At first this seems like an easy question to answer: catastrophic health care costs mean lots of money. But how do you define a lot? A million dollars? Ten thousand dollars? A hundred dollars?
One question is, should catastrophic be measured in absolute or relative terms. For instance, the a ten thousand dollar cost may be catastrohpic for most people, but probably not to Bill Gates. Thus, one solution would be to define catastrophic costs based on a fixed percentage of one’s income. However, this definiton is also problematic. Retirees will have fairly low income, but if they have saved money throughout their life, then they may have sufficient savings to cover the cost. Another approach would measure health care costs as a share of consumption. Since retirees consume more, this may be a better way. However, using consumption as a metric means that (counterintuitively) savers will appear to have more catastrophic costs, since they consume less compared to someone with the same income level who spends more.
Further, while annual income and consumption are easy to collect, what really matters is one’s permanent income. For instance, college students at Harvard may have low income, but because their lifetime income is likely high, they may be less concerned with high medical expenses than someone who is working at a low paying job who has higher income in the short-run, but worse long-run career prospects.
One way to think about if a cost is catastrophic is whether an individual’s current; nonmedical consumption falls substantially due to the out‐of‐pocket medical expenses necessitated by
a health shock. For instance, if the retiree with large savings or the Harvard student had a mild out-of-pocket cost, they likely wouldn’t offset their consumption much. However, if a retiree on a modest fixed income or a middle class individual without an ability to borrow incurred a large health care cost, they would need to drastically reduce their consumption to finance this cost.
A paper by Wagstaff (2019) delves into these issues in more detail:
…the question is which comes closer to the (more) theoretically correct catastrophic expenditure measure proposed by Flores et al. (2008), defined as the reduction in consumption due to the health shock necessitating the out‐of‐pocket expenses, expressed as a ratio of counterfactual consumption. The paper finds that when the individual is a borrower after a health shock, the consumption‐based and income‐based catastrophic payment ratios will both exceed Flores et al.’s more theoretically correct ratio, with the income‐based ratio overestimating it by more. However, when the individual is still a saver even after a health shock, the income‐based ratio will overestimate the FKOV ratio by less, and may not actually overestimate it at all.