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.


aSource: The Medical Expenditure Panel Survey, 2017

How to Lower Health Insurance Premiums

Continuing our outline of Medicare Prime (MP), an “optimal” public health insurance system based on economic principles and data-driven research, we explore one of its benefits for middle-income households, i.e. lower premiums.

Why Insurance Premiums Are So High

In an earlier post I explained how Medicare and Medicaid (M&M) affect the private insurance market. M&M competes with private insurers for healthcare providers, e.g. hospitals and doctors. Using its superior market power, M&M pays only the incremental operational costs of treating its enrollees. This forces providers to charge private insurers much higher rates than they otherwise would in order to cover their capital costs. On average, private insurers pay twice as much as M&M for the same services, excluding prescribed drugs.  These high rates are then passed along to households in the form of higher health insurance premiums.

Figure 16.1 illustrates this phenomenon. The supply curve for private insurance shifts upward. This is a decrease in supply. The result is an increase in the equilibrium price at a lower equilibrium quantity. Or in other words, public insurance partially crowds out private insurance and is one of the reasons the price of private insurance is so high.

Figure 16.1 The Market for Private Insurance

The Affordable Care Act (ACA) subsidies also affect premiums, but in a different way. Instead of decreasing the supply of private insurance, they increase the demand for it. Figure 16.2 shows the demand curve shifting upward by the amount of the subsidy. This causes the price (i.e. premium) to increase from P1 to P2. Households that qualify for the subsidy pay P2 minus the subsidy and increase their quantity from Q1 to Q2. Households that do not qualify for the subsidy pay P2 and decrease their quantity to Q3.  This is another example of crowding out and another reason why private insurance premiums are so high for households that make too much money to qualify for a premium subsidy.

Figure 16.2 Effect of ACA Subsidies on Private Insurance Market

Who Would Benefit from Medicare Prime?

In a previous post I stressed that for the rich and the poor, MP would be little different from the ACA. Households below 138% of the Federal Poverty Level (FPL) would still have 100% of their healthcare expenses covered by public insurance if they used only in-network providers. Affluent households would not directly benefit from this system. They would still need to pay their healthcare expenses through private insurance or out-of-pocket. Nothing new there.

The main difference in insurance coverage would be for households that fall in between, i.e. the middle-income households. These households earn too much money to have first-dollar coverage (i.e. zero deductibles) from MP. But that doesn’t mean they would not benefit from it.

A non-zero but relatively small MP deductible would mean that any potential private insurer would incur lower risk than would otherwise exist and would result in a lower private insurance premium. For many middle-income households, MP would be, in effect, a high-deductible, catastrophic coverage plan. But since MP is primary, that coverage protects both the household and its private insurer.

In the next post we will attempt to quantify the benefits of MP.

Medicare Prime

Our quest for an optimal health insurance system is starting to come into focus. It would have several features in common with Medicare For All (MFA), Obamacare, and The Public Option (TPO), but with a few critical differences.

Like MFA, it would be financed entirely through taxation, not premiums. It would recognize a minimally-acceptable level of healthcare as a human right. Involuntary exposure to large uninsured healthcare expenditures would be a thing of the past. Like Obamacare, it would recognize and even promote the vital contribution private insurance makes to financial security. And like TPO, it would give middle-income households a wider array of affordable health insurance choices.

What it would not do is cause unprecedented levels of moral hazard (like MFA), perpetual adverse selection (like Obamacare), or the crowding out of private insurance (like TPO). It wouldn’t rely on an individual mandate either. Or necessarily cost more in taxes than the current system.

I’ve referred to this optimal health insurance system as a free public option, but as an economist, my heart skips a beat every time I see the word “free” and it’s not really a public option anyway. The option is whether to buy private insurance to go along with the public insurance every household would be entitled to.

So, I need to come up with a better name. In my last post I explained that for this system to work, public insurance and private insurance need to change from substitutes into complements and that this could only be achieved by making public insurance primary and allowing some providers to balance bill.

By the title of this posting you might have guessed that the name I have selected is Medicare Prime. It would be a Federal program that uses Medicare payment levels to replace Medicaid, the Children’s Health Insurance Program (CHIP), and Obamacare, but would not replace Medicare Parts A, B, C and D. It would only affect people who don’t already qualify for traditional Medicare. In other words, people still in the prime of their lives. And more to the point, it would be primary. Hence the name.

Can Public and Private Health Insurance be Complimentary?

