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The wobbly stool: A primer on American health care costs

Elliott Parker
Elliott Parker
Opinion
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Few political dramas arouse more passion than the Patient Protection and Affordable Care Act (ACA) of 2010, a.k.a. Obamacare, and the effort to repeal it. It is easy to get caught up in the political football game of winners and losers. It is also easy to get lost in the minutiae of congressional bills, and the convoluted strategies to overcome the 60 vote threshold normally required for ending debate on the passage of new laws.

Perhaps it might help for a moment to take a few steps back, and look at the big picture.

We should first separate health care itself from health insurance. An economist much smarter than I has described health insurance as a three-legged stool, and I will explain that metaphor later. But we first need to think about why the stool is required to bear so much weight.

Americans spend an annual average of more than $10,000 per person on health care, the most of any major country in the world. It isn’t even close: we spend two-thirds more per person than either Australia or the Netherlands, which are in second and third place. We spend twice as much as Canada, Germany, and France, and almost three times as much per person as Great Britain or Ireland.

Although we have a higher average income than most of these countries, that doesn’t explain how much we spend. The USA spends 17 percent of our GDP on health care, and no other major country comes close. Canada and the countries in the European Union spend around 10 percent, and others spend even less. And this gap is even more striking when you only consider private spending on health care, and exclude what is publicly subsidized by the government. Our private sector spends 9 percent, while in Britain and almost every other major developed economy, the private sector spends only 2-3 percent. We are alone out on our ledge.

Costs

The reasons behind the high cost of health care could fill an economics textbook. One issue is the lack of price transparency. In a normal market, buyers know what they will pay and have some idea of what they are buying. In a competitive market, the same good or service would have the same price no matter the buyer or seller. But when we go to the hospital, we have no idea what we will pay, and we are unlikely to see the bill until long after we were treated. Prices vary widely, and the price charged rarely matches what is actually paid. Those without insurance companies to bargain for them are sometimes charged outrageously high prices for even simple services.

We don’t always care about the price, since demand for life-saving treatment can be extremely inelastic. When suffering a heart attack, you want to go to the nearest and best hospital, and don’t even ask how much it will cost (at least not until later, when you get the bill and have another heart attack).

There are many other factors. Medical education is often very expensive, in terms of both tuition and time, and doctors need high incomes just to repay their student loans. Medical schools are also famous for limiting the supply of doctors. We rely heavily on pharmaceuticals, which are protected by patents and often very profitable. Costs are further driven up by the high cost of administration, particularly in managing many different types of insurance and complicated billing practices. The threat of medical malpractice lawsuits can lead to high insurance premiums and defensive medicine, where unnecessary tests are paid for by the patient but are really to protect the provider.

Americans are also expensive to care for. On average, we are much more likely to be sedentary and obese; we drive more and we walk less. Our diet tends towards large portions of mostly-processed foods with ingredients we can’t pronounce. We eat fewer fruits and vegetables, and much more sugar and salt. Our life expectancy is lower than in most other wealthy countries, and not only because we are much more likely to die violently.

So the American stool of health insurance has a lot more weight to bear.

Insurance markets work because most people want to avoid extreme risks, and are willing to pay a premium to avoid the worst outcomes. This adds an extra cost to paying for health care, but when the market works it is worth the reduction in risk. Most people pay in to the system, while a small number are net recipients. The insurance company can pay for fixing your car after an accident, as long as most people don’t have accidents most of the time.

However, if only the people whose homes are likely to burn down buy fire insurance, the market will collapse. If only the people who are likely to cause car accidents buy liability insurance, or if only the people who think they need a doctor buy health insurance, the market will collapse. The insurance company needs a large pool of customers to prevent this.

Insurance companies don’t want to sell insurance to people with higher risk. To prevent that from reducing their profit, insurance companies can charge people with higher risk a premium so high that they opt out, or to put so many conditions in the contract that the company doesn’t have to pay very much out even when the high-risk customer buys a policy.

As a result, a lot of people will go without insurance, either because they don’t choose to buy insurance or the insurance company doesn’t want to sell it to them. What then? The DMV can tell drivers that don’t buy liability insurance that they may not drive on public roads. Banks can tell homeowners who don’t buy fire insurance that they cannot have a mortgage. But what do you say to people who don’t buy health insurance?

When people without health insurance have accidents, or get sick, they can go to the emergency room, which is required to provide at least essential treatment. But there is no free lunch. Not only is the emergency room an expensive way to treat patients, but if the patient can’t pay it then those costs are spread to those who can pay, through even higher prices. With good health care, a little prevention can sometimes go a long way, and be a very good investment. A sicker population is also more likely to spread disease to others, is less productive in the workplace, and is more likely to rely on social services. If they don’t pay for their health care, we all have to bear the cost one way or the other.

If we want people to have health insurance, we need three legs for it to be stable. First, we must require the insurance companies to sell insurance to all, and this means real insurance, not a junk policy that looks like insurance but really covers nothing. Second, we need everybody to buy insurance, whether or not they think they need it now. Third, we need to make it possible for those who can’t afford it to participate in the market, either through price controls or subsidies. If we knock out any one of the legs, the stool begins to wobble.

Most of us get health insurance through our employers. The policy is offered to all employees, all employees are required to participate, and we are subsidized by our employer (with the generous help of our tax system). All three legs are present. Even if the employer subsidy is small, the fact that we draw a paycheck usually means we can afford it. And people with these jobs tend to be healthier on average than people without, so it costs less.

