The Health Care Cost Problem We Refuse To See

May 17, 2010

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I agree with those who think the Patient Protection and Affordable Care Act doesn’t do enough soon enough to control the rate of increase in health insurance premiums. But I disagree that the solution is simply to pass more laws that regulate health insurance rates (as suggested in a May 9 New York Times editorial) or just to increase competition in the health insurance industry (as suggested in a May 6 Washington Times commentary). Such measures would be insufficient on their own and could even do some harm.

Our frustration with the soaring cost of health care is like a mother upset with the increasing price of bread. When her son returns from the market with another high-priced loaf she hatches a plan. The following week, when bread costs $5 a loaf, she attempts to control the price by sending him to the market with only $4. The family spends less on bread that week, but they also don’t eat any since the boy couldn’t find a merchant willing to sell below the market price.

The next week bread is selling at $6 a loaf, and the mother tries another plan. Thinking her son lazy, she attempts to discipline him with competition. She sends her daughter with him to the market. Whichever of the two can obtain the lowest bread price will win the family’s respect. The winning price, paid by the daughter, is $7. She and the boy competed, but the additional competition on the buyer side sent the price up, not down (as one should expect).

What the mother isn’t noticing about the bread market, and many don’t recognize about health care, is that suppliers (bread sellers, health care providers) play a role in establishing prices. Regulating the price paid by buyers or the level of competition among them isn’t likely to produce the outcomes we might hope for without parallel action on the provider side of the market.

Take increasing insurer competition, for example. Results presented in two papers in the International Journal of Health Care Finance and Economics and another in Health Affairs indicate diluting insurers’ market power would cause prices to rise, not fall. The reason is that hospitals maintain such high degrees of market power that high concentration in the insurer market is necessary as a counterweight. Weaker insurers would be less able to counteract the market clout of hospitals at the bargaining table. Clearly just decreasing concentration among insurers while ignoring that of hospitals is unlikely to be the solution to escalating health care premiums.

If concentrated insurers negotiate lower prices, what compels them to pass the savings on to consumers? Here, regulation can help, and it is already in place. The Patient Protection and Affordable Care Act regulates medical loss ratios (MLRs), the proportion of premium revenue that must be spent on health care claims, as opposed to administration and profit. Specifically, it requires insurers to spend 80% and 85% of premium revenue on claims in the individual/small and large group markets, respectively. That puts a cap on what insurers can retain for non-medical expenses.

If MLRs are computed fairly and regulated adequately (things to watch), the only source of health insurance rate increases would be medical costs. In principle one could regulate medical costs themselves by blocking insurers’ proposed rate increases if they were deemed excessive. Once insurers have already negotiated prices down as far as their market power will allow, and with the MLR minimums in place, the only substantial remaining driver of premiums that insurers can do anything about is utilization volume. The last time insurers made a serious effort to control that was during the era of managed care in the 1990s. We all know how much consumers loved their mid-90s HMOs (not very). Therefore, rate regulation above and beyond MLR minimums isn’t likely to get very far on its own.

At this point, we’re in the same position as the mother who wished to pay less for bread. Pressuring and regulating buyers (her children or our insurers) alone isn’t fruitful. To make headway, some attention must be paid to the seller side of the market. In the case of health care, changing how providers are paid–more on quality, less on volume–is a sensible idea. In fact, there are provisions in the Patient Protection and Affordable Care Act to do just that (e.g. payment bundling, accountable care organizations), but they won’t kick in for years, a political concession.

Our greatest hope for lower premiums is for those provider payment reforms to be allowed to work. Rather than continue to throw stones at insurers (or, at least in addition to doing so), we should be supporting political leaders who will not cave in to what is likely to be heavy industry pressure to weaken those reforms. The mother in the parable of bread prices kept proposing doomed solutions because she didn’t recognize the problem, dominant seller power. Are we any different?

Austin Frakt is a health economist and an Assistant Professor of Health Policy and Management at Boston University’s School of Public Health. He blogs at The Incidental Economist.