Two substitute goods each satisfy the same need while not enhancing the benefit of consuming the other. For example, Coca-Cola and Pepsi both satisfy the need for a cola-flavored soft drink. Most people either consume one or the other. Few people like to combine the two. And because they are substitutes, their suppliers are natural competitors.

In contrast, complements are normally consumed together — think milk and cereal or bread and mayonnaise. Consuming one enhances the benefit of consuming the other. The suppliers of complements cooperate rather than compete.

Under current government policy, public and private insurance are substitutes. Consequently, they compete. Competition between private insurers is beneficial to consumers, but competition between public and private insurers is not. It has contributed to high private insurance premiums and the coverage gap.

But I contend that this harmful competition is a result of bad government policies rather than the natural order of things. Public and private insurance could be complements if we only chose the right policies.

The Importance of Primacy

Some people are covered by more than one health insurer.  As profit-maximizing organizations, private insurers attempt to limit their financial liability by stipulating that all other insurers are primary.  In other words, only after coverage by the primary insurer is exhausted is the secondary insurer liable for any healthcare expenses.

When an individual is covered by two different private insurers, it is a matter for a court of law to determine which insurer is primary. Not so, however, when a patient is insured by a private insurer and a public insurer. Federal law clearly establishes that the private insurer is primary in such cases, except in rare instances. Consequently, if an individual is enrolled in Medicare because she is over age 65 and enrolled in a private insurance plan through her employer, the private plan is liable for almost all her medical bills. She has little incentive to pay a premium for the private insurance coverage and the private insurer has little market power to charge a premium high enough to cover its costs.

The Balance Billing Ban

The government prohibits balance billing by providers of healthcare to Medicare and Medicaid enrollees. When a healthcare provider accepts payment from Medicare or Medicaid, it must agree to forego the collection of any additional fees from the patient except normal cost-sharing like deductibles and copays. There is a partial exception to this prohibition in certain cases, but in general it holds. This guarantees that public insurance enrollees have access to healthcare, regardless of income.

Like insurance primacy, Medicare and Medicaid are following common health insurance industry practice by not allowing balance billing.  The typical managed care organization (MCO) contracts with a subset of available providers to form a network. These “in-network” providers agree to accept lower payments from the MCO with no balance billing in exchange for an increased volume of patients. They are also subject to practice constraints imposed by the MCO.

Since the MCO has no contract with “out-of-network” providers, it cannot stop them from balance billing MCO enrollees who choose to be treated by them. This is a strong incentive for enrollees to choose only in-network providers. Enrollees are further disincentivized from using out-of-network providers by bearing a greater share of costs.

They’re Substitutes Because They’re Not Substitutable … Huh?

Although private insurance primacy is a government policy meant to prevent the substitution of taxpayer funds for private funds, ironically this makes private and public insurance substitutes. It is commercially disadvantageous to offer private health insurance to individuals eligible for public insurance under the condition of private insurance primacy. The only exceptions are if the insurance is procured through a small employer (i.e. less than 20 employees) or for coverage of expenditures Medicare does not cover (i.e. Medi-gap insurance).

Also, the balance billing ban prevents public and private insurance from being complements which I contend is their preferred state. There is a reason that almost no one over the age of 65 has private insurance. And there won’t be any private insurance for people under 65 if either Medicare For All (MFA) or The Public Option (TPO) are adopted.

The way to make private and public insurance complementary is to stipulate that public insurance is primary and to allow balance billing by providers not in the public insurance network. For those long-acquainted with the health insurance industry, this first part will sound heretical while the second will sound somewhat familiar, if out of place.

A Variable Deductible

If public insurance was free and primary, wouldn’t providers always be paid by the government thus crowding out private insurance and forcing taxpayers to bear the full cost of the healthcare system, just like MFA?

Not if a household’s public insurance entitlement decreased as household income increased. For example, the ACA established a threshold for Medicaid eligibility at 138% of the Federal Poverty Level (FPL). This threshold applies only to those states that expanded Medicaid, however. For the other states, the threshold for Medicaid eligibility is somewhat lower. The free public option’s deductible could be set to zero for all families below this threshold and it would increase with household income above that initial level.

The result would be that the same households that qualified for Medicaid in the current system would have 100% public insurance coverage in the new system. There would be very little difference besides having a consistent threshold across the country instead of the highly variable and arbitrary one we have now.

