If the Market for Pharmaceutical Drugs is Sick, then What is the Cure?

Markets, like people, can be either healthy or sick. Healthy markets need no assistance from the government to provide adequate quantities at reasonable prices; however, sick markets do.

For a market to be healthy, its price must equal the marginal cost of production. In equation form this is P = MC. Marginal cost (MC) is the incremental cost of producing one more unit of a good and price (P) is the amount of money a consumer must pay for that unit. This equation is as fundamental for economics as “energy equals mass times the speed of light squared (E = MC2)” is for physics.

Sovaldi, a treatment for Hepatitis C, is just a combination of common chemicals. Consequently, the marginal cost of producing one additional pill of it is approximately the same as that for aspirin. You can buy the latter for a few cents, but one pill of Sovaldi will set you back around $1,000.

It is safe to say that the price of Sovaldi is no where near its marginal cost. This situation is quite common in the US and has led to the consensus that the pharmaceutical drug market is sick. There are several proposals for reducing drug prices that range from government production to partial regulation. Which is the best treatment for this illness?  

The Lone Economist has argued that healthcare policy proposals often seek to dictate a result without considering the root cause of the problem. They treat the symptom rather than the disease itself. So, it is important to understand why the pharmaceutical drug market is sick.

Research and Development are Sunk Costs

Unlike that of most goods, almost all the cost of producing a pharmaceutical drug is incurred before the first pill is even sold. Economists call them “sunk”. It may cost only a few cents to produce one additional pill of a new drug, but the research and development costs can be billions of dollars. Charging a price equal to the marginal cost would result in huge losses for the manufacturer.

How then can a pharmaceutical company earn a normal profit from its enormous investment? The answer is to grant them a monopoly — in the form of a patent — and allow them to earn monopoly profits to compensate them for their investment costs.

But aren’t monopolies bad? Don’t monopolies charge prices above the marginal cost of production and sell quantities below the optimal level?

The answer to these two questions is yes, in general. But if pharmaceutical companies could really maximize their profits, they would sell the optimal quantities of their drugs and, oddly enough, poor people would be able to buy the drug just as easily as rich people.

The Power of Price Discrimination

Price discrimination is the practice of charging a higher price to customers who are willing and able to pay a higher price and a lower price to the rest. The Lone Economist has explained that the U.S. healthcare system relies on price discrimination to shift much of the cost of healthcare for the poor and chronically sick to the healthy working-age population. Private insurers pay much more than public insurers for the same services.

The lone exception to this rule is the provision of pharmaceutical drugs. Private and public insurers pay approximately the same prices for the same drugs. The reason is that price discrimination is not as easy to enforce in the drug market as it is in the healthcare services market. This is unfortunate because taken to its logical conclusion, perfect price discrimination in the pharmaceutical market would result in poor people paying only a few cents for a pill and the rich paying thousands of dollars. Pharmaceutical companies might earn enormous excess profits, but the distributional problems that currently exist would not happen if perfect price discrimination was possible in the drug market.

Arbitrage in the International Drug Trade

Monopoly power is not the only condition needed for price discrimination to occur. The other one is the power to prevent arbitrage, the reselling of a good.  For example, if I wanted to sell you pills for $1,000 each and the same type of pills to somebody else for $100 each, then that person would have a large incentive to resell you their pills for $200 each. Unless I can stop them from doing that, I will not be able to price discriminate.

It is impossible to conduct arbitrage for a geographically fixed service like a hospital stay, but not so for a pill. As a result, there is very little price discrimination in the international pharmaceutical industry. The reason why is that these companies know that if they sell the same pill to the UK at a much lower price than they do in the US, then their US sales will be undercut from arbitrage. What usually happens is the UK either purchases a very small amount of the drug at the US price or refuses to buy it at all.

Economic Policy Myopia

Many of the proposals for fixing the pharmaceutical industry assume the U.S. government has the same amount of market power in that market as it does in the healthcare services market. The fact is that the government’s power to dictate pharmaceutical prices is much more limited than it is for services, like surgery. Pharmaceutical companies operate in a global market. The U.S. government is just one large payer out of several.

This policy myopia reminds me of the wealth tax proposals. A wealth tax is a tax on capital. Unlike the labor market, the capital market is global. This makes taxes on capital much less lucrative and much more expensive than taxes on labor. Capital can just as easily flow out of a country as it can flow into it. This is why we rely so heavily on taxes on labor.

The primary motivation for a wealth tax is that it is considered by many to be fair. Tax fairness is good, but like most other good things, it comes at a high price. We shouldn’t pay too much for it.

The most likely outcome of the current proposals for fixing the price of pharmaceutical drugs is a drastic decrease in investment into developing new drugs. In the long-run, this harms everybody.

The optimal policy must take into account the international nature of the pharmaceutical industry. There are huge opportunities for improving the performance of the international pharmaceutical market, if only we would exploit them.

More on that in future posts.

The Lone Economist Does Drugs

The prices of some life-saving drugs are astronomical in the United States with some treatments costing over $100,000 over the course of a year. Unlike its pricing policies for other types of healthcare, Medicare pays roughly the same for prescription drugs as private insurers.

This policy has come under attack by several policy-makers and politicians from both parties. The proposals differ in some details, but they generally advocate a more aggressive stance by Medicare to negotiate with pharmaceutical companies. These strategies range from using the government ‘s considerable market power – this is how it dictates prices for surgical procedures — to suspension of patent rights.

The Lone Economist agrees that the current policy leaves much to be desired. Medicare pays too much for these drugs and a more intelligent system would result in lower prices and longer lives. But like the proposals to eliminate the health insurance coverage gap, i.e. Medicare For All and The Public Option, the drug price proposals attack the symptoms and not the causes while ignoring the good parts of the status quo. In our effort to make the goose lay more golden eggs, let’s not kill the goose.

Granted, the causes of high drug prices are complex. An intelligent policy proposal would require a careful analysis of facts, an unsparing assessment of theories. Such analyses do not easily translate into marketable shibboleths. But the alternative is to squander real opportunities to improve the situation and ultimately result in policies that do more harm than good.

The next several posts will explain the complexity of the pharmaceutical industry using standard economic concepts. Here is a very brief synopsis of the major points:

  1. Cost structure: Unlike medical and surgical services, a large majority of the cost of producing pharmaceutical goods is incurred before the first unit is sold, i.e. the costs are “sunk”. It requires large investments of capital. The marginal cost of an extra unit is very small. The average cost declines significantly with higher levels of output.
  2. Corporate conduct: Pharmaceutical companies are multi-national corporations. They maximize profits by exploiting differences in national regulations, wealth and culture. Regardless of how unfair it may seem, labeling this behavior “bad” is not helpful. But it does point to an optimal strategy.
  3. Market efficiency: The principles of mutually beneficial exchange show that there are available reallocations that result in improvements for all parties.
  4. The bottom line: The governments of the U.S. and other countries and private insurers should form an international agency to negotiate with pharmaceutical corporations. This would result in lower prices and death rates world-wide and no decrease in pharmaceutical investment levels.

