1. 2. 3. There Aint No Such Thing as a Free Lunch: June 2011 4. 12. 15. 16. 19. 16. 19. 20. 21. 22. 23.

There Aint No Such Thing as a Free Lunch

24. 25. 26. 30. 26. 30. 31. 32. There Aint No Such Thing as a Free Lunch: June 2011

Wednesday, June 15, 2011

The Problem of Being Overinsured

One of the arguments for health care reform is that millions of Americans with employer provided health care are underinsured. Proponents of this view are saying that people are underinsured if they are paying too many of their health care costs out-of-pocket. A little reflection on what insurance is and is supposed to do suggests that the problem is really the opposite- many, if not most Americans are overinsured- they have too much health insurance coverage.

On what basis can I claim that Americans have too much health insurance? The purpose of insurance is to protect people from risk. Private companies offer affordable insurance against losses from automobile accidents, accidental death, fires, storms, and floods, among other things. These kinds of insurance arose in response people’s willingness to pay for a contract that will compensate them for losses due to a relatively low probability event over which the insured party has little or no control. Yet, unlike other kinds of insurance, most of what is covered by many health insurance plans does not fit this description. This is why so many people who do not have employer provided health insurance are either uninsured or purchase only catastrophic coverage.

The problem with many existing health insurance plans is that they cover the cost of routine treatment for illnesses, such as colds and flu that occur frequently or the cost of care for conditions, such as pregnancy, that are heavily dependent upon the choices of the person who is insured. Basic economics teaches that paying for routine treatment via a third party insurance company will raise the total cost of that treatment. This happens for two reasons. First the insurance company, as middleman between the consumer and the health care provider, has costs that must come out of what the consumer pays. Second, insurance that pays for routine care lowers the cost of each doctor visit to the consumer, thus increasing demand. Higher demand with a given supply means higher prices.

It does not matter whether consumers or employers pay health insurance premiums. The premiums are part of the cost of health care. Eliminating routine care from being covered by health insurance would mean premiums would decrease and employers could pass the savings along to their employees as higher wages. The average consumer would be better off as a result. If it were not for the tax deductibility of health insurance premiums, employers would not cover routine care and avoidable conditions as much as they do.

This is not to deny that many Americans do not have sufficient access to affordable health care nor that the inability of some to afford health insurance is something we should be concerned about. Although it does not make sense for insurance to cover the ordinary medical costs of child birth, treating chronic asthma, or flu symptoms, it may be a good idea to have insurance in case of complications resulting from childbirth or to cover hospitalization for pneumonia and other serious illnesses.

The best way to help those who cannot afford basic health insurance is not to require or subsidize the kind of comprehensive health insurance plans that most employers now offer. On the contrary, health care costs and the cost of health insurance that would cover life threatening illnesses and serious accidents would be considerably lower if the existing system of taxes, subsidies, and government regulations did not result in so many people being overinsured.

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Thursday, June 9, 2011

Controlling Health Care Costs when Government Pays

Government, as a purchaser of health care, has sought ways to control health care costs. One of the more effective approaches that helped bring Medicare costs down was the prospective payment system (PPS). Instead of paying hospitals for the services that they provide, under PPS, the government pays them per case. Medicare began offering a fixed payment for each patient admitted to a hospital based on a diagnosis related group (DRG) that the patient was assigned to.

Offering a fixed payment per patient has both advantages and disadvantages. A big advantage is that it offsets the incentive of doctors to provide additional services to patients when the marginal benefit is below the marginal cost. When the government or insurance companies pay doctors and hospitals for the services they provide, patients will usually agree to additional treatment recommended by their doctors, even if it is not cost effective. Many patients would not agree to additional treatment if they had to pay out of pocket. The prospective payment system has been quite effective at reducing the average length of hospital stays without any evident decline in the health of those treated.

One problem with paying a fixed payment for each case is that it fails to account for differences between patients within each treatment category. Each patient will receive the treatment that the government deems necessary for the average patient with a given health problem. Some patients may need more than the average while others need less. Offering a fixed payment also reduces the incentive of hospitals to compete on quality. Hospitals will have an incentive to pursue quality improvements that are accounted for by the government’s payment formula (such as changes that hasten patients’ rate of recovery). If they cannot charge the extra cost of a quality improvement to the government or an insurance company, hospitals will only pursue it if patients are willing to pay extra for it out-of-pocket.

When government or insurance companies pay for health care and limit their payments via a PPS system, covered patients need not get too few health services or inferior quality services provided they have the freedom to choose their doctor or hospital and to pay whatever PPS does not pay. In this case, patients could pay extra out-of pocket to get extra services or superior quality care if they value either more than the additional cost. By contrast, government payment will lead to some patients getting more health care or higher quality than they are willing to pay for. As long as a third party pays most of the cost of a procedure, some people will consume more health care than is consistent with their preferences. Although paternalistic arguments can be made for this approach, government lacks the information to account for all the factors that might justify giving priority to some patients over others in using scarce health care resources.

It is a good thing when government takes steps to limit health care costs as they have done with the PPS system, as long as patients are permitted to pay extra to consume more than the limited quantity or quality of service covered by the insurance or government program. There is, however, a fundamental problem with this approach, which is part of the reason why Medicare costs continue to rise so fast that Medicare appears to be financially unsustainable.

No matter how carefully a hospital is at diagnosing a patient when he is first admitted, hospitals often do not know ahead of time what sequence of treatments will be most effective for each particular patient. As a result, Medicare allows retrospective cost sharing based on treatment decisions hospitals make long after the initial diagnosis. It is often unclear whether a certain treatment is appropriate for a given patient. The more that Medicare allows retrospective cost sharing the greater the incentive of hospitals to err on the side of more intensive and costly treatment. As technology improves, hospitals also have an incentive to use more expensive treatments, if they can get reimbursed for the additional cost, regardless of how large or small the marginal benefit actually is.

Lacking a profitability constraint or even much of a budget constraint, government Medicare adminstrators have inadequate incentives to compare the marginal benefits of a more intensive treatment regimen with the marginal costs.

By contrast, if patients or their families were the ones paying for the treatment, they would have an incentive to make treatment decisions based on a comparison of anticipated marginal benefits with marginal costs. This would provide a much more powerful incentive to control costs than PPS provides, as it is currently administered by the government. The best way to control the costs of medical care for the elderly is to have patients and their families bear a greater share of the costs of medical care, since they are the ones most likely to make choices that will promote a cost efficient level of treatment.

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