are largely sound. Many of them have been made before: more transparent accounting, a tightening of rainy day fund rules (see our recent paper on Illinois), broad-based tax systems should replace narrow ones, the re-establishment of the Advisory Commission on Intergovernmental Relations (ACIR). Abolished in 1995 ACIR was concerned with evaluating the fiscal impact of federal policies in the states. Further the commission recommends the federal government work with the states to help control Medicaid costs, and the re-evaluation by states of their own local needs including municipal finances and infrastructure spending.
The report is timely, contains good information and brings many challenges to the fore. But this discussion can also benefit from a larger debate over the current federal-state-local spending model which dates largely to the middle of last century. This debate is not merely about how books are balanced but how citizens are governed in our federalist system. The Ravitch-Volker report is sober but cautious in this regard. The report sketches out the fiscal picture of the U.S. in broad strokes and offers general principles for states to follow and it is sure to create discussion among policymakers in the coming months.
As part of the economic stimulus, the DOT allocated $3.3 billion to California’s planned high-speed rail line, which has become bogged down in a high-stakes fight over its price tag and location. California risks losing those federal funds if the state Legislature doesn’t approve $2.7 billion in bonds by mid-June.
To understand the incentives of a state legislator, consider a hypothetical example. Imagine there is a new restaurant in town. It is called “matching formula.” The restaurant has fifty tables and offers a special deal: no matter what you order, you get to split half of your bill with the rest of the restaurant’s patrons.
Now think about the value you would derive from a nice steak meal. Let’s say it is worth $26.00 to you. Unfortunately, at this restaurant, the meal costs $50.00. Normally you wouldn’t pay that kind of money. But given the matching formula, it is only going to cost you $25.50 (that’s half the price, $25.00, plus one-fiftieth of the other half, $0.50). Since you derive $26.00 in value from the meal and since it only costs $25.50, you go ahead and order it.
But there’s more. The other patrons at the other 49 tables face the exact same incentive. If they too value the meal at $26.00, they too will order it. That’s another 49 meals, half the cost of which will be split 50 ways. Your share of their meals works out to $24.50 (that’s $25, times 49, divided by 50). So your final bill is $50.00 (that’s $25.50 for your meal, plus another $24.50 for everyone else’s).
Remember, you only valued it at $26. So on net, you are down $24 ($26 value, minus $50 cost). You might be thinking that it would be better to just order nothing. But if you do that, you still end up paying $24.50 for everyone else’s meal, but in this case you get nothing at all. It is better to be down $24 than $24.50.
Given the incentives of the restaurant, it is completely rational for you to order your meal and it is completely rational for everyone else to order theirs. The system as a whole, however, is nuts.
You could try convincing everyone else in the restaurant to order nothing. In that case, you would all be out $0. This is a winning strategy, but it can be very difficult to convince everyone. If 49 tables agree not to order anything, the 50th can get a GREAT deal: one steak valued at $26.00 that will cost them only $25.50. Once others see that the hold-out is profiting, they will refuse to abstain and the agreement will fall apart.
Strange as this story seems, this is exactly the way the federal government structures a number of federal-state programs. According to the story cited above, for example, California legislators can foist 55 percent of the cost of their high-speed rail on to federal taxpayers. And presumably other states’ legislators can do the same.
Under normal circumstances, the average state can export 58 percent of the cost of its Medicaid program on to federal taxpayers and some states can export up to 74 percent of the cost. But the stimulus bill temporarily enhanced these matching formulas so that now the average state can export 71 percent and some states can export up to 81 percent.
Notice that you don’t have to dislike steaks, trains, or Medicaid to find fault in these formulas. You just have to understand that there are costs and benefits to everything and recognize that these formulas bias cost/benefit calculations in favor of spending more than these things are worth.
The great 19th Century French economist Frédérick Bastiat once defined the state as, “that great fiction by which everyone tries to live at the expense of everyone else.”
Matching formulas institutionalize this fiction.
My apologies to Russ Roberts who once told a very similar story far better than I.
Representative Todd Rokita (R-IA) has proposed a new bill, the State Health Flexibility Act that could vastly improve incentives in state Medicaid administration. The bill would convert Medicaid and the Children’s Health Insurance Program (CHIP) into a block grant program under which states would have the freedom to shape the program as they see fit. Additionally, up to 30% of the block grant could be transferred into the state general fund if state lawmakers could administer the program for less than the grant amount.
