HLTH 4530 Week 3 Market Failure Essay Example

Three Places Where the Health Care Market Breaks: A Spinal Fusion Recommendation, a Supplemental Plan That Drew the Sickest Enrollees First and Tuberculosis Treatment That Protects the Neighbors, With the Institution That Grew in Each Gap

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Walden University

HLTH 4530: Healthcare Economics From a Population Health Perspective

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Month Day, Year

Three Places Where the Health Care Market Breaks: A Spinal Fusion Recommendation, a Supplemental Plan That Drew the Sickest Enrollees First and Tuberculosis Treatment That Protects the Neighbors, With the Institution That Grew in Each Gap

Introduction

A competitive market allocates goods efficiently under conditions that textbooks list: buyers and sellers are well informed, each bears the full costs and benefits of the transaction, and the product is standard enough to compare. Health care breaks these conditions in more than one place. In the paper often credited with founding health economics, Arrow (1963) traced medicine's unusual organization to uncertainty, both about falling ill and about whether treatment will work, and used it to explain why the industry runs on professional norms, licensing and trust rather than ordinary market exchange. This essay takes three separate breaks, information asymmetry, adverse selection and externalities, anchors each in a case and ends each section with the institution that grew up in the gap.

Information Asymmetry: The Spinal Fusion Recommendation

A 58-year-old warehouse supervisor with three years of low back pain sees a spine surgeon, who recommends a lumbar fusion. The patient has no way to judge the advice. He does not know how often fusion helps people with his kind of pain, what the alternatives are or whether the surgeon's judgment is typical. The surgeon knows far more, and is also paid to perform the procedure the surgeon recommends.

Arrow (1963) located the core of this problem in the nature of what the patient buys. The patient cannot test the product before purchase, cannot easily learn from repeat purchases and cannot judge the result afterward, because recovery or failure may have many causes. What the patient buys is a promise of competent effort, not a guaranteed result. The danger is that the seller's advice can shape the buyer's demand.

Variation in surgical rates suggests the danger is real. Using Medicare data for 306 hospital referral regions, Weinstein et al. (2006) found nearly a 20-fold range in regional rates of lumbar fusion among enrollees in 2002 and 2003, the largest variation seen with any surgical procedure, and Medicare spending on lumbar fusion rose more than 500% over the decade. Such variation does not prove that any individual recommendation was wrong, but it is hard to explain by differences in patients alone.

The institutions that grew in this gap are professional ones: licensing, which limits who may perform surgery; ethical codes that require the physician to put the patient's interest first; and second-opinion programs, which give the patient another informed agent. Arrow (1963) described these norms of trust as a response to the gap that prices cannot fill.

Adverse Selection: The Supplemental Plan That Drew the Sickest First

A composite regional employer, Hollis Freight, offers its workers a voluntary supplemental plan that pays extra benefits for hospital stays, priced on the assumption that its enrollees would be as healthy as the workforce as a whole. In its first year, enrollment comes disproportionately from workers who expect to need it: those with chronic conditions and those planning surgery. Claims run well above what the premium was set to cover. The insurer raises the premium for year two. Healthier workers, who were paying more than their expected benefits, drop out. The remaining pool is sicker still, and the premium rises again.

This is adverse selection. If the people buying coverage understand their likely claims better than the insurer pricing it, and the insurer cannot charge each according to that hidden risk, low-risk buyers drift away and the market can unravel. Rothschild and Stiglitz (1976) showed formally that competitive insurance markets with this kind of hidden information may have no stable equilibrium in which everyone is covered at a fair price.

A real case followed this path. Cutler and Reber (1998) studied Harvard University's employee health plans after the university changed its contribution so that employees paid the full extra cost of its most generous plan. Younger and healthier staff switched to lower-cost options, the PPO's premium climbed again, and within three years the university stopped offering it. The authors describe it as an adverse selection death spiral.

The institutions that grew in this gap pool risk deliberately: employer group coverage, which enrolls people for reasons other than their health; mandatory enrollment or automatic enrollment, which keeps low-risk people in the pool; and risk adjustment, which pays insurers more for sicker enrollees so they have less reason to avoid them.

Externalities: Tuberculosis Treatment That Protects the Neighbors

A 34-year-old restaurant cook is diagnosed with pulmonary tuberculosis. Treatment for drug-susceptible disease takes months of daily medication, and he begins to feel well after a few weeks. If he stops early, he risks relapse and drug-resistant disease, and he may infect his coworkers, his family and customers.

His decision to finish treatment creates a benefit for people who are not part of the transaction: they are protected from infection without paying anything. This is a positive externality. A market in which each person buys treatment only for their own benefit will produce less treatment completion than society would choose, because no one is paid for the protection their completed course gives others.

The institution that grew in this gap is public. Tuberculosis treatment in the United States is provided largely through health departments, often at no charge to the patient. National guidelines recommend case management and directly observed therapy, with a trained observer present as each dose is swallowed, as the standard of care for most patients (Nahid et al., 2016). The public pays for treatment completion because the public receives much of the benefit.

What the Three Have in Common

The three failures differ in kind. Information asymmetry concerns what the buyer knows about the product; adverse selection concerns what the seller knows about the buyer; externalities concern who receives the benefits. Each, however, produces the same result: a market left to itself would deliver too much of some care, too little of other care or no coverage at all for some people. And each has produced a nonmarket institution, professional norms, risk pooling or public provision, that health systems rely on.

Conclusion

Arrow's argument has held up for six decades because the conditions he identified still hold. Patients still buy promises they cannot test, insurers still face buyers who know their own risk, and some treatments still protect people who do not pay for them. The institutions built around these failures are imperfect, as the variation in spinal surgery shows, but they exist because prices alone cannot do the work.

References

Arrow, K. J. (1963). Uncertainty and the welfare economics of medical care. American Economic Review, 53(5), 941-973. https://www.jstor.org/stable/1812044

Cutler, D. M., & Reber, S. J. (1998). Paying for health insurance: The trade-off between competition and adverse selection. Quarterly Journal of Economics, 113(2), 433-466. https://doi.org/10.1162/003355398555649

Nahid, P., Dorman, S. E., Alipanah, N., Barry, P. M., Brozek, J. L., Cattamanchi, A., Chaisson, L. H., Chaisson, R. E., Daley, C. L., Grzemska, M., Higashi, J. M., Ho, C. S., Hopewell, P. C., Keshavjee, S. A., Lienhardt, C., Menzies, R., Merrifield, C., Narita, M., O'Brien, R., . . . Vernon, A. (2016). Official American Thoracic Society/Centers for Disease Control and Prevention/Infectious Diseases Society of America clinical practice guidelines: Treatment of drug-susceptible tuberculosis. Clinical Infectious Diseases, 63(7), e147-e195. https://doi.org/10.1093/cid/ciw376

Rothschild, M., & Stiglitz, J. (1976). Equilibrium in competitive insurance markets: An essay on the economics of imperfect information. Quarterly Journal of Economics, 90(4), 629-649. https://doi.org/10.2307/1885326

Weinstein, J. N., Lurie, J. D., Olson, P. R., Bronner, K. K., & Fisher, E. S. (2006). United States' trends and regional variations in lumbar spine surgery: 1992-2003. Spine, 31(23), 2707-2714. https://doi.org/10.1097/01.brs.0000248132.15231.fe