PrintDecember 2, 2009
Wrong Diagnosis, Wrong Treatment
Most of the energy of political work is devoted to correcting the effects of mismanagement of government.
-Milton Friedman
The art of medicine requires the health care provider to make an accurate diagnosis in order to formulate an effective treatment plan. This is also true of the art of policymaking. However, the importance of accuracy and effectiveness is magnified in the latter case by the fact that whereas a medical diagnosis affects only one person, one piece of legislation affects the lives of millions of individuals.
Proponents of the health care reform bills coming out of Congress claim the bills will decrease medical cost growth over time, making health care more affordable while insuring the majority of uninsured Americans. Unfortunately, the majority of politicians have grossly misdiagnosed the cause of health care costs and inflation. Therefore, the remedies employed by the current bills, namely mandating, subsidizing and directly providing third-party health insurance coverage, will only make these problems worse.
First, the misdiagnosis: The disproportionate rise in health care inflation is due to waste, fraud, abuse, and profit-seeking. This is a straw man. The same argument could be made for any services provided by the private sector; however, unlike health care, no other private-sector services or products have been subject to the same extra-inflationary bias over time. While each of the mechanisms described can affect health care costs, each has relatively little bearing on inflation. Instead, health care inflation is the result of loss of market mechanisms due to past legislation.
Until the 1960s, the price of medical services was determined primarily by the free market. Medical providers sought to provide the highest-quality care at an affordable price to compete for patients' business. Medical providers had the highest degree of autonomy to allocate their services as they saw fit, and patients had the highest degree of autonomy to seek health care services they deemed appropriate from whom they felt was most capable of providing them. Contrary to what some may now believe, individuals were not dying in the streets from lack of health care; and where individuals could not afford care, they could try to obtain it through private charity.
During this period, the private sector funded over three quarters of the country's health care expenditures, and individuals paid nearly one-half of total costs out-of-pocket. Subsequently, health care costs were affordable and medical care price inflation was in line with the consumer price index for inflation. However, beginning in the mid-1960s, political reform began to topple the medical marketplace, and health care costs and inflation took off. They have been sharply outpacing the general rate of inflation ever since. But before considering how these reforms affected health care costs, it is important to remember the following quote by Milton Friedman:
Legislation cannot repeal the nonlegislated law of demand and supply: the lower the price, the greater the quantity demanded; at a zero price, the quantity demanded becomes infinite.
Enactment of Medicare and Medicaid provided a direct subsidy for medical care. The cost grew much more rapidly than originally estimated, as the cost of any government-subsidized service inevitably does. The HMO Act of 1973 provided grants and loans to provide, start, or expand a Health Maintenance Organization (HMO). The Act gave HMOs greater access to the employer-based market, providing for the rapid expansion of managed care. Finally, the states and the federal government increasingly specified the coverage of insurance for medical care. The goal of each of these reforms was to transform the medical insurance market from one that provided protection against catastrophic risk into one that covered the costs of routine health care services -- so in keeping with the theme of the "nanny state," individuals would be able to easily acquire what they needed and would not have to forgo care. Managed care mechanisms were implemented to be the broker between the consumer and the provider. Sounds good, right? Not so fast.
This situation -- where a third-party inserts itself between the consumer and provider -- provides the direct mechanisms for health care inflation mainly because "nobody spends your money better than you do." When the consumer has a direct relationship with the provider, the consumer must rely on his own individual finances to make affordability decisions. He therefore exerts downward pressure on the price of the service he is consuming, which helps the price remain affordable. This relationship is severed when a third party covers the cost of routine health care services. Another point to consider is the following: The utilization of any service that is subsidized will naturally increase. Individuals respond to lower cost-sharing (more comprehensive coverage) by utilizing more care, as well as more expensive care because they do not face the full price of their decisions at the point of utilization.
Based on the mechanisms described above, the correct diagnosis for health care inflation is the third-party coverage of routine health care services and managed care, which has been thrust upon us with previous health care legislation. This brings us back to the opening quote from Friedman. To test this theory, let's consider the following graph created with data from the National Bureau of Labor Statistics and the Centers for Medicare and Medicaid.
The graph displays medical care price inflation (red) compared to the consumer price index, which includes medical care price inflation (blue) for the years 1947-2007 and shows a strong correlation between government policies and health care inflation. (The graph even underestimates the effect of Medicare and Medicaid because spending from these programs really didn't kick in until the early mid-70s). The graph also shows a strong inverse relationship between health care inflation and out-of-pocket expenses, which were nearly 50% prior to 1960 and account for only 10% of health care costs today. Despite these correlations, any good scientist knows that correlation does not imply causality -- so what would imply causality? The answer is a prospective experiment comparing health outcomes and total spending between groups of individuals assigned to different kinds of health insurance plans.
The RAND Health Insurance Experiment was the only study that performed this type of social experiment, and it provides the evidence for the causal link between the third-party coverage of routine health care services and health care inflation. The study assigned different levels of health insurance coverage to different groups of individuals and compared health outcomes as well as total spending and overall costs between the groups. These groups were assigned health insurance with varying levels of coverage or cost-sharing. The RAND experiment found no significant effect of the level of benefit coverage on various measures of health outcomes for the average adult. However, total health care spending increased significantly as benefit coverage increased. Put more simply, health insurance that covered more routine health care services led directly to over-utilization and higher costs without significantly improving health outcomes.
Now on to the treatment. The bills coming out of Congress utilize three major mechanisms to "bend the cost curve down and to insure more Americans." These are as follows: to mandate the purchase of highly regulated health insurance, which must cover the cost of a broad array of routine health care services; to subsidize the purchase of this type of insurance for individuals who qualify; and finally, to directly provide this type of health insurance through a new government entitlement program.
These pieces of legislation, which are designed to treat the problem of health care costs, will only make the problem worse. They will add fuel to the fire of health care costs and inflation by increasing the number of individuals with managed care plans who will then over-utilize the health care benefits they are entitled to. Proof that this scenario will play out can be found in Massachusetts. In 2006, Massachusetts passed sweeping health care legislation. Similar to the bills coming out of Congress, the Massachusetts reform included a mandate to purchase comprehensive health insurance, provided subsidies to individuals who qualified, and created a new government-subsidized insurance plan called Commonwealth Care.
The entire plan was projected to cost $1.56 billion per year, but will cost $1.9 billion in 2009, representing an 8% increase over a very short time period. Commonwealth Care, the public option in Massachusetts, was projected to cost taxpayers $725 million per year, but by 2008, the cost had risen to $869 million, representing a 20% increase over the projected yearly costs. By comparison, nationwide insurance costs rose by 6.1% in 2007, 4.7% in 2008, and are projected to increase 6.4% this year. Worst of all, emergency room visits increased. So much for government competition driving down costs.
In an ironic twist of fate -- or not so ironic, depending on your point of view -- the Massachusetts reforms bent the cost curve up instead of down. This is only a microcosm of what we can expect from the legislation coming out of Congress. Unfortunately, instead of learning from Massachusetts, congressional leaders are scurrying to implement Massachusetts-style reform throughout the country. Therefore, the results of the bills coming out of Congress should be rather obvious: Health care costs will continue to increase at an exorbitant rate, leading to big increases in federal spending, higher taxes, and the loss of individual freedom and economic prosperity that naturally follows.
When formulating an effective treatment strategy, it is critically important to have the proper diagnosis. In the case of current congressional reform efforts, the politicians have missed it by a mile. And we the people will pay.
Andrew Foy, MD and Brent Stransky are authors of the upcoming book The Young Conservative's Field Guide. They can be contacted through their website at www.aHardRight.com.