In contrast, high-income households would have very high deductibles, perhaps a hundred thousand dollars or more. They would almost never be able to rely on public insurance to pay part of their healthcare bills. Instead, they would need to cover all their healthcare expenditures via private insurance or out-of-pocket. This too is little different from the current situation.

In-Network Providers

Wouldn’t balance billing allow providers to bankrupt patients without private insurance?

Not if the free public option was operated like an MCO.  Providers that are willing to accept the relatively low payment levels of the free public option in full (i.e. without balance billing) in exchange for a steady volume of patients would be in-network. Out-of-network providers would be paid only a fraction of the rate paid to in-network providers but would be allowed to balance bill.  

If you believe that this would create a two-tier healthcare system, one for the poor and another for the rest, then you would be right, but a little late. Such a system already exists.  It is an underappreciated fact by those not intimately familiar with the American healthcare system that there is a wide gamut of healthcare providers.

For example, physicians range from foreign-trained immigrants who barely scrape by to Ivy League graduates who cater only to the upper class. Almost all the high-end physicians avoid treating Medicaid patients and many of them avoid treating Medicare patients as well. There is no trade off to accepting low public insurance payments the way that there is for in-network MCO providers. This has led to an appalling lack of access to physicians for Medicaid enrollees in some states.

Unlike high-end physicians, high-end hospitals cannot afford to reject Medicaid enrollees entirely, but many actively minimize their exposure to this population, nevertheless. I’ve consulted on a Certificate of Need application where a for-profit hospital intentionally chose a location because it had very few Medicaid enrollees nearby.

This two-tier system is a major reason why I think MFA and TPO would be so disastrous for the Democratic Party if either were adopted. Single-payer systems are one-size-fits-all.  There is no room for variation in quality or intensity. Many people who were satisfied with their private health insurance will be apoplectic when they realize their healthcare choices have been so curtailed. Many of the high-end providers would simply exit the market. The resulting shortages would be met with outrage.

Balance billing by out-of-network providers would allow middle-income households to purchase relatively inexpensive private insurance that would afford them a choice from a wider array of providers, both in-network and out-of-network.

More about this next time.

How to Close the Coverage Gap

I’ve written several posts explaining the twin problems of health insurance: adverse selection and moral hazard.  Rather than solve these twin problems, the two main health insurance proposals, Medicare For All (MFA) and The Public Option (TPO), would exacerbate them.

MFA would solve adverse selection by providing health insurance to everyone without premiums or out-of-pocket expenditures, but would cause run away moral hazard, e.g. long wait times, wasted resources on ineffective treatments, high taxes, etc.). It would also crowd out private insurance, thus eliminating one’s choice between a relatively more expensive provider and a less expensive one.

With its reliance on cost-sharing, TPO would cause less moral hazard, but because it would charge a premium, there would still be adverse selection, i.e. the coverage gap and the need for an individual mandate. And like MFA, it would crowd out private insurance, albeit more slowly.

So how do we close the coverage gap (i.e. adverse selection) without wasting resources (i.e. moral hazard) and without eliminating the private insurance market (i.e. crowding out)?

In brief, these three goals can be achieved respectively by: (1) offering a “free” public option, (2) providing it in the form of a managed care organization (MCO), and (3) making private and public insurance complements rather than substitutes. And here’s the kicker: do all this without increasing the burden on taxpayers from what it is now.

You might be skeptical that a “free” public option is even feasible. [I put the word “free” in quotes because as an economist I am duty-bound to point out that nothing is truly free, even public health insurance that does not charge a premium. The cost of this new public insurance will be borne by taxpayers and private insurance consumers, just like the current one]. You might ask, how would it leave room for private insurance and not be ruinously expensive?

I believe this new system is feasible for a number of reasons. First, the current system is so expensive and inefficient that we have a lot to play with here. In 2017, government-financed third-party payments to providers of healthcare to the under-65 population totaled $460 billion. That was 40% of all healthcare expenditures for that age group.

Second, calling it a public option is a bit misleading. Since there is no premium, everyone qualifies for it by default. The public “option” would actually be an entitlement that depends on one’s household income. You have it whether you want it or not, whether you even know it exists or not. That is the only way to get universal health insurance. On this point, I agree with the proponents of MFA. The real option is whether to purchase private insurance or not.

Lastly, this new system is feasible because it and the current one have more similarities than differences. Like the current system, nearly 100% of healthcare expenditures for households with low annual incomes will be paid for by the government. And also like the current system, nearly 100% of healthcare expenditures for households with average annual incomes or higher will not be paid for by the government.

