A commenter writes,

We are also allergic to the word “charity”. A lot of people want to benefit from free or subsidized health care (along with many other goodies) but would never want anyone to call what they receive charity. Charity is low status

Hence, health care spending shell game is popular. It is charity disguised as an entitlement.

John Cochrane writes,

Why, in order to provide for the unfortunate, do we not simply levy taxes, and pay for charity care, and leave the rest of us alone?

I think the answer is relatively simple. Our political system is allergic to the word “tax.” Instead of straightforwardly raising taxes in a non-distortionary way (a VAT, say), and providing charity care or subsidies — on budget, please, where we can see it — our political system prefers to fund things by forcing cross subsidies.

As I put it, we are not Denmark.

1. The American middle class does not believe in saving up for health care expenses. The idea that you should have $10,000 – $15,000 set aside for the occasional acute medical episode is abhorrent. The idea that you should save up for the inevitable medical expenses of old age is abhorrent. We are not Singapore.

2. The American middle class does not believe in paying taxes in order to support people who are very poor or very sick. We are not Denmark.

3. Americans are not willing to say, “The proposed treatment for this problem is not worth the cost. The individual should accept lower-cost treatments and live (or perhaps not live) with the consequences.”

4. Americans, and especially health care providers, do not want to think of health care as a commodity. The providers want to be paid, but they do not want to think of themselves as selling their services, so the payment comes from third parties and the price is hidden to consumers.

5. Americans are not willing to give up being the “early adopters” of new treatments, which are often much more expensive when they first appear than when they have been available for many years.

This was not as big a problem 40 years ago, when health care was a smaller share of the economy. It has grown larger because of new treatment options available. These often involve medical procedures that require expensive equipment and highly trained specialists. That is why I called my health care book Crisis of Abundance. As an example, I know someone with Parkinson’s who is getting “deep brain stimulation.” This is an incredibly exotic procedure, requiring a very powerful MRI machine, a highly skilled surgeon, and uniquely trained technicians. But it is a very promising treatment for a very difficult disease.

6. Americans seem to be more willing to spend public money on medical services than on public health. But I would think that there is more bang for the buck in getting people to change unhealthy lifestyles than there is in trying to treat the consequences of those lifestyles.

Put together these cultural traits and you end up, in Josh Barro’s words, with an economy that spends 1/6th of GDP on health care with nobody wanting to spend 1/6th of their income on it.

A commenter writes,

if you can’t decide who is going to pay for the chronically ill, then the number one game in town is the selection game. It is way more important to make sure that “the other guy” pays for the chronically ill. You even end up in situations where you don’t want to be too good at treating the chronically ill, lest all the chronically ill select your plan which is still a net negative.

I think the libertarian reluctance to admit these are going to be socialized costs has led to a patchwork of payers with more interest in playing the selection game then playing the cost control game. It’s also the case that their opponents in the cost control game, providers, have a lot more leverage over a divided foe then a unified foe (either single payer or strong government regulations on cost/utilization).

I think it is fair to point out that our health insurance market as it has emerged gives health insurance companies stronger incentives to hide from costs than to reduce costs.

Another point is that the politics of health care make it more attractive for politicians to help many people who are relatively healthy to handle routine low-cost illnesses, obtain birth control, etc., than it is to try to target support for the people who really need it. Hence, you get the shell game of Obamacare, where you try to give healthy people the sort of benefits that seem to help them, but stick them with premiums that include the cost of subsidizing the people with chronic illnesses.

Politically, what you want are policies with lots of beneficiaries. But the requirement of compassionate health care policy is a policy with few beneficiaries. (For a determined libertarian, this means placing very high expectations on charity.)

Hence, we play shell games. One of them we call “employer-provided” health insurance, as if employers simply give it away. In fact, if an employee is worth $40,000 a year to the company and health insurance costs $10,000, that means that the rest of the paycheck has to be worth no more than $30,000 a year. The cost of health insurance is borne by workers. That means that the workers with illnesses that require expensive treatment are subsidized by workers who are generally healthy.

