[ Monday, December 13, 2004 ]


Healthcare Economics: Something to keep in mind if you're economic thinking tends toward libertarian/free market beliefs: instituting drug price restrictions is bad for your health. Reducing the profitability of developing new drugs will cause pharma companies to reduce the money they spend on developing new drugs, and the lack of new drugs will result in shorter, lower quality lives than would be lived with the new drugs. The Manhattan Instutute sets out the specifics here. Well, duh.

Also, you may have noticed during the recent political season a lot of pandering talk about how expensive healthcare is and how expensive insurance is. My firm is currently going through the insurance re-enrollment process, so I know how expensive it is. Of course, some money in healthcare is poorly spent, some is wastefully spent, and some is fraudulently spent, but for the most part healthcare costs what it costs because that's what it costs. Miracle drugs are expensive because miracles are expensive. It costs a lot to do this stuff.

One other thing: do you want your doctor to be smarter than your lawyer? Do you want the brainiacs to spend their productive years writing code for the next version of "Grand Theft Auto," or do you want them to go into medicine? If you don't allow drug companies to make money on new drugs, they won't develop them. If you don't allow doctors to make a generous living, they will become software engineers or investment bankers or lawyers or some other highly-paid leech on society. The prestige of being a doctor will always attract some regardless of the compensation, but that's a pretty stupid economic model.

According to this report by HHS, in 1999 the average American purchased healthcare services in the amount of $3,834. That's for every man, woman, and child in America. With that in mind, let's consider what health insurance ought to cost. But first, let's consider what insurance is.

Insurance is the process of spreading the risk of an event causing loss or need over a larger population. An insurance company must take in enough money to pay all of the claims that will be made, plus some additional to pay for the costs of running the insurance company, paying salaries, etc. The insurance company must also have some pool of assets in hand at the beginning, since it won't know if the claims will come before the premium money gets in. So, the insurance company will also need to make some money to pay for the pool of assets it is using as a backstop. Someone will have to contribute that pool of assets or agree to loan the insurance company the pool of assets, and that someone will expect a rate of return on those assets (what the someone could make if the someone invested the assets elsewhere in an economically profitable enterprise). So, the insurance company must bring in premiums sufficient to cover the cost of care covered, the administrative costs of running the insurance business, and some profit to pay for the backstopping assets.

Let's start with the fact that the average healthcare spending is $ 3,834. And let's say that we want to provide insurance for that, but we only want put a couple of limits on the insurance: we will only cover 80% of costs generally, but will have an out-of-pocket ceiling where coverage goes up to 100%. Why? First, covering 100% of all costs is bad, because there's no restriction on spending that way and fraud is likely to occur. Back when I was in high school, a McDonalds opened in my home town of Deer Park, Texas. I got a job there, before it opened. They took all of us newbies to an already-operating McDonalds in Baytown to work a few shifts and learn how to operate the equipment. Then, the night before the first day the new Deer Park McDonalds was to open, we had a "shakedown cruise." All of us employees were allowed to invite family members to come eat for free, and we ran the restaurant as if it were open, except we didn't take any money. We "sold" more fried apple pies that night than we sold for the next three years. The positive response is strikingly different when you say, "Would you like a free hot apple pie with that?" versus "Would you like a hot apple pie with that?" We weren't sitting on crates of frozen pies during that first year, so I think the manager knew that the pie sales on opening night weren't a harbinger of things to come (if he just saw the "sales" from that night without knowing that they were all free, he might have thought that Deer Park was pie-eating capital of the world). So, do avoid the "free pie" problem, we'll only insure 80%.

At an 80% coverage ratio, assuming healthcare spending at 1999 levels, the insurance company will end up paying $3,067 per person, with each person paying about $750 a year out of pocket. For a family of 4, that's $3,000 a year. And if you're an average person aged 64 or higher, your average spending is about $11,000; your out-of-pocket 20% is $2,200 per person. And if you have a big health problem in a particular year, you can easily run up hundreds of thousands of dollars in healthcare costs. Let's say you're the odd case with one year of $100,000 in healthcare spending: you're 20% would be $20,000. Not too many people can pay that in a year, so we need some upper limit out-of-pocket cap. The specific statistics would give a better number, but adding an out-of-pocket cap would effectively push up the percentage paid by the insurance company from 80% to something higher. For our purposes, let's assume it would go to 85%.

85% of $3,834 is $3,259. So, our insurance company is going to pay out $3,259 per person covered, which means that our insurance company must bring in $3,259 per person in premium dollars; PLUS enough money to pay rent, salaries for the employees, costs of supplies, etc.; PLUS some money to pay for the backstopping assets. Let's say each of those is 10%, and we're up to almost $4,000 per man, woman, and child that needs to come in in premium dollars.

How much does your insurance cost you? That's not an easy question to answer. You probably elect some type of payroll deduction, so that's part of it. And your employer pays a chunk of it too. If you're on Medicare, Medicaid, or some other type of governmental program, then the government pays for it. But in each case, we all ultimately pay for it. Your employer might pay you more if he didn't have to pay part of your healthcare costs. The goods and services you buy would be cheaper if not for the fact that the seller needs to get back its employee healthcare costs. And your taxes would certainly be lower if the government didn't pay for this stuff.

If you're under 65, you're average healthcare spending is $3,352, not $3,834 (and your kids are much lower, at an average of $1,646), which might lead you to believe that your insurance costs should be lower. But that leads to a different question altogether: should an insurance company be able to exclude potentially-high-cost people? Or charge them a higher premium? Bad drivers have to pay more for auto insurance, should people who live unhealthy lifestyles have to pay more for health insurance? Maybe that's a good idea; if there was a transparent additional cost to bad behaviors, or a visible reward for healthy behaviors (not applied judgmentally, but strictly in relation to economic costs of actions), perhaps people would be a little more likely to avoid societally-costly activities (or at least shift less of that cost to the rest of us). How about people who, through no choice of their own, are born with health conditions that cause them to be higher utilizers of healthcare services? That's probably a different story, but in a libertarian model, shouldn't every citizen be required to carry their own weight? If you're born smart or strong or fast or tall, you get to take advantage of it by being a professional or a professional athlete; if you get to take advantage of your genetic advantages, shouldn't you be stuck with your genetic shortfalls?

Obviously, I've gotten a little far afield from where I started. But ultimately, we're looking at $3,834 per person to pay for healthcare in this country. That money is coming from somewhere. If you're not paying it visibly, you're paying it invisibly.

UDATE: one more thing before I leave this behind. Back to the political jaw-jawing: some politicians like to make hay out of the "uninsured" numbers, and talk about what it would cost to provide insurance to them. The problem is this (and it ties back into free pies): If you take the X million uninsured and multiply it by the cost of adding a person to an insurance program (governmental or otherwise), you get a number that would be a good cost number if nobody ever changed their behavior based on money. However, if you tell one segment of the population, "you haven't bought health insurance, so we will buy it for you," the rest of the population is going to quickly move into that category and drop their health insurance. I would certainly move quickly to get my firm to drop our insurance coverage if all of our employees could get insurance for free from the government.

Jeff [8:56 AM]

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