Optimal Medicare Expansion

I have explained Optimal Medicare Expansion (OME) in several posts but haven’t provided a comprehensive summary of all its features vis-a-vis the other public health insurance proposals.  Each proposal I have seen has at least one major flaw compared to OME. What follows is a brief synopsis of its features with comparisons to the major proposals. I’ve provided links to posts that explain the various features.

Basic Design

Beneficiaries: All residents not eligible for Medicare Parts A-D.

Coverage: All healthcare services covered by Medicare Parts A-D. Only applies to services after the household deductible is satisfied. Primary insurance.

Household deductible: Minimum is zero. No maximum. Zero for low-income households. Increases with household income and decreases with pre-existing conditions, including age and gender. Not based on actual payments to providers, but rather the payments that would be made to providers if they were paid Medicare rates.

In-network providers: Paid full Medicare rates with no balance billing allowed for services that exceed the deductible. No restrictions on payment rates or balance billing before services exceed the deductible.

Out-of-network providers: Paid partial Medicare rate for non-emergency services and full Medicare rate for emergency services after deductible is satisfied. Balance billing allowed for all non-emergency services. No balance billing allowed for emergency services after deductible satisfied.

Proposal Pros and Cons

Optimal Medicare Expansion (formerly called Medicare Prime)

Pros: Closes coverage gap. Stabilizes private insurance market. No individual mandate. Reduces price of private insurance for low-income and middle-income families. Does not require an increase in taxation. Allows families to pay more for higher intensity coverage. Reduces information asymmetry.

Cons: Does not minimize national costs per increased quality-adjusted life years.

Affordable Care Act (also known as Obamacare)

Pros: Decreases coverage gap. Reduces increase in premiums for pre-existing conditions including age and gender. Allows families to pay more for higher intensity coverage.

Cons: Creates dead-weight losses. Imposes costs on taxpayers. Does not close the coverage gap. Creates an unstable individual health insurance market. Increases price of private insurance for families that do not qualify for subsidies. Creates complex regulations. Does not minimize national costs per increased quality-adjusted life years.

Medicare-For-All (proposed by Bernie Sanders, Elizabeth Warren and others)

Pros: Closes coverage gap. No individual mandate. Eliminates premiums and out-of-pocket costs. Minimizes national costs per increased quality-adjusted life years.

Cons: Creates a massive increase in deadweight losses and costs borne by taxpayers. Crowds out private insurance. Causes a large decrease in quantity supplied of healthcare.

The Public Option (proposed by Pete Buttigieg, Michael Bloomberg and others)

Pros: Builds upon Obamacare. Further reduces coverage gap. Offers lower premium health insurance option.

Cons: Creates dead-weight losses. Imposes costs on taxpayers. Does not close the coverage gap. Creates an unstable individual health insurance market. Increases price of private insurance for families that do not qualify for subsidies. Creates complex regulations. Does not minimize national costs per increased quality-adjusted life years.

Hustlers, Handicaps and Health Insurance

I’ve been calling my idea for a better public health insurance system Medicare Prime. However, I should have Googled it first, since there is a company that has already trademarked that name. So, I’ll use Optimal Medicare Expansion (OME) from now on.

Part of the fun of being a masked vigilante is that I can insult self-important groups with reckless abandon. So, it’s high time the Lone Economist skewered that most solipsistic of associations, golfers. They’re crazy. I know this because I used to be the president of a local Rotary Club full of them. My job was to start every meeting with a few announcements and friendly banter. One of our members — I’ll call him “Steve” — had graduated from the cross-state rival of the university I graduated from. We often teased each other about the other’s alma mater.

On one occasion before I called the meeting to order, Steve let it drop that he had just returned from a pilgrimage/junket to the golfers’ holy land, Scotland. The other members were abuzz with admiration. So, I commenced the meeting with “I hear Steve is quite the golfer. Hey, Steve. What’s your handicap? I mean besides graduating from the University of __________”.

A sudden hush seized the congregation. This was what standup comedians call “misreading the room”. Joking about colleges was fine, but golf was sacrosanct!

What does golf have to do with health insurance? Here is a parable that tees up the relevant issues.

You wake up one morning with a fever and sore throat. Your mother, a registered nurse who knows that aspirin and rest is a cheap yet effective treatment, gives you an aspirin and orders you to bed. But the pain persists, and you don’t want to spend the day in bed. So, you appeal to your grandfather for help. He’s an irascible curmudgeon not afraid to opine on things about which he knows nothing. The old man hands you a bottle of Oxycodone, an opioid pain-killer, with a wink. He has an unlimited supply that he can pass along to you any time you need it.

Your grandfather’s remedy seems easy and costless, but you have this nagging feeling that something is not right. Aren’t opioids addictive? Could this be an example of a cure worse than the disease? Wouldn’t it be better to treat the cause of your problem (i.e. infection) rather than just the symptom (i.e. pain)?

This parable encapsulates many of the issues that fuel our health insurance policy debates. Private insurance markets suffer from adverse selection, the coverage gap that results from an information asymmetry between the insured and the insurer. Potential customers know more about their future healthcare needs than insurers. High-cost customers will pay relatively small premiums while low-cost customers will forego insurance. Insurers struggle to avoid bankruptcy while a lot of people are uninsured.

All the proposed remedies to adverse selection treat the symptom (i.e. coverage gap), but not the cause (i.e. information asymmetry). They concentrate on the weaknesses of our current public insurance system and ignore its strengths. Therefore, they decrease one problem while increasing another.

For example, Obamacare attempts to eliminate the coverage gap by subsidizing premiums for individual health insurance and mandating the purchase of insurance. But subsidies increase another problem caused by health insurance, moral hazard. They shift costs onto taxpayers and create an unstable insurance market. And the mandate (like your mother’s order to stay in bed) isn’t enforceable.

Proponents of Medicare-For-All and the Public Option demonstrate a surprising lack of knowledge about the U.S. healthcare system. (Guess who the irascible curmudgeon represents.) Medicare compensates healthcare providers for only part of the costs they incur caring for beneficiaries.  Private insurers make up the difference by paying providers more than the costs they incur treating the privately insured. Consequently, replacing private insurers with expanded Medicare coverage while paying providers Medicare rates, would amount to a large pay cut for providers. Many doctors would cease practicing medicine. Many hospitals would close their doors. And paying providers what they receive now from all payers would cost taxpayers much more than $32 trillion over ten years.