Another shell game is Medicare. Old people undergo a lot of expensive medical treatments. This cost is borne partly by taxes on the young. It is increasingly being deferred to taxes on people in the future. This Ponzi scheme faces a day of reckoning, which is likely to come within a decade. That is, if you believe the CBO analysis of Medicare, and I thought that fact-based people were supposed to believe in the CBO.

Relative to a policy of honestly taxing the healthy to pay for the sick, these shell games are inefficient. They cost more in terms of lost economic output. The labor market is distorted by “employer-provided” health insurance, leading to less employment and output. The health insurance market is distorted by Obamacare, and in fact that market is in trouble. Subsidized health insurance under Obamacare is sort of working. Mandated health insurance on the exchanges is imploding.

David Cutler writes,

Eighty-four percent of medical spending is for the 50 percent of people with at least one chronic disease; half of spending is for the 16 percent with three or more chronic conditions. People with chronic diseases know they will have them forever; those without have a low chance of contracting one in any year. Nearly half of people who are in the top 10 percent of spending in one year are in the top 10 percent the next year.

The central question for health policy is who should pay for the predictably expensive.

With these statements, David Cutler has not just pushed the goal posts on health care policy a few yards in one direction. He has moved them to the other side of the field.

Everyone is talking about how many households have insurance and acting as if the main challenge is to get healthy people to buy insurance. If Cutler is right, then health care policy boils down to:

1. Finding a fair way to share financial the burden of chronic illnesses. (Obviously, “fair” involves value judgments.)

2. Putting resources into public health measures and efforts to induce people to comply with behavioral advice that would help to prevent chronic illness.

If Cutler is right, then it seems to me that Obamacare and its relatives are beside the point. And I believe that he is right.

See also Benjamin Domenech, who writes,

By providing catastrophic care for all, President Trump could ensure that everyone has an ultimate backstop against medical bankruptcy, while freeing the states to experiment with options for reform. It would also enable the private sector to offer new insurance products to supplement the basic catastrophic care coverage.

That strikes me as much closer to the correct policy than either Obamacare or Repeal-ish. It certainly aims more squarely at the goal posts as placed by Cutler.

A commenter wonders,

I’ve never been told by my doctor “This medicine will cost you 47.50. It will only help 25% of the time. After 10 days your ailment may cure itself.”

Why is this not mandated?

A reader asks (referring to the prices for medical services),

How are people supposed to make decisions/ration their savings (if they have any) when no one can give you a straight answer about how much things cost?

In the United States, about 90 percent of health care spending is paid by third parties. The remaining 10 percent is called out-of-pocket. We have one of the lowest rates of out-of-pocket spending the world, even lower than that in Canada and other countries with more socialized systems.

Much of what seems economically irrational about health care comes from this use of third-party payments. Doctors do not themselves make hard-headed probability calculations, much less give patients the information to make such calculations. Prices are hidden from patients. We waste a lot of money on medical procedures that have high costs and low benefits.

It is natural for economists, like me, to suggest that the way to make the system more rational is to reduce the extent of third-party payments. In my book, Crisis of Abundance, I offered suggestions for reducing third-party payments from 90 percent to 50 percent. I do not think you can reduce them much below that. A large share of health care spending is on a small fraction of the population where the cost of treatment is high, and some combination of government/charity and health insurance is inevitable in those cases. Also, there are people who are so poor that somebody else has to pay for even basic health care for them.

Why do we have a system with such a high proportion of third-party payments? I do not think it is because some evil demon foisted it upon us. I think it is because people like it.

Fifty years ago, doctors liked it, because it encouraged demand. In those days, there were not so many expensive treatments out there, and insurance companies could operate by approving pretty much anything the doctor ordered and paying whatever were the “usual and customary” rates. More recently, as health care costs have started to take a larger and larger share of worker compensation, insurance companies are starting to negotiate harder, and friction is growing between doctors and insurance companies. Still, most doctors would rather take insurance than give up on it altogether. As frustrating as it can be, it is still less trouble than dealing directly with patients on money matters.

