Health Economics

Health Economics

Peter Zweifel · Friedrich Breyer · Mathias Kifmann

Health Economics

Second Edition

123

Original English edition published by Oxford University Press, 1997

ISBN 978-3-540-27804-7 e-ISBN 978-3-540-68540-1

DOI 10.1007/978-3-540-68540-1

Springer Dordrecht Heidelberg London New York

Library of Congress Control Number: 2009931221

c Springer-Verlag Berlin Heidelberg 2009

This work is subject to copyright. All rights are reserved, whether the whole or part of the material is

concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting,

reproduction on microfilm or in any other way, and storage in data banks. Duplication of this publication

or parts thereof is permitted only under the provisions of the German Copyright Law of September 9,

1965, in its current version, and permission for use must always be obtained from Springer. Violations

are liable to prosecution under the German Copyright Law.

The use of general descriptive names, registered names, trademarks, etc. in this publication does not

imply, even in the absence of a specific statement, that such names are exempt from the relevant protective

laws and regulations and therefore free for general use.

Cover design: WMX Design GmbH, Heidelberg

Printed on acid-free paper

Springer is part of Springer Science+Business Media (www.springer.com)

Professor Peter Zweifel

Socioeconomic Institute

University of Zurich

Hottingerstr. 10

8032 Zurich

Switzerland

[email protected]

Professor Friedrich Breyer

Department of Economics

University of Konstanz

Fach 135

78457 Konstanz

Germany

[email protected]

Professor Mathias Kifmann

Department of Economics

University of Augsburg

Universitatsstr. 16 ¨

86159 Augsburg

Germany

[email protected]

Preface

Health Economics is a fascinating subject. This book provides a systematic treatment

of this field of study. It is based on a German version which has been well received

since 1992, resulting in five editions so far. It serves both as a textbook in university

courses at the Master level and as a reference book.

The book’s distinguishing feature is that it consistently builds on formal eco￾nomic models that have been used in academic Health Economics journals for sev￾eral decades but have not been integrated in the leading undergraduate textbooks

of the field. As we are convinced that many problems in Health Economics are too

complicated to be analyzed only graphically, we are now offering this text for Master

level courses at universities worldwide. Our premise is that readers are familiar with

basic calculus. Some knowledge of econometrics is also useful. At the same time, we

have taken care to explain the reasoning in the more technical sections. In addition,

we state our main results in non-technical Conclusions and in Summaries at the end

of each chapter.

We are grateful to those who have provided their generous assistance to the com￾pletion of this book. Ana Ania, Han Bleichrodt, Laszlo Goerke, Normann Lorenz,

Thomas McGuire, Robert Nuscheler and Luigi Siciliani have read parts of the manu￾script and made valuable suggestions for improvement. We also would like to thank

Stefan Felder, Kristin Grabe, Andreas Haufler, Tobias Laun, Hansj¨org Lehmann,

Maximilian R¨uger, Florian Scheuer, Carlo Schultheiss, Lukas Steinmann, Harry

Telser, Silke Uebelmesser and Matthias Wrede for their comments on versions of

the German manuscript. Finally, we are grateful to Patrick Eugster, Ilja Neustadt,

Maurus Rischatsch, Kerstin Roeder, Maximilian R¨uger, Clarissa Schnekenburger,

Johannes Schoder, Susanna Sedlmeier, Mich`ele Sennhauser, Sandra Strametz and

Philippe Widmer for their assistance in preparing the manuscript.

Z¨urich, Konstanz and Augsburg Peter Zweifel

April 2009 Friedrich Breyer

Mathias Kifmann

Contents Overview

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Detailed Table of Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

2 Economic Valuation of Life and Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

3 Individuals as Producers of Their Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

4 Empirical Studies of the Production of Health . . . . . . . . . . . . . . . . . . . . . . . 119

5 Health Goods, Market Failure and Justice . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

6 Optimal Health Insurance Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203

7 Risk Selection in Health Insurance Markets . . . . . . . . . . . . . . . . . . . . . . . . . 253

8 Physicians as Suppliers of Medical Services . . . . . . . . . . . . . . . . . . . . . . . . . 293

9 Hospital Services and Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311

10 Paying Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331

11 Forms of Delivery of Medical Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 379

12 The Market for Pharmaceuticals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 401

13 The Political Economy of Health Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 429

14 Future Challenges to Health Care Systems . . . . . . . . . . . . . . . . . . . . . . . . . . 447

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 483

Author Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505

Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 513

Detailed Table of Contents

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v

Contents Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1.1 Health – a Priceless Commodity? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1.2 The Micro- and Macroeconomic Views of Health . . . . . . . . . . . . . . . . 3

