Monthly Archive
A Recipe for Reform
<< Back to Part I: How Insurance Works
<< Back to Part II: How Medical Insurance Was Broken
<< Back to Part III: Medicare
“Reality is that which, when you stop believing in it, doesn’t go away.”
– Phillip K. Dick
In this last installment I’d like to propose some solutions for policymakers, for doctors and for patients. My recommendations may be quite politically naïve, in that they are currently unpopular and are not likely to gain favor with politicians. But I believe they are economically sound. Popular opinion is fickle, but economic fundamentals are eternal. So the ideas will wait for an eloquent politician to popularize them, and in the meantime we will race in the opposite direction.
Recommendations for Lawmakers
The employer tax deduction for health insurance should be abolished. This action by itself would have a major positive impact, untying insurance from jobs and unburdening companies from crushing healthcare costs. Companies would go back to giving employees salaries and employees would do what they already do for houses, cars and food: they would shop around. Healthcare spending would plummet, so doctors’ lobbies and hospital lobbies are against it. (Another reason I’m not in the AMA.) Patients would buy cheap catastrophic policies and get rid of their expensive “everything’s covered” policies, so the insurance companies would oppose it. But patients and taxpayers would be much better off. Who represents them?
Most importantly this change would shift the debate from the mirage of universal coverage to ensuring the availability of high-quality affordable care. Getting everyone insurance isn’t the goal (unless you’re an insurance company). Getting everyone many choices of healthcare with reasonable prices and good quality is the goal. We should watch the universal coverage experiment unfold in Massachusetts very carefully before we spring this model on the nation. Early observations suggest that everyone there is insured and no one can find a doctor. I hope Part II of this series convinced you that insurance for routine care is the problem, not the solution.
A public debate should be reopened about the justification for Medicare. Why should age alone guarantee government sponsored insurance regardless of income or assets? Remember, there is already another program (Medicaid) for the indigent and the disabled. Any effort to limit Medicare benefits will be vigorously opposed by senior-citizen lobbies and by doctors’ and hospital lobbies. And enough people depend on it currently that simply abolishing it would not give current beneficiaries time to make alternate plans. My suggestion is that the age for Medicare eligibility should be increased by one year every two years. That way, no current beneficiary ever loses benefits, but as time goes on the age for enrolment would creep ever higher. So a current 60 year-old will not be able to enroll until the age of 70, and a current 40 year old will not be able to enroll until he reaches 90 (and will have plenty of time to budget for his health expenses).
In 1965 the first generation of Medicare beneficiaries never paid into the system. They were already retired and their benefits were supported by the working employees of that time. Conversely, there will have to be a generation which pays the payroll taxes for Medicare, but never gets the benefits, a generation which makes the financial sacrifice to phase out a destructive and unaffordable program. Should we accept that burden, or pass it to our children?
Recommendations for Doctors
To the extent that each doctor can afford to do so, doctors should remove themselves from contracts with insurance companies, especially with Medicare. This would force doctors to adopt business practices that are standard in other service industries: transparent reasonable prices, attentive customer service, and competition with other doctors on both quality and price. Doctors who opt out of Medicare save Medicare money, leaving more money for those with fewer options.
Doctors should donate some of their time to caring for indigent patients.
Doctors should not join physician lobby groups which aim to increase or maintain spending on healthcare.
Recommendations for Patients
To the extent that each patient can afford to do so, patients should buy catastrophic (i.e. high deductible) insurance and pay for routine care themselves.
Retirees should not join lobby groups which aim to increase or maintain spending on Medicare.
The national tide appears to be favoring taking ever more dollars and options away from patients and giving them to insurance companies or to the government. This promises to worsen the problems we learned about in the previous sections. Treating patients as customers is the only path forward.
“Facts are stubborn things; and whatever may be our wishes, our inclinations, or the dictates of our passions, they cannot alter the state of facts and evidence.”
– John Adams
———————————————————————————-
Notes and Sources:
I owe much of my understanding of how insurance companies and doctors could function in free markets and how the healthcare marketplace has been corrupted to an article written in 2001 by Milton Friedman, the Nobel laureate economist, How to Cure Healthcare. Though its conclusions may not be popular I have not seen its ideas convincingly refuted. I recommend the article to anyone who wants a more detailed understanding of the economics of American healthcare.
A more thorough description of the American healthcare system and how to fix it is in Dr. David Gratzer’s book The Cure: How Capitalism Can Save American Health Care which I reviewed two years ago.
The fact (in Part III) that Medicare costs doubled every four years between 1966 and 1980 is found on the Wikipedia article on Medicare which has some other important but little-known facts about Medicare.