I also think that there is a status issue involved. If the doctor does not have to talk about price with the patient, then the doctor is in the position of offering “the gift” of health care. That gives a doctor higher status than that of somebody who is selling you something.

Another point is that when we need health care we are vulnerable, and there is resentment involved in having to pay when you are vulnerable. We feel the same way about charging interest to people who are desperate for money. 2000 years ago, if the only lending had been to growing corporations, then nobody would have complained a bit about the practice of charging interest. Instead, usury was declared a sin because borrowers tended to be people in desperate straits. Even today, the sense of outrage at making vulnerable people pay interest can be seen in the stigma attached to payday lending. Similarly, if you break your arm, having to pay thousands of dollars in hospital bills feels cruel.

Let me repeat Josh Barro’s point that health care is 1/6th of our economy but nobody wants to spend 1/6th of their income on it. When health care spending was lower as a share of GDP, we had the luxury of setting up a system dominated by third-party payments, without the insurance companies or the government imposing difficult restrictions on what procedures could be approved or what doctors could receive in compensation. But health care spending has gotten to be too large a fraction of GDP to be handled that way. The system is bound to change, and the change is bound to feel uncomfortable to many people.

She writes,

how do you define ‘extreme circumstances’? By the cost of the treatment? By the severity of the disease? How and who defines ‘extreme circumstances’?

…Let’s say I get pneumonia. Doctor prescribes antibiotics that cost $100. I decide that the cost of the antibiotics are too high compared to the possible benefit (50/50 chance the antibiotics help) so I hope that enough rest and fluids cure me. Pneumonia gets worse. Now I’m hospitalized and it cost $10,000 a day to be in the hospital. Now my insurance company decides that $10,000 a day is an ‘extreme circumstance.’ How is this scenario more cost effective?

To answer these questions, use some standard insurance company terminology.

1. An insurable event is a rare, unpredictable, costly occurrence. A fire burns down your house. Someone runs into your new car and totals it. What I mean by an “extreme circumstance” is something that constitutes an insurable event. Let me come back to that in a moment.

2. Moral hazard is the failure of an insured person to undertake reasonable steps to reduce risk. Insurance companies address moral hazard through a combination of carrots and sticks. For example, a fire insurance company could offer you a discount on premiums if you have a working smoke alarm. Or they might provide you with a free smoke alarm. Also, because your behavior affects their risk, they might have a rule that says that if your house burns because of negligence (smoking in bed) then they are not liable to pay claims.

The pneumonia patient who decides not to take antibiotics is an illustration of the moral hazard problem. In theory, real health insurance would try to address this. The insurance company might offer a discount to people who obey doctor’s orders. It might offer to pay for the antibiotics. Or it might issue rules warning that it will not pay for hospitalizations that could have been prevented by following a doctor’s reasonable advice.

In any field of insurance, including health insurance, moral hazard is challenging to address. It is hard to list all of the things that insured individuals can do to reduce risk and to specify appropriate carrots and sticks to incent individuals to do those things. So moral hazard will never go away completely, but with well designed insurance contracts it may be reduced to a manageable level.

Now, back to the definition of the “insurable event” in health care. Consider long term care insurance, which pays for a nursing home if you need it. Let us say that a policy covers 10 years, meaning that if the event happens in the next 10 years, the coverage kicks in. If I get this long-term care insurance when I am 50, and I become decrepit at age 59, then the insurance will pay for my long care for the rest of my life. But if I am still independent at age 60, my policy has expired and I would have to get a new one if I want to remain insured. [I am not saying that actual long-term care policies are structured this way. Things are more complicated.]

If you are 40 years old, becoming decrepit any time in the next 10 years is an insurable event, because it occurs so rarely. If you are 70 years old, the chance of having to check into a nursing home some time in the next 10 years is so high that it is not an insurable event. The premiums would have to cost you nearly as much as the nursing home bills.