For the households in between, this new public insurance system would amount to a high deductible, catastrophic coverage insurance policy. The government would only pay for unusually high healthcare expenditures. The rest would be paid for by private insurance or the patient herself.

As I have explained in earlier posts, the ACA premium subsidies have increased the demand for private insurance (i.e. shifted the demand curve to the right). This has pushed premium rates higher than they would have been without the subsidies. Private premium rates are already elevated due to Medicare and Medicaid refusing to pay providers the capital costs of providing healthcare.  So, families without access to group insurance and that make too much income to qualify for a premium subsidy are forced to pay exceptionally high premiums.

As I will explain in future posts, this new system should lead to decreased private insurance premiums for these middle-income households and also stabilize the private insurance market. The ACA has setup an unstable system that is likely to collapse during a future recession.

Another question you might ask is, if this new system is feasible, has it been proposed before and, if not, why? I’m not aware of this kind of public health insurance being proposed before. As to why, my only guess is that it contradicts long-held conventions of the insurance industry. Some of it might even seem counterintuitive.

Why this new system is feasible and even efficient hinges on converting private and public insurance from substitutes into compliments. I’ll explain that in my next posting.

The Cost of Obamacare

Private health insurance alone can never provide protection for all Americans. People with pre-existing medical conditions (including old age) will not be able to afford the premiums charged to them and healthy, risk-neutral people will find the purchase of private insurance too much of an unfavorable bet.

To close this coverage gap, many government-financed solutions have been employed or proposed.  Obamacare, with its expansion of Medicaid and subsidized private health insurance, closed part of the gap, but has not achieved 100% coverage.  Several Public Options have been proposed to remedy this shortfall.

Medicare For All (MFA) has been proposed to not only replace Obamacare, but all private health insurance. One would imagine that MFA would be much more expensive than Obamacare, but it would at least close the coverage gap, something Obamacare failed to do completely.

I have written previously that the financial stability of the health insurance exchange created by Obamacare is highly suspect. The individual mandate is too weak, even when it is being enforced, to stop the collapse of the exchange when there is a shock to the market.

So, I predict Obamacare will have to be replaced eventually. This makes its cost and the costs of possible replacements or additional programs relevant to the discussion of how best to close the coverage gap.

So, what is the cost of this new program compared to other health insurance programs?

Table 2. Healthcare Expenditures by Coverage Type, 2017

*Adjusted for people covered by more than one insurer.

Table 2. shows my estimates based on the 2017 Medical Expenditure Panel Survey (MEPS). The number of enrollees is adjusted for people with more than one type of coverage. So, for example, if half of a person’s healthcare expenses were paid for by Medicare and the other half by Medicaid, that person counted as one half person enrolled in Medicare and one half in Medicaid.

The ACA “caused” via Medicaid eligibility expansion or the purchase of private insurance (i.e. premium subsidization and the individual mandate) 23 million previously uninsured people to be insured at an average cost of $3,180 per person.

The cost per person of the ACA compares favorably with that of Medicaid, Medicare and private insurance, but this is not because of some cost-saving feature of the ACA. It is because many of the previously uninsured are relatively young and healthy and have fewer healthcare needs than older and sicker people.

The real test of the efficiency of the ACA (from a taxpayer’s perspective) is found in the Average Discount column. Approximately half of the previously uninsured who are now insured because of the ACA are new Medicaid enrollees and the other half are privately insured. As you can see, Medicare and Medicaid enrollees receive the largest average discounts from billed changes at 65.6% and 66.6% respectively. Private enrollees receive the smallest discounts (48.2%). Consequently, the ACA population is in between (56%).

This 10% average discount difference between the ACA and Medicare amounts to $720 per person ($16 billion in total) that taxpayers and the newly insured are forced to pay for. This amounts to a large transfer of wealth from taxpayers and the previously uninsured to healthcare providers, especially hospitals. As I have written before, the biggest beneficiaries of Obamacare are healthcare providers, not the uninsured and definitely not taxpayers.

What’s Missing?

These costs only include expenditures by payers, i.e. insurers, and patients. They don’t include several other costs of providing health insurance. The MEPS doesn’t include the cost of premiums paid by enrollees nor the administrative costs incurred by insurers. I could have included an estimate of these extra costs, but I don’t think that would add anything to the accuracy of the comparisons.