Currently, Medicaid operates a little bit differently in each state, but most states receive matching funds from the federal government at levels between 50% and 74% of what they spend out of the state budget. This set up encourages states to overspend on this program because the federal government pays them to increase spending.
This program would bring all states in line with reforms already implemented in Rhode Island and Washington. In a recent podcast, Scott Beaulier discusses some of the benefits that these states have acheived through reform, both in their budgets and in their healthcare outcomes.
The State Health Flexibility Act would save money for taxpayers at the state and federal levels by capping federal spending at its current nominal amount. Both inflation and GDP growth would serve to reduce real Medicaid spending at the federal level. By removing the incentive for states to increase Medicaid spending to receive federal dollars, the bill would also reduce spending at the state level. Furthermore, states would enjoy freedom to determine Medicaid and CHIP spending for themselves, better tailoring the program to meet their citizens’ specific needs.
Despite reducing Medicaid spending, this reform bill would provide better incentives for improved outcomes by shifting state focus from matching funds to better healthcare. In Rhode Island and Washington, Beaulier found that states used cost saving measures such as not allowing Medicaid patients to use emergency rooms for non-emergency care and encouraging preventative care, improving healthcare while saving money.
Current Medicaid spending patterns are unsustainable. The State Health Flexibility Act provides an opportunity to save taxpayers money, put state budgets on a saner trajectory, and improve health outcomes for benefit recipients.
A deal has been struck between Governor Mark Dayton (D) and Republican legislative leaders in Minnesota to end the government shutdown . Instead of “raising taxes on the rich” (the preferred strategy of the Governor) Republicans prefer deferrals. The GOP proposal includes $700 million borrowed against the state’s portion of the Tobacco Settlement and $700 million in deferred school payments. Both must be repaid in the next two years. Fitch downgraded Minnesota from its AAA rating due to the state’s ongoing structural deficits, and the Tobacco Settlement bonds proposal. While Republicans say the compromise enables them to stop tax increases and a $500 million bond proposal, structural reforms are still lacking.
Spending has grown in Minnesota over the past several decades in particular in education and Medicaid as with most states. Pensions are undervalued and will require higher contributions. Depending on your view Minnesota either has a revenue problem (in that it can’t support the growing costs associated with these programs), or it has a spending problem (in that these costs continue to grow and demand more revenues.) It is not unlike the fundamental philosophical divide at the center of the debt-ceiling debate: do we support growing costs with more debt or do we cut costs by rethinking and restructuring what government is providing?
Effectively, Minnesota’s budget has been balanced by not engaging this debate but by attempting to reconcile two different views on the size of government. Spending growth can be supported by evasive techniques at least for awhile and people may be lulled into thinking you can have it all – lots of services and low taxes. But one-shots and short-term revenue sources eventually dry up leaving politicians with the uneviable choice of cutting programs or finding more revenues. Minnesota’s government has only purchased a little more time.
University of Kentucky Professor of Economics and Mercatus-affiliated scholar John Garen has a new paper on the growth of Medicaid in Kentucky. It is an enlightening read. For one thing, I learned that the latest estimates suggest that Medicaid crowds-out private insurance at the rate of 50 to 60 percent (i.e., 5 to 6 out of every 10 new entrants to the program would have obtained private insurance). The latest estimate, which looks at crowd-out in long-term care insurance, was obtained by Jeffrey Brown and Amy Finkelstein (incidentally, the latter just coauthored a piece that found Medicaid patients tend to be healthier than those without insurance, other things being equal).
I also learned about a number of reforms that have been shown to reduce costs and/or improve patient satisfaction. For example, Arkansas, New Jersey, and Florida have all received waivers to institute “Cash and Counseling” programs for disabled Medicaid recipients. Under this type of program, enrollees are given a budget for various personal and household Medicaid services. Then:
[W]ith guidance from a counselor, [they] can select the type, amount, and vendor of the services they purchase. In other words, they receive a voucher. Studies of this program indicate it has resulted in high recipient satisfaction, less fraud, and has saved on the use of expensive institutional care.
Here is one such study of the program.
Here is John’s website.