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It is no secret that the American health care system is a mess. Iraq gets the headlines, but the real blood and treasure is spent and squandered on health care, making it arguably the most important economic and political issue America faces today.

The financial dimension alone is enormous: 16% of our entire economy is devoted to health care, which came out to $2 trillion in 2005. We now spend over $6,000 per person per year, which is twice the average for developed nations and about $2,000 more than the next closest country, Switzerland. And what do we get for it? Lower life expectancies than most other developed nations, and over 50 million who are either uninsured or poorly insured, compared to almost none in our peer nations. Those numbers point to one central fact to guide our thinking about health care reform: one-third to one-half of our expenses can be cut without any loss in the overall health of the American people

We can save more money on health care each year than we currently spend in Iraq. Tens of billions of dollars more.

The social costs of our health care system are also huge: millions can't afford their medical bills and millions more are just an illness away from bankruptcy. On top of all that, hundreds of thousands die needlessly each year either through a lack of necessary care, infections acquired in hospitals or medical mistakes like administering the wrong drugs. Though there have been recent improvements, enough people are probably killed by America's medical system to populate a city the size of Minneapolis or Pittsburgh every single year. This is more than are dying in Iraq, even when you count both Americans and Iraqis in the total.

Sadly, Americans know very little about their own system of health care and much of what they think they know is wrong. I say that from a privileged position--or perhaps from the trenches, or from the belly of the beast, depending on how you look at it. You see, I work for a health insurance company. I won't describe my job because I need to stay anonymous, but I will say that my job has to do with understanding the healthcare marketplace, so it gives me a good perspective on the health care industry as a whole.

So what has my experience in the industry taught me? For one, blame needs to be spread very widely, because pretty much every part of the U.S. health care system is twice as expensive as it should be.

We all tend to focus on the cost and availability of health insurance, and rightly so: Health care in the US is so expensive that without health insurance to pay for it, anything more than routine checkups and tests is unaffordable for most people. Also, of course, fewer and fewer people are getting insured by their employers, leaving more to fend for themselves getting individual insurance (an ordeal, assuming you can even get it), or government-sponsored insurance (an ordeal, assuming you can even get it), or paying for everything out of pocket (an ordeal unless you're healthy or very wealthy).

But health insurance is expensive largely because health care is expensive. Health care is expensive because nearly every part of our system gets paid (roughly) twice as much as it would in a rational system. This applies not only to health insurers, but to doctors, hospitals, drug companies, technology/equipment companies, etc. Our doctors get paid up to twice as much as doctors in Europe. Our hospitals cost far more than twice as much. Our administrative costs (largely, but not entirely, connected with our insurance system) are also more than twice as high as in other developed countries.

To get a sense of how much money is getting funneled into health care and sloshed around,consider this: 1.7 million net jobs were created in health care in the last 5 years, while the rest of the economy combined created 0. Yes, it's great that jobs were created. But are these the right jobs? Are they the ones our economy needs? How are we better off if 25% of our economy is devoted to health care, which is where we're headed, rather than 10%, which is what other nations have? If we continue to get results that are no better than other nations, how does this benefit anyone who is not working in the industry?

Looking at the big picture, the only true fix is to create a system that does the following: provides universal health care, costs about half as much per person, and provides higher quality care with fewer errors.

OK, universal coverage at half the cost is a nice Shangri-La. But is it really achievable? And just what do we have to change? To save this long diary from getting even longer, I'm not going to talk about fixing the quality problems we have today in order to focus on the economics.

Universal Coverage Alone Isn't Enough
Making health care cost half as much per person cannot be achieved just by enacting universal coverage. Streamlining the benefits and the process of getting coverage will get rid of some admin overhead, but this will only amount to maybe a 15% reduction in total costs. Moreover, if the forces that keep driving up prices aren't stopped, that 15% savings will be eaten up in only about 2 years.

To really solve the problem of high and rising costs, we have to make technology and system improvements, as well as cut reimbursement for providers and suppliers of health care in a big way. If we make the hard choices needed to achieve the goals above, the total savings to the economy would be over $500 billion every year. Since government pays for half of all health expenditures in the US, it would save over $200 billion dollars. Those savings would be enough to pay for the uninsured, or close enough to make the extra taxes minimal. Insuring 30 million people (roughly the number of uninsured at a given moment) at a cost of $6,000 per person (roughly the national average) will amount to $180 billion. If we reduce health care costs 40%, insuring everyone will cost only a little over $100 billion. While government takes on the burden of the uninsured, individuals, employers and unions would reap the rewards of lower health insurance expenses.

