Why The US Healthcare System Fails to Lower Prices

Fort Belvoir Hospital, U.S. Department of Defense. Source

Brief summary:

• Insurance companies, of which there are relatively few, dictate prices to service providers.
• These prices are, to a large degree, “flat fees” paid to service providers.
• As such, a service provider gets paid the same amount regardless of the cost to the service provider.
• The service provider thus pockets any decrease in cost as profit while your premium stays the same.
• People think that insurance companies have a lot of bargaining power because of the significant amount of money they control.
• However, while this bargaining power is significantly greater than an individual’s, it pales in comparison to the bargaining power of 200 million+ consumers.
• Thus, reducing the influence of insurance companies (and government) while increasing the influence of consumers, who don’t dictate flat fees and are cost conscious, would significantly reduce the cost of healthcare.

There is no sole factor that determines healthcare costs, but this one is both significant and one that we can illustrate with easy to digest examples. Further, this doesn’t just apply to our current system, but also applies to single payer or any system that reduces the number of entities (people and companies) involved in the market.

Imagine a company pays various outside contractors $100 to fill out forms. This flat fee doesn’t change and won’t change. For various reasons, chief among them is ease in predicting costs, companies oftentimes have arrangements like this. In other words, they don’t care about the cost to the contractors or profit of the contractors. This means there is no price competition between the contractors. (This is the exact arrangement we had with companies when doing patent preparation and prosecution and is how that particular industry works nearly across the board.)

Now let’s say that you’re one of the contractors and that it costs you $50 to fill out each form, making a $50 profit. At some point you hire someone that can fill out the form for $25, increasing your profit to $75. Because the company dictates the flat fee, this “innovation” doesn’t actually change their cost and you reap all the rewards.

This, to some degree, is how the healthcare industry works. The insurance companies determine how much a particular procedure, drug, etc. (hereinafter “services”) should cost, and dictate that cost to entities (e.g., doctors, hospitals, etc.) in their network. Because they dictate the price they will pay, the underlying cost to the entities in the network has little influence on the price. If advances in the industry lower the average cost of the services within the industry, the cost will likely be adjusted. But again, there will be little change based on individual entities’ cost.

Let’s look at a practical example. Let’s say there are two general practitioners (GP) (i.e., the doctor you see for physicals and basic stuff), A and B. Doctor A uses the latest, most expensive x-ray machine while doctor B buys an x-ray machine that’s ten years old and costs half as much as the newer x-ray machine. Further assume that the newest x-ray machine has a 10% beetter chance of catching various conditions. However, for the majority of conditions that a GP will see, such as broken bones, their effectiveness is essentially the same. Further, if there is a possibility of a condition that the older x-ray machine won’t catch, doctor B can refer the patient to doctor A, who can then use the newer machine.

What’s the net effect? Doctor B lowers his cost, thereby increasing his profit, with no effect on the price paid by the insurance company. In other words, price innovation by the entities providing services has little impact on the actual price paid by the insurance companies and thus has little impact on the premiums you pay.

As mentioned in the comment from John Stossel on the video below, “[u]nder our current healthcare system, government and private insurance spend 7 out of 8 healthcare dollars.” (Statistic unverified but clearly accurate to some degree.) According to this organization, there were 858 health insurance companies in the U.S. (as illustrated below, the accuracy of this statistic is not particularly important). This means there is some price competition between insurance companies (the less they pay, the lower their premiums can be), but it’s between a fairly small number of entities.

Now let’s look at what would happen if we got rid of all insurance companies. In such a situation, people would pay out of pocket for their healthcare. “But healthcare is so expensive, few people would be able to afford it!” you say. Let’s go back and look at what happens with doctor A and doctor B in this scenario.

Now that consumers determine the price of services, we have introduced a significantly greater level of price competition (300 million people versus 900). Because doctor B, with his lower cost x-ray machine, can charge less than doctor A, he can lower his price to attract a larger number of patients, potentially making the same profit with virtually the same efficacy for the things that a GP is most likely to see (resulting in a similar risk of mistake to consumers at a lower cost).

This is how free market/capitalistic economies work (is “capitalistic” even a word?). By increasing the number of consumers in a market, there is greater price competition, providing a greater incentive to lower costs. Does an insurance company have greater power to affect prices than a single consumer? Yes. Does an insurance company have greater power to affect prices than 300 million consumers? No.

As a practical matter, we won’t have a healthcare system in which insurance companies don’t exist, nor would we want that. There will always be a necessity for insurance companies to exist, particularly to cover less common, more expensive issues (similar to how car insurance works, which doesn’t pay for oil changes but pays for wrecks).

However, we can “easily” reduce the impact of the insurance companies and increase the impact of consumers (by increasing the number of consumers that pay out of pocket) by reducing government intervention in the industry. First, we can eliminate the tax benefits for employer-sponsored health insurance. This reduces the incentive to provide health insurance as a perk, instead allowing them to offer higher salaries in place of the health insurance. Second, we can eliminate government mandates and incentives to purchase health insurance (e.g., the Affordable Care Act/Obamacare).

Does this mean poor people get screwed? No, not at all. This doesn’t require eliminating subsidies for those who can’t afford healthcare, it merely reduces the number of people who can’t afford it.

We haven’t had a truly free market healthcare system since the government started providing tax breaks to companies for employer-sponsored healthcare (which, as I recall, happened in the 1950s…it was quite a long time ago, regardless). People complain about rising healthcare costs even as the government becomes more involved in healthcare, and many people (typically liberals, of course) believe that more government intervention is necessary. While, in theory, it might reduce healthcare costs to some degree, it clearly can’t reduce healthcare costs as a free(r) market would.

Perhaps we should try something different?

Keep in mind there are a large number of factors that go into the cost of healthcare. However, in my mind, this would have the largest impact on reducing cost. A few examples of other cost factors include the cost of medical school, costs imposed by the FDA on things like medical devices and drug approvals, legal liability, and the cost of medication (driven mostly by patents).

Here is another example of what can happen when you take the government and insurance out of the market. There’s a new trend referred to as “direct primary care.” Essentially, one pays a low monthly fee and gets basic primary care as part of the “subscription.” The “catch” is that they don’t accept insurance. This catch, however, reduces administrative costs significantly, reducing the cost of care significantly. Here is a great example. For a monthly fee of $50, a thirty-five year old gets the following services:

• All office visits (well-child checks, sick visits, routine gynecological care, annual exams, physicals for school, sports, camps, etc.)
• Chronic disease management, advice and counseling, prescribing of medications
• In-office tests (EKGs, rapid strep, blood glucose, pulse oximetry, urinalysis [dipstick], fecal occult blood, urine pregnancy, IV fluids)
• Communication by phone, e-mail, and text
• Laceration repair (tissue adhesive, stitches, or staples); including topical or local anesthesia
• Skin tag/mole removal, skin biopsy, abscess incision and drainage
• Ingrown nail repair, ear wax removal, foreign body removal (e.g., from skin, ear, etc.)
• Basic wound care, splinting or wrapping of sprains, strains or minor fractures.

For. Fifty. Dollars. A. Month. That’s literally less than two months of insurance for me, a relatively healthy 36 year old. If that’s not sufficient to raise your eyebrows about how insurance and the government impacts our healthcare, you’re probably a lost cause.