Tuesday, February 21, 2012

Ridiculous debates on funding health care in Australia

There is a detailed academic debate surrounding health care funding and provision in Australia (as there is globally). 

But the debate is clouded by observer bias – by the relatively wealthy senior academics, government officials, and consultants, who provide the analysis in the policy-making environment.  If everyone involved feels burdened by their own choice to send their children to private school, or irrationally choose private health insurance, because of a culture of social class bias, what type of policy recommendations can you expect?

Consider the King-Gans argument, based on a theoretical micro-economic model of health insurance developed in this paper.  The model assumes individuals with perfect knowledge of future health care needs, which leads to a massive adverse selection problem for the private health insurance market.  After a few pages of intellectual mathematical masturbation, the conclusion follows that –
…those in society who are most likely to be ill will ‘opt out’ of public insurance and purchase private insurance. The public health insurance will only be used by those in society who are healthiest (i.e. least likely to become ill). The high-risk individuals are made worse off by the public insurance because they are required to cross-subsidise the public insurance of the low-risk individuals through the tax system (my emphasis).
This conclusion completely contradicts the current reality in Australian health care, whereby the public system typically deals with the most serious cases of trauma and chronic illness.  While the model conclusions are laughable, the policy implications that follow from this model outcome are being taken seriously. It's a worry.

As far as the details of the model are concerned, we all know the best measure of a model’s usefulness is how well it predicts outcomes.  The King-Gans model requires the following assumptions to come to the conclusion that a mix of private and public insurance will result in higher cost to the most ill people, because only the most ill will choose private health insurance –

1.     Adverse selection of private health insurance by a set of people who happen to know in advance their future health care needs and probability of illness
2.     People value actuarial fair insurance.  That is to say that they value insurance only as a tool for spreading health costs over their lifetime.
3.     They assume a perfectly competitive private insurance market.  While the market is good, I would be hesitant to got that far, but it is probably okay.
4.     They assume there are not ‘too few’ people with a high risk of being ill who know their risk in advance.
5.     They assume identical income for all individuals at a level that justifies PHI for those individuals who know their risk of illness, and subsequently their expected future health costs, in advance.
6.     The ignore all externalities associated with health care.

For me, apart from the above-list of possibly unrealistic assumptions, the analysis ignores the critical fact that risk averse wealthy people will both choose private health insurance (PHI) AND preventative health care through healthy living choices.  PHI is a complement to better voluntary health choices, so we should expect that private patients are typically the healthier members of society, and the publicly funded public hospitals will be treating the most ill patients.

This paper, by Buchmueller et al., finds empirical evidence that contradicts the result of the King-Gans theoretical model.  They find that there is beneficial selection of PHI in Australia, meaning that the healthiest people tend to be privately insured.  May I suggest this conflict between empirical ‘reality’ and theoretical abstraction is the result of the above ignore concept of complementarity of PHI and healthy lifestyle choices.

The conflicting result is also a product of ignoring the relationship between income, health, and PHI.  Higher income people both typically value health more highly (since the can, even though it may not be as high as a proportion of their income of many not-so-wealthy individuals), and are incentivised to be covered by PHI through tax rebates.

The second major shortcoming of the King-Gans model, and the analysis of health care funding and insurance more generally, is that it ignores the fact that end of life health costs are unavoidable.  Death is usually a costly process.  Thus, there is no way to adversely select health insurance for these ‘death costs’ in advance.

Third, many PHI covers are incomplete covers.  That is, that when a health service is claimed against the insurance cover, the reimbursement is a fraction of the total cost, and there are still out-of-pocket costs for the patient.  Thus, for anyone expecting to require a lot of non-elected medical care, public health provision may be the rational choice, given the risk-adjusted premiums for the most comprehensive PHI cover.

Fourth, PHI is incomplete in terms of scope of medical coverage.  Emergency departments, for example, are typically the domain of public hospitals, treating public and privately insured patients at public cost. 

