The True Usefulness of Cost Sharing Is Misunderstood

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“Cost sharing” refers to people paying money out of their own pocket to receive healthcare services. There are lots of forms of cost sharing—the most common ones are deductibles, copays, and coinsurance.

When healthcare reformers talk about cost sharing, they are often arguing that we should increase cost sharing so that people will stop overutilizing health services (especially low value ones). They call it getting consumers to have some “skin in the game.” The Rand Health Insurance Experiment found that this works, although people decrease their utilization of high-value services as well.

But this isn’t the thing we need cost sharing to do for us. What we need it to do is get people to start considering prices when they choose where to get care.

If people don’t care what the price of a procedure is, there’s no reason they would go out of their way to find one that is less expensive (while being of at least equivalent quality). In fact, they probably wouldn’t bother checking prices at all.

But when they are forced to pay at least some part of the price, they will start asking questions to find out the price of their options. Not everyone will, of course. But some will start doing that, especially when they discover that they could potentially pay thousands of dollars less for no worse quality.

Trying to find prices is a frustrating endeavor in our healthcare system because prices are still hard to come by. And often even the quoted price is an estimation, or it doesn’t include the same bundle of services as another provider’s quoted price.

But if people can successfully find prices and choose ones that are lower priced, do you know what happens? Providers start to see that their prices actually do impact how many patients choose to receive care from them. And then the market actually starts to function because competition (at least over prices) has begun.

To summarize, we don’t need cost sharing for the sake of skin in the game; we need it so patients can be put to work searching for the best deals (trying to save their hard-earned money) because this searching effort is the main prerequisite for competition.

By the way, I am not saying people need to pay the full price of every service. The key is that they pay at least some amount of the price differential between options. So if one provider quotes $4,000 and another quotes $5,000, all we need is for them to pay is a little more if they choose the $5,000 one. This could be through reference pricing, where they pay the full $1,000 difference. Or through other methods that only have them pay part of that $1,000, such as high coinsurance or tiered networks. There are many ways to achieve this.

PBMs Are Using the Same Strategy as Credit Card Companies

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Do you know how credit card companies can give you 2% or more cash back? They charge merchants 1-3% processing fees! Plus they earn interest when people carry credit card debt.

Why do merchants put up with these 1-3% fees? Because the credit card companies provide them with a valuable service. It makes getting payments from people easier, especially in the days of fewer people carrying cash. This expands their sales and more than makes up for the 1-3% fees they’re being charged by the credit card companies, although they’d rather not get charged such high fees, especially when many companies’ profits are not much more than 3%.

This is a tricky game the credit card companies are playing. They’ve found that to get more people to use their cards, they need to give rewards like cash back. And there’s this delicate balance created. They want to get the most people using their cards by offering the most generous rewards, but they can’t charge merchants too much to fund those rewards or else merchants will stop accepting those cards. Except that the biggest credit card companies are too important to stop accepting, so they can get away with charging even higher fees. It rewards size. The bigger companies are rewarded with even more market share. It tends toward monopoly, or at least oligopoly, which means the middle men will be empowered to take an even larger share of the total price paid.would make their cards’ usefulness lower and maybe not worth the more generous rewards.

Let’s look at what is happening in the market in aggregate. Merchants, to cover the added expense of high credit card fees, end up charging higher prices. And then the credit card companies are passing some of that money on to the consumer. It’s all because credit card companies are creatively finding ways to leverage their market power to win more customers.

Wouldn’t this all be simpler if credit card companies couldn’t give rewards? Then consumers would be faced with true prices from merchants rather than having to guess at the net price of things after accounting for rewards, and they’d probably lose less of the total price to extra profits for the middle men. With decreased complexity comes greater market transparency, which makes hiding extra profits in the shadows of complexity much more difficult.

Can you see how this is exactly the role pharmacy benefit managers (PBMs) play? They’re a middle man that gets the drug manufacturer to give them a bunch of money (“rebates”), and then they pass a portion of it on to the insurer in an attempt to win as many insurer contracts as possible. Instead of simply competing by offering the best service and charging reasonable fees to win insurer contracts, they’ve expanded into these strange (but ingenious) complexity-increasing strategies. I described the evolution of PBMs into this complicated middle man position here.

In business school, I didn’t learn about this middle man game of leveraging market power to take extra money from suppliers and pass some of it directly on to their customers. Maybe this is a well-understood phenomenon and there’s a term for it and I just have been unaware. But whatever we call it, I don’t like it because of the additional complexity it creates and how it rewards size with even more size (tending toward fewer market competitors). I haven’t noticed any other examples of this, but I’d be interested to hear if anyone has one.

How Pharmacy Benefit Managers Are Getting Away with More than They Should (And a Solution?)

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Ok I’ve got a couple more posts I wrote on pharmacy benefit managers (PBMs) to complete my efforts to work through what they are and how they work . . .

What do you think to yourself when you are at the supermarket and you see a toddler throwing a tantrum—clearly because he wants a chocolate bar—and then the mom, exasperated and embarrassed, finally agrees to buy him one just to shut him up?