What we really need to do is adopt a policy that attacks the root cause of adverse selection, information asymmetry. We need an antibiotic, not a pain-killer. This is where golf hustlers and handicaps come into play.

A golf hustler is someone who pretends to be a much worse golfer than he really is. By doing this, he can lure the unsuspecting average golfer into making an unfavorable bet. Once the average golfer loses to enough hustlers, he might refuse to play people he doesn’t already know from fear of being hustled. This is golf’s version of adverse selection caused by information asymmetry.

Golfers discovered long ago that simply prohibiting hustling doesn’t work well.  The financial incentives are too great. Instead, golfers solved their hustler problem by creating a handicap registry. A handicap is basically a golfer’s average score above par with some adjustments. By making every golfer’s handicap public information, registries discourage hustling.

Like golf, health insurance is another forum for gambling. When a company sells you insurance, it is gambling that the premiums you pay are greater than the healthcare costs it will incur on your behalf. Like the average golfer, it is afraid of being hustled by potential customers who hide their pre-existing health conditions.

OME would solve this problem by providing people with an incentive to share their information while compensating them for their pre-existing conditions. The lower a household’s OME deductible, the more insurance coverage they have access to. Even for households with non-zero deductibles, the cost of private insurance and the cost of being treated by out-of-network providers will be lower if their OME deductible is lower.

If the size of the deductible is dependent on pre-existing conditions, then the household has an incentive to reveal information about its conditions. They want a lower deductible. This would be a signal to the private insurer that would guarantee that there is no information asymmetry and that their liability is limited. In effect, the OME deductible acts like a golf handicap.

Medicare already uses handicapping to some extent. For example, Medicare Part C, aka Medicare Advantage, purchases health insurance from HMO’s for Medicare beneficiaries. The premiums paid by Medicare to HMOs are risk-adjusted, meaning that a higher premium is paid for beneficiaries with pre-existing conditions.

Health insurance should be a guard against uncertainty, not compensation for chronic sickness or poverty.  The former is a service best produced by a private market, while the latter is wealth redistribution, a service reserved for governments.

Relying on private organizations to serve both purposes does not work well. OME would fulfill the government’s role of wealth redistribution while facilitating private industry’s role of providing health insurance.

There is No Such Thing as Universal Healthcare

Medicare For All is often described as being one way to achieve universal healthcare, a system in which all residents are assured access to healthcare. Such descriptions remind me of the tired but true adage that there is no such thing as a free lunch.

A while back, the Lone Economist conceded that the USA spends much more money on healthcare per capita than other large economies while suffering a higher death rate, but that this was an irrelevant statistic from an individual perspective (It’s the Perspective, Stupid). The posting was light on details and might have given the impression that I am dismissive of the shortcomings of the USA healthcare system. So, let me better explain my position.

The evidence that the USA spends much more on healthcare per capita than other countries is very well established. But the evidence that the USA death rate is much higher than other countries is less so. Facile international comparisons often draw unjustified inferences. Underlying cultural differences in countries might be driving the results and obscuring the true relationship between healthcare provision and death rates.

To prove my point, I compare the USA death rate to those of two other countries, Canada and Great Britain (GB). [Technically, GB is not a country, but I could not find death statistics for Northern Ireland.] Although the healthcare systems of these countries are different from that of the USA (i.e. they both have universal healthcare), they are English-speaking with similar economic and legal systems. Consequently, the potential for confounding, i.e. mistakenly measuring the effect of health insurance coverage on death rates due to unobserved reasons, is reduced, but not eliminated.

Figure 22.1 illustrates the number of deaths per 100,000 people in Canada, the USA, and GB in 2015.  At 846, the USA’s death rate is comfortably between those of Canada (i.e. 740) and GB’s (i.e. 988); however, there are two underlying factors that confound their comparability.

Figure 22.1 Raw and Adjusted Death Rates per 100,000 persons in 2015

Data Sources:

National Center for Health Statistics (https://www.cdc.gov/nchs/data_access/vitalstatsonline.htm), Mortality Multiple Cause Files, mort2015us.zip;

Office for National Statistics (https://www.ons.gov.uk/peoplepopulationandcommunity/birthsdeathsandmarriages/deaths/datasets/deathsregisteredinenglandandwalesseriesdrreferencetables), drtables15.xls;

(https://www.ons.gov.uk/peoplepopulationandcommunity/populationandmigration/populationestimates/datasets/populationestimatesforukenglandandwalesscotlandandnorthernireland)

National Records of Scotland (https://www.nrscotland.gov.uk/statistics-and-data/statistics/statistics-by-theme/vital-events/general-publications/vital-events-reference-tables/2015/section-5-deaths)

Office for National Statistics

Statistics Canada (https://www150.statcan.gc.ca/t1/tbl1/en/tv.action?pid=1310071001)

First, death rates rise dramatically with age and both the populations of Canada and GB are older on average than that of the USA.  Therefore, other things the same, the death rates of Canada and GB should be higher than the USA’s.  If we adjust the populations of Canada and GB so that they have the same age distribution as that of the USA, their death rates shrink considerably.  In fact, after this adjustment the USA has a slightly higher death rate than GB.

The second reason the raw death rates are not comparable is that death is counted equally whether the decedent is old or young.  I think most people would admit that learning of the death of anyone causes sorrow, but that learning of the death of a child is especially horrifying.  I also think these feelings are not entirely subjective.  The younger one is, the more years of potential life one has, making death at a young age a worse – and objectively measurable – phenomenon than death at an old age.

If we accept the premise that the death of a child is worse than the death of an adult, then we should weight deaths of children more than deaths of adults.  Differentially weighting the age groups results in the third set of death rates in Figure 22.1 labeled YPLL(100)-adjusted.  After this last adjustment, the death rate of the USA is 75% greater than Great Britain’s and more than double Canada’s.

This weighting factor is based on Years of Potential Life Lost (YPLL).  PYLL is normally calculated as 75 minus the age at death for those who die before age 75.  But 75 is an arbitrary number that is supposed to indicate the age at which death is no longer considered premature.  The average life expectancy in the USA, GB and Canada is greater than 75 – especially for people in their 60’s – so I used 100 instead of 75.

