Why American Healthcare is So Expensive Part 3 – The Insurance System
Today the GOP is deep in its discussions about how to take apart The Affordable Care Act and to replace it with some other kind of system to pay for healthcare. So far, everybody in the healthcare delivery system hates it, and it may go nowhere. But I will continue to argue this – whatever they are trying to do, it won’t work.
Why won’t it work?
Not because the system that are creating is the wrong system. Sure maybe it is wrong. But that’s not the real problem.
As we said before, THE PROBLEM ISN’T HOW WE PAY FOR HEALTHCARE. THE PROBLEM IS HOW MUCH HEALTHCARE COSTS IN THIS COUNTRY.
So why is healthcare so expensive in this country? Last time we talked about how there are incredible incentives to create and use expensive healthcare equipment, even when such equipment does nothing for patients. Today we’re going to talk about something else: The Insurance System.
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I think a lot of people don’t fully understand why we have health insurance. Let’s start with why we have insurance for anything at all.
Insurance is needed when there is a potential future expense that you may not be able to pay for, but that may never happen. Ie its very expensive to repair your car if you smash it, and there is also heavy liability involved in potential damage to another vehicle or people within it, so you insure that potential expense. The vast majority of people who buy auto insurance do not have to make a claim, so insurance is relatively inexpensive relative to the potential size of the claims. You do not insure buying groceries because a) it isn’t that expensive to buy groceries and 2) everybody needs to buy groceries so there is no grocery-buying risk to spread out between different insured entities.
So based on this idea, and the current costs of serious healthcare interventions, it makes sense to insure healthcare.
We need insurance for healthcare because 1) you don’t know when and if you are going to need healthcare and 2) in most cases, when you need healthcare it is going to be more expensive than what you can comfortably pay at that moment. Furthermore, it is likely that the amount of healthcare a given person consumes is not balanced across their life. E.g. a given person is likely to consume relatively little healthcare resources when they are young and healthy, and is likely to consume relatively more healthcare resources as they age and inevitably start facing the healthcare problems that are associated with that aging. So by paying dollars into an insurance plan, young people are likely paying more than they receive, and the older people are likely getting more than they pay. As the young age, they end up on the other side of this equation. As long as a lot of young people do carry insurance, this should all work ok (though the ACA had difficulty convincing the young to actually carrying insurance, causing the entire system to break down.)
We can do that in two different ways – private and public. On the public side, we can figure out what a functioning healthcare system costs for the entire nation, and have the government tax each individual their share of that cost (in some way that the people in power think is fair.) In return for this tax, the government will then provide healthcare in some fashion, while trying to make some reasonable determination of what can be paid for and what cannot. If the government just pays for the care and the care is provided in the private world, this is a Single Payer System. If the government also owns the healthcare delivery system, this is a Socialized Healthcare System. The vast majority of countries on this planet operate with one of these two systems.
The other way to deliver care is to have individuals, or groups of individuals, buy insurance to pay for their care, either on an individual market or as a benefit of their employment.
BUT – let’s not confuse why people need health insurance for why the healthcare insurance industry exists.
People need health insurance to meet the financial realities of purchasing healthcare in our current system. But the Healthcare Insurance Industry, like all Insurance Industries, exists to take advantage of that financial reality to make money.
That’s it.
It’s a business. They take your money and then pay for your healthcare (more or less), and in return they make money on the whole process.
And herein lies the biggest problem with health insurance: I would argue that while we would like to have a less expensive healthcare system, the healthcare insurance system we have is actually incentivized to make the system increasingly expensive over time, and does not benefit by controlling the costs of care.
And here is why:
Most people think that insurance companies make their money by collecting 100 dollars in premiums and only paying out 80 dollars in healthcare. Perhaps they spend 10 dollars out of 100 in overhead, and then they make 10 dollars for every 100 dollars in premiums they collect. So insurance companies would have a strong incentive to control costs, since the less they spend on claims the money money they make! Wrong!!! They actually profit more by driving total costs up, not by saving money on claims.
In reality, underwriting is only a very small amount of how insurance companies make money. In some cases insurance companies can even be profitable even with an underwriting loss (meaning the claims and overhead is actually more than they collect). Because in the end, underwriting profit is never the primary motivator of insurance profit.
