• The Health Care Cost Problem We Refuse To See

    The following originally appeared in Kaiser Health News on 17 May 2010 and has been cited in the 27 May 2010 edition of Health Wonk Review.

    I agree with those who think the Patient Protection and Affordable Care Act doesn’t do enough soon enough to control the rate of increase in health insurance premiums. But I disagree that the solution is simply to pass more laws that regulate health insurance rates (as suggested in a May 9 New York Times editorial) or just to increase competition in the health insurance industry (as suggested in a May 6 Washington Times commentary). Such measures would be insufficient on their own and could even do some harm.

    Our frustration with the soaring cost of health care is like a mother upset with the increasing price of bread. When her son returns from the market with another high-priced loaf she hatches a plan. The following week, when bread costs $5 a loaf, she attempts to control the price by sending him to the market with only $4. The family spends less on bread that week, but they also don’t eat any since the boy couldn’t find a merchant willing to sell below the market price.

    The next week bread is selling at $6 a loaf, and the mother tries another plan. Thinking her son lazy, she attempts to discipline him with competition. She sends her daughter with him to the market. Whichever of the two can obtain the lowest bread price will win the family’s respect. This winning price, paid by the daughter is $7. She and the boy competed, but the additional competition on the buyer side sent the price up, not down (as one should expect).

    What the mother isn’t noticing about the bread market, and many don’t recognize about health care, is that suppliers (bread sellers, health care providers) play a role in establishing prices. Regulating the price paid by buyers or the level of competition among them isn’t likely to produce the outcomes we might hope for without parallel action on the provider side of the market.

    Take increasing insurer competition, for example. Results presented in two papers in the International Journal of Health Care Finance and Economics and another in Health Affairs indicate diluting insurers’ market power would cause prices to rise, not fall. The reason is that hospitals maintain such high degrees of market power that high concentration in the insurer market is necessary as a counterweight. Weaker insurers would be less able to counteract the market clout of hospitals at the bargaining table. Clearly just decreasing concentration among insurers while ignoring that of hospitals is unlikely to be the solution to escalating health care premiums.

    If concentrated insurers negotiate lower prices, what compels them to pass the savings on to consumers? Here, regulation can help, and it is already in place. The Patient Protection and Affordable Care Act regulates medical loss ratios (MLRs), the proportion of premium revenue that must be spent on health care claims, as opposed to administration and profit. Specifically, it requires insurers to spend 80% and 85% of premium revenue on claims in the individual/small and large group markets, respectively. That puts a cap on what insurers can retain for non-medical expenses.

    If MLRs are computed fairly and regulated adequately (things to watch), the only source of health insurance rate increases would be medical costs. In principle one could regulate medical costs themselves by blocking insurers’ proposed rate increases if they were deemed excessive. Once insurers have already negotiated prices down as far as their market power will allow, and with the MLR minimums in place, the only substantial remaining driver of premiums that insurers can do anything about is utilization volume. The last time insurers made a serious effort to control that was during the era of managed care in the 1990s. We all know how much consumers loved their mid-90s HMOs (not very). Therefore, rate regulation above and beyond MLR minimums isn’t likely to get very far on its own.

    At this point, we’re in the same position as the mother who wished to pay less for bread. Pressuring and regulating buyers (her children or our insurers) alone isn’t fruitful. To make headway, some attention must be paid to the seller side of the market. In the case of health care, changing how providers are paid–more on quality, less on volume–is a sensible idea. In fact, there are provisions in the Patient Protection and Affordable Care Act to do just that (e.g. payment bundling, accountable care organizations), but they won’t kick in for years, a political concession.

    Our greatest hope for lower premiums is for those provider payment reforms to be allowed to work. Rather than continue to throw stones at insurers (or, at least in addition to doing so), we should be supporting political leaders who will not cave in to what is likely to be heavy industry pressure to weaken those reforms. The mother in the parable of bread prices kept proposing doomed solutions because she didn’t recognize the problem, dominant seller power. Are we any different?

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    • Austin,

      I have a couple of comments. First, the CMS national health care data suggest that the health insurance expense load, the difference between premiums and medical benefits paid out, has ranged from 12 to 14 percent of premiums from 1960 to present day, so insurance companies can be ruled out as the culprit behind rising health care costs. Data suggest that the source of growing premiums is mainly rising medical claims costs (see Born and Santerre, Unraveling the Health Insurance Underwriting Cycle” Journal of Insurance Regulation, Spring 2008). Most agree, however, and empirical studies tend to confirm, that new medical technologies (although new drugs do often have a cost-offset effect) tend to be the main driver behind growing medical claims costs, explaining at least 50 percent of its growth. Consequently, any serious attempt at bending the curve would have to be directed at new medical technologies.