You can learn more about the effects of Massachusetts’ universal health insurance program in this Wall Street Journal Health Blog post: As Insurance Coverage Increases, ERs Get Busier and in this Wall Street Journal editorial: National Health Preview, The Massachusetts debacle, coming soon to your neighborhood.
Posting will be on hiatus for two weeks and will resume the week of July 13.
I’ll post the last part of The Healthcare Meltdown later this week, but meanwhile a quick post that deserves your attention.
What’s worse than a product that has never been shown to have any benefit whatsoever? A product that has never been shown to have any benefit whatsoever and has serious side-effects.
Last week the FDA warned that Zicam zinc-containing nasal cold-remedies have been implicated in over 130 cases of long lasting or permanent loss of smell. (Here’s a fun new word for you. Anosmia is the medical term for the absence of the sense of smell.) The FDA makes the point that the sense of smell is important for smelling smoke, a gas leak or spoiled food. This is true. The sense of smell is also critical for smelling a rose by any other name, smelling napalm in the morning, and sorting out who dealt it.
So please throw out your Zicam. Remember, no medicine or supplement has been shown to decrease the duration of the common cold. Sometimes the truth stinks.
Learn more:
FDA alert: Loss of Sense of Smell with Intranasal Cold Remedies Containing Zinc
My post about zinc for the common cold: Zinc Unproven in Treating Common Cold
Medicare
<< Back to Part I: How Insurance Works
<< Back to Part II: How Medical Insurance Was Broken
Thanks for sticking with the series so far. I know the last section was long and technical and I appreciate you slogging through it. The next parts should be a breeze in comparison.
In part II we saw how the employer tax deduction for health insurance tied insurance to jobs, transformed insurance from a protection against disaster to a way to obtain all care at a discount, and led to overutilization of care by shifting costs away from patient payments to premiums taken out of paychecks. Tying health insurance to patients’ jobs created another problem. It left retirees out of the tax subsidy that employees enjoyed. As healthcare became more and more expensive there was increased political pressure to extend affordable coverage to retirees.
(Note again how after World War II the language changed from getting patients high quality affordable care to getting them insurance coverage. Insurance became essentially the only way to access care.)
A simple way to even the playing field for retirees and to undo the myriad problems detailed in the last post would have been to eliminate the employer tax deduction. But doctors and hospitals were not keen on giving up their enormous subsidy. So in 1965 the Social Security Act created Medicare (and Medicaid). Medicare provides health insurance to Americans 65 and older and is funded by a payroll tax.
Medicare magnified many of the problems of the employer tax exemption. By creating a whole group of patients whose care was paid indirectly by all employees, costs were redistributed over even more people, further reducing any incentive to conserve. Utilization and costs rose even faster. The cost of Medicare doubled every four years between 1966 and 1980. This explosion in costs further cemented the fallacy in the minds of most patients that care is something that can only be obtained through insurance.
Now, I take care of lots of Medicare beneficiaries, and I can hear some of you objecting: “I might be able to afford to buy insurance if I didn’t have Medicare, but lots of people couldn’t. Have you seen how much medicines and doctor visits cost? Most people just can’t afford that.”
But that’s just it. Medicines and healthcare are expensive because they’re covered by insurance and patients aren’t exposed to the actual cost. There’s no viable business that produces goods and services that no one can afford. If patients paid directly, prices would plummet and patients (not insurance bureaucrats) would have to make the difficult decisions about how much they wanted to spend for the latest drug when a cheaper one is almost as good, or for the latest unproven surgery, or for the latest unproven scan. The point is that different patients would make different decisions, but many would save a lot of money by consuming less care than they do now. Catastrophic insurance would then be inexpensive and rarely used.
There would always be the truly indigent who can not afford any care at any price. They would rely on Medicaid, county facilities and private charities. But like in other marketplaces such as food, housing and transportation, that would be a tiny fraction of the population. Most people could afford their own care. The miscalculation that the insurance industry wants you to keep making is that insurance is what makes care affordable. Insurance, including Medicare, is what makes care unaffordable.
Next week, I’ll propose some changes that would actually help, though they are less likely to happen than that I am drafted by the Lakers.
How Medical Insurance Was Broken
<< Back to Part I: How Insurance Works
In the last post we learned the legitimate valuable role that insurance plays in collectivizing risk. In this post I will explain how that model broke for health insurance and how we are still suffering the consequences.
It seems incredible that our current difficulties with healthcare originated in the 1940s, but that is exactly the case. During World War II the federal government imposed wage and price controls. Because wages were kept below their market value, companies had a hard time attracting excellent applicants. So to circumvent the wage cap companies began offering increasingly generous fringe benefits. One of these benefits was health insurance. Employer-provided health insurance became so popular that Congress passed a law making it tax deductible. The wage and price controls were abolished after the war and are long forgotten, but the employer tax deduction for health insurance is with us over six decades later and has thoroughly disfigured the healthcare marketplace. Let me explain how.
