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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

Why Exactly Will Competition Between Insurers Lower Prices?



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Howard Gleckman of the Tax Policy Center, who isn’t exactly a fan of every conservative policy fad, describes Wyden-Ryan as “A Medicare Reform Plan That Just Might Work.” And why might it work? Part of it is the following:

For the first time, the proposal would cap Medicare cost growth. Thus, instead of continuing Medicare as an open-ended entitlement whose costs automatically rise with health expenditures, the program would impose a global budget on the program. In theory, at least, the combination of market competition and this overall budget would slow the growth of Medicare costs. This could be the most contentious element of the entire plan. [Emphasis added]

When pro-market types say “market competition,” those on the left hear, “hand-wave, hand-wave, hand-wave.” We have competing private insurers in the United States and this “market competition” hasn’t exactly restrained health inflation. We’ve been in the same ballpark as the rest of the rich world since the early 1990s, and our level of health expenditures is much higher than in our peer countries. So what gives?

The “market competition” we have at present isn’t really happening at the right level. Last spring, Clayton Christensen offered a useful framework for understanding the underlying issue in BusinessWeek:

Those who debate insurance reform in Washington and pit public against privately funded care are framing the problem incorrectly. Here’s a better way to think about it: Economists are wrong in asserting that competition controls costs. Most often innovation and competition drive prices up, not down, because bringing better, higher-priced products to market is more profitable. Hospital-vs.-hospital competition causes providers to expand their scope and offer more premium-priced services. Equipment suppliers boost the capability and cost of their machines and devices. Drugmakers develop products that bring the highest prices. It’s because we have such competition, not because we lack it, that health costs are rising by 10% a year. [Emphasis added]

That is, we have exactly the wrong kind of “market competition” in the U.S. health market insofar as our goal is to improve the quality and to lower the cost of care. 

The type of competition that brings prices down is disruptive innovation. Disruption in health care entails moving the simplest procedures now performed in expensive hospitals to outpatient clinics, retail clinics, and patients’ homes. Costs will drop as more of the tasks performed only by doctors shift to nurses and physicians’ assistants. Hoping that our hospitals and doctors will become cheap won’t make health care more affordable and accessible, but a move toward lower-cost venues and lower-cost caregivers will. 

Part of the reason is that hospitals and doctors are not going to sit idly by and accept deep cuts in payments from a centralized bureaucracy susceptible to political pressure. Why should they if they can flex their muscles instead? And given that it is the high level of expenditures that sets the U.S. apart rather than the high level of health inflation as such, we actually need to find some other way of driving down the cost of care, not just keeping it fairly steady. 

The public-private divide shows that the debate is stuck at the wrong fork in the road. Many public health systems, like Canada’s and Germany’s, are departmentalized, with separate administrators handling doctors, hospitals, drugs, insurance, and so on. Although government pays the costs, such public systems are similar to the American system, where employers pay for the services of independent insurers, hospitals, doctors’ practices, and drugs. In departmentalized structures, innovations that add costs in one silo in order to save money or improve performance in another cannot succeed because the overall system lacks a unified perspective. Independently managed hospitals have incentives to fill their beds; independent insurers have incentives to minimize reimbursement and access; and the ensuing gridlock prevents all but the most incremental of innovations.

In integrated systems—where the provider and insurer are the same entity—a single perspective enables providers to take actions in one place that will cut costs or lift performance in another. While hospitalization is a revenue opportunity to an independently managed hospital, in integrated systems hospitalization is seen as a failure. Integrated systems, including Kaiser Permanente in California, Geisinger Health System in Pennsylvania, the public systems in Finland and New Zealand, and the Veterans Administration in the U.S., can provide better care at 20% to 30% lower cost. Clearly, systemic problems require systemic solutions. [Emphasis added]

So one view — the view that I hold — is that we need competing integrated providers. Granted, the case for integration is also the case that at least some on the left make for a socialized system modeled on the National Health Service in Britain or the VHA. It’s not obvious to me that a single government-run integrated provider would prove more effective than competing integrated providers, particularly since a single government-run integrated provider would be unusually susceptible to political pressures against, for example, the offshoring of medical diagnosis and treatment, the substitution of technology for labor, periodic reforms of staffing and compensation, etc.

The goal is thus not competition between insurers as we know them. Rather, it is to first, in Christensen’s words, “put care and insurance in the same bed,” and then to have these new insurance entities duke it out. 

One of the goals of Medicare premium support is to encourage private insurers to form provider networks that can evolve into new integrated providers. The danger is that we won’t have enough competing integrated providers, a situation that could lead to excessive market power. Retaining traditional Medicare is, in theory, a firewall against that possibility. 



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