In the long run, the premiums received by insurers equal the payments to healthcare providers and the costs of administration. These include costs such as claim validation and payments to investors. For private insurers, these costs typically range from 6% to 10%. For public insurers, however, they are much less.

But as I have written before, our accounting systems don’t accurately capture the costs of providing public insurance. Private insurers must attract voluntary capital investment. In other words, they have to pay for it. Governments don’t have to voluntarily attract capital. They can appropriate capital through involuntary taxation. But taxation is not free. All taxes come with an added cost, called deadweight loss.

So, it is at least plausible and, in my opinion, very likely that the administrative costs of private insurance are balanced out and possibly even eclipsed by the deadweight losses caused by public insurance. Otherwise, why stop at public health insurance? Why not have the government pay for all food consumed? A lack of food can be as deadly as a lack of healthcare. Why not clothes and housing and any other necessity?

There is nothing special about healthcare that makes it particularly well-suited for 100% public provision. National defense, police protection and roads are non-excludable. There exists a free-rider problem that prevents their efficient provision by private markets. Yet, healthcare is completely excludable.  If you don’t pay for it, you don’t get it. There is no free-rider problem there.

Public education creates a large positive externality. A literate populace is necessary for a well-functioning democracy and equality of opportunity is the hallmark of a just society. However, healthcare does not create more positive externalities than most other privately provided goods and services, except for protection from communicable diseases via vaccination.

This is the core of the difference between centrally-planned (aka socialist) and market-driven (aka capitalist) economies.  Who is more likely to efficiently and fairly invest our scarce capital: the government or private investors? The Lone Economist clearly prefers the latter in most instances.

A Brief History of Public Health Insurance in the US

Any discussion of the health insurance policy debate will benefit from some historical context. Prior to the 1960’s, the U.S. government had very little impact on the provision of health insurance. Virtually all health insurance was provided through private companies.

For a private health insurance market to thrive, two conditions must exist.  The first condition is that a high degree of uncertainty must exist for both parties, the insurer and the insured. If one side of the transaction has a better understanding of the amount of risk, then adverse selection will occur.

The second condition is just as necessary but gets much less attention in public policy debates. The insured must be risk averse. This means that they are willing to pay additional money for the certainty of paying only the average cost of care. For example, suppose the average cost of caring for a group of people is $1,000 per month per person. If they are sufficiently risk averse, each person will be happy to pay a $1,000 monthly premium plus a little extra for the certainty of not having to pay a lot more than $1,000 if they incur medical bills. The little extra is the normal profit the private insurance company needs to receive in order to stay in business.

These two conditions together make it difficult for a purely private health insurance system to cover 100% of the population. People who know they are more likely to incur large health bills will pay the premium for health insurance and people who are relatively healthy and are not particularly risk averse with decline. The insurer will raise premiums to avoid losses. The end result is that premiums for people with pre-existing conditions including the elderly will be too high to afford and many healthy, risk-neutral people will choose to be uninsured.

Medicare Part A and B and Medicaid

This was, in fact, the situation in the 1960’s when Medicare Parts A (hospitalization) and B (physician services) were created to provide insurance for the elderly, disabled and people with kidney failure. Medicaid was created to provide health insurance for the poor.

These programs initially compensated hospitals and physicians on a per diem and percentage of billed charges basis. Providers quickly learned that by increasing their charge rates and hospital lengths of stay they could increase their profits. Consequently, charge rates skyrocketed. This led to a dramatic increase in the income of physicians and hospitals. So many new hospitals were constructed to cash in on this government-financed bonanza that an enormous number of unused hospital beds existed and a process to limit hospital construction (i.e. Certificate of Need) was created.

In the 1980’s Medicare Parts A and B and Medicaid reformed their provider compensation designs. For example, Medicare Part A adopted a “prospective” payment system. Instead of paying 80% of billed charges for a hospital stay, Medicare paid a fixed amount of money for each stay. The amount was determined by the diagnostic and procedure codes assigned by the hospital. This eliminated the incentive to keep the patient in the hospital longer than medically necessary. The excess number of hospital beds declined steadily for the following 20 years.

To compensate physicians, Medicare Part B now uses the Resource-Based Relative Value System (RBRVS). Like the prospective payment system for hospitals, this is a code-based system which assigns a dollar value for each Current Procedure Technology (CPT) code assigned to an office visit or surgical procedure.

