Does Fee-for-Service Explain Rising Health-Care Costs?

by Don Boudreaux on June 30, 2009

in Health

I argue here that rising medical-care costs are not explained by the fee-for-service method of delivery.

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John Dewey June 30, 2009 at 11:29 am

Your column makes sense to me, of course. But one point you and Arnold have made continues to puzzle me.

Would third-party payment lead to overuse of health care if insurers had more freedom to deny payments and to customize policy terms? If government intervention were eliminated, couldn't insurers write and enforce contract terms that effectively controlled medical care costs?

Arthor Bearing June 30, 2009 at 11:59 am

I believe the major obstacle blocking acceptance of the libertarian explanation of rising healthcare costs is not problems with its theoretical formulation or that we make poor arguments, but the perceived heartlessness of a theory which discourages the government from subsidizing the healthcare of the poor and elderly.

This is the major weapon that the liberal Republicrats have against libertarians. We can make brilliant, logically sound arguments until our faces turn blue, but the politicians will still have the people's hearts because they promise easy answers and the assurance that they can just magically make it work.

An intractable problem.

TrUmPiT June 30, 2009 at 12:36 pm

"Medicaid and Medicare are outright promises by Uncle Sam to pay for most of the medical care received by large groups of people – namely, poor Americans and the growing number of Americans 65 years and older."

I can understand helping poor people with their medical expenses, but why automatically those over 65? The fact that there are "large groups" that are poor is the problem to address. Lyndon Johnson made great strides to address the plight of poor, held-back America with his Great Society programs. Unfortuntately, the egocentric rich didn't want to ante up, so they got pro-rich Republicans elected to dissolve the programs. As a result, the rich got richer and poor had babies which they were forced to have before Roe v. Wade, or government subsidized abortions.

If Mormon (not moron) doctors tithed 10% of their medical services to the poor then, perhaps, we wouldn't be in the health care mess that we are in, at least in Utah. Along with the hippocratic oath, the requirement to serve the poor at no, or small charge should be part of their duty and pledge. Some law firms do pro-bono work. That should be the norm. Let's get the government out of the health care/insurance business. Let the charitible forces of successful professionals and business people of good will throughout the country do the necessary things to help the poor and give them a leg up. We are our brother's keeper contrary to libertarian theory.

There is a subtle argument here for tackling the problem of people who have vast fortunes that they selfishly hoard and keep all to themselves to societies great detriment. That bad acquisitive nature of some is the antithesis of charitable good works. Let's squash them like the greedy bugs that they are! Let's make the world a better place to live for all not just those with the means to enjoy the finer things in life.

Speedmaster June 30, 2009 at 12:56 pm

As usual, EXCELLENT work!

John Galt June 30, 2009 at 1:16 pm

TrUmPiT, do you realize that you are so over the top that you sound like a parody of yourself?

Where do your true beliefs end and the joke begin?

John Galt June 30, 2009 at 1:18 pm

"There is a subtle argument here for tackling the problem of people who have vast fortunes that they selfishly hoard and keep all to themselves to societies great detriment."

There is a massive argument here for ending public schools and requiring voters to take an economics course. Keep up the exemplary behavior.

Sam Grove June 30, 2009 at 1:26 pm

"There is a subtle argument here for tackling the problem of people who have vast fortunes that they selfishly hoard and keep all to themselves to societies great detriment."

Apparently the very wealthy have kidnapped large numbers of health care professionals and are holding them on an island somewhere.

Obviously a lot of people don't comprehend what the very wealthy actually own, which are basically numbers in various accounts.
The assumption is that these numbers can be divided up to make everybody else better off.

Brian T. Schwartz June 30, 2009 at 2:29 pm

Thank you Don for writing this piece and doing whatever you needed to get it published. I especially like the last two paragraphs. Your concluding sentence is a gem, and I intend to quote it in the context of political rationing when I can:

"Each of us, at the end of the day, has more control over the size of our bank accounts than we have over politically influenced bureaucrats."

piperTom June 30, 2009 at 2:32 pm

Even the "death bed" version of the price inelasticity tale isn't strictly true. I've heard many tales of responsible people who, knowing they must die, chose not to impose additional burdens on their families.

