Health incentives

Two nice articles came up recently on the health care and insurance mess. Cato’s Mike Cannon, free market health care stalwart, writes in National Affairs, and the WSJ editorial board writes about the 340B mess. I wrote about 340B in July, but it’s nice to see this insane cross-subsidy and classic case of unintended consequences get national attention.

Congress established the [340B] program in 1992 to help hospitals that disproportionately serve Medicaid and low-income patients. Such hospitals are allowed to buy outpatient drugs at steeply discounted rates, on average about 45% of a drug’s list price.

“Allowed to buy” means “drug companies are forced to sell to them” I believe.

Hospitals then charge insurers and Medicare a large mark-up on the drugs when their pharmacies administer them to patients, pocketing the difference.

Economics offers little mottoes to digest public affairs. One motto is: the government likes to hide taxing and spending in cross subsidies. It’s just as if the government levied a 45% tax on drug sales to the affected hospitals, and then gave those hospitals the money. Except cross subsidies have far worse incentives.

Another motto: nothing is free. Drug companies don’t have a huge pot of money that the government can direct as it pleases:

To offset the growing hospital discounts, drug makers raise prices.

There is a widespread illusion that if the government give someone a monopoly profit, they will, out of the goodness of their hearts, pass on the profit on as lower costs to a favored class of people. Note that the hospitals do not directly give lower drug costs to the consumers. The consumers don’t pay anyway, Medicare and Medicaid and Obamacare and insurers pay, and they still pay the same high drug prices. The hope is that hospitals will take the gift and provide more or lower cost care in other areas, such as treating uninsured people for free.

This is the same questionable theory by which the government (especially the Fed) protects big banks from competition, so the banks pay us low interest on deposits, all on the theory that the banks will turn around and out of the goodness of their hearts offer loans at lower rates, rather than, oh, send the money to shareholders. Hmm.

It’s funny, because the government is otherwise so hell-bent on persecuting perceived “monopolies.” Why break up standard oil and AT&T, or harass Microsoft and Google, or demand that McDonalds pay higher wages, if companies all turn around and give profits away to worthy causes?

Right on cue

Hospitals are supposed to use the discounts for low-income patients, but a report this spring by Senate Republicans found little evidence they do. A study this year by consulting shop Magnolia Market Access estimated that a third of the discount dollars are directed to hospitals’ financial portfolios—bonds, stocks, etc.

Another motto to remember is, if you offer an arbitrage opportunity, people will jump on it.

Spending in the program has surged 11-fold since 2010 and exceeds Medicaid pharmaceutical spending.

One culprit is ObamaCare’s Medicaid expansion, which made more hospitals eligible. Some 2,700 hospitals now qualify for discounts, up from 45 in 1992. These include such well-off hospitals as the Cleveland Clinic, New York’s Northwell Health system, Beverly Hills’s Cedars-Sinai and New York Presbyterian.

… the program has encouraged consolidation among providers since outpatient clinics and physicians owned by eligible hospitals benefit from discounts. So do pharmacies, which have 212,000 contract arrangements with 340B hospitals to administer medicines. That’s up from 1,700 in 2010.

… doctors employed by 340B hospitals are also more likely to prescribe higher-priced drugs. Why? Because the hospitals and their pharmacy partners reap bigger discounts on them than they do on generics. …

..If [ an ex-] patient fills a medicine prescribed by that rheumatologist at one of the hospital’s contracted pharmacies, the hospital and the pharmacy can claim the discount. Hospitals and pharmacies employ firms to scour patient records and prescriptions to maximize discounts.

I am reminded of my first memory of becoming an economist. I was about 15. Reading the local newspaper in Florence, the region had decided to deal with an infestation of poisonous snakes by offering a 1,000 Lira (about $0.75 then) bounty for each snake. Of course, the enterprising farmers started raising snakes by the truckload.

The WSJ reports on attempted “reforms,” and hospitals fighting back. Really, have we not learned from health and bank regulation that you can’t patch these boats? Like cancer, you need to cut the whole thing out or it will grow back. If they want to subsidize hospitals, pass some taxes, send some checks, on budget and visible to taxpayers.

******

Cannon starts with a persistent myth,

Many critiques of U.S. health care begin with the assumption that, as The Economist put it, the United States is “one of the only developed countries where health care is mostly left to the free market.” ..

The assumption pervades, that the US is some sort of Wild West free market capitalism. No, we’re just one step shy of Brussels. And in some areas worse.

In truth, among wealthy nations, the United States may have one of the least-free health-care markets.

the Organization for Economic Cooperation and Development (OECD) reports that in the United States, government controls 84% of health spending.

“Controls” is a carefully chosen word. You may spend it the money, but the government directs who to, how much you pay, and what you get, not much different from paying taxes and receiving (some) services.

Nor does the United States have market prices for health care. Direct government price-setting, price floors, and price ceilings determine prices for more than half of U.S. health spending, including virtually all health-insurance premiums….The myth that the U.S. health sector has “largely unregulated prices,” as the Los Angeles Times reported, is as stubborn as it is outrageous.

