Plain Sense Economics

For political junkies the next several weeks should be very interesting, as the Senate and House (and various splinter groups within each chamber) try to construct a healthcare reform package that works and will garner enough votes.

No one from Washington has called me – asking for my preferences, but in the interest of illuminating both current events and economic theory, here’s what I would say.

These are elements of a healthcare reform package that we need in order for it to work:

1. Universal coverage: every resident, regardless of immigration status, needs to be covered. Every time we carve out an exclusion the resulting system becomes much more complex and less effective.
2. No exclusions or limitations on pre-existing conditions, current claims history or the like. From a cost control point of view we need to lop off this part of the insurance industry business process. Insurance plans (public and private) need to accept all comers, and do away with the costly and disruptive denial processes that are designed to lower risk profiles among an insured population.
3. Item #2 is a big concern and issue for any plan (again, either public or private). To be fair and to keep these plans from imploding, we need mandatory coverage. If individuals can opt out of insurance, then the incentive structure will encourage healthy individuals to go bare, and will increase the level of risk and exposure and premiums for those people who want insurance.  In the insurance industry adverse selection is a valid concern. Insurance works best if a broad, large population is insured, made up of a wide distribution of risks.
4. The mandated coverage should be a basic plan, with good catastrophic coverage, and a core (but not very large) set of early intervention, preventive services covered. This core of preventive services should be limited to those that actually save expenses over the life of the resident. Many preventive services extend life, which we can agree is good, but not all of them save money.
5. Residents, at their option, can choose plans with greater coverage, at their own cost. There have been discussions of “cadillac” plans (with the interesting ironic twist on the current condition of General Motors…) and this is essentially that topic. For the healthcare market to work more efficiently, patients and their physicians (who act as their agents) need to feel the economic costs of diagnosis and treatment decisions. People who are more risk averse can choose a more comprehensive plan, but they should pay an actuarially adjusted premium for that protection.
6. Patient exposure to costs is not a silver bullet in healthcare reform, but it is an essential element. One of the market failures in our current system is that the costs of treatment decisions are often hidden from both the patient and the prescribing physician. For efficient, effective decisions each player needs to understand the costs of the decision, including opportunity costs.
7. We should phase out the tax benefits for employer sponsored health plans. These benefits distort the market, leading to costly and comprehensive benefit packages, with less attention to cost control. I’m not sure that our current system places our companies at a global disadvantage, but I am convinced the employer-based benefits add unwelcome torque to the market. This change has to be done carefully, of course, using new tax revenues to help individuals afford their growing share of premium costs. And we will need to design a way to keep this change from being a windfall to corporate profits.

Supply Side Reform

Universal, mandated coverage is hugely important – on the demand side of the healthcare market. We know, though, that increasing coverage will increase costs. More people will seek treatment, which is good – to a point. This increased demand will also increase prices, as the supply side ramps up to handle the increased demand. While many people will get more appropriate, early treatment and preventive care, there are not enough cost savings from fewer ER visits to offset the increased costs.

So, there are elements we need in healthcare reform that address the supply side.

1. Malpractice reform is an important piece. We want to protect victims from poor treatment, but the balance needs to shift to identifying and correcting fraudulent and negligent care, and away from using the tort system to punish all bad outcomes. This is not a sop to the medical community, beset by very high premiums. Instead malpractice reform will release the physician to make reasonable diagnosis and treatment decisions, without having to practice defensive medicine.
2. Physicians are smart people, and they respond to incentives just like all of us. We also know that medical care is done differently in different locales, with significant differences in costs, and often no differences in quality or outcomes. Our newly designed incentives should encourage movement towards more cost effective care. We can’t be distracted by labels like rationing, or government control of medicine. Instead we need to encourage more wide spread use of treatment strategies already in place in the private sector.
3. The supply side of healthcare needs more vertical integration. Physicians, hospitals, and other care providers need to manage patients and their risks collectively, and make decisions that result in good outcomes and lower costs, regardless of the treatment setting. This approach has worked for fifty years in organizations like Kaiser Permanente, InterMountain Health, the Mayo Clinic, Geisinger, Group Health of Puget Sound, and the VA.

The Role of Competition

In this post I’ve attempted to set aside the issue of political feasibility. That is for others to evaluate, and it is a mistake to “give in” on these checklist items too soon, if ever, in order to curry votes. One exception to this is that I’m not considering or proposing a single payer plan. There is much about single payer to like, but it flies so much in the face of American social attitudes that I can’t bring myself to consider it realistically.  Which leaves us with a multi-faceted system, involving both private and public elements.

As an economist, I have a basic belief in markets, and their ability to help individuals, families, and suppliers make efficient allocation decisions. I also understand that in the case of market failures or the presence of externalities, that government intervention is warranted and necessary. Generally, the best solution is to defer as much allocation decision making to markets, and for government to put a very light hand on the tiller.

1. Healthcare reform should leave individuals and families with choices. Choices should have different prices, depending on the benefits they deliver. Insurance and delivery systems that figure out how to improve healthcare and make it more efficient should enjoy lower costs and premiums, attracting more people to them. Health insurance purchasing cooperatives, while also not a silver bullet, are worth exploring.
2. The competitive playing field should be reasonably level. The basis of competition should be on outcomes and costs, not on risk-shedding or underwriting.
3. Assuming that some portion of the population will have their premiums paid or subsidized by the government, those payments should be risk-adjusted. For example, a disabled person with significant medical needs who is unable to work should bring with him a government subsidy that is higher than an average person. This way plans will be less concerned about the underwriting risk, and the good plans will be able to manage this person’s care thoughtfully and efficiently.
4. Insurance plans should be community rated. This means that everyone with the same set of benefits in a plan should pay the same premium. Experience rating is the current norm, where groups pay premiums based on their own experience. This pricing encourages aggressive underwriting – insurance companies compete to enroll young, healthy groups, and avoid older, sicker populations. And even without underwriting experience rating drives sicker populations away due to higher premiums.
5. The earlier points established, a public option is not really a necessity. It is a favorite rallying cry in the current debate, but mostly because some of us do not trust the government’s ability to regulate a competitive market of private plans. There are other, successful economies that have universal coverage without a public option.