Health Care for Profit

There are quite a few people who are opposed to the idea of profit in health care. Many apparently believe that for-profit entities have no legitimate place in an ideal health care system.

As I explained at The Health Care Blog the other day, my own view is the exact opposite. Were I a Health Care Czar, I would remove the nonprofit status from almost all health care organizations and force them to be for-profit under tax law. I would be willing to consider some exceptions here and there, and in special cases allow for-profits to set up nonprofit subsidiaries. But the vast majority of all patients in my ideal world would be dealing with for-profits — in getting health insurance and in getting medical care. And in return they would get lower-cost, higher-quality care.

Why are there such radically divergent views on this subject? As so often happens in public policy, much confusion is caused when people are not familiar with basic economic principles. In this case, the antiprofit folks are confused about (1) the economics of capital, (2) the economics of competition and (3) the economics of motivation in complex social systems.

Suppose the government builds a hospital and plans to have the entity be self-sustaining (all operating costs are to be paid from expected revenues). Following conventional public sector accounting, the cost of the capital needed to build the hospital will be treated as zero. (After all, all we need is for the Treasury to write a check.) And even though the plan to cover costs with patient revenues is far from certain to pan out, the accountants will also ignore the cost of that risky decision.

This example is Exhibit A in my case for abolishing the nonprofit status of hospitals. There is a real social cost of the capital used here. It is the social value of the next best use of those dollars. Because we build a hospital, we have to forgo the opportunity to build a school or a library or even an oil refinery. Note: This cost doesn’t vanish just because accountants don’t write it down on financial statements.

Making risky decisions is also costly, and the cost is implicitly borne by taxpayers. In the worst case, the hospital might never open its doors — in which case the taxpayers’ entire capital investment would be lost. More optimistically, the hospital might operate but incur large losses that will have to be covered with additional taxpayer assessments. Again, these costs don’t vanish just because accountants don’t record them.

A better approach is to make these costs transparent. If the hospital has to raise money in the capital market, the cost of capital will be made explicit. If its plan is an especially risky one, the cost of that risk will be reflected in the extra premium the capital market will charge. Not only would a for-profit approach be more transparent, it would also be less costly. The reason? The social cost of raising money on Wall Street is a lot lower than the social cost of collecting income taxes.

(Note: A similar argument applies to hospitals built with funds from voluntary donations.)

Like other for-profit entities, hospitals should have to report the cost of capital they accumulate and they should have to report the “profit” they earn in order to cover the cost of that capital. (See the discussion following Linda Gorman’s post.)

The second issue relates to the economics of competition. In my book, Regulation of Medical Care (Cato, 1980), I summarized organized medicine’s 20th century efforts to drive for-profit entities out of the market. In the early part of the century, for-profit medical schools were replaced with nonprofits. By midcentury, for-profit hospitals were almost completely driven from the market. After World War II, nonprofit health insurers (Blue Cross and Blue Shield) were established for the express purpose of completely changing the way doctors and hospitals would be paid. They tried to dominate the market and drive their for-profit rivals from the field. In the American Medical Association’s (AMA) ideal health care system, the only people earning a profit would be the doctors themselves!

We are still living with the vestiges of this history. But it would be a mistake to conclude that the real issue was profit vs. nonprofit. The AMA’s real goal was a medical marketplace in which all the entities were subservient to the interests and vision of organized medicine. The AMA assumed, probably correctly, that nonprofits operating in a not-very-competitive market would be easier to dominate and control.

Today, no one thinks hospitals, health insurance companies and other entities should exist to serve the interests of doctors. And today everyone recognizes that nonprofits can compete for patients based on price and quality just as vigorously and successfully as for-profits can. In fact, in today’s environment the whole distinction between for-profit and nonprofit is an irrelevant distraction.

The final issue is motivation. As Adam Smith discovered 200 years ago, as a producer in a competitive market, I cannot succeed without meeting other people’s needs. Of course, Smith realized that the butcher, the baker and the candlestick maker were not primarily motivated to help other people. They were self-interested. But they could not pursue their own interests without serving the interests of others.

