On the Economics of the New PSU Health Plan

Thinking About the New Health Plan

Penn State University has adopted a new health initiative. The wellness program requires employees to take a wellness test, schedule a biometric exam, and promise to take a physical or else see their insurance rates go up by $1200 per year. Smokers will see their health care costs rise by $75 per month. The idea, as explained by University President Rodney A. Erickson, is to cut growing health costs. According to Erickson,

“We are implementing a significant set of changes that will help us turn the tide on unmanageable increases in health care costs for our faculty and staff…Higher education is at the crossroads with respect to our responsibilities for greater cost control, and now is the time for decisive action. I have challenged our leadership in human resources to hold annual health care cost increases to the Consumer Price Index plus 2 percent, a goal that will help us to sustain the existing quality of employee health care options while easing pressures on tuition increases that face our students and their families.”

There are many questions about this plan. I am interested in the economics of it, however. Suppose that these wellness initiatives work. How can this plan result in any short-term cuts in health care costs? Penn State is self insured so the only way it saves on health care costs is if the population becomes healthier so fast that expenditures fall in the near term. As Erickson points out:

“Since Penn State is self-insured, we are providing health care benefits to eligible employees with our own funds. This is very different from fully insured plans where an employer contracts with an insurance company to cover employees and their dependents. Because of this self-insured arrangement, we assume the direct risk, but we also can reap substantial rewards when our medical and pharmacy bills (claims) are low. "

If Penn State purchased insurance then one can see how imposing restrictions may make us a better potential client and give the university leverage to reduce premiums. But if we are self-insured then this channel is not available.

Moreover, Erickson claims that this program is being initiated to cut expenditures by roughly 10%. How is this possible, given that the program relies on behavioral changes, aside from the smokers tax? At $900 per year, this would require 24,000 employees to admit to smoking to earn the required savings. With only 8,800 full and part time faculty this will be a hard target to reach.

It is not even clear that cost will fall at all in the near term. Suppose that I did not see my physician twice a year for physicals and take appropriate medicine and lab tests. Then this plan could lead to new information about my health that could seriously impact my long-term health trajectory. If I began to see a physician and take appropriate medicine now expenditures would rise, they would not fall. How then do we achieve the 10% savings? In the near term expenditures should rise as more health care is consumed due to learning about how sick we are. Moreover, even if wellness plans improve health in the long term it is not clear how much of those benefits PSU will even realize. If it improves health outcomes after age 65 it may be great for Medicare expenditures but its not clear how it helps PSU. At a minimum we would need to have a clearer picture of which segment of the employee population is generating the largest increases and then ask if wellness programs will affect them in the near term.

The only way the plan can cut expenditures in the near term is to induce people to leave the plan. If enough employees are annoyed, and if their spouses have competitive plans, perhaps they will leave our plan. This would reduce total health expenditures for PSU by reducing the size of the employee pool that is covered. This could reduce health expenditures.

Given that we are self-insured an obvious policy to reduce expenditures would be to increase co-pays. Presumably health care costs are rising because we are consuming too much health care. Make us pay a bit more. Then we will be more careful at the margin. This would lead to direct savings for a self-insured group. Why they did not choose this idea is not exactly clear.

Is Reich Dishonest or Uninformed?

Robert Reich's opinion piece in today's NYTimes is either intellectually dishonest or plain ill-informed. This does not detract from the lack of analysis.

The intellectually dishonest part refers to his argument that health insurers that are raising rates are earning super-profits:

This can’t be the whole story, because big health insurers are making boatloads of money. America’s five largest health insurers made a total profit of $12.2 billion last year; that was 56 percent higher than in 2008, according to a report from Health Care for America Now.

Surely, Reich knows that health insurance is not all that profitable a business. As noted opponent of the health insurance industry Tim Noah argued in Slate:

But the profits weren't across the board; Aetna saw an 8 percent decline. The huge combined increase was driven mostly by Cigna, whose 356 percent increase appears to be unrelated to its core health insurance business. As for declining private coverage: Health insurers argue (not implausibly) that it's largely driven by the tendency of young, healthy people to drop nongroup health insurance in tough economic times.

Or as Princeton economist Uwe Reinhardt argued in the NYTimes, looking at WellPoint's income statement:

As a percentage of total assets of $48,403.2 million deployed by the company (measured at the reported book value on the firm’s balance sheet), WellPoint’s profits in 2008 amounted to 5.14 percent in 2008 and 6.42 percent in 2007.

As a percentage of the equity shareholders had in WellPoint (also measured at the book values reported by accountants), WellPoint’s profits in were 11.62 percent in 2008 and 14.55 percent in 2007.

Relative to other industries, these are not particularly high numbers, nor are they particularly low.

So Reich clearly knows that health insurers profits vary and that they are not that high. But he must argue that they are so he can argue for removing their anti-trust exemption:

Anthem’s parent is WellPoint, one of the largest publicly traded health insurers in America, which runs Blue Cross and Blue Shield plans in 14 states and Unicare plans in several others. WellPoint, through Anthem, is the largest for-profit health insurer here in California, as it is in Maine, where it controls 78 percent of the market. In Missouri, WellPoint owns 68 percent of the market; in its home state, Indiana, 60 percent. With 35 million customers, WellPoint counts one out of every nine Americans as a member of one of its plans.

No discussion of course of the restriction against competing across state lines. So we have an industry with not very high profits, regulated by state insurance regulators, and Reich believes that competition will drive down rates!! Who would enter the market under the conditions he argues for?

If profits are high one might expect removing entry barriers to reduce prices. But the antitrust exemption is not the entry barrier, it is state regulation that is the entry barrier. The antitrust exemption is what allows insurers to share demographic information. But given that profits are not that high, insurance rates must be high because of the cost of health care, not the insurers. Certainly Reich must understand that.

So is he intellectually dishonest or uninformed? You decide.

Financial Innovation

Felix Salmon has a silly post arguing that financial innovation is a net waste to society. One problem with his argument is that his view of financial innovation is too narrow.

if you look at how fast the US economy managed to grow in the 50s and 60s without the benefit of Black-Scholes or the Gaussian copula function — or, for that matter, how fast the Chinese economy has grown of late with very strict fetters on financial activities — it looks very much as though most of the financial innovation in recent decades constitutes a history of increasingly-desperate attempts to eke out returns in the context of a naturally-slowing economy. And that history, I think, is doomed to failure.

There are two problems here. First, he simply ignores many innovations that are of recent vintage. In the period he castigates as net loser, we had such innovations as:

*money market investment funds
*NOW accounts
*municipal bond mutual funds
*IRA accounts
*Universal Life insurance policies
*ATM’s
*financial transactions by personal computer
*electronic funds transfer

and many others. For more see Van Horne's Presidential Address to the AFA in 1985. He discusses many financial innovations and possible excesses. At least the issue is taken seriously there.

The second problem, which is perhaps more significant, is that he only thinks about the impact of financial innovation on growth. But many financial innovations are ways to share risks. They may increase welfare without increasing growth. Think of any insurance. Without fire insurance I have to save more to cope with the state where my house burns down. My consumption is lower but my savings is higher. Growth might even be higher without the insurance because of higher savings. But welfare is lower because the goal of an economy is to allow people to consume.