“Risk” is a term that comes up frequently when people discuss medicine and health: What’s my risk of heart attack? Breast cancer? What’s my risk of dying from a complication of surgery? Or having a dangerous reaction to a drug? But according to Mark V. Pauly, Wharton professor of health care systems, consumers don’t necessarily use that term in the same way that medical and insurance experts do — which is a potential pitfall that can lead to less than optimal health care decisions and faulty policymaking.

In the May/June 2007 issue of Health Affairs, Pauly takes an economic view of risk and says that the concept is often misunderstood when it comes to health and health policy. “The language we have come to use in describing health, healthcare and medical spending sometimes gets in the way of clear thinking and sometimes reflects (without being explicit) quite different ways of thinking,” he writes. “There is no better example of this than the use of the term risk. Policy discussions talk about ‘trade-offs between the risks and benefits’ of medical interventions, ‘pooling risk’ through insurance, and ‘analyzing risk’ in clinical decisions, often as if there were consensus on the meaning ofthe term risk but in reality using that single short word in a variety of ways.”

While flawed thinking about risk can cause consumers to make decisions they like at the time, they may end up with poorer health prospects and more financial risk than if they had followed a model known as “expected utility maximization,” Pauly says. Used primarily by economists and decision theorists, the expected utility (EU) model “values risky prospects as a weighted average of the possible outcomes, with the weights being the probabilities and the values being the utility consumers attach to changes in well being in each situation.”

Such an approach could be applied, for instance, to deciding whether it’s better to buy an insurance policy with a high deductible but excellent catastrophic coverage should you need it, or a policy with a low deductible that will offer you more coverage for routine, lower-end expenses such as a doctor’s visit.

Pauly’s article, titled “Risks and Benefits in Health Care: The View from Economics,” grew out of planning for a conference that looked at various aspects of risk. He is especially interested in how perceptions, or misperceptions, about risk play out in the public arena, whether in the design of the Medicare Part D prescription drug plan or in the many proposals being floated about to provide coverage for uninsured or underinsured Americans.

“In a democracy, it is hard for experts to override the misperceptions of citizens, especially misperceptions about risk,” he says. “The key public policy question is that of which choice or preference should government use in designing intervention?” Should lawmakers go for an economically sensible solution — which may turn out to benefit only a fraction of voters and perhaps only make sense after the fact — or should they adopt policy that is less than optimal from an economic viewpoint but nonetheless pleasing to a wide constituency?

No Easy Answers

By definition, risk involves uncertainty, something that makes people uneasy, Pauly notes. “It’s not just that they do not like bad outcomes; rather, they do not like not knowing what the outcome will be,” he writes. “In the achievement of health and the use of healthcare, risk is ubiquitous. I do not know what my health state will be in the future — what accident or illness might occur. If I am sick, I do not know for certain the outcome of treatments or medications; I hope for the best but realize that adverse side effects can happen. And from a financial perspective, I do not know what my medical bills will be.”

While economists use the expected utility (EU) model to explain how people tend to make decisions in risky situations, in the “real world people don’t always make decisions this way,” Pauly says. Patients often misconstrue risk when they’re deciding among various medications or treatments — say, an experimental drug versus a standard treatment — or when deciding whether to purchase health insurance and what type and level of coverage to select.

“Consumers seem to value insurance that is likely to pay them back money to get a return on their investment,” he says. That’s different than viewing health insurance as protection against the risk of catastrophic illness, which probably won’t happen but could send the patient into financial ruin if it did.

“Some might reason, ‘I paid for this insurance for so many years and hardly ever used it. That was a bad decision,'” Pauly says. “The expected utility model in economics says, ‘No, that wasn’t a bad decision because had a catastrophic thing happened, you would benefit so much from the insurance that it would offset all the years of paying and getting nothing back.'”

Although most insurance policies offer coverage for big-ticket items such as inpatient hospitalization, a handful of health plans are attempting to attract lower-income, uninsured workers with low premiums that cover some outpatient services, which are more likely to be needed, while leaving less likely but far more expensive hospital costs uncovered or only partially covered. That approach, while perhaps appealing, is problematic from an economic standpoint, Pauly argues. Even though you’re much less likely to be hospitalized than require a doctor’s visit, “you want to protect yourself against the day of doom.”