1.2.1 A Simplified Microeconomic View of Health . . . . . . . . . . . . . 3

1.2.2 Health Care at the Macroeconomic Level . . . . . . . . . . . . . . . . 6

1.2.3 A Critique of Global Budgeting . . . . . . . . . . . . . . . . . . . . . . . . 7

1.3 ‘Economics of Health’ vs. ‘Economics of Health Care’ . . . . . . . . . . . 10

1.3.1 Economics of Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

1.3.2 Health and the Use of Health Care Services . . . . . . . . . . . . . . 11

1.3.3 Economics of Health Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

1.4 A System Analysis of the Economics of Health and Health Care . . . 12

1.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

2 Economic Valuation of Life and Health . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

2.2 Approaches to the Economic Evaluation of Health . . . . . . . . . . . . . . . 18

2.3 Cost-Utility Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

2.3.1 Concepts of Utility Measurement . . . . . . . . . . . . . . . . . . . . . . . 25

x Detailed Table of Contents

2.3.2 The QALY Concept . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

2.3.2.1 Calculating QALYs . . . . . . . . . . . . . . . . . . . . . . . . . . 26

2.3.2.2 Decision-Theoretic Foundation . . . . . . . . . . . . . . . . 28

2.3.2.3 QALYs and Consumption . . . . . . . . . . . . . . . . . . . . . 32

2.3.2.4 Aggregation of QALYs and Collective

Decision-Making . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

2.3.3 Evaluating Health States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

2.3.3.1 Rating Scale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

2.3.3.2 Time Trade-Off . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

2.3.3.3 Standard Gamble . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

2.4 Cost-Benefit Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

2.4.1 Ethical Objections and Counterarguments . . . . . . . . . . . . . . . . 40

2.4.1.1 Objections Against Weighing Life Against Money 40

2.4.1.2 Arguments Against a Finite Value of Life . . . . . . . . 42

2.4.2 The Human-Capital Approach . . . . . . . . . . . . . . . . . . . . . . . . . 43

2.4.3 The Willingness-To-Pay Approach . . . . . . . . . . . . . . . . . . . . . . 45

2.4.4 Aggregating Willingness To Pay and Principles of

Collective Decision-Making . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

