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.
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.
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.
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.