Healthcare Insurance: America’s Collective Action Nightmare

Across the country, ugly confrontations are occurring between Republican lawmakers who pledged to repeal Obamacare and Americans who are afraid of losing their healthcare coverage.  The protesters’ fears are understandable.  The cost of medical services can be devastating.  The chief selling point for Obamacare was that, between the guarantee of coverage on the exchanges and the expansion of Medicaid, the vast majority of Americans would be protected.  And the main difficulty that Republicans face in repealing Obamacare is the widespread concern that tens of millions of people might be tossed off the rolls.

The confrontations are the unavoidable consequence of a collective action dilemma.  The dilemma is this: To achieve good collective outcomes, government must often prevent people from doing what they think is best for themselves.  Individually, I might like to be free to dump trash in the most convenient place, to pollute the waterways and skies, to fish and hunt without limit, to drink and drive, or to use other people’s property and possessions without their permission.  Millions of other people might want these liberties too.  But collectively, we’re all vastly better off when everyone’s freedom to do these things is constrained.  One of the benefits of government is that it can prevent people from acting in ways that are individually rational but that, when practiced widely, make us collectively worse off.

In healthcare, the collective action dilemma stems from the fact that comprehensive coverage—by which I mean all forms of third-party payment, including Medicare and Medicaid, as well as private insurance—is the main driver of the healthcare cost spiral that gone unchecked since the mid-1900s.

The problem is a vicious circle.

  1. The more insurance a person has, the less the cost of health care figures in individual decision making.
  2. The less costs matter, the more willing people are to use healthcare, especially healthcare that is expensive.
  3. The more people consume, the more society spends and the pricier healthcare becomes.
  4. As healthcare costs increase, the more people want insurance and the more they want insurance that covers everything.
  5. Return to step #1.

In short, third-party payment got the healthcare cost spiral going and has fed off it ever since.  The cycle ends when millions of people start going bare because insurance has become too expensive for them to afford.  By that point, of course, healthcare is prohibitively expensive too, and people who are uninsured or at risk of becoming so are worried to death that they’ll be ruined financially should they or a loved one get sick.  That is the situation today.

The connection between third party payment and healthcare spending will be obvious to anyone who bothers to look.  In the figure below, the red line shows the ratio between the total amount that consumers paid out of pocket for healthcare and the amount that was spent by Medicare, Medicaid, and private insurers.  The line declines steeply, showing that, since 1960, an ever-increasing fraction of healthcare dollars has been routed through third-party payers.  (The decline is especially pronounced in the mid-1960s, when Medicare and Medicaid were introduced.)  The blue bars show annual healthcare spending per capita.  As the red line falls, per capita spending rises inexorably.  The logic is simple.  The more we rely on third party payers, the more we spend because the less each of us worries about costs when deciding how much healthcare to use.

The segment of the healthcare market in which people buy goods and services directly provides more evidence.  There is no cost crisis in this segment and never has been.  Prices for Lasik surgery, in vitro fertilization services, abortions, plastic surgery, and other treatments that aren’t covered by insurance are reasonable and often decline.  The same is true for over-the-counter drugs.  Hospitals can sell aspirin tablets for $10 apiece because insurers pay their bills.  The corner drugstore can charge only pennies because you do.

Often, the self-pay sector and the insurance sector operate side by side, and when they do the self-pay sector is always cheaper.  The prices that insurers and government agencies like Medicare pay for blood tests, MRIs, wheelchairs, vasectomies, and other medical goods and services greatly exceed those paid by patients who foot their own bills.  The reasons are simple. Self-pay patients seek out bargains and force providers to compete. Insurers don’t.  Providers can also serve self-pay patients more cheaply because they don’t have the administrative burdens that third party payment imposes.

To solve the cost crisis, then, America must transfer as much responsibility for healthcare purchasing as it can from Medicare, Medicaid, and other third-party payers to consumers.  Ideally, consumers would pay for everything except services that are required to meet catastrophic needs, for which insurance will always be essential.  The problem is how to get from where we are to where we ought to be, despite the hysteria that is gripping the nation.  There must be a transition, a sustained program of education, and a safety net for the poor.

A transition is needed because Americans will have to learn to save money to meet the predictable costs of healthcare and to feel comfortable buying services themselves.  Today’s seniors didn’t save as much as they should have during their working years because they expected Medicare to take care of them.  Today’s workers aren’t saving either.  They’re relying on their employers to withhold the money needed to cover their premiums and they’re hoping that when they retire, Medicare will take care of them too.  Both seniors and workers are also relying on third party payers to negotiate prices instead of shopping for good values themselves.  It will take time, probably a generation, to replace these bad habits with good ones.

Education is needed because Republicans have promised to replace Obamacare with something better, but for the vast majority of Americans “better” means as much insurance coverage as they currently have (or more) for a lower price than they currently pay.  No one can deliver that because, as private insurance, Medicare, and Medicaid drive prices and spending higher and higher, premiums and taxes have to increase.  Only when Americans realize that insurance is the problem, not the solution, will a program better than Obamacare be feasible politically.

A safety net is needed because there will always be people who are too poor to purchase their own medical treatments, just as there will always be people who are too poor to buy their own housing, transportation, or food.  The safety net will have to provide for them—but it should do so by giving them money or vouchers, not by providing insurance or Medicaid.  Food stamps aren’t insurance.  They’re vouchers that people use to buy what they want.  The Earned Income Tax Credit isn’t insurance either.  It is a source of funds that poor people use to cover their needs, and studies have repeatedly shown that it helps them immensely.  We should give poor people money to buy healthcare too.