2.4.4.1 Cost-Benefit Analysis and the Potential Pareto

Criterion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

2.4.4.2 Cost-Benefit Analysis with Many Interventions . . . 49

2.4.4.3 Cost-Benefit Analysis and Social Welfare Analysis 49

2.4.5 Measuring Willingness To Pay: Using Surveys . . . . . . . . . . . . 54

2.4.5.1 General Problems of Surveys . . . . . . . . . . . . . . . . . . 54

2.4.5.2 The Contingent Valuation Method . . . . . . . . . . . . . . 55

2.4.5.3 Discrete Choice Experiments . . . . . . . . . . . . . . . . . . 58

2.4.6 Measuring Willingness to Pay: Using Market Data . . . . . . . . 61

2.5 Cost-Utility, Cost-Benefit and Social Welfare Analysis . . . . . . . . . . . 63

2.5.1 Comparing Cost-Utility and Cost-Benefit Analysis . . . . . . . . 63

2.5.2 Social Welfare and QALYs . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

2.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

2.7 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

2.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71

Detailed Table of Contents xi

3 Individuals as Producers of Their Health . . . . . . . . . . . . . . . . . . . . . . . . . 75

3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

3.2 The Concept of Health Production . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

3.3 Health as Part of Human Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

3.3.1 A Simplified Grossman Model . . . . . . . . . . . . . . . . . . . . . . . . . 79

3.3.2 The Demand for Health and Medical Services . . . . . . . . . . . . 83

3.3.2.1 The Structural Demand Function for Medical

Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

3.3.2.2 The Demand Functions in the Investment Model . . 84

3.3.2.3 The Demand Functions in the Consumption Model 85

3.3.3 Preliminary Assessment of the Grossman Model . . . . . . . . . . 86

3.4 The Production of Health as the Modification of a Stochastic Process 89

3.4.1 Conditional Health Production Functions . . . . . . . . . . . . . . . . 89

3.4.2 Short-run Optimization and Willingness to Pay for Health . . 91

3.4.3 A Model with State-Dependent Production Possibilities:

The Short Term . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

3.4.3.1 State-Dependent Optimization of a Stochastic

Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

3.4.3.2 The Elements of the Model . . . . . . . . . . . . . . . . . . . . 96

3.4.3.3 Conditional Short-term Production Frontiers . . . . . 98

3.4.3.4 Alleged Instability of Health Behavior . . . . . . . . . . 101

3.4.4 State-Dependent Production Possibilities: The Longer Run . 103

3.4.4.1 The Longer-Run Trade-Off Given Good Health . . . 104

3.4.4.2 The Longer-Run Trade-Off Given Bad Health . . . . 106

3.4.5 Complementarity or Substitutability in the Production of

Health? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

3.4.5.1 Significance of the Issue . . . . . . . . . . . . . . . . . . . . . . 107

3.4.5.2 Substitutability in the Healthy State . . . . . . . . . . . . . 108

3.4.5.3 Complementarity in the Sick State . . . . . . . . . . . . . . 109

3.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

3.6 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

3.A Appendix to Chapter 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111

3.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118

xii Detailed Table of Contents

4 Empirical Studies of the Production of Health . . . . . . . . . . . . . . . . . . . . . 119

4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

4.2 Studies Based on Aggregate Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

4.2.1 Mortality Rates and Life Expectancy as Measures of Output? 121

4.2.2 Marginal Productivity of a Health Care System . . . . . . . . . . . 122

4.2.2.1 Early Evidence from the United States . . . . . . . . . . 122

4.2.2.2 Recent Evidence from the United States . . . . . . . . . 127

4.2.2.3 Evidence from Industrialized Countries. . . . . . . . . . 129

4.2.2.4 Evidence from a Comparison of Two Neighboring

Areas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131

4.2.2.5 Evidence from a Developing Region

(Sub-Saharan Africa) . . . . . . . . . . . . . . . . . . . . . . . . . 132

4.2.3 Marginal Productivity of Selected Medical Interventions . . . 135

4.2.4 Environmental Determinants of Health Status . . . . . . . . . . . . 136

4.2.5 Economic Instability and Health . . . . . . . . . . . . . . . . . . . . . . . . 137

4.3 Studies Based on Individual Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140

4.3.1 Measurement of Health Status . . . . . . . . . . . . . . . . . . . . . . . . . 140

4.3.2 Marginal Productivity of Medical Infrastructure at the

Individual Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

4.3.3 The Productivity of Medical Interventions at the Individual

Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142

4.3.4 Environmental Quality and the State of Health . . . . . . . . . . . . 143

4.3.4.1 Air Quality and Smoking as Exogenous Factors . . . 143

4.3.4.2 Smoking as an Endogenous Factor . . . . . . . . . . . . . . 146

4.4 Demand for Health, Demand for Health Services . . . . . . . . . . . . . . . . 148

4.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152

4.6 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152

4.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153

5 Health Goods, Market Failure and Justice . . . . . . . . . . . . . . . . . . . . . . . . 155

5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

5.2 Market Failure in Markets for Health Goods . . . . . . . . . . . . . . . . . . . . 157

5.2.1 Externalities and the Problem of Public Goods . . . . . . . . . . . . 157

5.2.2 Option-Good Property of Medical Services . . . . . . . . . . . . . . 159

Detailed Table of Contents xiii