That myth goes hand-in-hand with another: that government price-setting always pushes prices below market levels…. More often, however, federal and state governments push health-care prices higher than they would be in a free market. U.S. health-care prices are excessive because government controls them.

Prices are also high because the government restricts competition, imposes massive cross-subsidies, and requires services people don’t want. As it was with airlines, telephones, railroads, and trucks, government price regulation inevitably ends up raising prices to fatten profits.

A 2016 study of acute-care hospitals found that those located “in states with price regulation...tended to be more profitable than other hospitals.” The World Health Organization and the OECD concurred in a 2019 report: “Studies conducted in the USA generally conclude that price setting by a regulator...improved hospital financial stability.” If government price regulation restrained prices, we would expect to see the opposite.

Government price setting

In a free market supply and demand set prices. In a somewhat free market, there is enough supply and demand for price discovery, and then insurance pays the observed market price.

Medicare sets prices, in incredible detail. Once upon a time, it could base its prices on observed market prices, the way car insurance pays based on prices in the cash market. No more. Medicare now just makes up prices, though in a constant tug of war with providers. Private insurers pay Medicare plus x% and haggle with hospitals over the x%. The late great Ed Lazear told a story of visiting Gosplan, the Soviet price-setting agency. He found a copy of the Sears Catalogue. Gosplan, having no idea what prices to set on its own, used the Sears Catalogue. There is no Sears Catalogue for Medicare.

Government-set prices control more than half of U.S. health spending. Medicare, Medicaid, and other government programs account for 48% of such spending,

writes Cannon, though here referring only to directly government set prices and not to health insurers who base their payments on Medicare’s.

the traditional “fee-for-service” part of Medicare is the single-largest purchaser of medical care in the world. Each year, Medicare sets prices for 10,000 distinct physician services across 112 different “payment localities,” whose borders federal regulators also draw. Traditional Medicare has 20 such price-setting schemes for various types of facilities and suppliers.

Health insurance is a separate can of worms.

When government programs aren’t directly purchasing medical care, they pay for health insurance on enrollees’ behalf. More than 50% of eligible Medicare enrollees, 75% of Medicaid beneficiaries, and all who enroll in Obamacare have government-subsidized “private” coverage. In these cases, government controls two prices: the price that each enrollee pays, and the total price the insurer receives for that enrollee.

Cannon has fun with Medicare pricing “errors,” though they look to me more like deliberate cross-subsidies to different actors with different negotiating power or political favor vs. the government.

Medicare routinely sets different prices for identical items depending solely on who owns the facility. For instance, Medicare pays ambulatory surgical centers (ASCs) $1,000 per cataract surgery with intraocular lens insertion but pays hospitals $2,000 for the same procedure.

…Medicare paid an average of $1,300 for colonoscopies performed in doctors’ offices, but it shelled out $1,805 — 39 percent more — when these procedures were delivered at hospitals....When a hospital gives a lung cancer patient a dose of Alimta, its fee is about $4,300 larger than a doctor with an independent practice would receive.

Obviously (as per above) Medicare uses prices to favor certain kinds of providers, like big hospitals. Another central economic motto:

Don’t transfer income by distorting prices.

Politics likes the opposite.

Per the 340B story, people are good at changing organizational forms to capture subsidies

When a hospital purchases a physician practice or other facility, Medicare increases the prices it pays for the same people to provide the same services to the same patients in the same location….

The proliferation of physician-owned specialty hospitals is due largely to entrepreneurial physicians trying to capture the excessive prices Medicare conjures and pays for many procedures. In the early 2000s, Tom Scully explained how to spot excessive Medicare prices: “[A]ll of a sudden you start seeing ASCs pop up all over the place to do colonoscopies or to do outpatient surgery.” Obamacare subsequently banned Medicare subsidies to new physician-owned hospitals, a consequence of general hospitals’ lobbying to keep those excessive payments for themselves.

Cannon to some extent disputes my understanding that insurance pays Medicare +

Medicare and Medicaid often set the prices they pay for drugs at a percentage of whatever manufacturers charge private payers. Those price-setting rules lead manufacturers to increase private-sector prices, since doing so means they receive more money from those programs.

This doesn’t totally add up to me. Are drug manufacturers setting less than the profit maximizing price? How do they have room to “charge private payers” more? And “private payers” means insurance companies, and I thought they agreed to pay medicare prices plus.

A big difference to my previous understanding,

Providers object by insisting that Medicare and Medicaid actually set prices too low, which then forces them to increase prices for private payers — a practice providers and their lobbyists call “cost-shifting.”

Well “too low” relative to bloated costs, but I did understand the widespread fact that insurance pays more than Medicare and Medicaid for most procedures as a cross-subsidy designed to keep the full cost of those programs from the taxpayer. As evidence, Cannon offers

One study in 2017 estimated that “a $1.00 increase in Medicare’s [physician prices] increases corresponding private prices by $1.16.”

But that’s also consistent with my theory. I’ll leave whether private insurance cross-subsidizes Medicare and Medicaid as an open interesting question.

Health insurance is as regulated as health care.

Ever since Obamacare took full effect in 2014, nearly all health insurance in the United States has been subject to federal price controls that restrict or eliminate insurers’ ability to vary premiums according to an individual’s health risk.