Mr. Econotarian June 30, 2009 at 2:59 pm

According to the Congressional Research Service Report RL34175 "The U.S. Health Care Spending: Comparison with Other OECD Countries", Americans spend only 13.2% out-of-pocket for health care.

While France (7.6%) and the Netherlands (7.8%) spend less out-of-pocket, other countries with socialized medical schemes spend MORE out-of-pocket: Germany (13.3%), Ireland (13.5%), Canada (14.9%), Norway (15.7%), New Zealand (17.2%), Japan (17.3%), Switzerland (31.9%).

Source: http://wikileaks.org/leak/crs/RL34175.pdf

The standard public health benefits in France and Japan tend to cover 70% (of government "negotiated" costs), with private health insurance coverage above that (France will cover you 100% in a significant health event though).

Thomas DeMeo June 30, 2009 at 3:14 pm

There are many reasons why healthcare is different from food.

The burden of paying for food is very consistent, and the increments are quite small. People are always smarter when this is the case. Medical care can often have no cost at all for long stretches, followed by massive spikes. It is inherent to human nature to struggle with these types of responsibilities. This is made worse by the fact that consumption patterns are often concurrent with disability.

You don't have to depend on expensive expertise to feed yourself if you don't want to. You can take care of as much or as little of your own food needs as you want, with little consequence.

It is also far easier to depend on others. It is relatively easy to feed the weak and infirm, making it much easier for social networks to help those in need.

There is a limit to how much food can be consumed. Technology doesn't change this much, and it continues to drive the cost of food down. Healthcare, on the other hand, continues to grow in expense, scale and importance rapidly as technology advances.

I could go on and on…

S Andrews June 30, 2009 at 3:32 pm

The burden of paying for food is very consistent, and the increments are quite small. People are always smarter when this is the case. Medical care can often have no cost at all for long stretches, followed by massive spikes.

Which is why one should consider buying insurance against catastrophic events. You don't need medical insurance for common cold. We don't use car insurance for oil changes, but we do use them in case of a collision.

John Dewey June 30, 2009 at 3:49 pm

S Andrews: "One should consider buying insurance against catastrophic events. You don't need medical insurance for common cold. We don't use car insurance for oil changes, but we do use them in case of a collision."

I'm not so sure Americans are using insurance for the common cold.

If I want full health coverage insurance – and I'm willing to pay for it directly or through agreement with my employer – what's the problem?

The insurance company is willing to sell me that policy – either directly or through my employer. The health care providers agree to accept the terms my insurance company dictates.

So why do you and Arnold Kling and Russell Roberts and Don Boudreaux feel I should not have full health coverage insurance? Or do I misunderstand your argument?

S Andrews June 30, 2009 at 4:48 pm

I'm not so sure Americans are using insurance for the common cold.

If I want full health coverage insurance – and I'm willing to pay for it directly or through agreement with my employer – what's the problem?

No problem, so long as the treatment is the same for someone buying it though the employer and someone else buying it directly from the insurer. Also, people should be given an option to opt out of employer provided healthcare.

John Dewey June 30, 2009 at 5:16 pm

S Andrews: "so long as the treatment is the same for someone buying it though the employer and someone else buying it directly from the insurer."

I have no problem with allowing a tax deduction for direct purchases of health insurance.

S Andrews: "people should be given an option to opt out of employer provided healthcare."

I think some employers offer that option.

IMO, the employer should have the freedom to offer whatever combination of salary and benefits he deems appropriate. Through 100% participation, the employer can likely lower the health insurance costs for all employees. I think the employer should be free to make that a condition of employment.

S Andrews June 30, 2009 at 5:32 pm

I think the employer should be free to make that a condition of employment.

I agree.

John Galt June 30, 2009 at 5:55 pm

Sam Grove:
"Obviously a lot of people don't comprehend what the very wealthy actually own, which are basically numbers in various accounts.
The assumption is that these numbers can be divided up to make everybody else better off."