Although these code-based compensation systems solved many perverse incentive problems of the old charges-based system, they have their own incentive problems. Upcoding, the illegal practice of systematically assigning more expensive codes than justified, was attempted by several hospital systems and physicians. Tenet, a large for-profit hospital chain, was found guilty of gaming the prospective payment system by rapidly increasing its cost-to-charges ratios on a yearly basis. They were assessed a large fine by Medicare and the system was reformed to prevent this type of fraud from happening again. But perhaps the biggest perverse incentive created by the prospective payment system is to encourage the early discharge of patients so that they can be readmitted a day later, thus doubling the hospital’s payment.

One thing in common that the provider compensation systems of Medicare A and B and Medicaid have is that they are calibrated to pay only the marginal operational costs of providing care. In other words, they do not cover providers’ capital costs. To cover capitals costs, providers must charge much higher rates to private insurers.

This cross subsidization is a type of indirect tax discussed in my previous posting. There are some advantages to an indirect tax that will be discussed in a future post.

Although Medicare and Medicaid are enormously expensive, they would be even more so if both systems had to cover a proportional share of capital costs incurred by providers. By shifting coverage of capital costs onto private insurers, the deadweight loss of the avoided taxes is itself avoided. Additionally, indirect taxation creates the illusion that the tax burden of these public systems is smaller than it actually is, thus making it more politically palatable.

The Clinton Administration and the Managed Care Revolution

Medicare and Medicaid addressed much of the insurance coverage gap problem, but not all of it. By the start of the first Clinton Administration in 1993, 15% of Americans were still without health insurance. These were mainly people with preexisting medical conditions and healthy, risk-neutral people who chose not to purchase health insurance.

To bridge this coverage gap, the Clinton Administration proposed a system of subsidies that ultimately failed to win approval by Congress. The media portrayed this political debacle as a victory by vested interests, but that was only part of the reason. Besides a desire to fill the coverage gap, another major motivation for this legislation was to slow the rapid increase in the cost of healthcare.

Prior to the first Clinton Administration, annual healthcare costs had been rising by 8% or greater. (See Figure 6). The adoption of Health Maintenance Organizations (HMOs) on a wide basis in the 1990’s led to a significant slowdown in healthcare costs. There was a consensus that the market, through HMOs, was fixing the problem. Therefore, the need for a costly and divisive government program was unnecessary.

Figure 6.

HMO’s slowed the growth rate of healthcare expenditures by imposing incentives on providers to better control costs. There was a focus on primary care physicians acting as gate keepers in order to decrease the use of expensive specialists. Other incentives, like capitated fees, also contributed to slower growth.

The slowdown in healthcare cost growth was only temporary, however.  By 2001, HMO enrollment had peaked and started a long decline. In 2017 according to the Medical Expenditure Panel Survey, fewer than 19% of the US population were enrolled in a private HMO and those still enrolled are confronted with far fewer restrictions than in the past.

Although the Clinton Administration’s efforts to expand public insurance coverage were unsuccessful, I included this section to illustrate a point about the American healthcare consumer. HMOs and their cost controlling restrictions proved to be effective in controlling the growth rate of costs, but were nonetheless, very unpopular. Americans do not like restrictions on their choice of provider. American employers were forced to offer less restrictive HMOs and alternative plans, such as Preferred Provider Organizations (PPO’s), in order to compete for employees.

European-style, single-payer systems share many characteristics with HMO’s. Without cost controls, these systems would experience unconstrained growth and quickly swamp their respective healthcare systems. Promising to expand Medicare coverage to all age groups while eliminating private health insurance can only work by adopting strict cost controls, the very same cost controls emphatically rejected by most Americans in the 1990’s. I do not think the politicians promising Medicare-For-All or public options that will crowd out private insurance understand the trade-off they are proposing.

Medicare Parts C and D

Medicare is popular with the public in general, but being a form of socialized medicine, has always been unpopular in conservative political circles. So, when it became clear that the lack of prescription drug coverage was a political liability, the George W. Bush administration decided to create a market-oriented system to fill this coverage gap. The result was Medicare Part C (aka Medicare Advantage) and Medicare Part D.

Medicare Part C purchases private insurance on behalf of beneficiaries. The premium paid is the average expected healthcare costs that would be spent on the beneficiary had she been a Medicare Parts A and B (i.e. Pay-For-Performance (PFP)) enrollee. To induce private insurers to participate, an extra amount is paid to provide a normal profit.

