Why health care costs so goddamn much

Health care in America is very expensive relative to other wealthy developed countries because consumers don’t pay for most of their care.  Employers, facing a federal tax system that taxes contributions to wages but doesn’t tax contributions to health insurance, provide their employees with generous policies that insulate them from most of the cost of their care – insured consumers will pay a few hundred bucks for care that costs tens of thousands of dollars or more.  Therefore, consumers don’t make purchasing decisions on the basis of price and so hospitals and doctors don’t compete on the basis of price.  So providers basically charge what they want.  (In other countries patients don’t directly bear much of the cost of their care either, but the government forces providers to accept lower payments by using its bargaining power as the only significant purchaser of health care).
The obvious question in response to this argument is, why don’t private insurers use their bargaining power to compel providers to charge competitive prices? The answer: although insurers are able to negotiate down prices somewhat, ultimately providers have the upper hand.  Berenson, Holahan and Zuckerman of the Urban Institute explain:

“In response to insurer consolidation and the success of managed care, hospital markets (and to some extent other provider markets) have become increasingly concentrated (Berenson, Bodenheimer, and Pham 2006).  Eighty-eight percent of large metropolitan areas were considered to have highly concentrated hospital markets according to a 2006 study (Vogt and Town 2006; FTC and DOJ 2004).  There is considerable evidence that hospital rates are higher in more highly concentrated markets, by as much as 40 percent (Cueller and Gerler 2005; Capps, Dranove and Satterthwaite 2003; Capps and Dranove 2004; Dafny 2005; Keeler, Melnick and Zwanziger 1999; Dafny 2005).  Hospitals with considerable market power, often teaching hospitals, simply have too strong a market presence to be excluded from insurer networks; this strength allows them to have significant influence over the payment rates they require from insurance.

In addition to consolidating within markets, hospitals and, to a growing extent, physicians have used other strategies that increasingly have given them the upper hand in their negotiations with insurers.  These strategies include forming integrated delivery systems, multispecialty group practices, and independent practice associations (Berenson, Ginsburg, and Kemper forthcoming).  Although these new entities were not necessarily created to increase providers’ market power, they have effectively done so.  In fact, the strategies providers have adopted have not necessarily resulted in enhanced market concentration, yet they have resulted in provider price increases that far exceed current inflation rates [Footnote: For example, a hospital system with member hospitals in several markets can negotiate from strength as a system without having excessive concentration in any individual market].

Hospitals with extensive market power often use high levels of revenue either to accumulate reserves or to adopt new and expensive technologies and procedures, creating a “medical arms race” in which hospitals and physicians compete over the newest technologies and amenities, but not over prices. (Robinson and Luft 1987).”

Ezra Klein pithily summarizes:
“The base insight is that providers — doctors and hospitals, mainly — have most of the leverage in the battle with insurers.  If there’s one hospital in town, then either your insurer cuts a deal with them, or you get another insurer.  What you don’t get is another hospital.  The problem is exacerbated by the fact that the insurer doesn’t really care to negotiate prices.  They tried that in the late ’90s, and everyone hated them for it.  It turns out that workers don’t feel the cost of their health care because they think employers pay it, and employers don’t care that much about cost increases because they take it out of wages.  Neither group likes premium increase, but they don’t really care.  But everyone screams if you tighten networks and review care.  As such, providers have pretty free rein.”

The report from the Urban Institute argues that a strong public option tied to Medicare rates would solve the problem.  As a soft-core libertarian, I would prefer a solution that involved significant cost-sharing, selective contracting and more generally resurrecting 90’s-style managed care, and eliminating legal barriers to entry like CON laws and medical licensing – but none of that could ever happen unless the link between employment and health insurance was severed by ending the tax exemption on employer-provided health insurance.
More drastically, anti-trust action might be an effective way to break up hospital concentration.  Alternatively, one could make an argument that the status quo is good because it encourages technological innovation, and American medical innovation provides the world with a public good.  I wouldn’t rule this argument out a priori, but it would take a lot to persuade me that there aren’t better ways to encourage innovation than massive inefficiency.

Overall, it doesn’t help that while voters hate insurance companies (and they do suck), voters really, really love doctors and hospitals.

With this view in mind, watching the recent House MD episode “5 to 9” in which Cuddy gets a big evil insurance company to triple its payment rates to her virtuous little hospital made me very upset.

Stay tuned for more health care blogging.

Update: I never understood how the public option would control costs.  If the public option isn’t to receive special subsidies, how is it any different from a non-profit insurance cooperative (Senator Conrad’s alternative to the public option)?  The report cited above explains, “[Providers] who participate in Medicare would be required to participate in the public option…Without a participation requirement, it may be difficult to launch a new public option with a credible network of providers.”  Now I get it – providers have too much bargaining power.  Medicare is a huge source of revenue for health care providers.  By attaching the public option to Medicare, it gains the bargaining power necessary to deal with providers.

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