5.2.3 Lack of Consumer Sovereignty . . . . . . . . . . . . . . . . . . . . . . . . . 160

5.2.3.1 Incapability of Rational Decision Making . . . . . . . . 160

5.2.3.2 Excess Discounting of Future Needs . . . . . . . . . . . . 161

5.2.4 Lack of Perfect Information in Markets for Health Goods . . 161

5.3 Market Failure in Health Insurance Markets . . . . . . . . . . . . . . . . . . . . 163

5.3.1 The Basic Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

5.3.2 The Free-Rider Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

5.3.3 Asymmetric Information in the Health Insurance Market . . . 171

5.3.3.1 Risk Types . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

5.3.3.2 Market Equilibrium under Symmetric Information 172

5.3.3.3 Market Equilibrium under Asymmetric Information 173

5.3.3.4 Welfare-Enhancing Government Intervention in

Insurance Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . 176

5.3.3.5 Alternative Equilibrium Definitions . . . . . . . . . . . . . 178

5.3.4 Premium Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180

5.3.4.1 Pure-Market Solutions . . . . . . . . . . . . . . . . . . . . . . . . 181

5.3.4.2 Community Rating as a Solution . . . . . . . . . . . . . . . 185

5.3.4.3 Comparing the Solutions . . . . . . . . . . . . . . . . . . . . . . 187

5.4 Justice as an Argument in Favor of Government Intervention in

Health Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189

5.4.1 Willingness and Ability to Pay and Access to Health Care . . 189

5.4.2 Congenital Differences in Health and Access to Health

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 192

5.4.2.1 Redistribution and the Veil of Ignorance . . . . . . . . . 192

5.4.2.2 Implementing Cross-Subsidies between High and

Low Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 193

5.5 Rationing of Health Care Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194

5.5.1 The Concept of Rationing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195

5.5.2 Types of Primary Rationing. . . . . . . . . . . . . . . . . . . . . . . . . . . . 196

5.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198

5.7 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 199

5.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200

xiv Detailed Table of Contents

6 Optimal Health Insurance Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203

6.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203

6.2 Types of Health Insurance Contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . 205

6.3 Optimal Insurance Protection in the Absence of Moral Hazard . . . . . 208

6.3.1 Financial Consequences of Illness Only . . . . . . . . . . . . . . . . . 208

6.3.1.1 A Model with Two Health States . . . . . . . . . . . . . . . 209

6.3.1.2 A Model with an Arbitrary Number of Health States215

6.3.2 Direct Utility Effects of Illness . . . . . . . . . . . . . . . . . . . . . . . . . 221

6.3.3 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

6.4 Optimal Insurance Coverage with Moral Hazard . . . . . . . . . . . . . . . . . 224

6.4.1 Ex-Ante Moral Hazard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

6.4.1.1 Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

6.4.1.2 Optimal Prevention without Insurance . . . . . . . . . . . 226

6.4.1.3 The Optimum with Observable Prevention . . . . . . . 227

6.4.1.4 The Optimum with Unobservable Prevention . . . . . 228

6.4.1.5 Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232

6.4.1.6 Empirical Evidence on Ex-Ante Moral Hazard . . . . 232

6.4.2 Ex-Post Moral Hazard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233

6.4.2.1 Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233

6.4.2.2 Optimal Insurance Coverage with Observable

State of Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235

6.4.2.3 Optimal Insurance Coverage with Unobservable

State of Health . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

6.4.2.4 Implications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 241

6.4.2.5 The Empirical Relationship Between Insurance

Coverage and the Demand for Health Care Services 242

6.5 Consequences for the Design of Social Health Insurance . . . . . . . . . . 244

6.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246

6.7 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 247

6.A Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 248

6.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250

Detailed Table of Contents xv

7 Risk Selection in Health Insurance Markets . . . . . . . . . . . . . . . . . . . . . . . 253

7.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253

7.2 Modeling Risk Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255

7.2.1 Direct Risk Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255

7.2.2 Indirect Risk Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257

7.2.2.1 Indirect Risk Selection Using the Quantity of

Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259

7.2.2.2 Risk Selection Using the Structure of Benefits . . . . 270

7.3 Further Arguments in Favor of Risk Adjustment and Cost

Reimbursement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276

7.3.1 Fair Competition in the Health Insurance Market . . . . . . . . . . 277

7.3.2 Stabilization of the Health Insurance Market . . . . . . . . . . . . . 277

7.4 Designing Risk Adjustment Schemes . . . . . . . . . . . . . . . . . . . . . . . . . . 278

7.4.1 An Overview of Risk Adjusters . . . . . . . . . . . . . . . . . . . . . . . . 278

7.4.2 Costs and Payment Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

7.4.3 Calculating Risk Adjustment Payments . . . . . . . . . . . . . . . . . . 282

7.4.3.1 The Statistical Approach to Risk Adjustment . . . . . 282

7.4.3.2 The Incentive Approach to Risk Adjustment . . . . . 283