Do you think, “What a bratty child! I’m glad she finally got him to be quiet.”

Or do you (correctly) think, “I can’t believe she just gave in to that! She’s teaching him that if he wants something, he should throw a tantrum until he gets it. That’s probably why he still throws tantrums.”

This child’s behavior makes sense. Not that it’s desirable behaviour! But you have to give him credit for rationally responding to bad incentives–he’s found a way to get what he wants, and he’s leveraging that.

Applying this to pharmacy benefit managers (PBMs), they definitely have some undesirable behaviours, but they also have bad incentives. I’m not here to be a PBM apologist, but I’m also not here to misdiagnose the source of the issues. If we understand the incentives and then work to get them changed, the behaviours will change accordingly.

So, how are we giving PBMs the proverbial chocolate bar?

The normal incentive of a business is to maximize profit. In a well-functioning market, businesses achieve that by delivering better value (Value = Quality / Price) to customers than their competitors. Problems arise when customers are unable to determine the value of their various options. This is where the bad behaviour sneaks in: the company can get away with charging more or delivering less than a well-functioning market would dictate, and the customers don’t know.

In a prior post, I talked a little bit about how the PBM market is competitive as long as insurers have enough knowledge and expertise at their disposal to accurately identify the true quality and cost of their PBM options. My guess is that insurers often do not have this knowledge and expertise at their disposal, either in house or by not contracting with a consultant who really knows their stuff. Or maybe sometimes the issue is that insurers remain with a PBM for too long, so they are no longer getting a competitive deal. Either way, it leads to insurers (i.e., the customers) not being actively aware of the value of their various options, and PBMs are acting accordingly.

Example: A friend of mine used to run a private health insurance company, and he told me they were getting 5% of rebates from their PBM. He asked for more, and the PBM responded by giving him double! There was lots more on the table apparently.

Another example: An auditor frequently hired by insurers to audit their PBMs’ performance said that, in more than 400 audits, “we have never found a single situation where something wasn’t wrong.”

How bad are PBMs acting? Or, in other words, how much are they taking advantage of this contracting complexity/lack of transparency?

You would expect it to show up in their profits. The trouble is, PBM profitability is incredibly difficult to ascertain. But here’s an elegant visual estimation of how many dollars each link in the supply chain takes from a $100 drug expenditure. PBMs are estimated to account for about $7 of those $100. I think the important point isn’t the amount so much as that $7 is more than it could be.

In summary, insurers often are not getting the best deals from PBMs. The business relationship with their PBM is governed by an incredibly complex contract, and this complexity leads to insurers not knowing what they are leaving on the table. So PBMs surreptitiously scoop it off the table and into their pockets. They are responding totally rationally to bad incentives.

In my mind, the implied solution here is either to (1) legislate/standardize these insurer-PBM contracts so that they’re simpler or (2) encourage insurers to be much more proactive about making sure they’re getting the best deal possible from their PBM (which would probably cost a lot of money in consulting fees or in developing that knowledge in house).

One more related point: When insurers have medical loss ratio policies governing how much money they have to spend on care vs. non-care expenses (the “medical loss” is the amount of premiums received that they spend on care for patients), they are going to be less aggressive in trying to pursue cost containment, which would include worrying less about the excess money going to their PBM.

Blog Updates Again

This is me last summer. To put a face to a brain.

Ok I’m back! I never stopped thinking or researching about health policy in the 10 months since I stopped posting weekly. And I only published one post on The Incidental Economist (TIE) in that time. Here’s the brief explainer and update.

In short, I am going to be blogging primarily here again. There was some discussion with the editors of TIE about what would work for me to post, and they felt my proposed content wouldn’t fit well enough with what they’re looking for (their distinctive TIE brand that they’ve built). I felt that this was perfectly reasonable, and while I was sad that I would miss out on their much larger audience and the possible impact opportunities that would offer, it’s also a little bit of a relief to me to be back here with the flexibility and freedom to write about what I want and in the way I want to write about it. Because much of the purpose of this blog is for me to have an opportunity to synthesize what I’m learning, and when the form interferes with the synthesis itself, the learning process becomes much more difficult and time consuming.

So, moving forward here, I’m going to get back to writing like I did before–using fairly informal language, writing concise posts as much as possible, and writing on the things I am interested in. Basically, my posts will simply be my notes and thoughts about what I’m reading and figuring out.

In the last 10 months, I have saved up a lot of blog post ideas–some to complete my series on pharmacy benefit managers (exciting, right?), and some about a variety of other topics. After I get through those, I want to start a long-term series of basically going through my own health econ/health policy education from scratch again, but sharing the articles I’m reading and the insights gained from each one along the way. More on that when I get to it.

I still believe the way to grow a blog (as well as the way to keep me from getting lazy) is to have regular content, so I’ll be back to posting weekly on Tuesdays as often as my schedule allows. Ganbarimashou! (That’s Japanese for “Let’s keep going/try hard!”)

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