Quality Competition, Insurance, and Consumer Choice in Health Care - - PowerPoint PPT Presentation

Quality Competition, Insurance, and Consumer Choice in Health Care Markets

Thomas P. Lyon

in Journal of Economics & Management Strategy (1999) presented by John Strandholm

February 16, 2016

Thomas P. Lyon Lyon on Consumer Choice in Health Care 1

Research Question

• How does a consumer’s freedom of choice among different

hospitals affect each hospital’s behavior?

– Model allows consumers to choose between two types of insurance, one where they are forced to go to one hospital and

• ne where they can choose
• Model matches some stylized facts

Thomas P. Lyon Lyon on Consumer Choice in Health Care 2

Contributions

• Consumers can choose between two types of insurance
• Uncertainty over quality improvements
• Simple model that matches reality quite well

Thomas P. Lyon Lyon on Consumer Choice in Health Care 3

Model Structure

• Two hospitals located at the extremes of a Hotelling line

(Salop style), inelastic demand

• Both hospitals start with some quality and make an

investment in a fixed level increase in quality ∆

– Hospitals invest in the probability of successful increase in quality ρi – Cost of investment is Fi(ρi; ∆, γ) increasing and convex in all arguments – γ is a cost parameter – comes into play later

• Zero marginal costs to treating additional patients

Thomas P. Lyon Lyon on Consumer Choice in Health Care 4

Basic Setup of the Model

• Utility from each hospital:

– U0(x) = q0 − tx − p0 – U1(x) = q1 − t(1 − x) − p1

Thomas P. Lyon Lyon on Consumer Choice in Health Care 5

Model Timeline

Thomas P. Lyon Lyon on Consumer Choice in Health Care 6

Paper Outline

1 Welfare Maximizing Benchmark 2 Pure Managed Care

– Consumers locked into a hospital when they select their health plan

3 Pure Insurance

– Consumers not locked into a hospital when they select their health plan

4 Mixed Regime: Consumers have a choice of plans

– Some go managed care some go insurance

Thomas P. Lyon Lyon on Consumer Choice in Health Care 7

Welfare-Max: Switching Consumers

Thomas P. Lyon Lyon on Consumer Choice in Health Care 8

Welfare-max Notes

• Consumers divided into three groups
• Optimal investment when ρ = 1

2

• Fraction of population with choice increases with ∆ and

decreases with t

Thomas P. Lyon Lyon on Consumer Choice in Health Care 9

Pure Managed Case

• Patients lock into a hospital based on expected quality
• Prices set to maximize hospital profits taking into account

investment in quality

• Symmetric investments in quality cancel each other out and

have no effect on prices

– improving quality increases fixed costs but not variable (shortcoming?)

• Underinvestment in quality for costly improvements and
• Overinvestment in quality for inexpensive impreovements
• More costly quality investments can increase profits

(depending on cost function)

Thomas P. Lyon Lyon on Consumer Choice in Health Care 10

Pure Insurance Case

• This structure dominated US health care market until 1980s
• Consumers only differentiate on distance to hospital, so

consumers all pay the same premium

– Premium set to maximize consumer surplus taking cost of care as given – In reality, we know that consumers are heterogeneous in their risk, can this be accounted for in this model?

• Hospitals have an incentive to raise prices – a one dollar

increase in price only increases the premium by a fraction

Thomas P. Lyon Lyon on Consumer Choice in Health Care 11

Pure Insurance Case

• Pricing equilibria is such that neither hospital wants uninsured

consumers

– Raise prices until every consumer is just covered

• Pure Insurance results in higher prices and higher quality than

pure managed care

• Firms compete over market share through quality
• Results in an overinvestment in quality

Thomas P. Lyon Lyon on Consumer Choice in Health Care 12

Comparison of Regimes

Thomas P. Lyon Lyon on Consumer Choice in Health Care 13

Now for choice! → Mixed Regime

• Each hospital vertically integrates with an insurance provider

and is the exclusive hospital for the patients in that plan

• Consumers have a choice to either enter into an HMO and

choose a hospital ex ante or buy insurance and choose hospital ex post

• Consumers divided into three groups:

1 Only HMO1 2 Choose between HMO1 and insurance contract 3 Only HMO2

Thomas P. Lyon Lyon on Consumer Choice in Health Care 14

Mixed Regime Mechanics

• If only one hospital is successful in improving quality then all

insurance patients go to that hospital

• If both (or neither) succeeds, then the patients go to the

closest hospital

• Consumers will not pay more for managed care than insurance
• To the hospital, a managed care patient is certain revenue

while an insurance patient is not

• Managed care is key for a hospital to expand their market

share and guard against losing insurance patients (but must be offered at a lower price than insurance)

Thomas P. Lyon Lyon on Consumer Choice in Health Care 15

Equilibrium Comparison

• Prices:

– Pure Insurance > Pure Managed Care > Insurance Mix > HMO Mix

• Not enough choice in equilibrium

– Too few consumers buy insurance – The more costly quality is the less choice there is

• Prisoner’s Dilemma!

– If only one hospital offers managed care → higher profits for that hospital – If both firms offer managed care → lower profits for both

Thomas P. Lyon Lyon on Consumer Choice in Health Care 16

Existence of Mixed Regime

• If potential quality improvement ∆ is low then the mixed

regime will not exist

– low cost → pure insurance – high cost → pure managed care

• If ∆ is high and:

– low cost → pure insurance – high cost → pure managed care – in the middle → mixed

Thomas P. Lyon Lyon on Consumer Choice in Health Care 17

Summary

• Pure insurance allows hospitals to charge a huge price and

capture consumers by overinvesting in quality

• As the cost of quality increases, managed care plans are used

to lock up the market to prevent choice if the hospital is unsuccessful in improving quality, but prices and revenues fall

Thomas P. Lyon Lyon on Consumer Choice in Health Care 18

Comments

• Homogeneous consumers in terms of risk
• Same level of quality improvement
• In reality, not all consumers can afford insurance
• How much uncertainty is there and can consumers accurately

evaluate it?

• Zero marginal costs to treating patients

Thomas P. Lyon Lyon on Consumer Choice in Health Care 19