Garett Jones  

Will ACA's cost-cutters outcut private insurers?

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Earlier this month, health experts from the Obama Administration wrote up some advice on the next steps for health reform in the New England Journal of Medicine.  I recommend reading it: Not too technical, about 2500 words, it gives you a glance into your likely future.  

The paper's big push is for cost controls: And that means both lower prices per service and fewer services.  P and Q both get attention.  

I'm interested in a narrow set of questions: Which of the reforms they recommend were attempted by private insurance?  And if they failed when private insurers tried to bend the cost curve, what unique skills or legal powers will permit the federal government to do a better job?  

Three options come initially to mind, each belonging to a conventional field of economics. Keep in mind I'm intentionally focusing on rosy scenarios:

1.  Government will do a better job cutting costs than private insurers because it will use oligopoly and monopoly power to reap the rewards of increasing returns to scale. (Industrial Organization)

2.  Government will do a better job cutting costs than private insurers because it will have superior knowledge-sharing across providers. (Information Economics)

3.  Government will do a better job cutting costs because it's the government: It can subsidize behaviors its prefers, and tax or ban behaviors it dislikes.  (Public Finance)

Surely private firms have a strong incentive to cut costs--after all, profit is revenues minus costs.  Every dollar of cut costs is a dollar for shareholders.  It's difficult to imagine any collection of government agencies facing incentives that strong.  Perhaps private insurers tried to do all of 1-3 and faced legal barriers that outweighed the strong incentives they faced to cut costs.  Or maybe customers just didn't like it when they cut costs, and insurers responded to customers, so costs weren't cut that much. 

I recommend reading the whole article, asking yourself after each paragraph, "What friction kept the private sector from doing this?" 

I can summarize perhaps a third of it as saying "Do things that HMOs do." Fee for service gives bad incentives especially amid third-party-payers, so set "global targets" and "reduce payments to hospitals with high rates of readmissions" and buy inputs efficiently and the like.  HMOs have not been popular in most parts of the country. I had a great experience with mine a few years back in California but when I moved I switched back to regular insurance. Perhaps we'll like HMO-like service if almost everyone has it--I guess we'll see.  

The authors also recommend reducing regulatory barriers: They note that 34 states don't "allow advanced-practice nurses to practice without physician supervision." Insurance companies surely would have liked to reduce those barriers.  I wonder why they lost those battles.  

They also want the Federal Employees Health Benefits Program (FEHBP) to become more like Medicare and to engage in exemplary cost-cutting practices.  Federal employees may soon be part of an important experiment.  

Non-Pejorative Coda: The authors' claim that "insurance industry overhead" is a big source of waste is quite similar to the claims made for the superiority of communism.  People often forget--or have never heard--that efficiency was one of the big selling points of central planning.  

Communism, after all, would end the "wasteful duplication" of industries and advertising.  Why build two car company headquarters?  Why advertise for two similar carbonated beverages?  Irony aside, ending the waste looks great on the chalkboard.  Perhaps there's something special about the insurance industry that makes it true there, but not for automakers.  

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COMMENTS (13 to date)
C writes:

"allow advanced-practice nurses to practice without physician supervision." Insurance companies surely would have liked to reduce those barriers. I wonder why they lost those battles.

Insurance companies did not lose those battles--their numbers indicated this was a terrible idea for their overall health care costs.

Essentially, the most significant cost for care is not the physician labor but the ancillary care that a patient receives thanks to being seen by a physician (or other health care provider). Thus, even if you massively reduce the physician component of costs, you see a significant net rise in cost to the payor as access increases and more people are seen by NPs, etc. (especially because NPs tend to order more "useless" tests given a smaller knowledge base). Now if you could do a 1 for 1 substitution of NPs for physicians, then you could benefit insurance cos or the govt but in reality, we are just adding supply to a market where more supply means more costs.

This is arguably the unstated logic for why CMS refuses to increase funding for residency slots despite a looming physician shortage and lots of available foreign or domestic med students available to fill these slots. If we can't ration care explicitly, this is one way of doing the rationing secretly...

Rea Hederman writes:

Garett:

The problem that technocratic plans run into is that reality contains real people.

