What ails our heath care?

There is serious concern about the fiscal viability of the U.S. health care system. The share of national income spent on health care is already higher than in other developed nations and it is increasing. Other nations too will soon need to control their expenses on medical systems as the costs spiral upwards with developments in medicine, with the aging of population and changing social preferences. The general consensus is that the current system of delivering and paying for health care in the United States is unsustainable. US health care spending was 6 per cent of the gross national product (the value of all goods and services produced within the country) in 1965. Since then it has risen to 17 percent and, worse still, it is predicted to increase to 26 per cent by 2035. Yet attempts to reform the system get bogged down in intractable controversy about what is feasible and what is socially acceptable. Why is designing health care system so much harder than developing markets for other goods and services? Modern economic analysis has identified the conditions necessary for a market system to achieve efficient allocation of resources. The nature of health care is such that it is virtually impossible to fulfill those conditions and the choice is between alternatives each with its own limitations. The middle road is always a hard one to follow. The cost of health care is partly paid by the patient (out-of-pocket expenses) and partly by public or private medical insurance plans (if the individual is enrolled on one of them). Public programs are meant to assist those who are below a certain level of income or those past the retiring age of 65. Roughly 268 million out of the resident population of 308 million of the United States are below the age of 65. Among them 157 million are covered by employee-sponsored health insurance programs. Some others are covered by other programs while more than 50 million the number fluctuates from year to year depending on economic conditions - have no health insurance. The forty million above 65 years are eligible for Medicare, a federal program for the elderly. The expenditure on health care, as on any other commodity, is the product of the quantity transacted and the price and it can be reduced only by a reduction in one or the other. Regulatory agency in some European countries are authorized to deny medical procedures to certain patients if costs are judged to exceed the benefits but administrative control is not acceptable in the United States. How then does the market determine the availability of medical services? The long-term trend is determined by changes in medical technology. In short term, the willingness of insurance programs and patients to pay and the cost of providing the service are the determining factors. Another industry that recently went through a crisis provides some insights. Many automobile firms in Europe and the United States faced bankruptcy. The prices at which various models were sold could not match their costs of production. Part of the reason was that these models

were loaded with features that were not high on consumers preferences. Partly it is due to inefficiencies in production and distribution system. By international standards the British automobile plants were inefficient, the industry was in distress and all major brands were brought and restructured by foreign firms. In United States, the proliferation of car dealership led to an inefficient distribution system that was trimmed during the last recession. Services are much more elusive than products to define and to evaluate. International and interregional comparisons are used to measure the efficiency of medical delivery. One observation is that Medicare spending varies among regions within the United States without any significant differences in health outcomes. A leveling of expenses can result in substantial savings. Another yardstick to measure efficiency is comparison of costs across nations. Physicians and hospital costs per person in the United States is twice as that of Canada. Higher administrative cost, higher income of medical personnel and intense use of medical technology are offered as explanations for the international and interregional cost differences. Patients belong to different private insurance programs and each has its own regulations and filing requirements; they add to the workload to obtain reimbursements. For office based physicians in the U.S., there are more administrators than the nurses, clinical assistants and technical staff put together. Another indicator of the higher administrative cost is that it takes 770 employees to process $1billion medical reimbursements while other industries need only 100 employees to collect as much. Administrative costs for filing under Federal Medicare program is less but so are their reimbursement rates. In the United States and Europe, doctors are high income earners, earning on the average as much as the top five percent of the population. Whether their earning is excessive depends on the measure used to make the judgment. Doctors earn about six times U.S. per capita income and threeforth more than doctors in other developed nations. Yet the ratio of the average earnings of U.S. doctors to that of the top five percent is less than the corresponding ratios for European nations. Equipments based on newer technologies are generally more expensive but they have offsetting effects on health care costs. The increased cost for purchase and operation can be cancelled by cost savings from by early detection of medical conditions. Health care is demanded by the entire population. Improving the health of the population is the best way to increase the welfare of the people and reduce medical costs. Since 1970, ageadjusted mortality rate from coronary diseases has halved. Various statistical studies attribute half the reduction to lesser smoking, control of cholesterol and physical activity and the other half due to improvement in cardiological treatments. Even so, in 2004, 450,000 deaths in the United States were due to coronary diseases, costing $150 billion in direct health care. In spite of preventive measures, individuals do get sick and they have to be treated. Even if the patient is paying the doctor, misuse of resources arise as the interests of the doctor do not coincide with that of the patient. He may undertake procedures that, while not necessarily beneficial to the patient, increase his income. The lack of alignment of the interest of the doctor