Part C has proven to be very popular and now comprises one third of all Medicare enrollees. There is evidence that Medicare Advantage plans cherry-pick relatively healthy beneficiaries and that the premiums paid by Medicare over-compensate plans. Because Part C pays more than the average cost per member, it has accelerated the annual growth rate of Medicare.

Medicare Part D allows enrollees to purchase prescription drug coverage from private insurers. Although it subsidizes the program by compensating insurers for very expensive or low-income beneficiaries, unlike Medicare Parts A and B, it does not use its market power to pay lower prices for prescription drugs. Consequently, Medicare Part D beneficiaries pay as much for prescription drugs as privately insured people.

Ironically, the market-oriented approach to Medicare Parts C and D has contributed to the acceleration of the cost of the Medicare program and especially the amount of direct taxation to fund it. These programs are particularly expensive for tax-payers and Medicare enrollees. There are two groups that unequivocally benefitted from the design of Medicare Parts C and D, however, pharmaceutical manufacturers and private insurance companies.

The Affordable Care Act

After several decades of political stalemate, the Democrats seized the opportunity to address the insurance coverage gap when they took over the presidency and both houses of Congress in 2009. Instead of exclusively using the government’s market power to provide health insurance at the provider’s marginal cost, like Medicare Parts A and B, the Obama Administration chose a combination of program types. They expanded Medicaid eligibility (i.e. the providers’ marginal cost approach) and created a health insurance exchange, a Republican-style market-oriented approach like Medicare Part D.

By subsidizing the purchase of private insurance rather than providing public insurance at the marginal cost of care, Obamacare resulted in higher payments to hospitals and physicians at a higher cost to taxpayers. In addition, healthy, risk-neutral people were penalized if they did not choose to purchase private health insurance (i.e. the individual mandate).

Despite this mandate, the number of uninsured people in the US remains far above zero. Like Medicare Part D, the benefits of the program are mixed. Many people with pre-existing conditions are able to obtain health insurance, but some are not. Taxpayers shoulder the full cost of the program, including those who feel the mandate is fundamentally unfair. The only groups that unequivocally benefit from Obamacare are healthcare providers (i.e. hospitals and physicians) and private insurers.

The Next Phase

The current status of Obamacare is the Trump Administration no longer enforces the individual mandate and the percentage of the population uninsured is now increasing after dropping significantly following its passage. Candidates for the Democratic party presidential nomination have authored competing proposals that can be generally summarized into two different categories: Medicare-For-All and a Public Option.

Like most sweeping legislative proposals, many details are left for future negotiations. The projected costs are debatable, but there are some features that can be described. Medicare-For-All is a relatively simple plan to expand Medicare (Parts A, B and prescription drug) coverage to all age groups. This simplicity is, I suspect, a major reason for its popularity in public opinion surveys.

A major flaw in this proposal is that Medicare has few constraints on costs or utilization, a feature all single-payer systems must have. With its strict limitations on costs and coverage, Medicaid is a much more realistic model for a single-payer system in the US than Medicare. Although a more accurate and honest appellation, I doubt “Medicaid-For-All” would poll nearly as well.

The Public Option has been marketed as a more moderate approach to closing the coverage gap. The basic idea is for the government to sell insurance to anybody who wishes to purchase it. This would guarantee that there would be at least one supplier of high-quality insurance at a reasonable price (i.e. premium). Private insurance companies that charge unreasonably high premiums would be forced to lower their premiums in order to compete or exit the insurance market.

The biggest problem I see with the Public Option proposals is that their premiums can be set arbitrarily low while still providing high-quality insurance. The premium the government charges need not cover the cost of capital nor operational costs for that matter. No private insurance company has the financial resources to compete with the federal government. Over time they will not be able to recoup their cost of capital and will exit the market, leaving it entirely to the government. Therefore, the Public Option is simply Medicare-For-All in sheep’s clothing, a less transparent method of achieving essentially the same end. The only difference being a premium, that even if set very low and with an enforced individual mandate, will leave many people uninsured.

The only way to provide health insurance to the entire population is to provide a public option with a zero premium. But it should not crowd out private insurance, otherwise moral hazard and runaway costs would ensue.

This might sound like a contradiction. How can a private profit-maximizing insurer compete with free public health insurance if it can’t compete with low-priced public insurance? It can’t, obviously. But it doesn’t need to. The Public Option need only solve the coverage gap problem while being less desirable than private health insurance for those who have access to it. I’ll explain more in a future posting.