In dollar terms, I think that the threshold for an event to be insurable needs to be much higher than it is currently in health insurance. People need to get used to saving a lot of money in health savings accounts to deal with short hospitalizations, pregnancies, and the high medical costs of old age, including long term care. It is fair to wonder how practical it is to assign households the responsibility for accumulating this saving. The alternative is to use a government tax-and-transfer scheme. Some combination of both is inevitable, but the relative mix is a subject for discussion. You can think of this is the problem of where to draw the line between health insurance and health charity. How high should a household’s health care spending be as a percentage of income before you give them charity? Keep in mind that in the U.S. average health care spending is 15 percent of income (not nearly that much out of pocket, obviously), so it is mathematically impossible to draw the charity line below 15 percent for everyone.

In health insurance as it is currently designed, the “insurable event” is any expenditure that takes you over the deductible. That is very problematic.

Suppose that you have a chronic illness that is expensive to treat, with an average expense of $25,000 a year. As you apply for health insurance, having high medical expenses next year is not an insurable event. You know that you will have high expenses, and so does the insurance company. Fair premiums would be $25,000 or more, so you would not really benefit by obtaining insurance.

Or suppose that a week before your insurance policy comes up for renewal you get injured in a way that is going to require a sequence of expensive surgeries to fix. Those expensive surgeries are not an insurable event, so your insurance company is not going to renew your policy, and other insurance companies either will not cover you or will charge exorbitant premiums.

We need to change the way we think about insurable events in health care. For the case of the injury, the “insurable event” would be getting into the accident. An insurance adjuster should determine your compensation based on the estimated cost of fixing your body, just as with a car accident an insurance adjuster will determine compensation based on the expected cost of fixing the damage to your car.

It is possible that this “insurance adjuster” model also could be applied to a chronic illness. The “insurable event” would be the point at which you are diagnosed with the illness, and the adjuster would set compensation based on expectations of future treatment costs. However, because chronic illnesses require many years of treatment and the course is unpredictable, this may not be the most workable approach.

Another approach, suggested by John Cochrane (“the Grumpy economist”), is to make the insurable event an increase in your health insurance premiums. Suppose, for example, that you were cruising along paying $1,000 a year in health insurance premiums, and then you get diagnosed with a chronic illness that is expected to cost $25,000 a year. Your current health insurance company, ABC Insurance, is ready to drop you like a hot potato, so you shop for a new policy and you find that the best deal you can get is from XYZ insurance and costs $26,000 a year. If you end up with that policy, you pay $1000 a year, while ABC pays the extra $25,000 a year. That is, your original policy with ABC includes protection against becoming uninsurable!

There is more to this complex topic. I hope this helps.

Liz Sheld writes,

The implicit standard in analysis of the health insurance system is that every consumer must have government-selected coverage. But why? This chosen paradigm doesn’t take into consideration the most forceful motivation of human behavior, namely, whether a large expenditure of limited resources is in one’s economic interest. This standard of “universal coverage” is as artificial as the government’s bloated health care costs.

This is the debate that the Congressional Republicans are ducking. As a result, the Overton Window has moved to the point where Obamacare will not be replaced until the Democrats replace it with full-on single payer.

The points that I would make are:

1. What we call health “insurance” is not real insurance. It is instead a layer of insulation between the recipients of medical services and the providers of those services.

2. It seems that hardly anybody wants real health insurance, meaning a policy that pays benefits rarely and only under extreme circumstances. Instead, what people want as individuals is unlimited access to medical services without having to pay for them. If that is the definition of health insurance in the popular mind, then we are all going to lose our health insurance. Unlimited access to medical services without having to pay for them is an unsustainable approach.

3. There are two alternatives to the unsustainable approach. One alternative is to have people face more of the cost of medical services, in which case they ration their own use of those services. The other alternative is to have the government pay for medical services, in which case it will be the government that rations the use of those services.

4. Much of health care spending is on medical procedures that have high costs and low benefits. Socializing the cost of those procedures means that people will undertake more of them, until the government starts to get serious about health care rationing.

5. Health spending is approaching one fifth of all spending in the economy. If we become culturally committed to socialized medicine, then we can expect the usual consequences of socialism: productivity stagnation; the emergence of an underground economy; corruption; and government repression.