The primary way an insurance company makes money in on the float. What is the float? It is every dollar that you have paid into your policy that they haven’t yet had to spend on your claims. Basically this is money that you have loaned to the insurance company. As you age, you will consume more healthcare, and eventually they are going to have to start paying more claims than you are paying in premiums. But in the meantime, you have loaned them a tremendous amount of money. And did you get interest on that money? No not at all. In fact the insurance company got to take a healthy chunk out of your premium to cover overhead an (hopefully for them) underwriting profit. But more important than that, they got to have the use of your money in the meantime.
So how does the float lead to profit? Well it is said that the best way to make money is not to work for it, but to start with money and turn it into more money. And that’s what insurance companies do with the float. They invest it in the stock market. They invest in in real estate. They invest it in all kinds of things. Because when you have that much money (billions of dollars), making more money is actually not that hard. This is part of why the rich get richer. It’s hard to turn $10,000 into $20,000 in the stock market, but turning a billion into two billion is less difficult. Just ask Warren Buffet, the director Berkshire Hathaway, of one of the world’s most successful companies. The core of Berkshire Hathaway is a bunch of huge insurance companies (including GEICO), and thus a tremendous amount of float. And Warren Buffet uses this float to make money by buying other profitable companies, slowly growing the profits of the Berkshire Hathaway entity over time. And where does all this incredible leverage come from? It comes from the premiums that are loaned to the insurance part of his company until they are needed to pay claims later.
So if you were an insurance company, and your primary way of making money was to use the float you collect through premiums for investing, would you want healthcare to be less expensive? Of course not! You would want healthcare to be as expensive as possible.
Because the more expensive healthcare is to deliver, the more you can justify for premiums, and the bigger your float will be. And that, ladies and gentleman, is the big problem.
The entities we have entrusted to manage our healthcare dollars make more money the more healthcare costs, and less money when healthcare costs are controlled.
This is the classic situation of the fox guarding the henhouse. We tell the insurance companies to guard our money and pay for our healthcare when we need it, and all the while they are hugely incentivized to spend money, not to save it.
So when the ACA said that pregnancy care has to be covered in all policies did insurance companies say “NO we don’t want to pay for that it will be expensive!!”. Heck no. They loved it. They just got to click into their calculators and figure out how much it will cost to insure this benefit for all, and tack it on to every policy. MORE FLOAT. When the ACA said all birth control had to be covered, same thing. A few bucks more per policy, benefit provided, MORE FLOAT. How about something more controversial, like robotic surgery? Maybe it is better surgery, maybe it isn’t. So at first insurance doesn’t want to pay for it, because they haven’t collected premiums for it. But once doctors and hospitals decide they like it, insurance is all for it! They get to increase premiums to cover it and you guessed it, MORE FLOAT!! In fact, nothing makes an insurance executive more excited than a new expensive technology or new expensive medicine that the healthcare system decides is absolutely necessary, because they will get to roll it into premiums and make MORE FLOAT.
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So this is a big problem. If we are ever going to control the cost of healthcare in America, every party has to be incentived to make it less expensive. Right now, our insurance system has just the opposite incentive.
So how the hell do we fix this?
Last time I argued that docs should make less expensive choices, but this is a tougher one. We do need a way to spread healthcare costs among all members who utilize healthcare. As much as the GOP would like it, its not practical for each individual to pay for their own healthcare as they need it. There is just too much disparity between ability to pay and need to consume, both in societal class structure and also a temporal difference between when you have money and when you need to spend it. If we were totally capitalist about it, the poor just wouldn’t get care, and to me that is unacceptable. At the same time, a system that does not expose heathcare consumers at all to the costs of their healthcare consumption choices tends to balloon costs as well.
To me the thing that works the best is a system that accepts premiums and pays claims and at the end has no money left over, and therefore no float to play with. So basically that would be a non-profit insurance system like Medicaid or Medicare. A lot of people abhor this idea, since it means that the government owns healthcare finance. But this is the way it works in pretty much every other country, and I think it could work here as well. People argue that Medicare and Medicaid pay doctors so little that they don’t to provide. That’s true – but its the subject of another essay.
What I would like to see is a hybrid system, where the core is made up from a non-profit system that paid for basic healthcare, with the ability to purchase healthcare outside the system when a higher level of healthcare is desired (faster, higher tech, etc.) A lot of European countries do this, and it works fairly well.