The latest example is merely over the idea that electronic records will reduce health costs. The NY Times shows that's not quite the case.

"But, in reality, the move to electronic health records may be contributing to billions of dollars in higher costs for Medicare, private insurers and patients by making it easier for hospitals and physicians to bill more for their services, whether or not they provide additional care."

Upbilling will become a bigger problem as price controls become more forceful, especially under the ACA. Why should I treat you for 1 disease, when clearly you have 3 or 4 problems?

andy writes:

A funny side note about what happened in Czech Republic - the government sets the rates that are paid from the public insurance for different drugs. Because health care is supposed to be free, they have to consult this with the pharmaceuticals and agree on some price.
This year the government was very succesful in using their monopoly (or monopsony?) power to cut the prices of drugs. So successful, that some drugs cannot be bought - 'somehow' they get exported to germany... while the pharmaceutical companies claim, that they surely do deliver enough drugs for the Czech market....

The private insurance companies are heavily regulated, and aren't allowed to offered cheaper alternative policies. Insurance is a lousy way to pay for anything, anyway.

Thomas DeMeo writes:

Heavy regulation not only often prevents insurance companies from offering cheaper policies, it also removes incentives to even try. When rates are regulated, aren't the long term margins really being set by the states? Can an insurer really seek to pay less $$$ in paid care while keeping margins higher? I don't think that works today.

Doug writes:

"No, no, no. This time socialism is different. It will totally work. This isn't like that staid over Soviet socialism. This is new style socialism. Have you see Obama, the man *screams* hope and change. If anyone can make communism work after centuries of failure it's a hip, cool, mulch-cultural groovy community organizer."

MingoV writes:

The federal government has had decades of nearly full control over health care costs at its Veterans Health Administration. The VHA owns more than 150 VA hospitals or medical centers and numerous outpatient care clinics. The VHA has capitation-based contracts with private practice clinicians to serve veterans in localities distant from a VHA-owned facility.

The VHA's efforts to contain health care costs have not been very effective. The most effective action was nationwide contracts for medical supplies and drugs, but that effectiveness was no greater than that of private health care corporations that own scores of hospitals or of the Consortium of Academic Medical Centers (that negotiates group purchasing discounts with vendors). The VHA saves money by not covering certain therapies and procedures, but that's no different and no more effective than what private insurers do.

The VHA could save lots of money on both inpatient and outpatient care by widespread implementation of clinical practice guidelines (also know as care maps). However, when I left the VHA at the end of 2007, only a handful of clinical practice guidelines were in use. Most were implemented at the individual facility level rather than nationwide. Instead, the VHA focused on meeting every one of the Joint Commission's quality guidelines (even the ones that were outdated). The Memphis VA Medical Center where I worked dropped computer reminders related to diabetes clinical care guidelines because they were no longer on the Joint Commission's list. The clinicians were annoyed, because the diabetes care reminders were excellent. This is a typical example of bureaucratic priorities resulting in better "scores" but lower quality of care and higher costs.

Pemakin writes:
Surely private firms have a strong incentive to cut costs--after all, profit is revenues minus costs. Every dollar of cut costs is a dollar for shareholders.

I as free market a guy as there is but I am not sure in the long-run that private insurance firms have any incentive to cut cost (at least collectively) in healthcare anymore than they do anywhere else.

For instance, in auto insurance, its clear that industry groups like the Insurance Institute for Highway Safety tend to favor regulations that raise the cost of the auto or the cost of repair and justify these as leading to greater personal safety (as they often do). But more expensive cars/more expensive damage lead to larger insurance premiums. The basic rule is that if insurance margins are thought of a fixed percentage of the covered assets/claims (which tends to happen in a competitive market), then raising the amount of the assets/claims is in every insurers collective interest.

Given that their collective incentive is to raise the cost of insurance in the long-run, its fair to scrutize whether the benefit (greater safety) really merits the cost. They act as a powerful lobbying group that is often largely unopposed since the manufacturers have little reason to fight regulatory mandated cost increases driven by safety and the buyers of cars are a largely diffuse public that naturally sees the appeal of greather safety. As an illustration, remember automatic seat-belts, that offered no benefit over an ordinary seat belt except requiring their use at some additional cost.