As Mike and I have written extensively elsewhere, this is not necessary to allow everyone access.

German residents have the freedom to purchase affordable, secure, lifelong health insurance at actuarially fair rates.

(Disclaimer, I don’t know anything about German health insurance other than this sentence.)

The result, of course, is that

Insurers must design their policies to be “unattractive to people with expensive health conditions,”

A standard complaint of Econ 101 is that health insurance is impossible because people know more about their health and thus health costs than insurers, so markets break down just along these lines. “Asymmetric information” and resulting “adverse selection.”

But wait a minute, doesn’t an insurance company, armed with your electronic health records, a vast AI based computer, and cost database know much more than you could possibly know based on your private information about aches and pains? That’s asymmetric information too, but not one that destroys markets. It’s one that makes sick people pay more (if we don’t have health status insurance), which you might think unfair, but it’s not a market failure. Everyone would get insurance in this market.

We have asymmetric information and market failure because insurers aren’t allowed to use even basic obvious information.

The result has been a race to the bottom in terms of the quality of insurance coverage for the sick. …individual-market provider networks [have] narrow[ed] significantly… They have eroded coverage through “poor coverage for the medications demanded by [the sick]” … higher deductibles and copayments; mandatory drug substitutions and coverage exclusions for certain drugs; more frequent and tighter preauthorization requirements; highly variable coinsurance requirements; inaccurate provider directories; and exclusions of top specialists, high-quality hospitals, and leading cancer centers from their networks. ….

The healthy suffer, too. … “currently healthy consumers cannot be adequately insured against the negative shock of transitioning to one of the poorly covered chronic disease states.” A coalition of dozens of patient groups has complained that this dynamic “completely undermines the goal of the [Affordable Care Act].”

Maybe they will rediscover health status insurance.

The result has been simple: more subsidies to take care of sick patients.

community rating causes premiums to rise so precipitously that insurance markets often shrink or disappear altogether…. Lavish taxpayer subsidies appear to be the only thing preventing Obamacare’s health-insurance Exchanges from imploding.

And of course, people who don’t see prices don't work to lower costs.

Reform

This isn’t news

The U.S. Federal Trade Commission and the Department of Justice have complained about Medicare’s “site-of-service” pricing errors for at least two decades. In 2018, Medicare’s price-setting advisory panel — the Medicare Payment Advisory Commission — confessed it has a “long-standing concern” that Medicare sets prices for procedure-based specialists and radiologists too high relative to primary-care physicians.

Railing about how stupid this all is, as both Cannon and I are doing, is not likely to work. Everybody knows how stupid it is. But there is a lot of money and politics keeping it this way. And reforms by the same group that wrote these rules is just going to make it worse. It should be clear that another hundred thousand pages of rules will contain clever profit opportunities.

What to do? Cannon offers the simple and obvious answer

let consumers control all $5.6 trillion in U.S. health spending. When 340 million consumers find that they — rather than employers, insurers, or the government — get to keep the savings from price-conscious purchasing, they will spark price competition that will cause prices to plummet and thereby make health care continuously more universal. Insurers and providers will offer consumers what they want — better, more affordable, more secure health care — or go out of business. The government could still redistribute to the elderly, the poor, and the sick. But it would do so as Social Security does: with cash. No more centralized economic planning to drive up health-care prices and reduce health-care quality.

The all in (employer plus employee) cost for my Stanford health insurance is about $26,000 per year, and I pay copays on top of that. Having that money spent more wisely would make a lot of difference to many people’s lives.

I might offer a voucher rather than cash. I’m paternalistic enough to worry that people might choose to spend cash on other things, then show up sick at the emergency room, and we will never say go die in the gutter. (And we should not.) Michael is a purer libertarian than I am. But providing health care to the poor and needy does not require screwing up health care and insurance for you and me.

The next step would be to eliminate the reams of regulations that block access to lower-cost, higher-quality health insurance and medical care.

Eliminate. Don’t try to rewrite, like the 340B. It’s a zombie movie.

Cannon concludes

The health-care debate is not between one tribe that wants universal health care and another that does not. It is between people who know that making health care universal requires free markets, and those who cannot recognize government failure even when they are drowning in it.

I wish he were right. It seems to me to there is one tribe that wants complete government (read, political) provision of health care a la NHS. They maybe will allow a private market to exist on top of that, as Europe does, or they may disallow even that in the name of “equity,” and you have to fly to Dubai or something if you want better care. The other tribe wants to keep going the current incredibly expensive and dysfunctional crony-capitalist government subsidized system that keeps reams of administrators, lawyers, lobbyists, and health economists employed. It still provides decent care at astronomical prices. The free market tribe is a third group, but there are about 5 of us, and we have essentially no voice in the common debate. Which is the point of Cannon’s article. National Affairs essentially prints it as “wow, here are these crazy free marketers too” as sort of a cultural exploration of a foreign land.

I am often asked, “Isn’t health care a basic human right?” I answer “Yes! It is a basic human right that I should be free to offer my money to a willing physician or hospital, in a brutally competitive and innovative market.”