But in the end, I do not believe we will get a true handle on our rising healthcare costs while we temporarily loan our healthcare dollars to for-profit insurance companies who are incentivized to keep costs high. We need a better system.
Dr. Fogelson is a gynecologic surgeon and endometriosis specialist who practices at Northwest Endometriosis and Pelvic Surgery in Portland, OR. Call 503-715-1377 for clinical consultation. http://www.nwendometriosis.com
Academic OB/GYN 
In the paragraph starting with “Last time I argued…”, you break off in the middle of the sentence: “I also believe that a”
Have you read Rand Paul’s plan to replace Obamacare? It’s only 4 pages. Here’s a link [http://www.cscmediagroupus.com/robert-zerfing/rand-paul-obamacare-replacement].
One thing that would help, is that it allows people to pay into their own HSAs, and for that money to accumulate. It seems like this would bridge the gap between what you talk about, when you said that young people typically don’t pay much in health-care costs, but they do typically pay more when they’re older. If people can put in $5k/yr (which they’d be more likely to do if it’s pre-tax dollars), and then spend it when and how they want, as long as it’s for health care, then healthy people can sock away $5k/yr for 30 years while spending relatively little of it (if it can be interest-bearing, that’s even better, because like any investment, it accumulates even more money than the people saved), and then when they need something expensive, they can pay for it out of that money.
There is no single, perfect system; all systems will have “cracks” through which people can fall. Currently, most socialized or single-payer systems have the “cracks” that, though everyone is covered, many people have to wait in such long lines that they never get care, or don’t get it in a timely manner; some things just aren’t covered at all. These two things have the same effect as what you decry in your article, as the poor not getting medical care at all.
What can plug the “cracks” in a capitalistic system, is charity care — Shriner’s, St. Jude’s, etc., where people can donate money to hospitals or doctors to pay for the care of those who cannot afford it.
How much does stuff *really* cost? I mean **really**? In the past two articles you’ve written, you’ve made a great case that costs are artificially driven up, because people aren’t directly paying for it (you may not have meant to make that case, but it was made nonetheless). Insurance companies and hospitals both have a vested interest in padding costs and using expensive “bells and whistles”; the average person doesn’t see the costs and can’t “comparison shop” to get lower costs or the best care for the money. With the current costs and cost structure, it may be impossible to conceive of people paying for medical care out of pocket, but how much does X medical procedure *really* cost? I submit to you that we don’t know.
First, there is a great deal of padding, as you already said. Second, there are layers of additional expense from “bureaucracy” — the doctor and hospital have to employ people (sometimes a team of people) to file insurance claims, and to deal with the inevitable denials which they then try to reverse, etc.,etc.
There have been doctors who went to accepting direct payments only (cash, credit/debit cards, checks), and they were able to reduce their staffing requirements to a single person to set up appointments, check people in, and accept their payments. This allowed them to offer quality care at a reasonable rate. [I read articles about this pre-ACA, before the days of forcing people to buy insurance.] Some said that they expected that their primary clientele would be those without insurance, but they were surprised that many of their clients actually had insurance, but found that it was cheaper to pay directly, than to pay the co-pay and deductible of their insurance and go with a different doctor. They could also turn in what their receipts to their insurance company, and part of that would go towards their deductible, and/or their insurance company might reimburse them part of the expense. Also, because the people were directly paying, doctors could charge more for longer visits if they were necessary, rather than being paid a single, set amount from the insurance company.
One more thing that you mentioned in the article, was that we don’t have insurance to buy groceries but we do have automobile insurance. Combining these two things, as a thought experiment, what would happen if automobile insurance covered the cost of fuel, tires, oil changes, etc.? The cost would undoubtedly increase. Yet, as you pointed out about groceries, it’s not sustainable to “insure” the cost of groceries, since everybody eats. In a similar manner, health insurance is expensive in part because it covers small, day-to-day expenses — “groceries” or “oil changes” by analogy. Health insurance was a lot cheaper when it was like automobile or house insurance — it covered only the big stuff, while everything else was paid directly by the consumer.
