Third-Party Payment Is The Root Cause of Health System Dysfunction

InsFormSmall(A version of this Health Alert was published by RealClearHealth.)

Largely absent from the vigorous debate over reforming the nation’s health care laws is the understanding that simply being covered by health insurance does not reduce health care costs.

Before the Affordable Care Act (ACA) passed in March 2010, President Obama repeatedly promised that the typical family’s health premiums would go down by (sometimes “up to” but frequently “on average”) $2,500. That decline did not occur because the ACA strengthened the control that insurance companies—as opposed to patients—have over health care spending. In fact, Americans’ increasing dependence on health insurance over the last seven decades has been a major contributor to exploding health costs.

It’s a fundamental economic truth that too much health insurance actually increases costs. That is why other types of insurance—think of car accidents or warehouse fires—only cover catastrophic costs. The full cost impact of our over reliance on health insurance, provided by both government and private insurers, is staggering.

In 2014, real health spending per person was $9,532. However, if government policy had not encouraged control of health spending to shift from patients to governments and insurers, spending would have been about $4,316 per person—less than half of what we actually spend.

The difference is explained by waste, fraud, and abuse that quickly finds its way into markets controlled by third-party payers, who then impose costs to try to control these problems.

If a politician promised to reduce the cost of driving by forcing auto insurers to pay for our cars, gasoline, tires, engine oil, windshield-wiper fluid, and all the other items and services we need to be on the road, we would all understand why our premiums would skyrocket—because those added costs would have to be accounted for.

And that’s just the beginning. Since drivers would not pay for our cars directly, we wouldn’t be careful about how we managed their costs. We wouldn’t search for cheaper gas or efficient mechanics, or care whether a more expensive tire was really worth it. We’d go to Maserati dealers for their latest model without worrying about how to finance the purchase, and simply tell the salesperson which insurer to bill.

Obviously, auto insurers would respond the same way health insurers have: Build networks of dealers, gas stations, and mechanics; and impose all kinds of rules and bureaucracies between them and drivers. However, because insurers are removed from drivers’ experiences, those rules would be ineffective—just like they have proved in health care.

In 1999 and 2001, the Institute of Medicine at the National Academies of Science published two scathing reports on health quality. The first concluded that tens of thousands of patients died in hospitals unnecessarily.

The second recommended principles to guide the health system across the so-called “quality chasm.” It noted payment was an important factor in improving quality, and that “even among health professionals motivated to provide the best care possible, the structure of payment incentives may not facilitate the actions needed to systematically improve the quality of care, and may even prevent such actions.”

A decade later, the institute published an equally disturbing 825-page report on waste. Experts convened by the institute concluded that $765 billion (31 percent) of the $2.5 trillion spent on U.S. health care that year was wasted.

Clearly, the rules and bureaucracies imposed by third-party payers are not improving our health care or making it more affordable. However, control by third-party payers is not some law of nature. It is the result of deliberate policies that can be amended or reversed.

As recently as 1960, just under half of health spending was controlled directly by patients. Because the costs paid by insurers were mostly related to hospitalization; That meant many families that needed only primary care went for years without ever processing a claim through a health insurer. Nevertheless, they had access to doctors.

Today, only 11 percent of health spending is controlled directly by patients, but solutions are at hand. Among the privately insured, the dominance of third-party payers is the consequence of decades-old tax policy that allowed medical spending covered by insurers to be excluded from taxable income, while direct spending was taxable income. This was fixed somewhat through Health Savings Accounts, which came into being in 2005 and allows beneficiaries to spend pre-tax dollars directly on medical care. Similar mechanisms could be used in Medicare, Medicaid, and other government programs to reduce costs.

We need to do more than repeal and replace the ACA. We need to repeal insurers’ and governments’ control over our health spending and replace it with a payment system controlled directly by patients.

Comments (15)

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  1. Jimbino says:

    Clearly, the rise and fall in healthcare premiums tracks the rise and fall in healthcare costs, only that insurance premiums ultimately add 25% to the cost of healthcare for the nation. That’s the implication of the 80% “loss-ratio” for insurance programmed into Obamacare.

    Fiddling with policy over who it is that pays for healthcare or the expensive insurance that covers it is just rearranging deck chairs on the Obamacare Titanic. To lower both healthcare costs and healthcare insurance costs, we have to introduce mandatory healthcare pricing in order to facilitate operation of a free market.

  2. Allan says:

    “we have to introduce mandatory healthcare pricing in order to facilitate operation of a free market.”

    Price fixing doesn’t represent a free marketplace.

    • Jimbino says:

      Alan, I agree. I should have said that healthcare providers should be required to publish their prices on the Web, just as Home Depot, Lowe’s, Amazon and Harbor Freight freely do, not that gummint should set prices. You can’t have a free market without price signaling.

      • Allan says:

        Jimbino, do you know why Home Depot, Lowe’s, Amazon, and Harbor Freight have to publish their rates? It isn’t because government made them. It was an economic decision where they knew if they didn’t publish the rates people wouldn’t buy from them. Medical pricing is a bit more difficult when you are dealing with services, but is the same when one is talking about non-invasive radiology, laboratory and a whole host of other things.

        The problem in healthcare is that government has created policies that make patients indifferent to price.

        • Paul Nelson says:

          The experience over many years of State mandated price fixing for hospitals isn’t very good. Its long been known that the number of T&As in a community was related to the number of ENT specialists and the number of hysterectomies was related to the number of Gynecologists. I could be mistaken, but I vaguely remember that the cost of healthcare for a community is related to the number of non-Primary Healthcare physicians in a community, such as cities with a medical school HOSPITAL. Price fixing already exists through Medicare, and it sure hasn’t…….