Now let’s suppose that Adam Smith was wrong about people’s motivations. Suppose that a lot of producers are actually completely altruistic. We can use modern economics to show that no matter what motivates the producer, he can’t survive in a competitive market without meeting other people’s needs the same way that all his selfishly motivated rivals are meeting them. Put differently, in competitive markets, the motivation of any particular producer really doesn’t matter very much.

More to the point, you and I cannot control other people’s motives. But we can control public policies. With that in mind, it is in our interest as patients to promote institutional environments in which providers of medical care find it in their economic self-interest to deliver low-cost, high-quality care. And this is true regardless of all the many and complex factors that make up the underlying motivations of the doctors and institutional administrators who provide that care.

Comments (16)

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  1. Ken says:

    Good post. I agree totally.

  2. Vicki says:

    Where’s our musical pairing? I feel cheated.

  3. John Goodman says:

    Vicki, I had a great Youtube video from “Irma la Douce,” but it was nixed by the NCPA internal censors. The very same people who have banned many of my other inspirations.

  4. Greg Scandlen says:

    I worked in the (at the time) not-for-profit Blue Cross Blue Shield system for a long time. The only difference I could detect between that and a profit-making insurer was that the management of the Blues was not accountable to anybody. Yes it had a Board of Directors, but the Board was chosen by management. The Board wasn’t about to challenge management decisions.

    Even outside regulators felt it was beyond their scope to question management decisions. As long as the company was in compliance with state law and could show solvency (i.e. reserves adequate to risk exposure), management practices were out of bounds.

    For-profits at least have shareholders watching over management (at least in theory if not in practice.)

  5. Dr. Tony Dale says:

    John, the principle of “self-sustainability is vital within health care as in any other area if we want to help all people. I have been intimately involved in a rural health care project in India (see for more detail) where we are seeking to create models of health care for the poorest of the poor that are truly scalable. Charity, like Margaret Thatcher’s famous comments on socialism not working because you ultimately run out of other people’s money, is not scalable. Our initial pilot for 5000 village women only partially worked because the non-profit that was managing the program on the ground could not cope with needing to charge the women the small (25 cents a month) “premium” that we needed to sustain the program. They kept letting some women get away with not paying and in the end the charitable capital we had provided ran out!

    With no more capital we could not expand the pilot to 50,000 women. Whether it is foreign aid or public health, if we do not work towards self-sustaining models, it will ultimately collapse!

  6. Joe S. says:

    Greg makes a good point. Why should Blue Cross escape property taxes, sales taxes and corporate income taxes that are paid by Aetna, United Health and other for-profit rivals?

  7. Steve Buckstein says:

    One great example of how the profit motive in health care can benefit consumers is the Wal-Mart generic prescription drug program, which dropped prices from $20 or $30 per month per prescription to just $4 a month. I wrote about this at:

    “Keep the Profit Motive in Health Care”

  8. Laurence Brody says:

    Thanks John. Non-profits must make revenues in excess of expenses or go out of business, unless taqxpayer money supports them.

    I think years ago, people respected that the butcher, the baker and the candlestick maker provided services and goods which were necessary. Business was on a cash and carry basis, and debt was personal.

    Now we are a consumer/credit society with unlimited appetite. The appeal of government implying “we will take care of you,” is too powerful and appealing for many people. I don’t think we can pull back. Government is very powerful and the appetite of the consumer for goods and services to too great.

  9. Virginia says:

    I attended the America Speaks town hall meeting this weekend and was shocked by how many people honestly hated the for-profit health care industry (and corporate America). How do they think we got to be such a great nation?

    I enjoyed Greg’s post about management and acocuntability.

    In my own experience with retirement communities, I’ve seen the NFP’s tend to make good friends in the community because they’re known for their commitment to their mission. FP’s tend to deliver cheaper care that is standardized across states and cities. I’ve seen a few FP’s that are known for luxury care. The worst I’ve seen are the government-owned nursing homes.