In all, these overlooked considerations render the theoretical outcomes of the King-Gans model inaccurate, and the policy implications that follow from it to be counterproductive.  The reality of beneficial selection of PHI means that wealthy sick individuals are provided a premium health insurance service, because their insurance funds are pooled with a selection of healthy people, to offer an attractive way of making elective health services more affordable.

While King and Gans acknowledge some of these shortcomings, they stand by the conclusions of their model, which feed into their policy recommendations.  Given their academic reputations in the policy-making community, this is dangerous territory.

Finally, my personal gripe with the paper, and the policy agenda being pushed of a result of this (and similar) analysis, is that it ignores the social agreement that has evolved to the current provision of a pooled national health insurance program.  When PHI coverage was over 70% in the 1970s, reforms were aimed at generating a more equitable and broader system of public health coverage.  The very nature of a mostly private health care system is that the unhealthy poor have both the highest need, and the least ability to pay for health services.

That basic philosophy of public health care is that national insurance, funded in a progressive manner through the tax system rather than through actuarial risk-reflective premiums, is provided by publicly run enterprises to fulfill equity considerations (for example, geographically equitable access to health care) and provide broad external community benefits by having a healthier population.

It is also easier to evolve a publicly run system of hospitals and health services to become a platform for implementing auxiliary health policy goals, such as vaccination programs, education programs, doctor training programs, and research.  The current system provides, on the whole, quite a reasonable combination of the benefits of both a private and public system, even if it does perpetuate notions of social class in Australia.

All things considered, the legislation currently being proposed to remove the income tax rebate for individuals covered by PHI may actually promote a more effective market for PHI to offer simple top-up coverage at reduced cost, and generate a welfare shift from the wealthy insured to the poor uninsured. Back in 2004, Dawkins et al. noted that the implementation of the 30% rebate for PHI in 1999 (following more subtle incentives in 1997 and the implementation of ‘lifetime’ health cover) made those on high incomes better off –
There is strong evidence that not only a larger number of households of higher income and socio-economic standings responded to the policy changes, but also they were more likely to have PHI even without the policy changes. These latter households enjoyed “deadweight benefits,” in the sense they needed no such benefits to purchase PHI to begin with. Given that households who took up PHI ought, by their revealed preference, to be better off, we can reasonably conclude that households with high income and socio-economic standings are the main beneficiaries of the policy changes.
As we have seen above, the idea that the ill rich are paying twice for health care is surely not at all representative of the present situation in the Australian health care system, and furthermore, policy advice derived from a bizarre theoretical model whose results oppose the empirical evidence should be carefully scrutinized with a dose of old-fashioned commonsense.

Sunday, February 12, 2012

US gas glut may dampen energy markets

Article first appeared at MacroBusiness

The US economy has shown some signs of stabilisation over the past few months.  For example, retail spending appears to be revisiting a growth path.  According to some commentators, the US economic green shoots appear robust and healthy, while I remain cautious about projecting anything more than muddling though, with a drawn-out grinding improvement in employment as the consumer debt burden is reduced by inflation, repayment and default.

The US ‘recovery’ is the result of many factors, including the relatively cheap US dollar (the US TWI is back at levels last seen in the mid 1990s), but importantly, and often overlooked in financial discussions, relatively cheap domestic energy fuel prices.  WTI crude is hovering around $100/barrel, still 25% down on the pre-crisis boom period.

But the key energy consideration for the US recovery, and future US political–economic trade policy, is the current domestic natural gas boom which has meant the US has shifted from gas net importer to net exporter.

Below we can see the recent rise in natural gas production, mostly as a result of the emergence of economical shale-gas extraction, for the past three years or so.  With natural gas comprising a quarter of domestic US energy needs, the scale of this boost in energy supply is significant.  Some have gone so far as to suggest that the natural gas boom, as a result of fracking and coal seam technology, is leading to a ‘new world energy order”.