        • Jimbino says:

          “indifferent to price.” Correct, and for that reason it isn’t safe to venture onto streets where all drivers are mandated to carry insurance. Insurance is almost by definition pure moral hazard.

          • Allan says:

            Jimbino, I understand your logic, but I think you carried it a bit further than reasonable.

  3. Bob Hertz says:

    I live about 150 miles from a nation called Canada, where patients pay next to nothing and yet costs have not gone up nearly as fast as America’s in recent decades.
    Other nations including France and Germany are not as extreme as Canada, but individuals again make few of the payments. The maximum deductible in Germany last I checked was about $250 for the year.

    These nations have much stronger bureaucracies than America’s terms of controlling medical prices.

    That may lead to poorer medical care, I simply do not know.
    And I do not feel that America could adopt a Canadian system and save money.

    My only point is that third party payment can in theory include cost control. Only in America, it does not.

    • Allan says:

      “costs have not gone up nearly as fast as America’s in recent decades.”

      Bob, That may be true but the lines are getting longer and you don’t know their true costs because the costs are so tied into taxation and we always forget the hidden costs. How much money is lost because of lines? On the other hand that is good for our economy as Canadians travel to the US for care.

      A second item you are not considering is that one of the reasons our costs are climbing so fast is because of poor government policy and to much government intervention.

      “that third party payment can in theory include cost control.”

      Can it? …Or is that an illusion? We have third party payment here and that is probably the lead or one of the lead causes of our healthcare dysfunction.

  4. Bob Hertz says:

    Thanks Allan, good points about Canada.

    In terms of cost control, one comment I read frequently is that other nations have about the same rate of spending growth as the USA. However, the USA started so much higher than these nations that our spending seems more out of control.

    I would amend one of your sentences. You cite ‘too much government intervention’ as a source of medical inflation.

    In my opinion, there is not enough government intervention in areas like pharmaceuticals and the pricing of a day in the hospital. Too much price gouging is permitted without any effective intervention.

    • Allan says:

      We may have to disagree, but there is only so much price gouging that can be done and that leaves a bad taste in the mouth of a buyer. The remedy for gouging that we all agree is gouging is worse than the disease.

      I’d like to add a side point. What is or is not gouging is sometimes hard to determine. I have seen politicians use the word gouging when needs are greater than available. They even pass laws to prevent what was called gouging and those laws led to less product being available when the product was needed the most. In those cases the public was better served by the so called gougers than by the politicians that passed anti-gouging laws.

      • Bob Hertz says:

        The drug companies seem to have been price gouging us for many years. They have finally met some resistance with grotesque price increases on drugs that they bought without spending a penny on research… but meanwhile, the gouging continues….

        see the attached comments from an MD………..

        “I’ve witnessed the steady decline in the average American’s ability to pay for the basic health care they need to stay alive. In just one example, albuterol, a drug that gives quick relief from asthma when you can’t breathe, was once generic and inexpensive until a new way to deliver the drug was needed (for environmental reasons). The HFA delivery system was patented and priced so high that many asthma patients could no longer afford the medication that enabled them to breathe and stay out of the emergency room. To this day, all three brands of albuterol HFA inhalers are still not generic.

        In another example, new studies established a set dosing pattern for colchicine, an inexpensive generic drug used for decades to treat painful gout. You guessed it; it suddenly became an expensive patented medication again, and now those patients who can no longer afford the drug miss three or more days of work when they get an attack of gout. Why are we accepting this?

        The best forms of prescription insulin, the hormone replacement drug that controls diabetes and prevents amputations, blindness and kidney failure, are so expensive, many patients cannot adequately control their diabetes. They develop premature kidney failure and must go on dialysis, or they have an amputation which could have been delayed or prevented. At that point, they are prematurely disabled. They can no longer work and must either pay for their own expensive health insurance or go uninsured for two years, then transition to Medicare.
        Drug companies charge Americans the world’s highest out-of-pocket prices for medication, consequently making those same drugs cheaper for Europeans and others whose governments negotiate a lower price for their citizens. So we Americans, in effect, subsidize cheaper drugs for Canada, Europe, Japan, Taiwan and other countries.”

        • Allan says:

          “until a new way to deliver the drug was needed (for environmental reasons)”

          Bob, what is that doctor saying about gouging? Very little except that the EPA made huge numbers of people suffer and the atmosphere got how much benefit? Probably minimal if any. But, the pharmaceutical company knew they could profit off of this so likely they strongly supported the action. There was no powerful group representing asthmatics that were short on cash.

          We could have waited, letting the inexpensive generics compete while the companies developed new drugs with the newer delivery systems. Eventually, those drugs as well go off patent. There would have been a slight delay for the environment, but well worth it.

          “colchicine” There was no reason to remove that drug. The claim was it wasn’t evidence based and the new drug was. That is BS and another example of blame being placed on a pharmaceutical company rather than the government office responsible. Again the pharmaceutical company will provide all sorts of reasons why this should have been done, but there will be no powerful group representing those using colchicine that were also short on cash.

          “Drug companies charge Americans the world’s highest out-of-pocket prices for medication”

          …And who prevents the people from buying those medications outside of the US?

          Not the pharmaceutical houses for they don’t create those laws. Once again it is a government agency that holds the blame.

          The job of pharmaceutical companies is to make a profit. It is those profits that incentivizes the creation of life saving drugs. Thus, as long as they work within the law they are doing what they are supposed to. Generally they are not the bad people if we wish to characterize anyone as bad. The fault lies in politics and those that make the laws.

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