In the short run, the education program is the most urgently needed.  Republicans will have to teach fearful Americans that healthcare is expensive because it is insured.  This will be hard to do.  Democrats, most of whom want universal insurance coverage for everything and all of whom want to kick the Republicans out of office, will do what they can to stoke voters’ fears.  Health care businesses will too.  They know that private insurance, Medicare, and Medicaid are their cash-cows, so they will say and do what they must to protect them.

Worst of all, Republicans have undermined their ability to teach anyone anything by cultivating a reputation for being stupid, dishonest, and corrupt.  They have sided with superstition against science, have embraced the least educated portion of the electorate, have repeatedly lied about things like “death panels” and defensive medicine, have cried “rationing” whenever any effort has been made to rein in healthcare spending, and have sold their souls to drug companies and other industry interests.  No wonder millions of Americans think they’re mendacious.  I don’t trust them, and I am aligned with them in this debate.  If we can’t get from where we are to where we need to be, it will be partly because so few Republican officeholders have the credibility to lead.

Charles Silver is a professor at the University of Texas School of Law, a leading medical malpractice researcher, and a co-author of After Obamacare: Making American Health Care Better and Cheaper (forthcoming 2017).

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6 replies »

  1. Hi James, Thanks for the comment. We agree. Quality matters, as well as price. In retail markets, though, sellers have strong incentives to provide good info about both–and also strong incentives to get better at both by offering more for less. I think we’re seeing this in the IVF area, where patients pay for services directly and providers keep statistics on pregnancy rates, try hard to get better, and compete on price. As you say, though, a switch from 3rd party payment to 1st party payment would come as a big shock to mainstream healthcare providers, who aren’t used to having to compete. Best wishes, Charlie

  2. Hi Michael, Many newspapers have run stories comparing insured costs to direct pay costs of medical goods and services. Here’s an example from a chapter in my book: “In New York, the cash price for a vasectomy performed at one of Dr. Thomas Rechtschaffen’s offices in Scarsdale or Yonkers is $450. At the Weill-Cornell Medical College, located in New York City, the cash price is $3,500. By taking Amtrak to Yonkers or the Metro-North to Scarsdale, a Manhattan dweller can save $3,000, more than enough to buy the best corned beef sandwich in NYC to eat along the way.” As for the services you mention, walk-in clinics, which often serve patients who are self-pay, are quickly making in-roads and showing that they can undercut the prices of providers that rely on insurance. Look around and you find many more comparisons on the internet. Lastly, I sort of see why you got to the conclusion that single payer would “best address this negative cycle.” But governments have proven themselves incapable of controlling healthcare spending. Medicare and Medicaid are huge contributors to cost growth, as Martin Feldstein showed way back in the 1970s and Amy Finkelstein demonstrated more recently. Best wishes, Charlie

  3. Hi William, Personally I would give poor people money via a negative income tax and let them buy whatever combination of insurance and medical services they think best. I would also let them spend the money on non-health needs because I think over-spending on medical treatments is rampant while we spend to little on things like housing and education that also contribute to health and well-being. I find it interesting that Singapore lapped us in the categories of life expectancy and infant mortality by requiring savings and letting people spend money on housing Singapore now has the highest savings rate and home ownership rate in the world. The benefits of intensive medical services are over-rated, I believe. Best wishes, Charlie

  4. Charles, Will the provider who receives the voucher or the Medi-buck or the tax credit money be as willing to make a deal with the patient as if he had received cash from the patient? Do these surrogate forms of payment serve as well in the shopping exercise as cash? I don’t think we know the answer to this.

    We have two canonical needs: 1. We have to help the needy by giving them something they can use to buy health care. We can pay their bills using a third party payer as we do now…which leaves us with the third party conundrum mentioned in the article. Or we can use tax credits, vouchers, chits called Medi-bucks, or we could pass claim money through the patient first as in the indemnity-style insurance of yore. All these allow money equivalents to be passed directly from the patient to the provider. By doing this maybe we have made the provider feel he is dealing with a person and not an insurance company ( as you said in your article.). Thus, the shopping experience has hopefully occurred. Note that altruism is still possible, even if we tell the needy to shop with a voucher.

    2. We need desperately some vector to push prices down. Monopsonic purchasing does this and shopping does this. Nothing else works. This country has politically said “no” to monopsonic purchasing. You will say “why not just give cash to the patient?” The thinking is that this would probably lead to too much diversion toward non-health needs.

  5. “Often, the self-pay sector and the insurance sector operate side by side, and when they do the self-pay sector is always cheaper.” – where is the evidence that the self-pay sector is always cheaper? For those that are uninsured and have catastrophic medical expenses due to preventable and treatable conditions such as asthma, diabetes, hypertension, hyperlipidemia, tobacco use, depression, I find it hard to believe that self-pay (ie also uninsured) ends up being cheaper for health care costs for the entire population OR to the individual as this ends up passing the cost down to everyone else (hospital expenses, etc) or incurring individual medical debt. The first half of this article also seems to imply that a single payer or even a public option type of scenario would best address this negative cycle of healthcare spending in the US as this fits the paradigm of the collective action dilemma. Why is this not even mentioned in our current debate about the fate of Obamacare?

  6. Charles: Good article. It may well be that the historical perversity of insurers paying directly to providers has to be undone. Providers will scream. Set reimbursement prices at a UCR or average cost with some push downward, and have the patients shop for care w/in the payments or below so they can pocket the difference. To do that, we need transparency of both cost and quality. Just cost alone is a dangerous way to shop. The juxtaposition of more and more “care” being covered by insurance which isn’t traditional insurance at all, but rather financing of mostly predictable routine needs, has distorted all normal buyer/seller behaviors. Why shouldn’t providers have to justify their fees directly with their patients? Might change some behavior, you think?