Sam, it's comforting to know there are others out there who understand this. I fear for this country because there are so few such people left. Thank you for saying it so eloquently.

brotio June 30, 2009 at 6:53 pm

Does Fee-for-Service Explain Rising Health-Care Costs?

Many doctors in the US make so much money that they can afford yearly (carbon-intensive) Alaska vacations, along with frequent trips to Yosemite. I wonder how much of an impact they are having on health care costs?

Dr. T June 30, 2009 at 6:57 pm

TrUmPiT said: "Along with the hippocratic oath, the requirement to serve the poor at no, or small charge should be part of their duty and pledge."

It just amazes me that people have the gall to tell physicians to donate time and supplies to caring for the poor. Do grocers give 10% of their food to the poor? Do clothing stores give 10% of their clothes? How about book stores, hardware stores, plumbers, tax return preparers, trash haulers, car dealers? Why is it that just one class of professionals is expected to donate time and goods to the poor?

Instead of expecting doctors to provide free care for the poor, how about expecting that family, friends, and neighbors collect money so the poor patient can go to a doctor and pay for the visit.

Dr. T June 30, 2009 at 7:03 pm

John Dewey said: "So why do you and Arnold Kling and Russell Roberts and Don Boudreaux feel I should not have full health coverage insurance? Or do I misunderstand your argument?"

Full health care coverage, in and of itself, is not wrong. The problem has been that nearly everyone has full health coverage and doesn't directly pay for medical services. This has allowed doctors and hospitals to rapidly raise charges. It also promulgated the idea that everyone is owed platinum-plated healthcare: minor injuries get MRI scans, a questionable problem gets assessed with three dozen lab tests, a dying person gets $30,000 of care in his final few days, etc. Much of the "waste" in health care is due to the attitude of "so what, the insurance company will pay for it."

Pingry June 30, 2009 at 7:06 pm

As I have said before in the comments section here at Cafe Hayek, healthcare spending in the U.S. is ridiculously out of control because of the excessive development and use of medical technology brought about by the third party payer system.

The third party payer system has little, if any way to control costs because the incentive to equate costs with benefits at the margin is nonexistent.

Any use of medical technology which yields even a small marginal benefit will likely get used, irrespective of the marginal cost to society, because the marginal cost to the individual is small.

That is, the third party payer system is really just a massive form of the tragedy of the commons created by government.

Thus, the third party payer system has created incentives to develop and use a far greater amount of medical technology than would otherwise occur if marginal costs would be higher.

Insurance, both public and private, has basically encouraged extensive research into and development of medical technology through their willingness to pay for new treatments irrespective of price and number of patients, and the result has been a bloated healthcare sector which is a much larger fraction of GDP than in other OECD countries ***

Therefore, after adjusting for the spillover benefits, we are still consuming healthcare at the point in which marginal cost greatly exceeds the marginal benefit, resulting in allocative inefficiency.

The production and consumption of healthcare, at the margin, is worth less than the alternative goods and services that otherwise could have been produced, and society incurs a very large, real economic loss.

And, of course, the fee-for-service payment system (along with the medical belief of the "best treatment available") aggravates this problem.

So, if our healthcare sector is allocatively inefficient, then we should reduce the amount of healthcare relative to GDP (and much evidence suggests that spending could be reduced without adversely affecting health outcomes) to the point in which costs and benefits at the margin are equal.

The best way (although not particularly practical, given the vested interests) is to simply eradicate the third party payer system.

***And as a side note, while I do not advocate nationalized care, many people have claimed that while taxes in these countries are higher to fund such a universal, nationalized system, it is almost as if our taxes are similarly high to fund our healthcare system because the rising costs of healthcare has lead to slower wage growth, in effect, "taxing" employees, particularly healthy ones who are personally responsible for maintaining a healthy lifestyle while America devolves into obesity and disease.

John Dewey June 30, 2009 at 7:20 pm

Dr T: "The problem has been that nearly everyone has full health coverage and doesn't directly pay for medical services."

No. We pay for health insurance. How is that a problem?

Dr T: "It also promulgated the idea that everyone is owed platinum-plated healthcare"

If we pay for a health insurance contract that specifies "platinum-plated healthcare", then that is what we are owed, isn't it?