To understand why this adjustment makes such a large difference, see Figure 22.2.  This graph shows GB/USA and Canada/USA death rate ratios by age group in 2015.  If the distribution of death rates were the same for different age groups in each country, the bars in the graph would have approximately the same height.  In fact, the death rate ratios for both Canada and GB are approximately 70% to 80% in the youngest age groups, i.e. 0-14, and are especially low in the working-age groups, i.e. 15-64.  It is only in the retirement-age groups, i.e. 65 and older, that the death rate ratios are close to 100% or greater.  This illustrates that comparative death rates in Canada and GB vis-à-vis the USA are especially low in the younger age groups when years of potential life are at their highest.

Figure 22.2 GB/USA and Canada/USA Death Rate Ratios by Age Group, 2015

The different death rates by age group between countries are a result of many factors, not just the availability of health insurance.  For example, relatively permissive gun control laws in the USA explain some of the difference, but even after excluding all deaths due to external causes, such as gunshot wounds and suicides, the adjusted death rate for the USA is much larger than that of the other two countries.  Immigrants have relatively long life-expectancies and Canada has a 50% higher proportion of immigrants than the USA; however, Great Britain has the same proportion of immigrants as the USA, so the “immigrant effect” does not explain the very significant differences in adjusted national death rates.

Back to my main point, no country can afford to provide unlimited healthcare to everyone. There are not enough doctors, nurses, and pharmacists in existence or even potentially in existence to do this. Even countries with universal healthcare must limit the provision of healthcare in some way.

Figure 22.2 is particularly telling about the consequences of the different ways GB and the USA limit healthcare. GB limits healthcare by intensity of treatment while the USA limits it by age. Great Britain’s National Health Service does not pay for several expensive procedures and medications that the USA’s Medicare and private health insurers pay for, but a significant percentage of the USA population under age 65 have only the relatively stingy Medicaid or no health insurance at all. Consequently, GB has significantly lower death rates for people under age 65 and significantly higher death rates for people age 75 and older.

From a national perspective, there is an undeniable arithmetic logic to universal healthcare. It results in fewer years of potential life lost. From an individual perspective, however, the math is much different. People who would otherwise not be able to obtain private health insurance, a minority of the population under age 65, gain while the majority loses. The fact that the sum of the gains is far greater than the sum of the losses does not change this distributional reality.

For many cultural and historical reasons, getting people to look at our healthcare system from a national perspective is a heavier lift in the USA than it is in the rest of the world. Individualism is our defining national characteristic. Calling single-payer systems, like Medicare For All, “universal” implies that we can have a system that imposes no individual sacrifices. Unfortunately, there is no such system.

Free PIE for Everyone!

Readers of my blog are aware that I am not a big fan of Obamacare and Medicare For All (MFA). I have proposed an alternative to these two programs, Medicare Prime (MP). But the term “alternative” implies that this new proposal is opposed to Obamacare and MFA. The fact is that MP is a generalized version of MFA that borrows many features from Obamacare. MP bridges the gap between the current program, Obamacare, and its proposed replacement, MFA. If we understand this, we better understand the trade-offs we are proposing and the relative strengths and weaknesses of these programs.

The Lone Economist likes to elucidate through historical perspective. So, let me explain what I mean by “generalized version” using this technique. In 1905, a little known 26-year old clerk in the Swiss patent office published a peer-reviewed article, “On the Electrodynamics of Moving Bodies“, in the German-language Annals of Physics. It was only later that the author, Albert Einstein, realized his theory of moving bodies was a special case of a more general explanation of gravity. The original paper was then dubbed the special theory of relativity when a subsequent paper published in 1916 publicized his general theory of relativity. Neither paper was known outside the German-speaking scientific community until after the end of the First World War. The international fame these two papers eventually received publicized the concept that debates over opposing ideas were sometimes about special cases of the same general theory.

It was 1936 when economists, not of the Marxian persuasion, found themselves in existential crisis. Since the beginning of the Great Depression in 1929, large market-directed western economies had been in continuous recession. The prevailing theory for nearly a century predicted that such extended periods of high unemployment were not possible in such economies. Therefore, this theory was useless when formulating a policy that would end the slump.

In that year, a British economist, John M. Keynes, published a book that claimed the prevailing theory of how market-directed economies worked was only a special case of how they worked in general. According to Keynes, market-directed economies quickly regained full employment under certain conditions but not under others. In effect, there were times when an economy could get stuck in neutral and only a push by the national government could get it moving again. It was only after the publication of this book that the prevailing special case theory was even given a name, Classical. With a nod toward Einstein’s contribution to scientific discourse, Keynes titled his book, The General Theory of Employment, Interest and Money.

The General Theory of Public Insurance Expansion

So, standing on the shoulders of giants, the Lone Economist identified his own general theory. Public insurance expansion (PIE) is a policy of extending Medicare and Medicaid coverage to more people than currently qualify, i.e. people over age 65, the disabled, and the poor. Although Medicare currently charges a premium and shares some costs with its beneficiaries, its proposed expansion would do away with these features. So, we’re talking about expanding the breadth of coverage as well as the number of covered persons.

MFA is the special case of PIE where coverage is extended to everybody. But is that the optimal amount? Is there a point at which the benefits of additional PIE are outweighed by its costs?

To answer this question, we must acknowledge that PIE affects more than just patients. It also affects healthcare providers and taxpayers. By outlawing private insurance, we would be effectively nationalizing the healthcare industry. All doctors and hospitals would involuntarily and exclusively become government vendors. The Lone Economist is no lawyer, but I can’t imagine a set of circumstances where our federal judiciary would find that constitutional.

In my previous posts, I’ve described the general conditions necessary that would allow a less extreme version of PIE that just might survive judicial review. Individuals would be free to purchase private insurance or not. Private insurers would be free to sell insurance of whatever quantity and quality to whomever they wish or not. Providers would be free to join a public network with limitations on payments and quality or not.

For adverse selection to be eliminated and moral hazard contained while allowing these freedoms to exist, public insurance would need to be primary regardless of provider and non-exclusive for out-of-network providers. Most importantly, the degree of coverage would need to be dependent on household income and preexisting medical conditions, including age.

To see why MFA and MP are separate special cases of PIE, consider my suggestions for the parameter values that would determine the cost of MP. Using a simple model, I estimated that the combination of parameter values a = .5, b = 1.38, c = 4, and d = .35 would result in government expenditures approximately the same as they are currently. This would also result in more families qualifying for 100% coverage than currently qualify for Medicaid. Families that now qualify for a premium subsidy would benefit from lower premiums under MP.