and the patient is known as agency problem. Even today, in countries like India, doctors expect patients to accept their judgment on faith and refuse to discuss medical procedures with patients. If the payment is made by a third party, the insurance program, the problem becomes even more complex. Insurance is a contract that certain payment will be made if a contingency (a fire, a car accident or illness) occurs. The procedure for ascertaining the occurrence of the loss, the actions needed to correct any damages and compensation for the loss must be agreed upon at the time insurance is issued. No insurance contract can foresee all possible contingencies. In the case of a car accident, it is easy to determine that it occurred. Qualified assessors can determine the extent of damage to the cars. In health care, there is a subjective element in decisions as health conditions of patients vary so much and the options for treatment are many. Patients can demand expensive medication or medical procedures to extend the life of a critical patient for a short time and doctors can prescribe expensive procedures to increase their earnings. Health insurance programs that offered a fee for service is defective in offering neither the providers of health care (doctors or hospitals) or the patients incentive to weigh the cost of health care to the benefits. As long as payments are greater than the cost of incremental services, the providers benefit from offering more. Patients choose overconsumption as the major portion of the treatment cost is born by the insurance program. To limit such behavior, the patient is made to share a part of the medical expense. Studies indicate that patients are sensitive to price. The challenge then is structure the share born by patients to minimize present and future medical costs. If higher prices lead to patients to economize or avoid taking prescription medication, they can develop complications requiring expensive treatment and even hospitalization; economist estimate that it is cost effective to provide some medications free of cost to the patient. Paying only for visits to doctors precludes development of arrangements to check if patients are diligent in taking medication or following other instructions of the doctor in between visits. Because of poor incentive to control costs, the fee-for service programs that use to be the standard almost to the end of twentieth century has practically disappeared. Innovations focus on incentive to health provider to control cost. One of the defects of fee-forservice is multiple payments to physicians, hospitals, laboratories, pharmacies and other producers. This has been replaced by bundled payments for treating diagnostic-related groups. In 1983 Medicare has pioneered the move to bundled payments to paying hospitals. The challenge is now to extend it to incorporate payments to multiple providers who are involved in treatment of a medical condition. The two major problems facing health care system in the United States are extending insurance to the 50 million uninsured and to control the cost of Medicare plans. One of the problems in offering health insurance to individuals or small groups is that those who are sick or expect to have medical problems will take insurance while those who expect to remain healthy will avoid it (in insurance terminology it is known as adverse selection). Concerned about the high medical expenses of those who elect to take insurance, the premiums will be set too high to be affordable

for many. Employee-sponsored programs avoid adverse selection as all employee, old and young, healthy and sick, are enrolled and paying premiums. The expenses of a few are spread over many and premiums are low. If the firm has only few employees, a medical emergency by one employee creates a spike in medical expenses and insurance company will require an increase in premium. This is the one of the reasons for so many in the United States are without health insurance. One solution is to mandate that individuals take insurance or at least they pay a penalty if they do not. This is the approach taken in the Affordable Care Act of 2010 (critics call it Obamacare) but the provision is challenged in courts as unconstitutional; a definitive judgment from the United States Supreme Court is awaited. The other problem is the insolvency of Medicare, the program for elderly. As life expectancy increase, those above the age of 65 are increasing and the enrollment in Medicare is expected to increase as much as 30 percent in the next decade. At the same time, the fall in birth rate compressed the age pyramid at the bottom. The ratio of those contributing to social security programs to those availing of its benefits is decreasing. Finally, the prices of medical procedures are increasing faster than inflation and economic growth. As with any market transaction, the reduction of the cost of product or service transacted involves either a changes in price or of quantity. The quantity demanded is sensitive to what the patient has to pay but increasing prices deny affordable care to individuals with low incomes; it is considered socially unacceptable. Making those better-off pay more is proposed but has run into political opposition. Limiting availability by administrative decisions, as in done in some European nations, is unacceptable in the United Sates. Another choice is to pressure pharmaceuticals and medical providers to cut costs; while it is attempted, the growth in the price index for medical services exceeds the general price index. The economic problem is the familiar one of adjusting quantity demanded to supply; the challenge is to find the one feasible choice that is age-adjusted socially acceptable. Data sources: Symposia: Constraining Healthcare Costs, Journal of Economic Perspectives Spring 2011, pp.2 -110. Newhouse, Joseph H., Medical Care Costs: How Much Welfare Loss, Journal of Economic Perspectives 1992, pp.13-29. Ramachandran, Rama, Insurance, Opportunities and choices: Understanding our economic decisions, 2011, pp. 165-168, http://www.scribd.com/doc/49513234/Opportunities-and-Choices Reinhart, Uwe Restructuring Medicare and the Rivlin-Ryan Plan, http://economix.blogs.nytimes.com/2011/02/04/restructuring-medicare-and-the-rivlin-ryan-plan/ The Henry J. Kaiser Foundation, The Uninsured: A Premier, 2010 http://www.kff.org/uninsured/upload/7451-06.pdf U.S. Census Bureau, Population Profile of the United States, http://www.census.gov/population/www/pop-profile/natproj.html

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