Health Insurance and the Demand for Medical Care: Instrumental Variable Estimates using Health Insurer Claims

Although it has been more than 30 years since the RAND experiment was conducted, it remains the gold standard for understanding consumer responsiveness to out-of-pocket price. However, the study has several limitations. Most importantly, since the study was conducted, the share of GDP devoted to medical care has doubled and medical technologies have changed substantially. These dramatic changes suggest that the evidence from the RAND experiment may be relatively dated and there are also questions regarding medical care demand that remain unanswered in today's environment. Consequently, researchers have continued to search for alternative approaches to estimating the demand for medical care.

This paper takes a different approach to estimating demand, which relies on an often noted industry feature: the out-of-pocket price paid by the consumer is typically not the same as the full price paid to the medical care provider (i.e., the allowed amount). With this in mind, this paper argues that the negotiated price between insurers and medical providers in an MSA may be thought of as a textbook "cost shifter" instrument. The theoretical justification is clear: the package of benefits offered to enrollees will be affected by profit maximizing insurers responding to the negotiated price for medical services in an area. At the same time, the negotiated price should be uncorrelated with the selection of an insurance plan, since consumers are typically unaware of the negotiated prices with providers.

The demand model is estimated using individual micro data from the MarketScan commercial claims database for the years 2006 and 2007. The MarketScan data is a convenience sample of enrollees from insurers and large employers. The data includes the demographic information of individuals, such as the age, sex, and type of insurance plan. Most importantly, the data includes information on the medical conditions of the enrollees, utilization of medical care services, and expenditures. The expenditure data indicates both the amount paid out-of-pocket by the enrollee and the total allowed amount paid to the providers.

The main result of the paper is that the individual price elasticity of medical care utilization is about -0.20, which matches the estimate found in the RAND study. Following the RAND study, this paper looks at price responsiveness at the disease episode level, investigating the effect of price on the intensive margin (i.e., utilization per disease episode) and the extensive margin (i.e., the number of episodes). Similar to the RAND study, price responsiveness on the intensive margin accounts for only a small fraction of the total elasticity. Most of the individual responsiveness to the out-of-pocket price is on the number of episode occurrences. These findings confirm the relevance of the RAND estimates in the current environment and outside of the experimental setting. Overall, the methodology and empirical findings in this paper are of general interest as they uncover a new way of identifying consumer responsiveness from real world price movements.