The Proper Role of Government in Health Care
As I've mentioned, almost 50% of expenses are paid by government already, mostly at the federal level but also state and local. The standard conservative line is that government is inefficient, in health care as in everywhere else. What this knee-jerk reaction ignores are two critical facts. First, our government's effectiveness is deliberately hamstrung by conservatives. For example, Medicare is prevented from negotiating to get the best prices for drugs. Second, government-run health care systems, even in the US, are sometimes highly efficient and provide better care than you get in the private sphere. A great example is the VA system. Disciplined by tight budgets and given the freedom to reshape itself, it has become one of the best systems in the country, beating every single private MCO in quality measures in recent studies. They did it in part because they were able and willing to make massive investments in an IT system that connected all parts of care delivery. Just as important, the VA system is an "integrated" delivery system. That means the same organization makes coverage decisions, handles billing and claims, runs the hospitals, employs the doctors and provides and manages the care. It uses evidence-based models of best medical practices to deliver coordinated, top-notch health care. The care you receive, in comparison, is almost certainly a patchwork of poorly connected mini-systems of hospitals, private practices, pharmacies and insurers, with critical information either not passed from one organization to another, or never collected at all, and with the standardization of care delivery processes in a comparatively rudimentary state.

OK, so government-run systems not only can do just fine, but when designed right they beat the commercial systems we currently have. But the knee-jerk conservative is not finished. It's time to trot out another claim in defense of the myth that the solution lies in less government involvement: the problem comes from mandated benefits.

Some insurance companies and many Republicans love to complain about this one. They say, remove the restrictions and mandates and millions more will get insurance because they'll be able to afford more limited forms of insurance that don't cover every condition politicians have seen fit to include. The problem with this proposal is that it's been tried, and it has failed every time. Several states have allowed bare-bones health plans in the belief that some insurance is better than none. But health-insurance 'lite' has few voluntary takers among individuals, because in order to offer significant savings the plans have to remove so many benefits that consumers judge them not worth the money. For example, Florida's "Health Flex" plan gained a grand total of about 400 people in 3 years. Why? Because the underlying health care services are so expensive that any plan with a meaningful benefit set is going to be expensive, and plans with thin and spotty benefits aren't attractive. They barely count as insurance, given all the out-of-pocket spending you are likely to do.

High-deductible and limited-benefit health plans are growing, but they are only taking a small dent out of the uninsured population. Some people don't make enough money to afford even $100 a month in premiums. Others could afford it, but see themselves as basically healthy and aren't willing to shell out so much money for coverage they don't expect to use. Mostly, they're right to make this gamble. But that means there is less of a subsidization effect in the health insurance system (insurance depends on the lucky subsidizing the unlucky). So, those who still do have private insurance are forced to pay more for it. The new HSA plans that the Bush administration is touting have the same effect: for each person who has one, about $1000 a year that would have gone to pay the premium and subsidize the unlucky now stays with the individual who gets the insurance policy. In effect, you're insuring yourself, which pretty much defeats the purpose of insurance. Of course, the Bush administration has added a tax break to make this "self-insurance" more than just an exercise in idiocy. If you stay healthy you could come out ahead, but again at the expense of making less money available for others who get sick. From a Social-Darwinist perspective, that's a good thing. For anyone else, it's a dereliction of social responsibility.

And I haven't even discussed the nightmare that is the individual insurance market in most states. Nearly 9 of 10 people who sought coverage in the individual market never bought a plan because they couldn't afford the rate offered or were turned down. This nightmare is the direct result of two sorts of factor. On the one hand, there are misdirected incentives that create crappy cost controls and bloated bureaucracy, and on the other hand there is a marketplace that lacks guaranteed universal coverage, and in which medical underwriting is therefore practiced as vigorously as possible. If you make coverage universal and offer a base plan that everyone gets at the same price (or a price determined by income), you get rid of medical underwriting. If you get rid of underwriting, you get rid of the self-destruct sequence in which the healthy play a smaller and smaller role in subsidizing care for the unhealthy. Also, universal coverage will standardize benefits and eligibility, which on its own will reduce the bloated administrative expenses.

