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Increase copays and increase medical spending?

Most economists believe that increasing the price of an item will decrease demand for the item. Health care is no different from any other good. If you increase the copayment or coinsurance rate, people will consume fewer medical services. The famous RAND Health Insurance Experiment (HIE) demonstrated that higher coinsurance rates discourage medical care consumption. As I said, health care is no different from any other good…or is it?

Dana Goldman and Tomas Philipson argue in their 2007 NBER working paper (“Integrated insurance design in the presence of multiple medical technologies“) that the problem of moral hazard in the health insurance market is different from moral hazard under most other insurance markets. For most other types of insurance, only one good is insured (e.g.: a car, a house, etc.). Health insurance, however, covers a wide variety of different services. Thus the authors claim that increasing prescription drug copay costs can actually increase health care spending and make patients worse off. Let us assume that prescription drugs and medical services are substitutes. If the price of prescription drugs increases, it is likely that the individual will consume the more of the expensive medical services which are fully covered by insurance. They suggest that a zero or negative copay may be optimal for some prescription drugs.

The optimal copay is determined by the patients elasticity of demand and the degree to which other medical services are complements or substitutes to the original item in question. The authors give some empirical evidence from other studies to support their claim:

  • Soumerai, Ross-Degnan, Avorn, McLaughlin and Choodnovsky (NEJM 1991) compare Medicaid patients in New Hampshire “who had a three-drug limit per patient” and Medicaid patients in New Jersey without the limit. The authors found a 35% reduction in drug use, but a doubling in nursing home admission rates.
  • Soumerai, McLaughlin, Ross-Degnan, Casteris, and Bollini (NEJM 1994) look at individuals on psychotropic medications and find that a drug cap led to a 15%-49% reduction in the use of drugs but a 43%-57% increase in mental health visits and emergency mental health services.
  • Horn, Sharkey, Tracey, Horn, James and Goodwin (Am. J Man Care 1996) find that formulary limitations in 6 HMOs were associated with increased ER visits and hospitalizations for otitis media, atraumatic arthritis, ulcers, hypertension, and asthma.
  • Gaynor, Li, and Vogt (NBER 2005) find that higher drug co-payments in a given year lead to increased spending during the following year.
  • On the other hand, studies such as Johnson, Goodman, Hornbrook and Eldredge (Med Care 1997) and Tamblyn, Reid, Mayo, McLeod, and Churchill-Smith (J Clin Epidemio. 2000) found that increased co-pays did not increase outpatient visits, hospitalizations or ER visits.

The authors conclude that “the preponderance of evidence suggests strong negative cross-price elasticities between drugs and other medical spending, at least for patients with chronic disease.”