We can also see that the US domestic spot price for natural gas has remained quite subdued in this period due to a combined of demand destruction, particularly during the financial crisis period between 2008 and 2010, and increased domestic supply.

The US government closely regulates natural gas exports, and any import or export of natural gas requires approval of the Department of Energy, as per Section 3 of the Natural Gas Ast 1938. (approvals in progress are here).

Debate is now brewing over the direction of US energy policy in the treatment of export approvals for the natural gas glut, given the significant profits to be made from liquefaction and export to Asian markets.
As the Wall Street Journal notes:
The U.S. already exports some natural gas, mostly via pipeline to Canada and Mexico. A recent wave of export proposals by energy firms seeks to liquefy gas and ship it overseas in tankers.
U.S. natural-gas prices have fallen below $3 per million British thermal units, pushed down by swelling production that became possible with the advent of new drilling technologies. With prices so low, U.S. producers are eager to reach customers in other parts of the world, such as Japan, that pay three to four times as much as U.S. users.
Collectively, they want to ship out about 14 billion cubic feet of natural gas a day, roughly 20% of current U.S. production.
But some lawmakers on Capitol Hill are opposed to increased exports and are urging the Department of Energy not to issue the required permits. The department will use the findings released Thursday in making its decision.
The administration is reviewing the export proposals “to ensure they are in the best interests of American taxpayers,” Energy Department spokeswoman Jen Stutsman said.
One argument is that maintaining a tight limit on exports will keep the domestic price low, and domestic energy intensive industry more globally competitive:
 The estimate by the Energy Information Administration, which compared gas-price projections in given years with and without higher exports, appeared to bolster assertions by U.S. manufacturers that they could face stiffer prices for natural gas and lose a competitive edge over companies abroad.
“Higher levels of exports would certainly impact the manufacturing recovery that has been revitalized in the U.S.,” said George Biltz, Dow Chemical Co.’s vice president for energy and climate change. “Exporting too much natural gas simply exports well-paying U.S. jobs.”
US Energy Information Administration (EIA) analysis of price impacts from increased exports shows that, under various scenarios, of high and low growth paths for shale-gas production, and rapid and slow scale up to exports, domestic price increases could be in the order of 15-35%, depending on the speed of development of export capacity.  See their chart of model results below.

As secondary concern has been whether exposing US domestic natural gas production to the global market will import price volatility due to global events.  If export capacity is high enough, this may be the case.  But if export capacity is limited by physical capital – the number and size of pipelines, and finite capacity of LNG conversion and loading facilities which would require a decade or so lead time to expand – then domestic prices will not capture global volatility, as high prices cannot be passed through to the domestic market.

The big question for US energy policy, is how best to share the benefits of this new energy supply.  The way I see it, maintaining tight control on export markets keeps prices for domestic gas users at a globally low level, making a diverse range of US industries more globally competitive.  However, this benefit comes at a cost to the gas industry that is being denied access and profits from global markets, such as Japan, Korea, China and India, where gas prices are significantly higher.

Indeed, allowing exports would in a way provide economic benefits to the destination countries, as the global price of LNG will be reduced as the increased supply comes on board.  For Australia, where the infant Coal Seam Gas (CSG) industry is being relied upon as a driver of economic growth, increased global competition in the gas market from US exporters may be cause to pull pack some of their price forecasts in the short term. Last week, Fitch placed the entire sector on negative watch for this reason among a growing list of other negatives.
The current US debate is interesting from the lens of an Australian resource State, where almost all energy resources are developed for export markets.  It is surely inconceivable that Australian authorities would consider such regulation to ensure competitiveness among our own industry. (Although, as mentioned earlier, the ability for export markets to compete with domestic energy markets is dependent on the interconnection of the supply chain.)
It is worth keeping a close eye on how US energy policy plays out in the treatment of the shale-gas boom, and the potential implications for LNG markets globally.

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