But adding a universal coverage system, by itself, doesn't reduce very much of the cost. Right now, health insurers have admin expenses of 12-15% on average (this comes to less than 8% of total national health care expenditures). Government, hospitals, physician practices, etc. add perhaps another 20% of admin, for a combined total of roughly 30% of total health care expenditures on admin. Let's say we have a massively standardized and integrated system, in which there is no private insurance and all providers are either employed by the government or work for large regional health systems that function as quasi-public entities. Under this sort of system, we could reduce our admin expenditures to maybe 15% of total expenditures(even Canada spends about 17% on administration). That's the figure I stated above for savings from creating a universal coverage system, and it's the most extreme case. If we adopt a Massachusetts-style system in which there is still a wide range of insurance options, then the administrative savings will be less.

Either way, universal coverage would still be an obvious improvement for the overall health and security of the American people. But the biggest economic benefits would come at the cost of massive restructuring, and we would still be the most expensive nation in the world for health care, by far. Even the Swiss would beat us. How is this possible, you might ask? Aren't there billions in profits from health insurers that we can remove, and won't that get us in line with other nations? Yes, there are a few billions that could be removed, but no, it won't get us anywhere near other nations in terms of costs.

Health Insurance Companies Are Health Care's Scapegoat
I know I'll lose credibility in saying this (all those insurance paychecks must have warped my mind), but it is a myth that the greed and profit of insurers play the main role in inflating American health care costs. The average profit margin for an MCO these days is roughly 5%, and that's about as high as it's ever gotten. Remember, I'm talking about an average. For every Unitedhealthcare above 5%, there are plans like Highmark BCBS of Pennsylvania and HealthPartners in Minnesota below 5%. The long-term profit margin average is 3-5%, which is lower than most industries. The growth of the big for-profit managed care companies (United, WellPoint, Aetna, CIGNA, Humana and Coventry) is definitely changing the picture somewhat, but non-profits still insure almost half of Americans who get their insurance through private insurers.

I should take a moment to clarify terminology. "MCO" stands for managed care organization, which is more appropriate than "HMO" because almost all health insurers today sell a range of plans, only one of which is HMO. The others are PPO, POS and traditional indemnity. About 25% of MCO business is in HMOs, while 60% is in PPOs and most of the rest is in POS plans.

To understand how MCOs do and do not contribute to our problems, you have to first understand that for-profit MCOs insure only a small portion of all Americans, around 25%. The rest is taken up by (1) federal, state and local government programs, (2) non-profit insurers, (3) self-insuring organizations and (4) the uninsured.

Most people are surprised to learn that self-insuring organizations are a big part of the picture. Most don't even know what self-insurance or "self-funding" means. It means that your company (or union) literally is your insurer. If your company has more than 500 employees or your union has several thousand members, the chances are high that your insurer is your employer or union--not Aetna, CIGNA, Blue Cross, etc. The MCOs in these cases are outsourcers that provide "administrative services only". In other words, if you find a benefit denied in these cases, it is your union or employer that is responsible for setting the ground rules about what gets covered and paid for, and then actually pays the claims. The MCO in these cases does not have a direct incentive to make money by denying care because it gets paid for every claim processed or it gets a flat fee for the account based on the number of members. It is your employer or union that has the incentive to cut costs by restricting what is covered, because it is the insurer. Of course, a self-insuring company or union can also outsource cost-cutting measures and pay an MCO or a TPA (third-party administrator) to do it by enforcing more stringent rules on paying claims. In such cases the MCO or TPA becomes the hit man, but your employer is the don that called the shots.

By the way, none of this answers the argument that there should be no monetary incentive to restrict health services. Is it ever a good idea to restrict access to care in order to save money? Consider other nations of the world, including any nation you would like the US to emulate. You will find that every single nation rations care in one way or another. The storied "waiting lists" for some procedures are overhyped by conservatives trying to scare people away from socialized medicine, but they do exist in many countries, and the reason they exist is that governments are trying to save money by restricting the availability of services. This is one of the ways that other countries control costs while insuring everyone. (They control costs for the most part, however, by having highly integrated systems that have much lower administrative costs than our own and by price controls on providers that dramatically reduce prices for hospitals, drugs, doctors, etc.)

No universal coverage system has ever ignored monetary constraints, and we cannot and will not avoid them ourselves. What we need to do is find the right incentives to providers so that the best, most efficient care is also the care that is most rewarded. Ultimately, we need to reward providers for giving better care, not for giving more care, as we do today.

Let's get back to the "insurers are evil bloodsuckers" line of thought. Around a third of the people who actually are insured by an MCO (as opposed to their employer, their union or the government) are insured by a non-profit. Most Blue Cross/Blue Shield plans are still non-profit, as are many of the old-school HMOs like Kaiser, Harvard Pilgrim, Group Health of Puget Sound and HIP of Greater New York. The physician groups associated with these companies are sometimes for-profit. The behavior of non-profits and for-profits differs, but what difference there is actually makes little impact on the growth in US health care costs. There are small gains in efficiency for for-profit plans, but these are roughly offset by the increases in profit, so that the total amount of money paid to insurers that doesn't go to pay for health expenses remains about the same (15-20%).

