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The Elasticity of Demand for Health Care : A Review of the Literature and ItsApplication to the Military Health System

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Understanding the effects of changes in health insurance policies on the demand for health care services is an important and timely topic. As the Military Health System (MHS) has evolved over time, it has begun to adopt cost-containment strategies that have been tested in private health plans. These strategies have led to changes in many aspects of the health care services offered to Department of Defense (DoD) beneficiaries. Each change potentially can affect the number of people accessing services, the intensity of use, and the cost to the DoD. The goal of this report is to summarize the research relevant for considering the effects of policy changes on the demand for DoD health care services and associated costs.
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Content Preview
The Elasticity of Demand
for Health Care
A Review of the Literature
and Its Application to the Military
Health System
Jeanne S. Ringel
Susan D. Hosek
Ben A. Vollaard
Sergej Mahnovski

Prepared for the Office of the Secretary of Defense
National Defense Research Institute
R H e a l t h
R
Approved for public release; distribution unlimited
H e a l t h

PREFACE
This report reviews the health economic research conducted at
RAND and elsewhere in an effort to summarize what this research
has to say about the elasticity of demand for health care and to con-
sider how this set of results applies to the problem of estimating the
demand for health care that is provided by the Department of
Defense to military members, their families, and retirees.
The work reported here was sponsored by PA&E and was carried out
jointly by RAND Health’s Center for Military Health Policy Research
and the Forces and Resources Policy Center of the National Defense
Research Institute. The latter is a federally funded research and de-
velopment center sponsored by the Office of the Secretary of
Defense, the Joint Staff, the unified commands, and the defense
agencies.
iii

CONTENTS
Preface .........................................

iii
Tables..........................................

vii
Summary .......................................

ix
Acknowledgments.................................

xvii
Chapter One
INTRODUCTION ..............................

1
A Brief Description of the Military Health System .......

2
Key Differences Between the Military and Civilian Health
Systems ..................................

3
Chapter Two
METHODS ...................................

9
Description of Elasticity Measures ..................

9
Own-Price Elasticity of Demand ..................

9
Income Elasticity of Demand ....................

10
Cross-Price Elasticity of Demand .................

11
Special Issues Regarding the Elasticity of Demand for
Health ...................................

11
Measures of Health Care Demand ................

11
Price of Health Care ...........................

12
Time Prices and Health Care ....................

12
Types of Health Care ..........................

13
Interrelationships Between the Demand for Health
Insurance and Health Care....................

14
Selection Effects..............................

15
v

vi
The Elasticity of Demand for Health Care: A Review of the Literature
Moral Hazard................................

15
Provider Behavior ............................

16
Chapter Three
REVIEW OF THE EMPIRICAL LITERATURE ...........

17
The Elasticity of Demand for Health Care.............

17
Methodologies Used in the Literature ..............

17
Main Findings ...............................

20
Price Elasticity of Demand for Health Care ..........

20
Income Elasticity of Demand for Health Care ........

27
Time Price Elasticity of Demand for Health Care ......

28
Price Elasticity of Demand for Specific Types of
Services ..................................

29
Main Findings ...............................

29
Inpatient Versus Outpatient Demand Elasticities .....

32
Preventive Care Versus Acute Care Demand
Elasticities ................................

34
Price Elasticity of Demand for Prescription Drugs .....

35
Price Elasticity of Demand for Mental Health Services ..
37
The Elasticity of Demand for Health Insurance ........

39
Main Findings ...............................

39
Studies on the Price Elasticity of Demand for Different
Health Plans ..............................

41
The Income Elasticity of Demand for Different Health
Plans ....................................

44
The Price Elasticity of Demand for Supplementary
Insurance ................................

44
Chapter Four
CONSIDERING THE POTENTIAL EFFECTS OF CURRENT
AND PROPOSED CHANGES IN TRICARE BENEFITS ....

47
Expansion of Pharmacy Benefits ...................

47
TRICARE for Life ...............................

48
Elimination of Copayments in TRICARE Prime.........

49
TRICARE Prime Remote .........................

50
Bibliography .....................................

51

TABLES
1.1. TRICARE Benefits for Active Duty Family Members ..

4
1.2. TRICARE Benefits for Retirees, Their Dependents, and
Others Under Age 65 .........................

4
3.1. Key Studies with Price Elasticities for All Services ....