Would you deny me the right, Dr T, to pay for and be owed "platinum-plated healthcare'?

Dr T: "Much of the "waste" in health care is due to the attitude of "so what, the insurance company will pay for it."

I'm paying for the health care insurance I desire. Health insurance companies are making decent profits. Health care providers are making decent earmnings. Why do you see this as a waste?

The problem, as I see it, is that too many people who do not pay for "platinum-plated healthcare" believe they are entitled to it as well.

John Dewey June 30, 2009 at 7:38 pm

Pingry: "The third party payer system has little, if any way to control costs "

I do not understand why so many people believe this and promote this idea.

Health insurance companies compete for the dollars of large employers. These insurance companies must limit the premiums they charge those employers. In order to earn a profit, they must – and they do – control their payments to health care providers.

Are they controlling costs as much as we wish? Apparently so, because we keep paying them for health insurance.

Seth June 30, 2009 at 7:44 pm

"…but the perceived heartlessness of a theory which discourages the government from subsidizing the healthcare of the poor and elderly."-Arthor Bearing

I agree Arthor. For those easily swayed by compassion rather than logic we need to find ways to show them that the compassionate solution hurts worse. Always open for suggestions.

Pingry June 30, 2009 at 9:15 pm

John Dewey:

Of course it is good that "Health insurance companies compete for the dollars of large employers," and all else aside, it is better to have more competition, not less.

The real issue is that the marginal costs of producing and consuming healthcare exceed the marginal benefits because those with insurance are not facing the full cost of their own decisions, that is, some of the costs, spillover to others, and prices tend to rise higher than they would otherwise, irrespective of the structure of the output market for health insurance.

Now, a qualification is in order here. Technically, these are not the typical externalities which economists talk about because they are, for the most part, reflected in the price.

Instead, economists would recognize them as pecuniary externalities, but nevertheless, there is an overallocation of scarce resources to healthcare, and this has led to many deleterious effects.

Accounting for spillover benefits and improved quality in healthcare goods and services, we see that the demand for healthcare is increasing faster than the supply, very much due to the third party payer system.

But then you write: "Are they controlling costs as much as we wish? Apparently so, because we keep paying them for health insurance."

Again, the issue is that we certainly are paying them for health insurance, just not directly, which gets to the crux of the matter.

If we paid directly, without a third party system, then it would be allocatively efficient. But instead, someone else is paying a large portion of the bill for us (among other things), which insulates us from equating costs and benefits at the margin, and so we typically consume far too much.

But, of course, this is not a free lunch. For example, if employers wish to continue provide their employees the same healthcare insurance as part of their salary despite the rise in healthcare costs from this tragedy of the healthcare commons, then all else aside, they must necessarily lower the growth rate of wages.

And that is a big way in which we're "paying" for health insurance, albeit in an indirect manner as the upward spiral continues.

So, my point is that it is better to pay for things directly, rather than indirectly via market distortions.

John Dewey June 30, 2009 at 10:51 pm

pingry: "my point is that it is better to pay for things directly, rather than indirectly via market distortions."

So you say. I see it diferently. What does "better" mean?

Sorry, but I don't see in the purchase and use of private health insurance the market distortions you refer to. Health insurers have included the expected use of health care into the price they offer. Those insurers are making a profit. Consumers of health insurance are receiving the service they purchased.

The upward spiral you refer to is caused not by a third party system but rather by government interference in the market:

- all costs of Medicare and Medicaid are not paid for by the consumers who use those insurance plans;

- consumers of health insurance are not permitted to purchase health insurance from other states;

- state governments mandate coverage which health insurance consumers might not desire to pay for.

The problem is not insurance. The problem is that markets are not free.

muirgeo July 1, 2009 at 12:39 am

"In either case, some people will be denied care. I'd prefer that the impersonal forces of the market direct such decisions than to have them made by bureaucrats."

So people who can't pay just get no treatment and die?

Your argument is a little like saying the cost of national defense would go down if each person just was responsible for their own defense.

muirgeo July 1, 2009 at 12:42 am

An intractable problem.