Young adults, in particular, fail to weigh risk optimally, thinking they shouldn’t spend money on a policy because their chances of falling seriously ill are small. In this case, one possible solution is designing a health plan exclusively for young people, Pauly suggests. “They might agree to contributea payment to a young people’s mutual insurance plan, in return for the promise that if they are right and are all low users, premiums will be refunded. Such a plan would agree to pay back ‘dividends’ to policyholders if benefits pay-outs are low; usually these payments are used to lower future premiums. Thus, young people who think that they rarely get sick should still be willing to join this plan as long as they know that the other insured people are like themselves and have the same risk as they — whatever that risk ‘really’ is.”

Medicare and New Drugs

Politics can unduly influence decisions that involve risk, according to Pauly. The Medicare Part D prescription drug plan for elderly Americans is an example of health policy that is based not on a rational response to risk, but rather on “political catering to consumers’ misperceptions.” The plan, while providing coverage at the lower and upper ends of expenditures, allows for a coverage gap in the middle.

“In particular, the stylized form for the new middle-class Medicare drug benefitis not full (catastrophic) coverage above a deductible but rather is so-called doughnut coverage, with a modest deductible, then 75% coverage over a range of expenses, then 100% cost sharing (the ‘doughnut hole’), and finally a return to virtually complete catastrophic coverage,” he writes. “Compared to traditional catastrophic coverage with a deductible,the politician-designers of Part D reduced coverage for people with high expenses (where, in theory, people would have gotten the most utility value from coverage) to offer rather generous coverage for people who happened to have low expenses (where, in theory, coverage should be less valuable), to provide most beneficiaries with a return on their premium.”

It would have made sense to concentrate more of the Medicare prescription drug money on upper-end, catastrophic coverage, Pauly says, but politics won out. “The gap in the middle doesn’t make much logical sense, but it allows the politicians to say that a large number of elderly people will benefit from this plan.”

Proper risk assessment is also critical for new drug treatments. Patients and doctors often weigh the pros and cons of one treatment versus another, and policymakers also wrestle with the tradeoffs between risks and benefits. Many patients think the Food and Drug Administration should do more to ensure the safety of new drugs and expose potential side effects before a drug comes into widespread use. Patients who have a life-threatening illness for which there is no effective treatment, however, may be willing to assume the risk of taking a drug that hasn’t been studied very long if it offers them a shot at a cure.

“There is a tug of war between the two mindsets,” says Pauly. “In the EU model, decisions cannot be based only on clinical or medical knowledge but depend in part on patients’ preferences, about which the FDA has no great expertise. The real question is which (or whose) preferences should dominate…. Virtually any product will be too risky for the most risk-averse people, but any delay will be too long for many more willing to take a chance for a much better outcome.”

Also in the equation are the interests of pharmaceutical companies, which want the FDA to approve new drugs as quickly as possible so they will begin getting a return on the money they spent in development.

Pauly says patients with advanced cancer now are arguing for something closer to the EU model when it comes to approval of new drugs. They are willing to run the risk of side effects from treatments that hold a promise for remission or cure because they attach more value to the possibility of good outcomes and less value to the possibility of side effects. The FDA and its expert panels, on the other hand, place more weight on the risk of side effects.

Meeting of Minds

In his article, Pauly notes that there has been some meeting of the minds when it comes to differing perceptions of risk. The National Vaccine Injury Compensation Program is one example.

“This program arose in part because different groups had very different views on the risks posed by pediatric vaccines. Some people believed that there was a high risk of side effects; others, that it was low,” he writes. “The strategy then was to levy what effectively was an excise tax on vaccine sales, use the proceeds to set up a trust fund, and pay claims for actual damages (on a no-fault basis). After an initial flurry of payments for previous injuries, the level of payments fell dramatically, and the trust-fund balance grew. Those who thought that adverse effects would be common turned out to be wrong. But the point is that those who thought side effects unlikely expected to get money back, and those who thought them likely felt that they were protected; both groups could agree with the proposal.”

Pauly expects health care to be a major issue in the 2008 presidential campaign, but he doubts there will be solutions anytime soon to the problems of uninsured Americans and rising costs of health care. And no matter what, issues involving risk will continue to be up for debate by patients and politicians alike.

“Given the difficulty people have in understanding risk, much less dealing with it optimally, there might be a role for public policy,” he writes. “But it is far from clear how the objectives of that policy ought to be defined.”

He says, for instance that health policy could be determined by a “Man of the People” strategy, where policymakers make their decisions based on the public’s perceptions of, and preferences about, risk. At the other extreme, health policymakers could force “EU-maximizing outcomes on a reluctant public,” even if it means disappointing many people who would end up not benefiting from the policy.

“It is still far from clear whether there are better ways of defining the objectives of policy or even framing the choices, but the stakes are high enough that we should keep trying,” he says.