Cost - Demand Side Options (Part 1)

As I discussed in my last post, there are options for controlling healthcare costs that focus on the demand side of the equation. My next posts will examine several of these options.

Demand could be shifted through options such as increasing the percentage of co-pays and other out-of-pocket expenses to increase the price sensitivity of consumers. This could shift the demand in a way that could lower prices somewhat as healthcare consumers become more cost-conscious.

Let's look at an example of how this works from an economics perspective. In Figure 1 below, we start with a scenario where there is no cost sharing by the consumer. In this scenario, there is very little price sensitivity because the consumer is not paying for any of the costs of service. This results in the demand curve labeled D1. Note that this results in a quantity demanded of Q1 and an equilibrium price of P1.

If we introduce a co-payment of $25, some interesting changes occur. The consumer is actually price sensitive up to the amount of $25. After that amount, the consumer is not paying any additional amount for additional services. This results in the new demand curve labeled D2. Two significant things happened with this change:

1. Demand for the services decreased to Q2
2. The price for the services decreased from P1 to P2

So, the addition of the co-pay or other cost-sharing mechanism shifts the demand curve and results in lower prices for services.

At least with private insurance, consumers are already sharing more in the cost of care through co-pays, deductibles, and through consumer-driven plans that use a high deductible plan in combination with a Health Savings Account (HSA). However, costs are still rising overall, and the future of consumer-driven plans is unclear at this point given that the health reform bill requires minimum benefit levels that may exclude high-deductible insurance plans that are required in order for consumers to qualify to use an HSA. In addition, the use of Flexible Spending Accounts (FSAs) to purchase over-the–counter medications will be severely limited, and the maximum amount of money that can be set aside in an FSA will be reduced to $2,500.

In addition, the health reform bill includes requirements that Medicare and new private insurer plans make preventive services available with no deductible or copayment. This is likely to increase demand for primary care services at a time when many expect a growing shortage of primary care physicians.

What is interesting is that cost sharing actually has the effect of reducing demand without significant negative effect on outcomes, and making healthcare services available with no cost sharing has actually been found to have little positive effect on patient outcomes. A report by The Kaiser Family Foundation examined the findings of the RAND Health Insurance Experiment and other more recent studies and actually found that "higher co-insurance rates, with an out-of-pocket limit, can significantly reduce health care use without sacrificing health outcomes for the typical person." They also found that "there are no “substantial benefits” from being on the free-care plan for the typical enrollee".

The health reform bill is actually moving us away from using these cost sharing options as a method for controlling costs by reducing demand. In fact, it will likely serve to increase demand rather than constraining it, ultimately resulting in increased costs.