Older Americans account for about 15 percent of the population, and most are eligible for Medicare. This is a second stool in which the government acts as the insurance company. It is a larger share of total medical expenses, since the elderly account for a large share of medical costs, especially in the last year of life.

Medicaid is another government program that works with the states to provide health care to the poor, and many elderly also rely on this if they go into a nursing home or hospice. Some of us receive care from the government in other ways: active duty military personnel and their dependents receive free care directly from military doctors and hospitals, while veterans have access to VA hospitals and services.

Some of us don’t really need insurance. The top 0.1 percent can afford to pay for their medical care, no matter the disease, so they can self-insure and avoid the cost of the middleman. But some of us only think we don’t need insurance. Maybe we exercise and eat right, and we have no family history of illness. This works until it doesn’t, and lightning strikes, we learn we have cancer, or an accident happens. Then we want health insurance but nobody wants to sell us a policy. We go to the emergency room and hope the taxpayers or other patients will pay for our health care.

The Affordable Care Act

For all its faults – and any complicated legislation has faults – the ACA tried to provide a three-legged stool to those without access to employer or government insurance. It required insurance companies to sell real policies to everybody, without pre-existing conditions or similar clauses to avoid payouts, and it regulated how much the prices could vary. It required everybody to have insurance, though the penalty is not easy to enforce (especially when the administration doesn’t want to enforce it). And third, it provided subsidies to those with lower incomes.

A record 6.4 million people currently signed up for health insurance in 2017 through the federal exchanges, but this was still not as many as originally predicted. Not as many employers cut their insurance as predicted, which is a good thing, and the penalty for not having health insurance was low enough to make it worthwhile for another 6.5 million people to go without.

The stool was relatively basic, with a high deductible that meant most people would be paying in, not taking out. Even so, this new stool wasn’t for everybody. Some young adults were covered by an extension of their parents’ employer insurance, at least through age 26. Others with low incomes could be covered by an expansion of the Medicaid program, at least where the states agreed.

Most of the reduction in the number of uninsured came from this expansion of Medicaid. In 2012, before the expansion, 54 million Americans were enrolled. By 2016, this number increased by more than 14 million people in the 30 states which chose to participate, and the expansion included 3.3 million – mostly children – who were already eligible. Many of the newly enrolled appear to have gone without health care for some time, and the backlog of demand for services put strain on many providers.

But 20 states declined to expand Medicaid, leaving an estimated 7 million low-income Americans uncovered. Some joined the federal insurance exchanges, but most just went without a stool to sit on.

Since introduction of the exchanges, premiums have risen significantly in some, particularly in the states where Medicaid was not expanded or there is little competition. Insurance companies underestimated the backlog of untreated patients, and the pool of people paying into insurance is still sicker than it should be, as many in the healthier half of the potentially-insured population are still just paying the penalty and opting out.

The arguments

Some have argued that the ACA made health care more expensive, and not just because people who had not been treated for years began to visit the doctor. However, this argument confuses health care with health insurance. Spending on health care was already rising fast, rising from 13 percent of GDP in 1995 to 17 percent in 2010, before the law was ever passed. However, this ratio has remained relatively steady since 2010 in spite of the fact that the post-WWII baby boom began to turn 65 in 2011. We are getting older, and our health costs should be expected to rise.

Many have argued that the ACA didn’t do enough to get costs down, and the argument has some merit, though the ACA at least made an effort. It is a huge problem.

Others have made the ideological argument about the proper role of government and the public-private split. Expanding access to Medicaid and subsidizing the purchase of private insurance is not cheap, and (unlike the 2003 expansion of Medicare Part D) the program was not unfunded. This meant new taxes, especially the 3.8 percent surtax on investment income. This tax took the Medicare payroll tax that we already pay on labor income and applied it to capital income. Not surprisingly, wealthy people were not happy about it.

But the Affordable Care Act was always a relatively conservative plan to help more Americans get health insurance. It worked with private insurance companies, private pharmaceutical companies, and private doctors and hospitals. We are the only major country to do it this way. Some countries provide health care directly, such as Great Britain’s National Health Service. Most developed economies – like Canada – have a public single-payer insurance system with private health care, sort of like Medicare and Medicaid for all. Some less-developed countries have no working system at all, and when their citizens get sick, they tend to die. The simple argument that the private sector is virtuous and the public sector is wasteful does not go very far in helping us find a solution.

What do we do now? Is the effort to repeal Obamacare dead, or will it be back in another form? Do we try to go back to the system we had before where more than 40 million Americans lacked health insurance, and where those without insurance tended to be less healthy and die younger, and two-thirds of bankruptcies were due to unpaid medical bills? Do we kick out one or more of the three legs of the insurance stool, and then stand there like Captain Renault in Casablanca, “shocked! shocked!” to find the system collapsing? Do we try to make it work, by firming up all three legs and doing a better job of getting costs down? Or do we push for even more, such as a single-payer option, or even a system in which private insurance companies have to get out of the business of essential health care services? Only time will tell.

Elliott Parker is Professor of Economics at the University of Nevada, Reno. His new book, Nevada’s Great Recession: Looking Back, Moving Forward, with Kate Marshall, is available from the University of Nevada Press.

 

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