7.5 Designing Cost Reimbursement Schemes . . . . . . . . . . . . . . . . . . . . . . 284

7.5.1 The Basis of Cost Reimbursement . . . . . . . . . . . . . . . . . . . . . . 285

7.5.2 The Structure of Cost Reimbursement . . . . . . . . . . . . . . . . . . . 285

7.5.3 Findings of Empirical Studies . . . . . . . . . . . . . . . . . . . . . . . . . . 286

7.6 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287

7.7 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289

7.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290

8 Physicians as Suppliers of Medical Services . . . . . . . . . . . . . . . . . . . . . . . 293

8.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293

8.2 The Relationship Between Physician Density and the Utilization of

Medical Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294

8.3 The Hypothesis of Supplier-Induced Demand for Ambulatory

Medical Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

xvi Detailed Table of Contents

8.4 Utility Maximization of the Physician and Supplier-Induced Demand 298

8.4.1 A Model of Physician Behavior . . . . . . . . . . . . . . . . . . . . . . . . 298

8.4.2 Increasing Physician Density . . . . . . . . . . . . . . . . . . . . . . . . . . 300

8.4.3 Increasing Fee Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304

8.5 Physician Density and Utilization of Medical Services: Alternative

Explanations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304

8.6 Empirical Examination of the Supplier-Induced Demand Hypothesis 306

8.6.1 Physician Density and Volume of Services . . . . . . . . . . . . . . . 306

8.6.2 Regulated Fees and Volume of Services . . . . . . . . . . . . . . . . . 307

8.7 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308

8.8 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309

8.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 309

9 Hospital Services and Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311

9.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311

9.2 The Hospital as a Productive Unit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 312

9.2.1 Hospital Output: Health as a Latent Variable . . . . . . . . . . . . . 312

9.2.2 The Multi-Stage Character of Production in the Hospital . . . 313

9.2.3 The Heterogeneity of Hospital Output . . . . . . . . . . . . . . . . . . . 317

9.3 Comparing Hospital Efficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 318

9.3.1 Regulation and Asymmetric Information . . . . . . . . . . . . . . . . . 318

9.3.2 Hospital Cost Functions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 319

9.3.3 Data Envelopment Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 322

9.3.3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 322

9.3.3.2 Comparing the Efficiency of Swiss Hospitals . . . . . 324

9.3.4 Potential and Limits of Efficiency Measurement . . . . . . . . . . 328

9.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 328

9.5 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329

9.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 329

10 Paying Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331

10.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331

10.2 Paying Providers to Achieve Cost Control . . . . . . . . . . . . . . . . . . . . . . 333

10.2.1 The Principle of Full Cost Responsibility . . . . . . . . . . . . . . . . 333

Detailed Table of Contents xvii

10.2.1.1 The Basic Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . 333

10.2.1.2 The First-Best Payment System . . . . . . . . . . . . . . . . 334

10.2.1.3 Implementing the First-Best Solution . . . . . . . . . . . 336

10.2.2 Paying Risk-Averse Providers . . . . . . . . . . . . . . . . . . . . . . . . . . 338

10.2.2.1 Contractible Effort to Control Costs . . . . . . . . . . . . . 338

10.2.2.2 Noncontractible Effort to Control Costs . . . . . . . . . 340

10.2.3 Casemix and Information Rent . . . . . . . . . . . . . . . . . . . . . . . . . 344

10.2.3.1 Symmetric Information about Casemix . . . . . . . . . . 344

10.2.3.2 Asymmetric Information about Casemix . . . . . . . . . 344

10.3 Concerns Beyond Cost Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

10.3.1 Quality of Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 348

10.3.1.1 Extending the Basic Model . . . . . . . . . . . . . . . . . . . . 348

10.3.1.2 Verifiable Quality or Treatment Outcomes . . . . . . . 350

10.3.1.3 Unverifiable Quality and Treatment Outcomes . . . . 351

10.3.2 Patient Selection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355

10.3.2.1 Extending the Basic Model . . . . . . . . . . . . . . . . . . . . 356

10.3.2.2 Symmetric Information about Patients’ Cost Types 358

10.3.2.3 Asymmetric Information about Patients’ Cost Types359

10.4 Implications for the Design of Payment Systems . . . . . . . . . . . . . . . . 363

10.4.1 General Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363

10.4.2 Paying Physicians . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 365

10.4.2.1 Overview of Payment Systems . . . . . . . . . . . . . . . . . 365

10.4.2.2 Optimal Physician Payment . . . . . . . . . . . . . . . . . . . 366

10.4.3 Paying Hospitals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 368

10.4.3.1 Overview of Payment Systems . . . . . . . . . . . . . . . . . 368

10.4.3.2 Optimal Hospital Payment . . . . . . . . . . . . . . . . . . . . 368

10.4.3.3 Hospital Payment Based on Diagnosis Related

Groups . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370

10.5 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 371

10.6 Further Reading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372

10.A Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 372

10.E Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 374