If we consider the parameter value combination of a = 0, b = 0, c = ∞, and d = 1, we get MFA. Everyone would be included in the middle-income group and everyone’s MP deductible would be zero. There would be no distinction between an in-network provider and an out-of-network provider. All providers would be paid the full Medicare rate. Thus, all healthcare expenditures would be paid by the government.

This is how the Lone Economist summarizes these health insurance proposals. MFA is free PIE for everyone, while MP is free PIE for the poor and sick, no PIE for the rich and half-priced PIE for everyone in between. The latter is just not as catchy as the former, but a lot more realistic.

How Much Would Medicare Prime Cost?

In 2018, expenditures by Medicare and Medicaid combined grew 4.9%. To put these rates in perspective, U.S. gross domestic product (GDP) grew only 2.9% that same year. Medicare and Medicaid expenditures have grown faster than the U.S economy for a long time.

Needless to say, this situation is not sustainable indefinitely. Eventually the growth of Medicare and Medicaid will have to be constrained in some way. Most likely by imposing limits on coverage as single-payer countries do.

Proposals to indiscriminately expand Medicare without imposing limits on coverage, i.e. Medicare For All (MFA), test the bounds of credulity. The Urban Institute and Commonwealth Fund estimate the cost of MFA would be $3.2 trillion per year from 2020 to 2029. That is an eye-popping amount, but one that is almost certainly too low. According to that same study, even without MFA, government expenditures on healthcare in 2020 are expected to be $1.6 trillion. We’re talking about doubling something that is already growing unsustainably.

Proponents of MFA counter with the defense that higher taxes will be compensated by the elimination of premiums and out-of-pocket costs. In the aggregate this argument might seem valid, but it relies on an “apples-to-oranges” belief that a billion dollars of private expenditures on healthcare equal a billion dollars of tax revenues. They don’t.

This argument also ignores an even more onerous consequence of MFA than its total dollar cost, i.e., a large redistribution of healthcare. When robbing Peter to pay Paul, Peter might object.

My idea for an alternative to MFA, Medicare Prime (MP), would achieve many of the same goals without MFA’s ruinous costs. To demonstrate this, I created a model using data from the 2017 Medical Expenditure Panel Survey (MEPS). Make no mistake, this model would not pass muster with the Congressional Budget Office (CBO). It relies on several assumptions about healthcare demand elasticity and consumer preferences that are too numerous to describe in detail in a blog. Also, the MEPS is known to undermeasure total healthcare costs. But the model does give a good back-of-the-envelope estimate of MP’s likely cost compared to our current system.

A Model of Medicare Prime

In a previous post, I offered a simple formula for determining a household’s MP deductible. It relied on three parameters: a, b, and c. Parameter a determines the deductible’s size as a percentage of middle-income above the federal poverty level (FPL) while parameters b and c determine the lower and upper bounds of middle-incomes. A fourth parameter, d, determines the fraction of the Medicare rate that would be paid to out-of-network providers.

When b = 1.38 and c = 4, the middle-income range is the same as that for households eligible for ACA premium subsidies. So, for comparison sake, the only two parameter values we need to explore is for a and d.

From a budgetary perspective, the interaction of these two parameters determine how generous we can afford to be with middle-income households versus out-of-network providers. The smaller the deductible, i.e. parameter a, the less we can afford to pay out-of-network providers, i.e. parameter d.

From an incentive perspective, the more we encourage households to use less expensive in-network providers, i.e. set a low value for parameter a, the more we need to encourage providers to choose to be in-network, i.e. set a low value for parameter d. Therefore, the values of feasible values for a and d are directly related or positively correlated.

According to the MEPS in 2017, Medicaid expenditures for people under age 65 were $195 billion. This is likely an underestimate, but since this is a comparative study, that shouldn’t matter much. ACA premium subsidies were approximately $45 billion that year. Total healthcare expenditures by the government for the non-Medicare population, therefore, were $240 billion in 2017.

Figure 20.1 illustrates the government healthcare expenditures under MP for the range of values from zero to 1 for both parameters a and d. For a given value of a, the amount of government expenditures would increase as we increase the value of parameter d. For a given value of parameter d, the amount of government expenditures would increase as we decrease the value of parameter a.

Figure 20.1 Annual Government Expenditures and Values for Parameters a and d

The horizontal dotted line indicates the current level of government expenditures for healthcare for the under age 65 population. The points where it intersects with the different values of parameter a indicate the budget neutral combinations of a and d. These are illustrated in Figure 20.2.

Figure 20.2 Budget Neutral Combinations of Parameters a and d

A policy that greatly incentivized low and middle-income households to use only in-network providers would be represented by the bottom point of the budget-neutral curve, where a = .25 and d = .03. At the other extreme, a policy that maximized low and middle-income households’ choices of providers would be represented by the top point of the curve, a = 1.0 and d = .85.

The objective of this exercise was to demonstrate that MP would not necessarily require a large increase in government expenditures and taxation the way MFA does. The optimal point along this curve would depend on factors such as how much low and middle-income households value choice of provider over out-of-pocket costs and premiums and the number of providers willing to be in-network. I made some reasonable guesses, but that is all they are, guesses. Additional research is needed to discover better informed policy options.

The Lone Economist Does the Urban Institute Study

I was all set to discuss the estimated cost of Medicare Prime (MP), my alternative proposal that would achieve many of the same goals as Medicare For All (MFA), but at a fraction of the cost to taxpayers. Then I looked at the detailed report of the $32 trillion 10-year cost estimate of MFA by the Urban Institute and Commonwealth Fund that has received so much press coverage lately.

Before I give my unsparing assessment, let me explain the predicament I believe the authors of this study found themselves in. The Urban Institute and Commonwealth Fund are associated with progressive causes and consequently also the Democratic Party. Two major presidential candidates for the Democratic nomination publicly proposed MFA, a policy so radical that it is difficult for people who know a lot about the healthcare industry and economics to take seriously.  But unlike me, a masked vigilante with a persecution complex, they can’t publicly point a finger at these candidates and burst out laughing. They have revenue streams to maintain, future employment opportunities to protect.   

So how does one convey to an impassioned base and credulous media just how over-the-top this proposal is without committing career suicide? Their strategy appears to have been to produce a comparative study of MFA and several alternative proposals rather than an unbiased estimate of the cost of MFA. Without the constraint of statistical unbiasedness, they were able to make ridiculously unrealistic assumptions about the cost savings of MFA. Yet, even with these assumptions, they still predicted a gigantic increase in federal expenditures.  It’s like giving a poor student an easy test and when they still fail, there is little doubt about the fairness of the process.

If you believe this to be a negative assessment, then you are mistaken. I am honestly very favorably impressed with this report. It is a thorough and transparent analysis of the relative costs and benefits of these proposals. To their credit, the authors chose the least bad of several bad options.

