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Gerald Friedman

Health Care

Why Market Competition Hasn’t Brought Down Healthcare Costs

Each attempt to fix the problems has led to more administrative red tape

Published: Tuesday, August 8, 2017 - 12:01

It’s easier than ever to buy stuff. You can purchase almost anything on Amazon with a click, and it is only slightly harder to find a place to stay in a foreign city on Airbnb. So why can’t we pay for healthcare the same way?

My research into the economics of healthcare suggests we should be able to do just that, but only if we say goodbye to our current system of private insurance—and the heavy administrative burden that goes along with it. Republican efforts to repeal the Affordable Care Act (ACA) would take us in the wrong direction.

What makes healthcare so complicated

In a way, the reason buying healthcare is different than shopping for a garden gnome or short-term apartment seems obvious. Picking the right doctor, for example, involves a lot more anxiety and uncertainty, and concerns matters of life and death.

But that’s not really the reason we can’t purchase healthcare the same way we buy an iPhone. In 1969, this would almost be true (for a rotary phone, anyway). Back then, the bill for a birth in a New Jersey hospital looked a lot like the receipt you’d get for buying pretty much anything else: customer name, amount, and a box to be checked for payment by check, charge, or money order.

Today, paying for even the simplest office visit can become a nightmare, requiring insurance preauthorization, reimbursements adjusted for in-network or out-of-network copays and deductibles and the physician “tier” (or how your prospective doctor is evaluated for cost and quality by the insurance company).

Prescriptions require even more authorizations, while follow-up care necessitates coordinated review—and it goes without saying that many forms will have to be completed. And this doesn’t end when you arrive at the doctor’s office. A large chunk of any visit is spent with a beleaguered nurse, or even the physician, filling out a required checklist of insurance-mandated questions.

The growing complexity of health care finance explains why it’s becoming more and more expensive even though there has been little or no improvement in quality. Since 1971, the share of our national income spent on health care has doubled.

We can blame a significant part of the soaring cost of healthcare on the ever-increasing burden of administrative complexity, whose cost has climbed at a pace of more than 10 percent a year since 1971 and now consumes more than 4 percent of GDP, up from less than 1 percent back then.

Lemons and cherries

So if the rising cost of administration is a primary force driving healthcare inflation, why don’t we do something about it?

That’s because administrative complexity and waste are no accident but rather are baked into our private health insurance system and made worse by continuing attempts to use competitive market processes to achieve social ends other than maximizing profit.

Paying a doctor was relatively simple in the 1960s. Most people had the same insurance policy, issued by Blue Cross and Blue Shield, which back then was a private company but operated like a nonprofit under strict regulation.

But in hopes of controlling steadily rising costs, policymakers encouraged insurers besides Blue Cross to enter health insurance markets, beginning with the HMO Act of 1973. The proliferation of for-profit companies with competing plans raised billing costs for healthcare providers, which now had to submit claims to a multitude of different insurers, each with its own codes, forms, and regulations.

Not only that, but insurers quickly discovered the dirty secret of healthcare finance: Sick people are expensive and make up most costs, while healthy people are profitable.

In other words, the vital lesson for an insurer looking to make money is to identify the few sick people and get them to go away (“lemon dropping”), and find the healthy majority and do things that attract them to your plan (“cherry picking”).

Insurers are happy to offer discounts on fitness club memberships to attract healthy people, for example. But they punish the sick with higher co-pays and deductibles, as well as increasingly restrictive and intrusive regulations on preauthorization.

Economists call it “adverse selection.” Regular people call it paperwork hell. Whatever the name, it’s the purpose of increasingly complicated insurance plans and reimbursement forms.

A failure to fix

The public and government authorities figured this out quickly, but too often the cures have been as bad as the disease.

We could, and I believe should, have abandoned the use of for-profit private insurance to adopt a simple single-payer system, in which a government agency would provide coverage to everyone in the United States. Instead, in forging the ACA and in every other health reform enacted in the past 40 years, policymakers decided to work with private insurance while trying to fix some of its evils.

We adopted the “Patient’s Bill of Rights” around the turn of the century, and created processes to allow patients and providers to appeal medical decisions made by insurers. State health commissioners now have considerable power to supervise insurers, while the ACA mandates certain essential benefits be provided in all insurance plans.

Yet each of these efforts to protect the sick from abuses inherent in the for-profit insurance system only added to the administrative burden, and the costs, on the entire industry.

Some perceived the problem as a lack of market competition so governments freed hospitals and other healthcare providers from regulations on prices and restrictions on mergers, advertising, and other practices. But according to research, deregulation made both problems worse by allowing the formation of networks of hospitals and providers that use advertising and other business and financial practices to control markets and stifle competition.

Simply put, each attempt to fix a problem has led to more administration because we have kept intact the system of private health insurance—and for-profit medicine—that is at the root of at the dual problems of rising healthcare costs and growing complexity.

It’s time to take a step back

Clearly, our experiment in market-driven healthcare has gone awry.

Before we introduced competition and deregulation into healthcare, things were relatively simple, with most revenue going to providers. We could save a lot of money if we went backward and adopted a single-payer system like Canada’s, where insurers do not engage in systematic preauthorization or utilization review, and hospitals and pharmaceutical companies do not form monopolies to profit at the expense of the public.

Largely by reducing administrative costs within the insurance industry and to providers, a single-payer program could save enough money to provide healthcare to all Americans.

Compared with Canada’s single payer system, American doctors and hospitals have nearly twice as many administrative staff workers.

The ConversationSo whether the ACA remains in force or it’s replaced by something else, I believe we won’t be able to control health costs—and make healthcare affordable for all Americans—until we revamp the system with something like single payer.

This article was originally published on The Conversation. Read the original article.


About The Author

Gerald Friedman’s picture

Gerald Friedman

A professor of Economics at the University of Massachusetts at Amherst, Gerald Friedman writes on the labor history of the United States and Europe, on healthcare policy, and on political economy. He is the author of three books.


What explains elective surgery?

Market competition has brought down the cost of elective surgeries such as Lasik, breast implants, liposuction, etc.  Granted, these are not typically covered by insurance but the prices have come down without a single-payer model.

Could this be part of the solution?  Health insurance for catastrophic situations and pay-as-you-go for health maintenance and minor health problems.  This seems to work well for auto insurance provided by for-profit companies.  (Imagine how the situation would change if auto insurance was required to cover oil changes.)