I would like to buy that kind of health insurance — the kind that would cover the cost of hospitalization for heart attack or cancer, while I could pay for doctor’s visits and other “oil change” expenses myself. If I have to pay for braces out-of-pocket, you better believe I’ll shop around and get the best deal I can. If Dentist X will charge me $5k while Dentist Y will charge only $2k, and they have the same or similar results, which one will I pick? If I tell Dentist X that Dentist Y will do it for $2k, Dentist X may come in with a lower bid. This sort of savings cannot be realized under the current system, as you have shown so well.
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Kathy thanks for your detailed thoughts and comments. I think the system you propose may work very well for most people. I do think that people who pay for their own health care will be more responsible for how their healthcare dollars are spent, and so the model of a healthcare savings plan may be a very good one. I agree that in the past insurance was for hospitalization and surgery and not for every little thing that one may do. As I said above, the decision to create HMOs and a full meal deal kind of health insurance benefits the insurance companies greatly, as it allows them to insure a much larger amount of needs, and thus have a lot more money to play with.
The trouble with HSAs is that we are by and large very bad at saving money. Even when it makes all the sense in the world, it is very hard to convince people to do it.
Perhaps a good model would be that there was a mandatory contribution in some way, but that a certain portion of this mandatory contribution was kept in an account for each individual to spend on routine care, and the remainder went to pay for insurance for high ticket items.
You are right that real cost figures are hard to define. Hospitals have tremendous amounts of unfunded expenses that get wrapped into every item they can actually charge for. That ten dollar tylenol isn’t really a ten dollar tylenol. Its a 50 cent tylenol wrapped attached to 9.50 of bureaucracy and regulations that have to be paid for, as well as ordinary business expenses like insurance, electricity, and the like. In my office we own our own operating room, which allows us to see very clearly what it costs to delivery quality health care for less money. We are able to do a surgery for 12-14k all in, including surgeon’s fees, anethesia, and facility fees, and at the same time delivery far better quality that most hospital based surgeons.
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What is also interesting is that my underlying thesis is that the problem isn’t so much how we pay for healthcare that is the problem, but that our healthcare delivery system is fundamentally unaffordable as it is. You are arguing that in fact a large element of the unaffordability of the system is because of how we pay for it. Its a very interesting point that I have to consider further as I continue to write about it. I do think that a system that allows individuals to shop for their healthcare in a transparent pricing system is optimal. We do need though to figure out how to deliver care to those who cannot afford basically nothing. A system that doesn’t care for the poor is not a system that I want.
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Thank you for your thoughtful response. I too don’t want people to go without necessary health care.
Americans are charitable. How many millions of dollars are donated year after year to various organizations that fight (or claim to fight, or seek for cures/prevention, anyway) everything from homelessness to cancer? In the same way, charities can be established (or current charities can add a branch of service) to provide medical care for those in need.
Using just the financial incentive of lower taxes, by having donations to charity and money given to HSAs come from pre-tax dollars, many people will be encouraged to give and save.
Pre-ACA, I loved the idea of HSAs, but did not actually have one nor contribute to one, because, at the time, any money put into an HSA that was not used in that calendar year, was forfeited at the end of it. Thus, it made no sense to me to go through the hassle of creating and maintaining an HSA, when I likely would spend less than $1k (usually less) for our whole family, and if I didn’t spend the money, I’d lose it. It just didn’t make any financial sense to me.
However, if I could invest $5k (for my whole family or per individual), and then keep that money year after year if I didn’t spend it, then I’d sign up for an HSA tomorrow, and contribute regularly to it. Also (going back to the charitable discussion), if I could use some of *my* HSA money for someone else’s medical expenses, I would likely do it — especially if I could “double dip” on tax write-offs — that is, if I could use pre-tax dollars when putting money into my HSA, and could get another write-off for whatever I donate to charity.
Even though the govt would “lose” my tax revenue, they would still be better off, because whatever I donate goes fully (or nearly fully) for charitable medical care, so if I donated $1k, the govt would “lose” 15-30% of that revenue, but wouldn’t have to pay the full $1k for the person’s medical care. It’s a win-win-win. I pay less taxes, the govt spends less money, and the person gets the medical care he needs.
Plus since I would be giving my own money, I would tend to make a wise decision about the charity to whom I would donate and/or in regards to the person who needs the medical care. This also would reduce the amount of money spent on health-care, without a sacrifice of actual health outcomes, since fewer people would try to game a charity than the govt.
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