21
3.2. Key Studies with Price Elasticity Estimates for Specific
Medical Services ............................

30
3.3. Key Studies on the Elasticity of Demand for Health
Insurance .................................

40
vii

SUMMARY
Understanding the effects of changes in health insurance policies on
the demand for health care services is an important and timely topic.
As the Military Health System (MHS) has evolved over time, it has
begun to adopt cost-containment strategies that have been tested in
private health plans. These strategies have led to changes in many
aspects of the health care services offered to Department of Defense
(DoD) beneficiaries. Each change potentially can affect the number
of people accessing services, the intensity of use, and the cost to the
DoD. The goal of this report is to summarize the research relevant
for considering the effects of policy changes on the demand for DoD
health care services and associated costs.
DIFFERENCES BETWEEN DEMAND FOR HEALTH CARE IN
GENERAL AND MILITARY HEALTH CARE

Very little of the existing literature speaks directly to demand for
DoD-paid health care, which differs in several important ways from
the demand for health care services in general. To use the estimates
from the literature to predict the effects of changes in DoD health
benefit packages on the use of DoD services, one must understand
the differences, which derive from the unusual organizational struc-
ture of the MHS. We have identified four key differences. First, ac-
tive duty personnel have less discretion in seeking care than their
civilian counterparts and some military duties involve higher risk.
Moreover, to ensure that active duty personnel are healthy and fit for
duty, they are provided more frequent preventive and routine care
than would be typical for civilians the same age (Hosek et al., 1995).
ix

x
The Elasticity of Demand for Health Care: A Review of the Literature
Changes in MHS benefits can be expected to have little effect on use
by active duty personnel.
Second, many retirees and some active duty spouses are eligible for
other health insurance (Hosek et al., 1995), usually through their cur-
rent employers. These beneficiaries may elect not to participate in
this other insurance, especially if they must pay a share of the pre-
mium. If they do participate, they may obtain their health care
through their other insurance, the MHS, or both. Changes in the
MHS benefits can be expected to affect both the number of benefi-
ciaries relying on the MHS (rather than on other insurance) and the
intensity of service use among all enrollees.
Third, MHS benefits can differ substantially for military treatment
facility (MTF) versus civilian care. As a result, government and
beneficiary costs depend on both the level of demand and its alloca-
tion between the MTFs and civilian providers. Costs in other health
plans may also differ according to the mix of providers used, but few
vary benefits in the same way that TRICARE does. Studies that esti-
mate the effects of differential benefits on provider choice may be
useful in assessing MTF-civilian provider choice in TRICARE.
Fourth, military beneficiaries typically use substantially more health
care services than comparable civilians do (Hosek et al., 1995). This
difference may be due to better benefits in the MHS. If this is so, the
general health demand literature may be safely applied because use
by the military is described by the same demand curve as use by the
general population, but with the two groups positioned at different
points on the curve. Alternatively, differences in use might reflect
different demand responses to the same benefits. In this case, the
demand curves differ and the general literature may not be applica-
ble. There is some reason for believing the first explanation. A large
share of active duty personnel and their families receive care free of
charge at MTFs. Out-of-pocket costs for those using civilian care ap-
pear to be no more than costs in other plans (Levy et al., 2000).
Although there are a variety of differences between the demand for
health care in general and the demand for DoD health care specifi-
cally, the existing empirical research on the demand for health care,
on the demand for health insurance, and on the choice of providers
offers useful information about how people respond to changes in

Summary
xi
the price of health care. The differences outlined above merely
provide a framework for applying the existing estimates to the
unique situations faced by DoD.
THE ELASTICITY OF DEMAND
The elasticity of demand is a measure of the responsiveness of prod-
uct demand to changes in one of its determinants. The demand de-
terminants for which elasticity measures are typically computed are
the price of the good or service, the income of the consumer, and the
prices of related goods or services. Elasticity measures are particu-
larly useful because they focus on the relative magnitudes of changes
rather than the absolute. As such, elasticity measures are free of
units of measurement. This characteristic makes them particularly
useful for comparing demand responses across products, countries,
and individuals.
RESULTS
Elasticity of Demand for Health Care in General
Despite a wide variety of empirical methods and data sources, the
demand for health care is consistently found to be price inelastic.
Although the range of price elasticity estimates is relatively wide, it
tends to center on –0.17, meaning that a 1 percent increase in the
price of health care will lead to a 0.17 percent reduction in health
care expenditures. The price-induced changes in demand for health
care can in large part be attributed to changes in the probability of
accessing any care rather than to changes in the number of visits
once care has been accessed. In addition, the studies consistently
find lower levels of demand elasticity at lower levels of cost-sharing.
The demand for health is also found to be income inelastic. The es-
timates of income elasticity of demand are in the range of 0 to 0.2.
The positive sign of the elasticity measure indicates that as income
increases, the demand for health care services also increases. The
magnitude of the elasticity, however, suggests that the demand re-
sponse is relatively small. Studies based on long time series data
tend to report higher income elasticities. The difference in estimates
across time frames is due to the incorporation of the effects of