Healthcare insurance shares many of the same principles. The evidence is that level of care has steadily increased over time as premiums have long grown in the teens and margins have remained steady. If I'm running a health insurer, why would I not want to keep that going.

Now you could argue that their clients, the private employers, have every incentive to prevent the creep of higher levels of coverage. However, most HR departments would say that this is a cherished benefit relative to others provided and it has a tax subsidy, making it a relatively attractive benefit for employers to provide.

In the end, you could argue that removing the tax subsidy would get us to a more rational outcome (I would). But as long as its in place, I think that the government has a better chance of cutting costs by restricting services than the current "private sector" dynamic.

Taras Smereka writes:

I happen to work as an internal audit intern at an insurance company. I like to show up to company events where they talk about actuarial trends, even though I never handle the stuff myself. Our actuaries are projecting that the cost of coverage for a 20 year old male to increase by 200 to 300%, due to the cross subsidization of women and the elderly, the elimination of underwriting, and unhealthy uninsureds joining the insurance pool.

I and my family happen to be refugees from the former CCCP. When I talked to my father about healthcare reform, he actually stated that argument that socialized healthcare removes "wasteful duplication". Competition is not wasteful duplication. Competition is actuaries, accountants, underwriters, sales people, customer service reps, and software developers coordinating to get the customer affordable coverage.

Garett Jones writes:

Great comments, all---I hope many readers click through to read.

Shayne Cook writes:

The article and discussions emphasize some mythical "competition" among providers/suppliers in the health care industry as the mechanism for containing cost growth. True competition can indeed have that effect.

I wonder if that includes foreign competition?

I've read of and know of (a close relative) folks who have negotiated with their insurance providers to be reimbursed for medical procedures performed outside the U.S. In the case of a cousin of mine, the procedure was a hip replacement - performed in India, at roughly 15% of the cost (including travel) of having the same procedure performed anywhere in the U.S. His insurance company was more than happy to allow him to do that - and fully reimbursed him both for the procedure, and the travel.

As an aside, my cousin had this procedure done over two years ago (in India), and was/is quite pleased with the results.

Josh S writes:

Couple quickies:

-Government already intervenes heavily in the private insurance market (beyond outright socializing around 2/3 of medicine in the first place). Papers that ignore this and talk about private insurance as though it's reacting to free-market incentives aren't engaging reality.

-I'm surprised that after Buchanan's development of public-choice theory, *anyone* is still writing at the academic level about what government "could" do. The whole point of economics is to figure out what institutions will actually do in a given incentive environment and why. This entire paper doesn't even acknowledge that government has incentives motivating its actions. It simply assumes that government will automatically move toward some kind of Pareto efficiency or something. As we can see in pretty much every government program ever, nothing could be further from the truth. This is because, as Buchanan showed, government's incentives are political. So regarding the three things:

1. Economies of scale occur when more productive methods are discovered and implemented. For example, there's no economy of scale for automobiles without the invention of the assembly line and other techniques of mass production. Profit provides the incentive to create and implement such techniques; government has no incentive to economize as it grows.

2. One of the most important methods of knowledge-sharing is the price mechanism, something the internal operations of government completely lack. When it comes to information, there can actually be large diseconomies of scale, because institutional change is harder with larger institution. To large institutions, information that requires rapid, agile change may as well not even exist. There is no reason to believe no such information exists in health care. And, of course, government lacks a profit incentive to respond to information. For example, its own internal audit found Head Start provides absolutely zero return on investment. If the government were GE, it would shut down the Head Start program. But it continues to spend money on it for entirely political reasons.

3. This logic seems backward to me. The fact that the government can incentivize behaviors that the market rejects is, in general, a cost-increasing measure. It pushes resource utilization *away* from its optimum (however you want to define that). This almost by definition increases costs, since resources are now being used in economically inefficient, but politically pleasing ways.

Jeff writes:
2. Government will do a better job cutting costs than private insurers because it will have superior knowledge-sharing across providers. (Information Economics)

The company I work for is a contractor for the Center for Medicare Services. I read this and had myself a hearty chuckle.

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