Clearly, this is too much either way. But almost everyone who is mad at MCOs is wrong about why the administrative costs are high, and believes that the profits are much higher than they really are. Executive compensation, for example, is not a major factor. There is a very small number of extremely well-paid CEOs, and it doesn't make a significant impact on the big picture. Total executive compensation of MCOs was less than 1% of health care costs. MCO profits are also about 1% of total health care expenditures (don't forget that more than half of health spending is from the government or is out-of-pocket).

If you still think it's the profit incentive for MCOs that makes premiums go up much faster than inflation, consider the following: 1) profit incentives also exist in other insurance industries (property insurance, car insurance), and yet costs are not out of control there. What's different about health care is not the nature of the insurance, but the nature of the supply of and demand for health care. 2) When the government pays for medical expenses directly, as it does through the Medicare and Medicaid programs, it also pays far more per person than do health systems in other nations. The rate of increase per person is lower than with private health plans, but the reason for this is that the government gets to set rates to physicians, hospitals and other providers. The providers, of course, fight this and argue for the highest rates they can get. Right now the AMA is fighting reductions in Medicare payments, for example.

The government in this matter does what MCOs would do if they had more power: keep the increase in fees in line with general inflation, in line with budgets, and with some allowance for improvements in technology and utilization as people age. Government is more effective than private MCOs at limiting rate increases, but not because the profit motive of MCOs inhibits them. Rather, it is the limited size and influence of MCOs that prevents them from being as effective at controlling costs as the government. I know that doctors don't feel like they have a lot of power when negotiating with MCOs. It's true that hospitals that have the better leverage, and use it, but in the aggregate physicians definitely have an impact. Paying lower rates results in more physicians opting out of networks, so MCOs have to set rates at whatever level they need to have the network size they think they need. Physicians also have their own ways of blunting cost control efforts. The most important of these is finding more and more billable procedures, so that even if rates don't go up much per service, doctors keep billing for more services and up-coding to more expensive ones where possible. Of course, there are plenty of honest physicians who don't do this. There are also plenty of physicians who think of themselves as honest who do.

MCOs compete for the business of individuals and companies in large part based on price (or more accurately, the amount of benefits they can provide for a given price). So, if there is any part of the health care industry as currently structured that has a core incentive to put a damper on expenses, the MCOs are it. Though the public has little understanding of this, doctors and hospitals know that insurers are the price-dampeners. And that fact is the basis for almost all of the fights between them MCOs and health care providers. Much of the bad press about MCOs for the last 10 years has actually been generated by the animus that physican and hospital groups feel for MCOs that put pressure on their fees.

Physicians frame the fight in terms of the nasty MCO denying services to patients. Technically, MCOs don't do that. They refuse to pay for services that they decide are not covered. Of course, for a $20,000 hospital bill the refusal to pay is almost the same thing as a denial of care. I don't know whether it makes it better or worse that people often learn of the denial after the fact and get stuck with the check. They got the care, but now they're broke.

There are lots of reasons why denials happen. Some are bad (incompetence, malfeasance) and some are on the whole good (refusing to pay for expensive procedures that have not been established effective) In our health care system, it is the MCO that gets stuck playing the bad cop and saying "no" when patients and/or providers want a service that is costly and of doubtful health value. Profitability is a consideration for the MCO, no question, but we're talking about a business that only aims for 3-5% margin most of the time. And don't forget that less than half of Americans are insured by MCOs. There are other quite important things on an MCO's mind, such as containing premium prices, reducing waste and fraud, and paying for treatments that are proven to work.

A large amount of the dreaded paperwork MCOs require has to do with attempting to catch waste and fraud, which diverts tens of billions of dollars from the health care people need. Fraud occurs at astronomical values in health care, in the tens or even hundreds of billions. From the point of view of the MCO, being stingy is about keeping a lid on fees that physicians and hospitals get paid, rejecting superfluous services that pad the physician's or hospital's balance sheet at the expense of everyone else, and rejecting especially risky treatments which cost millions and others pay for. These are all attempts to keep premiums lower and, ultimately, to be fair and follow the same rules for everyone else. Believe it or not, that is how people inside an MCO generally think. If they let you get the experimental hip replacement that costs five times as much as the standard procedure, then they have to let others get it as well, and that means that everyone would have to pay more in insurance costs. If a company's competitors don't offer that same experimental treatment, then their premiums are going to be lower and they will take business away. Notice that concern for the bottom line is connected to concern about high premiums. In a low-margin business like health insurance, the two are not separable. Most people seeking health care don't understand this big picture or don't care, and so the MCOs come out looking like cruel, greedy bastards.