xii
The Elasticity of Demand for Health Care: A Review of the Literature
changes in medical technology in studies that use long time series of
data.
Elasticity of Demand for Specific Classes of Health Care
Services

Although the price elasticity of demand for medical care in general is
relatively low, certain types of care are found to be somewhat more
price sensitive. Preventive care and pharmacy benefits are among
those medical services with larger price elasticities. The finding that
the demand for preventive care is more price sensitive than the de-
mand for other types of care is not surprising. The number of avail-
able substitutes for a product is a major determinant of demand
elasticity. In the case of preventive care, a number of goods and ser-
vices could possibly serve as substitutes. As a result, when the price
of care increases, consumers are able to substitute away from pre-
ventive care toward other goods and services that promote health
such as nutritional supplements and healthy foods. In addition, pre-
ventive medical services may be seen more as a luxury than a
necessity and, thus, may be put off when the price of such care in-
creases. Further, the opportunity cost of obtaining preventive care is
much higher than it is when the patient is sick, particularly if the ill-
ness keeps the individual out of work. It is also likely, that since the
benefits of preventive care accrue in the long-term, they are heavily
discounted. The difference in elasticities may also reflect the fact
that preventive care and prescription drugs are typically not as well
covered by insurance.
Elasticity of Demand for Health Insurance
Apart from studies on the responsiveness of the demand for health
care to price and income, there is growing attention to the respon-
siveness of demand for different health plans to changes in the price
of insurance. This literature is of particular importance when con-
sidering the demand for health care services provided by a particular
health plan. Any change in the out-of-pocket costs of services or
premium costs will have an effect on the number of plan enrollees
and, thus, on the demand for health care services paid for by that
plan.

Summary xiii
According to Royalty and Solomon (1998), “there is no definitely es-
tablished range of price elasticities [of health plan choice] in the lit-
erature.” Econometric studies of health care plan choice vary dra-
matically not only in their price elasticity estimates but also in the
data sources, econometric methods, and experimental design. For
example, the articles reviewed in this report use datasets of individ-
ual employees and their health plan choices in various professional
and demographic settings, such as a single university, 20 firms within
one city, a single company with four plants across the United States,
and a national cross-section, among others. Based on this literature,
the estimates of the elasticity of the demand for health insurance
with respect to price range between –1.8 and –0.1.
USING ESTIMATES FROM THE LITERATURE TO PREDICT
THE EFFECTS OF CHANGES IN THE MHS SYSTEM

The FY 2001 National Defense Authorization Act was signed into law
by President Clinton on October 30, 2000. Although the act contains
numerous changes, four new TRICARE initiatives will have important
effects on uniformed services retirees and their spouses.

Expanding pharmacy benefits for seniors to include access to
MTF pharmacies, the National Mail Order Pharmacy Program,
and retail pharmacies,

Making TRICARE a second payer to Medicare (TRICARE for Life),

Eliminating coinsurance payments under TRICARE Prime for
dependents of active duty personnel, and

Expanding TRICARE Prime Remote benefits to active duty family
members and nonuniformed service members.
All of these new initiatives expand services and reduce the costs of
health care for some group of MHS beneficiaries. Consequently, we
would expect to see greater demand for MHS services as these poli-
cies are implemented. For example, expanding pharmacy benefits to
seniors will likely increase the demand for pharmaceuticals paid for
by MHS as Medicare-eligible beneficiaries who previously paid out-
of-pocket for prescriptions will now get them through the TRICARE
program. In addition, the reduction in the price of prescriptions will
induce some beneficiaries to purchase a greater number of prescrip-

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