Posted by: Arthor Bearing

Yeah explaining how you are going to let people who are denied insurance or can't afford care just die in the streets is a bit of a problem. But yeah the rest of the argument is sound logic.

muirgeo July 1, 2009 at 12:48 am

"Each of us, at the end of the day, has more control over the size of our bank accounts than we have over politically influenced bureaucrats."

Posted by: Brian T. Schwartz

Yes, especially premature babies born to poor people. They should be allowed to control their bank accounts and be left alone by "bureaucrats".

I've said it said it before but I really don't think you've thought of the real world consequences of your position. Please answer. Does the baby just die in its mother arms?

S Andrews July 1, 2009 at 1:38 am

Does the baby just die in its mother arms?

This has been answered here and you know it you little twerp. Some premies will die regardless of whether they are born to a poor mother or a rich one.

I have not seen religious charities raising money to support poor in need of medical treatment. I am sure there are exceptions, but I am talking about the rule. I have seen plenty of them raising money give school supplies, school lunches, homes for the homeless, free meals etc. I think I know why! The need doesn't exist.

brotio July 1, 2009 at 1:55 am

So people who can't pay just get no treatment and die? – Yasafi

Maybe they can't pay because their hypocrite doctor is making so much profit in the health care industry that he can afford to go trotting across the globe several times a year. Meanwhile, babies are dying in their mother's arms while this hypocrite, who has the knowledge that that baby needs to survive, has callously put a price on his services!

Babinich July 1, 2009 at 5:39 am

TrUmPiT said: "Along with the hippocratic oath, the requirement to serve the poor at no, or small charge should be part of their duty and pledge."

TrUmpit,

What do you charge the poor when you serve them? Do you even serve them?

chsforging July 1, 2009 at 7:18 am

I don't think free service increasing the cost of health care. Actually it could reduce the cost if government adopt the suitable policy.

John July 1, 2009 at 8:07 am

Why should they hypocrite pediatrician give his services to the poor for free or at a reduced rate when he is guaranteed payment from the government?

John Dewey July 1, 2009 at 10:06 am

S Andrews: "I have not seen religious charities raising money to support poor in need of medical treatment."

Perhaps government medical care programs have reduced the need for charity support of medical care. But i think it still exists.

I have read about the Catholic Church raising money for health clinics in poor Hispanic neighborhoods.

The Methodist Church and other religions have supported missionaries who provided education and medical care. My uncle and aunt were such missionaries in Africa back in the early 1960's.

Approximately 60 percent on acute care general hospitals in the U.S. are non-profits. I can't find recent data, but a decade ago about a third of the non-profits were controlled by organized religions. In order to retain tax-exempt non profit status, hospitals must provide community benefits such as care for the indigent.

Rick July 1, 2009 at 10:27 am

I can sometimes buy food on an outcome, rather than fee-for-service basis, at an all-you-can-eat buffet. I just don't get as much choice or the same degree of quality.

Sam Grove July 1, 2009 at 10:48 am

Typical feely type resorting to emotional manipulation rather than attempting to suggest positive solutions.

That's why they think of hammers to even fasten several sheets of paper together.

Government can solve all problems by threatening people with force of arms.

Who needs creative solutions when pointing guns at people seems so efficacious?

Duplicitous thieves from the beginning, they steal labels that they find will sell their program of redistribution.

John July 1, 2009 at 11:24 am

Looks like Mr Grove finally figured out that the only difference between government and organized crime is the number of guns.

David Onkels July 1, 2009 at 11:57 am

Pingry,
Very nicely stated, sir.
I noticed that you made your case without the usual detour into "malpractice" costs.

Direct payment for medical services, together with patient ownership of insurance policies, equal tax treatment of medical care expenditures among different classes of consumers, and the establishment of a national market for health insurance, so that a consumer could purchase a policy from a financially-qualified company in any state without care- or provider-mandates
would facilitate a more rational market for medical care.

The transformation of the market requires price transparency at every level, of course.

Among the results of a less distorted market for medical care would be reduced capacity utilization, which would lead to reduced investments in health care facilities and cutting-edge pharmaceuticals. As a consequence, drug companies, medical equipment manufacturers, and corporations that own hospitals might be expected to oppose a move toward a more rational market. (The FDA's cumbersome approval process is a topic for another day, but a transformation there to better align it with libertarian principles would reduce the cost of new drugs considerably.)

