Health-care Reform: Will it work?

By Marianne Hill

This is a web-only article from Dollars & Sense: Real World Economics, available at

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Finally, after decades of debate, at last we have health-care reform, or at least a milestone piece of legislation that is supposed to address the key issues of lack of access to care and the high cost of care. The big question, of course, is will the Patient Protection and Affordable Care Act (PPACA), aka “Obamacare,” do the job? There is no doubt that more people will have access to health insurance by 2014, when key provisions of the PPACA go into effect—either through expansion of Medicaid, through state insurance exchanges, through those employers now mandated to provide coverage, or through private insurance companies that will be required to accept all comers regardless of pre-existing conditions. Coverage will also improve for many. By 2014, all insurance plans will be required to offer certain basic benefits, and limits on annual and lifetime payouts will be ended.

It was long past time to ensure that families and individuals have access to affordable health care. The majority of private sector firms in many states do not provide health care coverage; in the United States as a whole, 44% of firms do not offer health insurance. About 45,000 Americans die annually as a result of lack of access to adequate medical care, a 2009 Harvard study estimated.

But the cost of insurance premiums under employer-sponsored plans averages over $12,000 annually for a family. Can the government afford to subsidize premiums for everyone who needs help to buy coverage? Health care already absorbs almost one in five dollars spent in the United States and is a major cause of fiscal stress for governments, businesses, and families. Our exorbitantly high spending on health care threatens the downfall of current reform efforts—we simply cannot increase the percentage of national income going to health care.

The Source of the Costs

Although the United States spends much more on health care than is the norm in wealthy countries, the U.S. ranking in life expectancy is low (we’re 28th in the world). Even for the insured population, outcomes are often no better than elsewhere; in fact, carefully controlled studies have found that countries such as Canada perform better than the United States.

A 2007 study of thirteen countries in the Organization for Economic Cooperation and Development (OECD) by the McKinsey Global Institute found that the United States spent 28% more than the OECD norm, even after adjusting for per capita income levels. This higher spending was not due to a higher incidence of more costly diseases, either; by itself, that factor accounts for less that 5% of the cost gap.

The McKinsey study measured seven key categories of health-care spending; in five of them, the United States spent from 19% to 40% more than the OECD norm in the first five. What were the biggest culprits?

1. Higher administrative costs. The McKinsey study found administrative costs were 82% higher in the United States, which accounted for 17% of the total gap in spending. However, this study only included the administrative costs of insurance companies and government health plans like Medicare. Including the administrative costs of employers, hospitals, and others, administrative costs accounted for 31% of United States health-care expenditures on those services for which data could be found, according to a 2003 article in the New England Journal of Medicine. The figure for Canada was 17%. In terms of spending on all health services in the United States, the administrative costs identified by the study made up 25% of overall total spending.

Different plans, different forms, and incompatible electronic information systems contribute to administrative costs. (Insurance companies devote 17% of premiums received to administration; Medicare’s percentage is 5%.)

2. Higher labor costs. In U.S. hospitals and outpatient clinics, medical labor costs 30% more than the OECD norm. The U.S. fee-for-service payment structure is considered a major source of these high labor costs. Fees that reward medical personnel on the basis of services provided offer incentives for more, but not necessarily better, treatments.

The fear of lawsuits also drives up the number of services provided, although it is difficult to estimate the extent to which this occurs. Medical malpractice insurance alone accounts for only 6% of operational costs, however—if this cost were zero, operational costs in the United States would still be 39% higher than the OECD norm.

Also, consider these facts: Physicians in the United States often co-own outpatient facilities. Those who own imaging equipment, for example, refer between two and eight times more tests than their peers who do not. The United States has three to six times more imaging scanners than Germany, the UK, France, and Canada. The McKinsey study notes that physicians in the United States average 1.6 times more patient visits than do other OECD physicians.

Based on the experience of health-care reform in Massachusetts, which in many ways served as a model for national reforms, the pressure to increase premium rates is likely to continue as long as payments are based on the quantity of services provided as much as on quality of outcomes.

Some hospitals, such as the Mayo Clinic and the Cleveland Clinic, follow an alternative incentive structure. These providers have a large number of doctors receiving fixed salaries, as well as incentive structures based on outcomes.

Another point to considere is that the supply of physicians is limited by factors including the high debt levels required to finance medical training. This drives up the doctor-patient ratio. The high debt levels also steer many aspiring physicians away from primary care toward specialties.

3. Higher drug costs. The McKinsey study found that, surprisingly, U.S. patients consumed about 20% fewer prescription drugs than patients in Germany, Canada, and the UK After comparing the cost of drugs in nine therapeutic categories, researchers estimated that drug costs are about 70% higher in the protected U.S. market than in peer nations. In part, this is due to a lack of competition: the Federal Drug Administration prohibits importing pharmaceutical drugs into the United States from other countries.

4. Higher profits. Most health care in the United States is provided by private firms, and the drive for profits, or higher net incomes in the case of nonprofits, often increases prices here. Several large corporations in the health-care industry have double-digit profit rates, including pharmaceutical companies, medical appliance manufacturers, biotechnology firms, and some health insurance companies.

The high profit rates of some for-profit insurance companies providing small-group coverage was a major concern during the drive for health reform. A 2009 Government Accountability Office study of carriers in the small-group market found that regional markets for health insurance are dominated by a few firms. The cost of insurance to individuals and small businesses has soared as a result, along with company profits. The new insurance exchanges mandated by PPACA, however, will address this problem.

Policies offered to small groups and individuals through insurance exchanges will be regulated in terms of coverage and premiums charged. The goal is to bring premium costs down to levels similar to those of employer-sponsored plans. While these lower premiums will help several segments of the population, even insurance premiums at the rates of state insurance plans will have to be subsidized for many. The median family premium under state employee plans was $12,900 in 2009, very similar to that under private employer-sponsored plans ($12,300 in 2008).