I don't want to paint a rosy picture of MCOs. MCOs are not trying to reduce fraud and waste out of altruism any more than hospitals and doctors are performing more and more procedures and tests (for their insured patients) out of altruism. While the actors involved have ethics that guide them to one degree or another, they also seek their economic self-interest.

The bad effects of MCO economic incentives are well-known. For one, price competition occurs mostly for large accounts (greater than 100 members), not in the realm of individual insurance. Bigger risk pools are easier to predict and need less of a cushion in pricing. Moreover, the bigger the account, the more MCOs are willing to provide discounts and compete with each other to win it. That's why almost anyone who has sought individual insurance has had an experience somewhere between unpleasant and terrifying. It's sort of like how a big bank treats a small depositor, but worse. For a bank, the potential gain from having you as a customer is small (a couple hundred dollars in investment income a year, at most), but there is a limited downside. For an MCO, the potential loss is much larger. A bank has much surer safeguards to prevent an account holder from running off with its money than a health insurer does. And so the health plan basically treats you like you're guilty until proven innocent, trying to root out and eliminate coverage for "pre-existing conditions."

No health insurer wants to insure a person with a chronic condition for the same reason that no property insurer wants to insure a burning house. And here I'm not even talking about the abuses, such as we've seen with Blue Cross of California. I'm talking about the way this market operates at it's best.The result is that in a free market, individual health insurance is a paradox: the more you need it, the harder it is to get. Meanwhile, the person seeking insurance is in a state of acute anxiety: a supplicant with no safety net except, ironically, poverty. Because once you get below the federal poverty level, at least Medicaid kicks in.

Our current system of health insurance does a terrible job of insuring the working poor, but this has little to do with the "greed" of health insurers and everything to do with the nature of insurance when insurers have to use underwriting to survive. One advantage of a national system is that by insuring everyone, the need for underwriting can essentially disappear.

To finish up this discussion of misunderstandings surrounding health insurance, there's also a conservative version that blames the health care crisis on insurance in a very different way. According to conservatives who take the idea of an "ownership society" very seriously, the fact that people don't pay out of pocket for most of their care leads them to ignore the costs and demand expensive services they otherwise would not. There is some truth to this: if I would pay the same out of pocket to go to a $1,000/day hospital or a $2,000/day hospital, why not go to the more expensive one which probably has nicer amenities and doctors with better pedigrees? After all, I don't pay a dime more for it! And why not take the prescription drug that costs 10 times as much as an over-the-counter drug that works almost as well, when my copay makes them come out almost even as far as my own costs go? Take these decisions, multiply by all the insured people who face the same circumstances, and you have a recipe for ballooning health care costs. There isn't any real question that this phenomenon exists. The problem is that conservatives draw the conclusion that we need to pay more out of pocket in order to reduce costs. In short, they claim, we need less insurance.

The counterexamples that knock down this conclusion are by now familiar: Europe, Japan, Canada, etc., etc. Health care costs in universally-insured nations are considerably cheaper than here and they often pay little out of pocket, so it can't be generous insurance by itself that creates the problem. The reality is that outside pressures, economic and political, can keep premiums and health care costs in check even if out-of-pocket costs are kept very low. These outside pressures reduce health care costs for national health systems in the same way that MCOs do--by reducing prices and controlling utilization--but in a more effective way because the government has much more weight to throw around than an MCO.

And this is the key: health care costs will only truly get under control when the government uses its market power to restrict costs. Don't think it can work? Well, it is what almost every other developed nation does, and it works for them. I'd say that's evidence to the contrary.

However, what it means is this: true health care reform isn't just going to threaten health insurers, it is going to threaten the incomes and practices of every single part of the system. And this means we have a litmus test: if the AMA, AHA, PHARMA and other industry lobbies don't oppose a health care reform bill, it's probably not real reform.

I'll have to stop here on a negative note. I have much more to say on American health care, as well as some thoughts on what our new system should look like, but that will have to wait for another diary, and another day.

Originally posted to jd in nyc on Tue Sep 26, 2006 at 06:12 PM PDT.

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