What's left to consider is a way to maximize the size of insurance pools to prevent adverse self-selection and death spirals, a backstop mechanism for indigents with chronic diseases, and a way to alter the societal expectation that every adverse outcome merits a financial reward.

Now, a note about our "epidemic of obesity": In today's society, food is cheap and exercise is expensive. People respond to incentives, don't they?

Sam Grove July 1, 2009 at 12:15 pm

Looks like Mr Grove finally figured out that the only difference between government and organized crime is the number of guns.

I do take issue with the "finally".

Sam Grove July 1, 2009 at 12:17 pm

Insuring every medical expenditure amounts to subscription medical coverage.

Insurance is supposed to provide coverage for the rare and unlikely.

John July 1, 2009 at 12:18 pm

I do take issue with the "finally".

My apologies.

John Dewey July 1, 2009 at 12:47 pm

sam grove: "Insurance is supposed to provide coverage for the rare and unlikely."

Why? Because that's what you believe?

Why cannot insurance provide subscription medical coverage? If subscription medical coverage is what consumers want – and if they are willing to pay for it – what is the problem?

For me – and I suspect for many other consumers – there is great value in having a fixed cost for medical care. We'll let the insurance companies figure out how to price it.

Your values may be different. If so, I recommend that you pursue a different arrangement. But please do not try to restrict my choices.

John July 1, 2009 at 1:00 pm

Why? Because that's what you believe?

No, semantics.

John Dewey July 1, 2009 at 1:25 pm

John: "No, semantics."

Please provide a source.

Here's the definitions I'm familiar with:

From Merriam Webster online:

"coverage by contract whereby one party undertakes to indemnify or guarantee another against loss by a specified contingency or peril"

Nothing there says that says the contingency need be rare or unlikely.

From Princeton's WordNetWeb:

"promise of reimbursement in the case of loss; paid to people or companies so concerned about hazards that they have made prepayments to an insurance company"

Nothing in that definition indicates the loss or hazard need be rare or unlikely.

John July 1, 2009 at 1:36 pm

Please provide a source.

I would but it's dead.

John July 1, 2009 at 1:44 pm

Dewey,
You're right in that insurance is whatever the contract says it is.

Larry Sheldon July 1, 2009 at 1:56 pm

As a well-experienced user of the medical and health care systems (but without any credentialed analyses to support my position) I believe "who pays" is largely (but not entirely, see below) irrelevant to the problem of medical and health care costs.

For openers, I believe, but can not prove (neat book title–you should read it) that the costs stated as a function of hours-worked-to-pay-for-it is not that bad. Particularly of you somehow factor in the social costs of people not living as long.

But I believe, but can not prove, that the rising costs in the near past are mostly due to these factors;

1. Exorbitant and unconscionable "damage" suit awards.

2. Costs of insurance to protect practitioners and infrastructure operators from the effects of 1. above.

3. Defensive medicine practiced to try and prevent or at least ameliorate the costs of 1. and 2. above.

4. Cost of acquisition and maintenance of infrastructure (e. g. NMRI labs) needed only for 3. above.

5. Plain old economics of shortage of supply caused bu the reluctance of people to enter the trade because of the issues given here, exacerbated by union-mandated reduction of medical school seats.

6. Because a third person is the primary receiver of billing information the incentive and ability for anybody to audit a bill against services and products received are removed. We have found huge errors (frauds?) in bills, but there is no place to report them to and no hope for correction.

Seth July 1, 2009 at 2:44 pm

"There are many reasons why healthcare is different from food. …" – Thomas DeMeo

Yes, that's why central food planning has worked wonderfully where it's been tried. Send your table scraps to North Korea.

http://www.earthtimes.org/articles/show/275591,north-korea-faces-new-food-crisis-un-warns.html

Sam Grove July 1, 2009 at 2:48 pm

7. People are living longer. Longer retirement means more people consuming care while not producing. End of life care is also very expensive.

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