Remember the example of Bob’s Insurance Company in the last post? Imagine, for example, a world in which employer-provided home insurance became tax deductible. Everyone would get their home insurance policy through their work. Let’s also agree, just to keep the numbers simple, that most employees pay about a quarter of their income in taxes. The homeowner’s policy in the last post cost $1.50 per year, but prior to the tax exemption law each family would have to generate $2 in income to pay 50 cents in tax (25%) and have $1.50 left over to pay as their insurance premium. After the tax exemption law passes, their boss can buy insurance for each employee for $1.50 pre-tax, leaving the $0.50 for additional salary or other benefits. But this also completely skews what insurance can and should be used for. In the last post we explained why insurance was a terrible deal for routine, frequent expenses. Now, imagine that having a gardening service cost $150 per month. Prior to the tax exemption, this would require $200 in pre-tax income (since a quarter, or $50 would go to taxes). But now, Bob has a strong incentive to sell a policy that pays for gardening. He can offer the policy for $175 per month, which the employer can deduct from the employee’s salary. Since employers can get the insurance with pre-tax dollars, it’s suddenly cheaper to hire a gardener through your job-offered home insurance than directly. Everyone wins in the short term: Bob can pay the gardener $150 and still make $25 in profit. The employee gets a gardener for $175 rather than $200, and the employer saves on payroll taxes.
See what’s happened? The tax deduction has made it cheaper to buy something through pre-tax insurance than to buy the same thing directly with post-tax wages. Suddenly the insurance company has been transformed from a protection against unpredictable and unaffordable disaster to a way to get routine services at a discount.
Obviously, in the real world the tax deduction was for health insurance not home insurance. Now we begin to understand why health insurance has become so dysfunctional, even though most other types of insurance (think of life, auto, home…) are relatively inexpensive and almost never used. The reason is that it became cheaper for all of us to get routine care through our employer-provided insurance rather than to pay for it ourselves.
But this had other destructive consequences. First of all, it ties our ability to obtain routine healthcare to our job. Unlike equally important goods and services, like food and housing, if one loses one’s job in this new system, one usually loses access to healthcare. In the old system healthcare was just like food and housing – your employer gave you a salary and you shopped for the quality and price that was right for you. If you lost your job you might have less money, but you were still in control of what you wanted to spend your money on. You could still afford a doctor’s visit. Even if you briefly lost your insurance, that wouldn’t have been as big a loss as it is today, since insurance only covered a disaster. Now, insurance is the key to the doctor’s waiting room.
This handcuffing of employees to their jobs would have been bad enough, but the tax deduction had other perverse incentives. For the employee, it made healthcare expenditures cheaper than general household expenses. Using the simple example of 25% taxes, $400 in income can be used to either buy $400 in additional health insurance or $300 in other household expenses (after paying $100 in taxes). So this scheme encourages more spending on healthcare and less on everything else. Of course, doctors and hospitals didn’t complain as this amounted to a huge (but hidden) tax subsidy of the healthcare industry.
But a bigger problem caused by the tax exemption was that suddenly routine care was “covered”. To individual patients/employees that meant that their employer was paying for their routine care by paying for their insurance and that their out-of-pocket expense for any specific item of care was very low. This encouraged over-utilization. Any economics student knows that when anything gets cheaper consumers will demand more of it. Routine care became cheaper to the patient, so patients wanted more. But remember what we learned in part I. Redistributing cost through insurance doesn’t make anything cheaper. It adds a layer of expense since the insurance company keeps some of the money as profit. But this additional expense isn’t paid by the patient at the time care is delivered. It’s siphoned out of his paycheck whether he goes to the doctor or not. Each visit is cheap to the patient, so there is no incentive to conserve; the only incentive is to consume.
Predictably, utilization of healthcare and prices for services exploded. In fact, since World War II healthcare has consistently risen in price more than the general inflation.
This led to efforts to control costs and utilization through increasingly complex bureaucracy. Managed care was born. Physicians had to comply with progressively more onerous rules about what was covered and what wasn’t. Increasingly physicians worked for a boss other than their patient who dictated the quality and the reimbursement for the care they delivered. Patients found themselves unable to demand quality and shop for a better price (like they could in every other marketplace) while the amount taken out of their paycheck for their insurance continued to climb.