Nonprofit insurance and nonprofit hospitals both play major roles in the health-care industry, but they have had little impact on rising costs. We have seen that insurance premiums are very similar under nonprofit and for-profit plans (though coverage may vary significantly). About 98 million people, or almost one-third of the U.S. population, are covered by nonprofit plans. Similarly, nonprofit hospitals do not differ significantly from for-profit hospitals in terms of costs: the prices charged by for-profit and nonprofit hospitals are very similar for the same services. The earnings of hospitals, whether for-profit or nonprofit, are also similar, with a profit rate of about 5% in 2004, according to the American Hospital Association. In fact, a hospital’s choice of nonprofit status is often driven primarily by tax and fundraising considerations.

Nonprofits are not a solution to the problem of high and rising health-care costs. Rather, a greater emphasis on public interest is needed throughout the wide range of private and public institutions driving decisions in the health-care sector.

What the New Reform Is Supposed to Do

The Patient Protection and Affordable Care Act addresses these high costs on several fronts. But will the Act’s measures be able to remedy such basic problems? They probably won’t, although they can have a positive impact. The PPACA funds pilot programs for new payment systems, more preventive medicine, improved information systems, wellness programs, workforce development, and studies that are charged with making recommendations related to problem areas. There are also provisions limiting the rate of increase in Medicaid and Medicare payments.

Some specific measures:

  • One PPACA provision requires insurance companies to spend 85% of premiums on clinical services by 2011—any spending in excess of that must be refunded to consumers. This would bring administrative costs of insurance companies down to 15% from its current rate of about 17%.

  • The PPACA encourages new approaches to medical malpractice through grants to the states to develop and implement alternatives to current tort litigation, such as medical courts where cases would be decided by judges or other professionals.

  • The PPACA also establishes an Independent (Medicare) Payment Advisory Board that may manage to keep the growth rate of Medicare spending close to that of gross domestic product. By 2018, if Medicare per capita spending exceeds the growth rate of GDP per capita by more than 1%, the Board will submit proposals to Congress for immediate consideration. Congress cannot modify these proposals, and if it wants to reject them it must find another way to save the same amount of money.

  • A key provision of the PPACA reduces the rate of increase in Medicare and Medicaid spending as productivity growth reduces costs. Over half of the projected cost of the PPACA to the federal government from 2010 to 2019 will be paid for by the $545 billion saved by this productivity provision, according to the Congressional Budget Office (CBO). (Critics note that medical services that have not benefited from productivity increases, such as hospice care perhaps, may receive lower payments and be forced to reduce the quality of services as a result of this provision.)

  • The PPACA mandates free coverage of certain preventive services and screenings, and promotes healthy lifestyles, with the aim of reducing the need for services, particularly the high cost services associated with chronic disease, which accounts for 75% of health expenditures according to the Centers for Disease Control.

All these steps are well and good, but they do not transform the system. Fee-for-service payment systems, high levels of compensation, weak regulatory oversight of drug prices, and the search for profits remain at play. In comparison to countries with national health plans, cost control is also more difficult here because most U.S. health-care providers are not under pressure to stay within an annual budget.

Despite its high price tag, the cost of the PPACA to the federal government is covered until 2019, according to the CBO. This assumes an average subsidy in state insurance exchanges of $5,200 per person in 2015 and rising thereafter—the largest single new expense. It also assumes a slowing rate of increase in the price of care and takes into account the imposition of new taxes on insurance companies, on drug manufacturers, and on individuals with incomes over $200,000.

The cost of health care to states, employers, and individuals under the PPACA may prove to be a more immediate issue. States must establish and oversee insurance exchanges and enforce new insurance regulations. They must also provide 10% of funds needed for the increased number of Medicaid enrollees by 2019, which may require a revision of state taxes.

Large employers must provide coverage and individuals must sign up for insurance. If firms opt out of providing coverage, they must pay a penalty (at a maximum of $3,000 per fulltime employee). Individuals can opt out of coverage for a relatively small penalty (about $700 in 2016), an alternative made more attractive since individuals can opt back in should the need arise. But if too many firms and individuals opt out of these mandates, the levels of federal subsidies that must go to the exchanges will likely increase—along with premium levels.

The Prospects of Reform

If health-care costs continue to skyrocket, families will continue to face rising premiums, businesses may reduce the benefits they provide, and governments may cut back on other public services to finance health-care obligations. In brief, successful health care reform requires bringing costs back down to earth.

This is doable, but the reform and restructuring of the health-care system will be neither easy nor straightforward. The new requirements demanded of insurance companies and employers under the PPACA, along with the mobilization of consumers, mark a significant step forward. The basic health-care plan available through insurance exchanges and mandated for large employers moves us closer to universal coverage by providing all citizens access to a minimum level of coverage at prices that are more affordable.

However, the PPACA does not go far enough in increasing the regulation of drug and insurance companies, in overhauling payment systems, in improving access to medical school, and in other areas. The key to moving forward on all these fronts is to increase political support for national oversight and regulation of health care, with a view to increasing quality while reducing prices.

Marianne Hill, an economist and former D&S collective member, has published articles in the Journal of Human Development, Feminist Economics, and other economics journals.

SOURCES: Centers for Disease Control; Commonwealth Fund; Congressional Budget Office; Council for Affordable Health Insurance; Government Accountability Office reports GAO-09-363R and GAO-05-743T, Kaiser Family Foundation; McKinsey Global Institute “Accounting for the Cost of Health Care in the United States”, January 2007; National Coalition on Health Care; Physicians for a National Health Program; Robert Wood Johnson Foundation; Urban Institute.
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