  10. Don Levit says:

    As many of you know, the IRS is beginning a project of making sure that hospitals earn their tax-exempt status, by distinguishing themselves from their for-profit competitors.
    The luxury of tax-exempt status carries with it the responsibility of setting themselves apart from the for-profits.
    This is why the Blues lost their federal taxe-exempt status in 1986 – they were seen as no different than their for-profit competiytors.
    Non-profit insurers have the opportunity to set themselves apart from the for-profits by how they operate, what types of products they offer.
    Not-for-profits must be truly innovative, they must stay ahead of their for-profit competitors.
    One way they could do so would be to provide unique savings and insurance products.
    Theoretically, at least, the possibilities are unlimited, as long as the insurer was solvent.
    The federal government could not dictate to not-for-profits that they must operate on the same playing field as for-profit insurers.
    If that was the case, what would be the purpose of the not-for-profit designation?
    According to an IRS paper
    On page 1 – “Congress determined that although the Blues and plans similar to them historically operated in a manner that furthered community benefit and social welfare, these plans had evolved to the point where many of the characteristics that distinguished them from the commercial insurance carriers were no longer apparent. Therefore, there was no longer any justification for the continuing exemption for service benefit plans if their primary purpose was providing medical insurance indistinguishable from that provided by commercial carriers. It was Congress’ look at the Blues’ exemptuion that served as the impetus for the enactment of 501(m).”
    Go to:
    Don Levit

  11. Devon Herrick says:

    Early in my career, I spent six years working as an accountant for a non-profit hospital system. The notion that we were not out to make a profit is ludicrous! A non-profit hospital wants to avoid money-losing patients the same way for-profit hospitals do. Both will go out of business if they fail to earn a profit (or break even). Non-profit status is a tax election. As Greg stated, the only real difference is there are no shareholders.

    Non-profit hospitals in Texas (where I live) are required to provide something like 4% to 5% of their net revenue in charity care each year. In return, they pay no taxes (including income tax, sales tax and property tax). In addition, non-profit hospitals must plow profits back into expansion. That is a deal most for-profit hospitals would probably jump at.

  12. Blake Woodard says:

    John –

    Your vast wisdom grows each day.

    — Why do tax-exempt hospitals spend millions of dollars advertising for patients?

    — If they are non-profit, why do they send outrageous bills for one night in the hospital, only to have their bills slashed by the insurers? (My wife was billed $42,000 from Baylor All Saints for 4 hours of surgery plus one night.) Are they losing money on insured patients and making up these losses on cash patients, or are they making a small profit on insured patients and an obscene profit on cash patients?

    — Why are hospitals (tax-exempt and for profit), who provide services to ERISA-governed employee benefit plans (health plans), not subject to the fiduciary standards that all other ERISA plan service providers are subject to? (The federal government is about to release expansive new fiduciary standards for service providers of qualified retirement plans.) I don’t see how hospitals and doctors can avoid a similar fiduciary standard as providers to welfare benefit plans. A fiduciary of an ERISA plan is supposed to look out for the best interest of plan participants. Are hospitals doing this when they bill ERISA plans obscene fees for their services?

    Blake Woodard

  13. Anne RN says:

    This is a very interesting post. I agree that there is little difference between the for-profits and non-profits. Both are quite interested in the bottom line. I have worked for both non-profit and for-profit hospitals and could tell little difference in services provided. Also, they were both quite judicious in watching every penny spent. It was quite apparent that the non-profits institutions were just as interested in making money as the for-profits.

  14. Matt says:

    You can see a quick snapshot of each hospitals financial statements by going to The hospitals in the DFW area collectively made just under $1 billion in net income. This includes both for profit and non profit hospitals. To further expand on Devon’s comments the amount of charity care provided at a hospital is calculated using the hospitals gross billed charges ($35 Tylenol etc..) rather then what it actually cost the hospital to provide the care. That is no different then donating a pair of old socks to Goodwill and writing $1,000 off of your income taxes.

  15. Kartik says:

    Michael Moore conveniently forgot to mention that most US hospitals, including the very best ones, are not for profit (and he demonizes them as evil and profit hungry) amd that most Americans get private insurance throught not for profit insurers.

    Moore should read this..

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