If the media interpreted their findings more literally than intended, that is not their fault. Henri Theil famously said, “Models are to be used, not believed”. The usefulness of their model is that it provides estimates of eight different health insurance reform proposals that rely on the same data and set of explicit assumptions. Consequently, the estimated costs are good relative measures, even if they are lousy absolute ones.

So, what evidence do I have that this was their strategy? It’s not from any direct communication with the authors. If I am right, they couldn’t give an honest answer to a direct question. I did correspond with the lead author, but that was about some technical issues concerning the data they used.

I’m basing my theory on the truly indefensible assumptions the authors adopt and on a statement the lead author gave to a reporter, “We felt we were making pretty optimistic, aggressive assumptions”. If you were trying for an unbiased estimate, that is not how you would do it.

But strange as it might sound, if the authors had made fewer outlandish assumptions, their cost estimate would have been even more biased. Let me explain.

What is “cost”?

You might think the answer to this question is obvious, but it isn’t. I’ll explain by way of parable because it succinctly conveys a complicated concept and gives me another opportunity to insult politicians.

A low-level politician who aspires for higher office drives a car for 20 years until it simply doesn’t run anymore. The most a junk yard will pay for it is $500, so he parks it in front of his house with a for-sale sign that says “$20,000”. After several weeks with no offers, he receives a notice from the city ordering him to remove the unsightly piece of junk from his front yard. Seeing an opportunity, he gives the car to a homeless person. The next day a headline appears in the newspaper “Politician Gives Homeless Person $20,000 Car!”

If you find this story absurd, then you know how I feel about healthcare accounting practices (and some newspaper reporters). Every year, almost all hospitals and many physicians essentially do what the fictional politician in my story does. They provide uncompensated healthcare services to poor people because they are professionally and often legally required to do so and then wildly exaggerate the dollar value of this care.

As I have detailed in a previous post, healthcare costs are initially reported as “undiscounted charges”. The average hospital’s markup from costs to charges is over three hundred percent. Some hospitals markup over 1,000 percent. Neither private nor public insurance providers pay the undiscounted charges, but uninsured patients are supposed to even though they rarely can. Nevertheless, hospitals that spend, for example, $500,000 treating indigent patients often claim that they provided charitable care worth several million dollars.

So, what was the cost of the car given to the homeless person? The $500 the junkyard offered to pay for it or the $20,000 the politician was asking for it? I think it is obvious that the $500 figure is more accurate.

Accounting vs. Economics

Economics is the science of how societies use scarce resources to produce valuable goods and services and distribute them among different people. Accounting is the science of measuring, processing, and communicating economic data. Although the two are intricately linked, economics is mainly concerned with theories while accounting is firmly rooted in the real world.

Consequently, “cost” can mean one thing to an economist and something different to an accountant. To an economist, “cost” is the foregone benefit of consuming a good or service. We call it “opportunity cost”. To an accountant, “cost” is the number of dollars that change hands in a transaction.

Normally the difference between these two definitions is small. But even when it isn’t, it’s considered unavoidable. Economists must use the data they have, not the data they wish they had, is the old saying.

I contend that this bromide should not and need not be followed when debating healthcare policy. Undiscounted charges are a poor proxy for the opportunity cost of healthcare. Almost nobody pays them. Why we continue to use them for measuring uncompensated healthcare costs eludes me.

The Urban Institute Assumptions

The dichotomy between accounting and economics plays a key role in the Urban Institute’s choice of assumptions. I’m not going to nitpick every assumption they made, but there are two, in particular, that deserve some discussion.

The study assumes that MFA can be achieved by lowering the price of healthcare and increasing the quantity supplied of healthcare at the same time. Figure 19.1 illustrates these two assumptions. The supply curve would have to shift to the right, leading to a lower equilibrium price and a higher equilibrium quantity.

Figure 19.1 Increase in Supply Leads to Higher Quantity and Lower Price

Specifically, the authors assume that MFA would pay all physicians the Medicare rate for physician services and the Medicare rate plus 15% for all hospital services. To put this into perspective, remember that private insurers pay approximately 50% more than Medicare for a physician office visit and 100% more for a hospital stay. So, the authors assume that physicians will accept a 33% cut in the average price of office visits by patients under age 65 and hospitals will accept a 43% cut in the average price of hospital stays from the same patients and their reaction will be to increase the number of patients they treat by more than 20%.

Separately, both assumptions are absurd on their face. Yet, had the authors not assumed supply would respond this way, their estimate would have been even less believable.

Figure 19.2 illustrates what would happen if we didn’t assume MFA would cause an increase in the supply of healthcare. By imposing a price ceiling well below the equilibrium price, the quantity supplied would decrease while the quantity demanded would increase. The result would be excess demand, i.e. a shortage.

Figure 19.2 Price Ceiling Causes Excess Demand

The combination of a decrease in price and a decrease in quantity supplied would result in a large decrease in the number of dollars spent on healthcare. Therefore, using the accounting definition of cost, MFA would decrease the total cost of healthcare and the increase in federal expenditures would be much less than $32 trillion.

The opportunity cost of MFA, a much more accurate measure of the economic cost, would be far greater than 32$ trillion, but that fact would be lost in the arcane definitions of “cost”. So, rather than make their underestimate even greater than it already was, the authors chose the lesser of two evils.

So, let’s see. I’ve insulted politicians, hospital accountants and the media, but hopefully not the authors of the Urban Institute study. Not bad for one post. Next time I’ll talk about the relative cost of Medicare Prime.

The Medicare Prime Deductible

To fully appreciate the costs and benefits of Medicare Prime (MP), we need to explore its possible budgetary and distributional effects. There are several factors to be considered. One is how much the deductible would vary with income and other household characteristics.

There are an endless number of possible formulas to determine a household’s MP deductible. How do we narrow them down to a few reasonable options? The objective of the MP deductible is to close the coverage gap for the poor and the chronically unhealthy at a minimum cost to taxpayers. Therefore, one common feature is that the deductible must be zero for households too poor to purchase private insurance and it must increase with household income.

Healthcare expenditures are highly correlated with age. In fact, age is often used by insurers as an easily observed indicator of likely healthcare costs, a.k.a. preexisting conditions. That is the reason Medicare was created in the 1960’s. Without it, elderly Americans would find it nearly impossible to obtain affordable health insurance. Additionally, the Affordable Care Act (ACA) restricts the amount an insurer can increase premiums with age. So, another possible feature of the deductible formula could be that the deductible would decrease with age. 