      Second, thinking that the minimum MLRs can be “computed fairly and regulated adequately” by the government is way off the mark. Years of regulatory experience in the U.S. suggest that prices tend to decline rather than increase with the removal of regulations. The special interest group theory of regulation, particularly the capture theory, offers a reason for the observed inefficiencies associated with regulations. Indeed, empirical studies indicate that certificate-of-need laws – a type of regulation – have seriously lowered the number of hospital facilities, providing entrenched hospitals with some market power to raise price in some areas of the U.S. But of course, even in this case, a regulation can only offer a reason why costs may be high at a particular point in time but not necessarily why they tend to grow over time.


      • @Rex – I don’t have anything to add to your first paragraph. It doesn’t seem inconsistent with what I wrote in any case. Thanks for the references.

        As for the second, I agree that fair computation and regulation of MLRs is a tall order. In principal, under an assumption of some “ideal” implementation, can the minimums produce downward pressure on prices? I think that’s an interesting questions since they’re not direct regulation of prices per se but of the proportion of revenue that can be spent in a certain way. Are there studies or examples of this very type of regulation? What would one expect in theory? The answer must depend on the structure of the market. How much competition is required?

        But, ultimately what I was saying is that MLR minimums can’t do the whole job. They can’t bend the cost curve even if they can produce a one-time shift in premiums (which as you suggest, is itself debatable). So, my defense of MLR minimums isn’t a strong one.

        I think the unambiguous value of the MLR minimums is political. Incorrectly, the public wants to punish or pressure the insurance industry and only the insurance industry. Once the public is satisfied that has been done and costs are still rising, that leaves only one other place to look (the provider side). I think we should be looking there sooner rather than later. Showing that even ideal (unrealistic?) results from policies already implemented are insufficient is my small contribution toward that end.

    • Austin – and perhaps @Rex…

      Isn’t one of the things that could – or should be done a deeper look at the demand side…

      I see some opportunities that could be productive…

      1. Reducing the scope of mandated [covered] care. If we focus on the things that are critical and “affordable” – and eliminate some things that are not, what does that do to the demand side equation. Of course this is going to be politically challenging – at the extreme we will have to wrestle with the appropriate boundaries for extra ordinary and experimental care – what we can “afford” to pay for is not going to be either pretty or easy.

      2. Pushing providers to decouple themselves from ownership interests in alternative profit sources. I have used myself as a personal example of how this affects demands in a number of posts elsewhere. My insurance plan would pay for 4 blood tests a year for me – I don’t like to go through the hassle so negotiated my Doctor back to two a year – he was not pleased since he and his partners in the practice own the testing facility. Finding a way to get the choice about what to do based on what the patient needs – not on what is
      covered and what is not would go a long way towards reducing demand for the kind of services that @Rex talks about – once you have the MRI machine you have got to feed it – whether the patient needs it or not…

      Point 2 probably has some relation to tort reform – providers will squeal loudly if they cannot protect themselves by protective testing.

      Personally I am not in the group that has much hope for getting relief on costs from insurers – they make great political targets – but they generally transfer costs in my experience.

      • @LL – I think consumers will be paying more for their care in the future. What’s needed to make that work are (1) appropriate subsidies for low-income individuals (the new law has that) and (2) much better information to consumers about prices and effectiveness of therapies (the new law might make a start on that). It is not reasonable to expect consumers to play a productive role in the market unless and until access to quality, comprehensive, understandable information on efficacy and cost are available. In many areas of medicine physicians don’t even know what works or what things cost. This transition will take time.

    • I have a personal example that can help illustrate my take on this post: my father, an orthopedic surgeon, could perform certain surgeries in his small clinic (operations such as certain types of arthroscopies). However, he cannot because of state (in Illinois, at least) regulation that requires these operations be performed in a hospital. Thus most of the cost of that operation goes to a “hospital fee,” not for the actual surgery. Many simple and basic operations that could be performed outside hospitals cannot because of these laws–perhaps that is why they have such a concentrated market power. Maybe more attention should be payed to the bread sellers.

    • I like the bread story, but would it be more analogous to health insurance competition if the mom sent the son to buy 2 loaves of bread the first time, then sent the son and daughter to buy 1 each the next?