To summarize, the employer tax-deduction for healthcare led directly (though unintentionally) to a system in which
This sounds horrific enough, but in 1965 we demonstrated that no marketplace is so terrible that we can’t make it worse. That will be the subject of next week’s post in part III. In two weeks the series will conclude with my suggestions of some ways out of this mess.
Forward to Part III: Medicare >>
Forward to Part IV: A Recipe for Reform >>
How Insurance Works
For many families healthcare is increasingly expensive while simultaneously increasingly mediocre. A recent study in the American Journal of Medicine found that two thirds of bankruptcies were due in part to medical expenses, and surprisingly, over three quarters of the individuals going bankrupt had health insurance. There is no denying that the American healthcare marketplace is broken. The problem for many of us is that we don’t know enough history to understand how it broke and we don’t know enough economics to know how to fix it. So we’re left listening to politicians, insurance lobbyists and doctors’ groups each of whom have their own (self-interested) agenda.
I would like in the next few posts to explain how American healthcare got here. The complexity of the problem works to our disadvantage because it makes us reach for any solution without understanding the details, and some of the currently proposed solutions would be even worse than the status quo. (And some solutions have already been tried in other countries or in American states with disappointing results.) Every involved group has a lobby advancing their interests except patients and taxpayers (who are approximately the same people), so it’s hard to imagine a good outcome unless we all accept the difficult burden of democracy: informing ourselves.
The following may be condescendingly obvious to those with a math or economics background, but please bear with me as I try to clarify the details to a broader audience.
Before we start, we have to understand the legitimate purpose of insurance and how it works in settings other than healthcare. That’s the goal of this first post.
To understand the point of insurance, let’s imagine a world in which insurance hasn’t been invented yet. Let’s imagine a city of a million homes and let’s say that the homes average one million dollars in value. Now, occasionally some unforeseen disaster happens – a fire burns a house down. And let’s also assume that this happens on average to one home per year. To the average family in this town this would be financially ruinous. They would be unable to afford rebuilding their home and would lose the lifetime of work that was their equity in their home. Besides the families who are irreversibly impoverished by the actual fire, many other families are very worried that their house could be next.
So one of the town residents, Bob, finds a solution. He realizes that the loss of a house is too big of a loss for any single family to afford, but not for the whole town. So he suggests that the town protect itself by having each family pay $1.50 into a fund every year. That fund would be used to rebuild any house that is lost to fire. Since on average the fund would pay out $1,000,000 every year but would take in $1,500,000 (since a million families are each paying $1.50) there should be extra money left over to pay Bob to handle the administrative work, make a profit, and save for the occasional year that two houses burn down. Thus the first insurance company is born.
The important points to learn here is that the town is losing money on every house it rebuilds, since it’s paying a middleman, Bob, to rebuild the houses. It’s paying a million and a half annually for a million dollar house. Nevertheless, everyone wins, because what each family is purchasing with the extra money that Bob keeps is peace of mind. By collectivizing their risk, they each lose a little money but avoid going broke. That’s the legitimate service that insurance provides: the insurance company takes a risk off your hands and makes a profit for doing so.
The take-home points are that
So in general you should never buy insurance against an event that is affordable. For example, buying an extended warranty on a new TV is rarely a good idea. If the TV breaks, most of us could survive without it until we saved up enough to buy a new one. Buying the insurance just means paying extra to buy it through the middleman. Since the company selling you the insurance knows the likelihood that it’ll break (and you don’t) the price of the policy will always be more than enough to cover the risk and make the company a profit. Unless you’ll lose sleep about the event you’re insuring against, that’s a bad deal.
For the same reason, it doesn’t make sense to insure against an event that happens frequently. For example, if the residents in Bob’s town wanted their insurance policy to also pay for their weekly visit from the gardener or to repaint their house every year, they would be foolish. Bob would be happy to sell them such a policy, but would charge them more than the gardener or the painting would cost. It’s much cheaper for each family to pay for predictable costs themselves and only buy insurance for rare and devastating ones.
This is how most insurance works when it works well, and this is how American health insurance worked for a long time. It covered only catastrophes. For everything else, patients paid themselves. Doctors and pharmacists set their prices and patients paid them. Health insurance was relatively inexpensive and was used rarely. Doctors were affordable because they had to be; an unaffordable doctor would have no patients. So how did we end up with health insurance that is both expensive and doesn’t protect people from bankruptcy?
In 1943, with the best of intentions, the old health insurance system was destroyed. Sixty-six years later we are still reeling from the consequences. Next week I’ll explain what happened.
Learn more:
Wall Street Journal Health Blog: Medical Bills Are Found Linked to Most Bankruptcies
Forward to Part II: How Medical Insurance Was Broken >>
Forward to Part III: Medicare >>
Forward to Part IV: A Recipe for Reform >>