The MP deductible could even be directly determined by the existence of diagnoses of chronic medical conditions, like breast cancer or heart disease. The more preexisting conditions a person has, the smaller his deductible. By risk-adjusting the MP deductible, enrollees would have an incentive to divulge their preexisting health problems, thus eliminating the informational asymmetry that is the root cause of adverse selection.

To investigate MP’s feasibility relative to Medicare For All (MFA) and The Public Option (TPO), let’s start with only considering household income. Our goal is to identify three income levels: low — for household’s that need free [There’s that word again!] health insurance; middle — for households that need some government assistance in obtaining private health insurance; and high — for households that do not need any government assistance. Using Occam’s Razor as a guide, I start with the simplest formula I can think of:

Parameter a is the rate at which the deductible grows as household income increases — a parameter that should lie somewhere between 0 and 1.

Parameter b is the fraction or multiple of the Federal Poverty Level (FPL) that determines the upper limit of income where the deductible is zero, in other words, low-income households. In today’s all-or-nothing public insurance system, this is analogous to qualifying for Medicaid.

Parameter c is the multiple of the FPL that determines the upper limit of middle-income households. Above this income level, households would not benefit from MP.

The ACA sought to establish 138% of the FPL as the income upper limit for Medicaid qualification, therefore, let’s set b to 1.38. The ACA also established the income upper limit for premium subsidies at 400% of the FPL. That would translate to a value of c = 4.

What would be a reasonable value for parameter a? The lower its value the greater the benefit to middle-income households and the higher the cost to taxpayers. Figure 18.1 illustrates the relationship between the MP deductible and income for a one-person household in 2017 for three different values of parameter a. The horizontal intercept, the income level that separated low-income individuals from middle-income individuals, was $16,643. At an income of $30,000, the deductible would have been $3,339 when parameter a = 0.25. The deductible would have been $6,679 when a = 0.5 and $13,357 when a = 1.0. Regardless of the value of parameter a, the value of the deductible would be irrelevant for incomes greater than $48,240. Those individuals would not benefit from MP.

Figure 18.1 Medicare Prime Deductible Lines

What is the Benefit for Middle-Income Households?

The benefit of MP for low-income households is easy to see. If they use only in-network providers, all their healthcare expenses are paid for by MP. Even if they do use the occasional out-of-network provider, their burden is decreased due to the policy of partial payments to such providers.

The harder question to answer succinctly concerns the benefit for middle-income households. These households must satisfy their deductible before MP pays anything. As the examples demonstrated above, the deductible can be several thousand dollars even for an individual who earns only $30,000 a year. And the MP deductible is not even the maximum out-of-pocket expenditures the beneficiary must pay. It is the maximum expenditures Medicare would pay (if it covered all expenditures) before it pays anything. The middle-income beneficiary and her insurer, if she has one, will likely pay more than that.

An Illustrative Example

To understand what I’m getting at, let’s consider an appendectomy. This procedure is typically performed at a hospital by a surgeon. Medicare has two different systems that pay for this — one for the hospital and another for the surgeon.

Medicare uses the Inpatient Prospective Payment System (IPPS) to pay hospitals. The Diagnosis-Related Group (DRG) code for “appendectomy w/o complications” is 343. Since the hospital’s payment depends on the DRG code as well as the location and type of hospital, I’ll specify the Southeast Alabama Medical Center because it is the first hospital in the U.S. … by Medicare Provider Number (i.e. 010001). In 2017 Medicare paid this hospital exactly $5,716.01 for each hospital stay with this DRG. (Source: 2017 Medicare Pricer)

Surgeons are paid separately from hospitals. Medicare uses the Resource-Based Relative Value System (RBRVS) for surgeon payments. The Current Procedural Terminology (CPT) code for an appendectomy is 44950. For this procedure, Medicare pays the surgeon exactly $667.17. This does not include any office visits related to the procedure. (Source: CMS Physician Fee Schedule Search)

The total Medicare payment would be $6,383.18. While the Medicare payment systems are publicly known, a provider’s undiscounted charges for performing an appendectomy and any discounts negotiated with private insurers are not. But based on national averages, we can estimate the undiscounted charges would have been $26,268.23 and the price paid by a typical private insurer would have been $12,004.58.

If an individual in the middle-income group had needed an appendectomy, what direct benefit would MP have provided for them? If her deductible was over $6,383.18 and she had no other healthcare expenses that year, the answer would be zero. If she had no private insurance, she would have owed the undiscounted charges, $26,268.23. If she had private insurance, she and her insurer would have shared the $12,004.58 in obligations.

Direct benefits would only accrue to individuals with deductibles less than $6,383.18. Figure 18.2 illustrates the beneficiary liabilities at three different deductible levels: $1,000; $5,000; and $10,000. Even a household with a MP deductible as small as $1,000 would still be liable for over $1,000 in expenses if it had private insurance and several thousands of dollars if it didn’t.

Figure 18.2 Patient Expenses by Deductible Level

So, the direct benefit of MP to middle-income households would be very limited. The tangible benefit of MP to middle-income households would be mostly indirect in the form of lower private insurance premiums. In today’s market, the private insurer is primary. For any single customer, its liability is virtually unlimited. The MP deductible would truncate the private insurer’s liability, allowing it to charge a lower premium.

For example, healthcare expenditures by the 4,346 middle-income households that responded to the 2017 Medical Expenditure Panel Survey would have ranged from zero to $352,983 had they paid Medicare rates. 23% (i.e. 1,008) of these households would have paid more than $5,000. 13% (i.e. 563) would have paid more than $10,000. The losses suffered by private insurers of these households would have been greatly curtailed if MP had been in operation.

Next time I’ll explore the possible budgetary impact of MP.

It’s the Perspective, Stupid

Medicare Prime (MP) is my proposal for a health insurance system that would avoid many of the problems created by our current one. One of its proposed features is the classification of healthcare providers into two camps: in-network and out-of-network. The benefits of this bifurcation of providers deserve further explanation.

As explained in a previous post, providers charge patients the same amount of money for the same type of service regardless of the type of insurance they have or their income level. Only after the bill has been calculated are these charges discounted according to the patient’s insurance status. Public insurers, such as Medicare and Medicaid, get the largest discounts (61% and 67% on averagea, respectively), while private insurers receive only a 42% discount on averagea. Uninsured patients officially get no discount at all, but often default on their obligations through personal bankruptcy and effectively get a 47% discount on averagea.

Under MP, in-network providers would be paid the Medicare rate for services rendered to patients that have surpassed their MP deductibles.  In exchange, these providers agree not to charge patients any additional money for services paid by MP. In other words, they will not be allowed to balance bill patients who have satisfied their deductible.

