How To Fix American Health Care

August 14, 2009

By Jeffrey McCombs

Why is health care so expensive? Why are the costs of programs such as Medicare and Medicaid out-of-control and resistant to cost-containment efforts? Can health care reform be structured to reduce costs, improve quality, promote electronic medical records and increase prevention, or are President Obama and Congress simply pouring gasoline on the fire?

The answers to these questions are remarkably simple, once you understand the pathology behind the symptoms that plague America’s current health care system. Put simply, traditional indemnity health insurance plans and the Medicare and Medicaid programs are based on a three-party system consisting of the patient, the care provider and the insurance company/government program. The physician and patient make the decisions that determine the amount of care to be paid for, and the insurance company/government program pays the bills. In this situation, when we get sick, we want the “best” care possible, regardless of cost, and the physician has no incentive to balance the benefits of the treatment decision with its costs. Patients have little incentive to object to high unit prices, because they are paying only a fraction of the total bill. This fee-for-service health care system is resistant to cost containment, because that would require the insurance company/government program to “poke its nose” into the clinical interaction between patient and provider to ration — or rationalize? — treatment decisions. Only the treating physician has the knowledge and information to make these decisions on a case-by-case basis. On the price side, the insurance company/government program has more leverage; it often reduces the price paid per unit of service by fiat. This administrative approach to setting health care prices is rarely accurate, and it forces physicians, hospitals and other providers to increase the prices charged to other patients (a practice known as cost shifting). Thus any health care reform plan that simply increases the number of people covered by fee-for-service-based insurance will simply fan the flames.

So how well do the reforms under consideration in Congress cure the dysfunction in the U.S. health care system? A government-run, single-payer approach (Medicare for all) must continue to pay for health services using a fee-for-service payment system; there are no alternatives. Cost containment in this environment would interject government into the medical decisions of physicians and patients. Decisions on rationing would be political and would be quickly controlled by providers to their benefit, and thus would fail to rein in use of services or cost per unit. One need only look at the sad history of Medicare’s efforts to institute competitive bidding systems to see how providers resist efforts at cost containment. Imagine the morass that would be produced by bureaucratic systems designed to control day-to-day medical decisions.

The government could run the health care system directly, as the United Kingdom does in a system that resembles our Department of Veterans Affairs (V.A.) services. Physicians would be salaried government employees, with no direct incentive to provide high-quality care at a reasonable cost. Under either the “Medicare for all” or “V.A. for all” approaches, citizens wouldn’t be able to select a different plan unless they had sufficient resources to pay both their health care taxes and the cost of outside health services. We run our public schools this way, and what do we have? Low quality, and well-to-do families opting out of the system entirely.

Fortunately, there is a third option, which shifts the insurance responsibility to the physicians: the HMO. Under HMOs, the physician group is paid a flat fee per month and has to balance the cost of medical decisions against the benefits received by the patient. If they fail to balance costs and benefits, they won’t have sufficient resources to treat other patients or to pay salaries and bonuses. Some people fear that in this type of system physicians will skimp on care and pocket the extra money, but there are a few factors that prevent this from happening. First, if physicians don’t provide necessary services and a patient’s health declines, the doctors must pay the cost of the bad outcomes. Second, if an HMO pursues this strategy, it will lose subscribers, because patients have other options. Consumers will reject poor performance and high premiums in the open market — a choice not available to them under the “Medicare for all” and “V.A. for all” proposals.

There is abundant evidence that HMOs in the U.S. perform in the best interest of enrolled patients. Research that compares the relative performance of HMO systems and fee-for-service insurance shows clearly that HMOs emphasize prevention, use electronic medical record systems, ration care to those patients for whom the benefits justify the cost, and save considerable money, all without outside intervention or regulation. It is consumers who regulate HMOs, once a year when the open enrollment period comes around. HMO dis-enrollment rates tend to be very low.

The current proposals for health care reform largely build on competition between health insurance plans. For an example of this strategy at work, look at the Medicare Part D drug coverage program, which allows beneficiaries to enroll in a long list of alternative plans. The actual cost of the program turned out to be well below estimates. (When was the last time a new government benefit came in below budget?)

The health care debate really boils down to the government option that is proposed in most Democrat-sponsored approaches. This is a poison pill to health care reform, for several reasons. The government option must be based either on a fee-for-service payment system (Medicare for all) or on a government-run delivery system (V.A. for all). Either will fail if required to compete against private plans. Though ideally the consumers who picked the government option would pay the full cost of the government program, that is unlikely to happen; thus the government would subsidize the government option with the tax money of people who selected private plans.

So what is the bottom line? Health care reform really isn’t that hard to figure out. Provide U.S. citizens with the resources to purchase a basic plan on the open market, allowing consumers to buy better coverage out-of-pocket if they wish. If there is a government option, make it collect premiums sufficient to cover its costs. There are hurdles to be crossed, but at least this approach won’t interfere with the decision process that is at the heart of the physician-patient relationship.

Jeffrey McCombs is associate professor of Pharmaceutical Economics and Policy, Gerontology and Public Administration at the USC School of Pharmacy, as well as senior research associate in the Division of Policy and Services Research at the Andrus Gerontology Center’s Gerontology Research Institute. He is an expert on health care reform, medication pricing and HMO performance.