Out-of-network providers, however, are a different matter. They will not be a party to any contract with the government and therefore will be free to balance bill their patients. Given this lack of a quid pro quo, one might believe that MP should not pay anything for services from out-of-network providers. But I would disagree with this sentiment. There are several good reasons that out-of-network providers should be paid a partial Medicare payment despite their freedom to balance bill patients.

The Case for a Two-Tier Healthcare System

Creation of a two-tier healthcare system might seem contrary to egalitarian ideals, but such a system effectively already exists in the US and there are several reasons why this makes economic sense. To see how this might be correct, we need to consider the uniqueness of the American healthcare system.

But first, a joke.

Two balloonists become lost while sailing through a wind-swept fog. Seeing a pedestrian below they call out, “where are we?”. The man below yells back, “you’re in a balloon”. One balloonist says to the other, “he must be a mathematical economist”. “How can you tell?” asks the other. To which the first balloonist replies, “his answer was perfectly accurate and completely irrelevant”.

“What does this joke have to do with our healthcare system?” you might wonder. One of the advantages of being a masked vigilante is the freedom to insult whole professions with impunity, even my own. It’s the new year and I haven’t insulted anybody in quite a while.

But the main point is to highlight a fact frequently cited by politicians and economists: the US spends much more money per capita on healthcare than any other country while suffering a high death rate. While mathematically correct, the insinuation that this is somehow a negative feature of our healthcare system is more a product of subjective perspective than some careful objective analysis. Like the pedestrian’s answer, it is perfectly accurate and completely irrelevant.

Public health is the science of protecting and improving the health of people and their communities. Its perspective is exclusively global as opposed to individual. So, when considering whether to approve payment for a new cancer drug, for example, a typical public health expert would compare the number of lives saved for each dollar spent to that of other cancer drugs and even treatments for other diseases.

Suppose the new cancer drug saves one year of life for every hundred thousand dollars spent. Is that too much to spend? The answer to that question depends more on one’s perspective than it does on the drug’s relative cost and effectiveness. Anti-biotics, for instance, are very effective fighting deadly infections and very cheap. They might save 1,000 life-years for every hundred thousand dollars spent. From a global perspective, it makes no sense to spend additional money on the new cancer drug as long as spending that same additional money on anti-biotics saves more life-years.

In economic terms, we would say that any expenditure on the new cancer drug is past its point of diminishing marginal returns. From a global perspective, expenditure on the new cancer drug would cost more lives than it saved. This is why denial of coverage for expensive drugs by single-payer healthcare systems is quite common. Since these systems rely exclusively on public money, they take an exclusively global perspective, the same perspective taken by most public health experts.

If you ever completed a high-school course on American literature, you should be well-acquainted with the characteristic that practically defines the American psyche, individualism. It should come as no surprise then that the US rejects the global perspective of public health more than any other wealthy country.

From an individual perspective, that hundred-thousand-dollar expenditure on the new cancer drug makes perfect sense. If you have that much money to spend or more likely, that much insurance coverage, you would spend it without hesitation. The fact that you could save more lives if you would only sacrifice yours is not persuasive to most Americans.

Suppose you were a beneficent ruler with absolute power. If an advisor proposed a policy that would cost two lives for every three lives it saved, would you implement it? If you took a global perspective and you valued all human lives equally, you probably would. How could you not accept a policy that lowered the death rate by 33%? That would be a great policy — unless you are one of the people sacrificed. Then it wouldn’t be so appealing. 

So, from a global perspective the fact that the US spends more money per capita on healthcare than any other country, while suffering one of the highest death rates is clearly a bad result. But from an individual perspective, it is indicative of the ability of many Americans to marshal vast resources to fight deadly diseases. The fact that we could save more lives while spending less money if we didn’t care exactly whose lives we saved is irrelevant.

Single-payer systems don’t allow different levels of healthcare intensity. It’s one-size-fits-all. There are not enough resources, i.e. doctors, hospitals, drugs, etc., to treat everyone at the same high-intensity level that many Americans can afford today. Any politician or economist who implies otherwise is either misinformed or lying.

The two-tier system of MP would provide a minimally-acceptable intensity of healthcare for those receiving taxpayer-financed health insurance while allowing those households that can afford it to purchase more intensive healthcare with their own money.

The Case for MP Payments to Out-of-Network Providers

To fully appreciate why out-of-network providers should be paid a partial MP payment, think back to why the ACA exchange market was created. The all-or-nothing nature of public insurance in the US forces private insurance premiums upward to cover the capital costs of treating publicly insured patients. Before the ACA, these high premiums did not discriminate between wealthy households and households that almost qualified for Medicaid. The elevated premiums were especially bad for people with pre-existing medical conditions.

The ACA tackles this problem by subsidizing the private insurance premiums of middle-income households. As we illustrated in our last post, subsidizing premiums in this way forces the equilibrium premium upward, partially off-setting the benefits of the subsidies and even making the situation worse for households with incomes greater than 400% of the FPL.

The ACA also restricts private insurers’ ability to charge higher premiums to people with pre-existing conditions and mandates that all citizens obtain health insurance. In the political debates that preceded its passage, the individual mandate was advertised as a fair quid pro quo for the premium restrictions imposed on insurers. That justification wasn’t false, but it wasn’t the main reason for the mandate either. The main reason was to stabilize the health insurance market. Without it, a shock to the system, in the form of an economic recession for example, would lead to its collapse.

MP would use a different tack to benefit middle-income households. Although the deductibles for middle-income households would not be zero, they would be much smaller than the deductibles for high-income households. When the patient uses an in-network provider, she and her private insurer would need to only cover the MP deductible. That would be a clear benefit to both the patient and her private insurer, if she had one.

But even when the patient uses an out-of-network provider, she would still benefit because a partial MP payment to the provider would lower her and her private insurer’s liability. Lower liability for the private insurer would lead to lower premiums for the patient.

For services provided by in-network providers, there would be a quid pro quo between MP and those same providers: full Medicare payments in exchange for no balance billing. For services provided by out-of-network providers, the quid pro quo would be between MP and private insurers: partial Medicare payments in exchange for not charging higher premiums to people with pre-existing medical conditions.

Unlike the ACA, under MP there would be no need for an individual mandate. As the primary insurer, MP protects both patient and private insurer. Rather than setup an inherently unstable health insurance market (like the ACA), MP would stabilize it.

In my next post, I’ll discuss how much MP would cost relative to our current system.

Footnotes

aSource: The Medical Expenditure Panel Survey, 2017