Is Private Health Insurance More Costly Than Public Health Insurance? Five Principles

Uwe Reinhardt had a post the other day at The New York Times economics blog comparing Medicare with Medicare Advantage (MA) plans. He basically sifts through the evidence on which is less costly: Medicare (a public plan) or the private MA plans. But while his column is definitely worth reading, it does not go far enough.

Uwe Reinhardt had a post the other day at The New York Times economics blog comparing Medicare with Medicare Advantage (MA) plans. He basically sifts through the evidence on which is less costly: Medicare (a public plan) or the private MA plans. But while his column is definitely worth reading, it does not go far enough. In fact, given the persistent obsession with this question — especially by people on the left — I don’t understand why competent health care economists don’t clear the air of nonsense more decisively.

I consider the titular question of this post a silly question. People who think this is a legitimate issue invariably are making errors in economics or committing errors of logic or misunderstanding  institutional details or (as is the case with Paul Krugman) making all three mistakes in a single editorial. Notice I didn’t say anything about empirical evidence. Tom Saving and I did a bit of that for Health Affairs sometime back. But, we don’t need empirical evidence to resolve issues that arise only because someone hasn’t mastered the syllogism.

To help everyone think through this, I offer five principles.

Principle 1: There is almost nothing the government can do that the private sector cannot do as well or better.

Do you think a surgeon is likely to perform better surgery or more efficient surgery if he gets his fee from the government instead of Blue Cross? How about a nurse? Or a hospital administrator? If the answer is “no,” and it surely is, what is it about government that could possibly lower the cost of health care? The answer is: almost nothing.

It is sometimes said that government can produce things at a lower cost because the government doesn’t have to earn a profit. But people who say this never learned the concept of profit in Econ 101. Every hospital, every physician’s office, every other health care business requires capital. There is a cost of capital. If there are risks involved (the risk, for example, that aggregate fees will not be high enough to cover outlays) then the cost of capital is higher. These costs have nothing whatsoever to do with whether the entity is public or private.

Here is what is true: accountants do not typically record the cost of capital in the financial statements of public entities. But failure to record a cost doesn’t make it go away. To the contrary, ignoring the cost of capital in public accounting unquestionably makes public ventures prima facie less efficient — because investment decisions will tend to be made without regard to their real costs.

What about the idea that whole systems (with all their complexity) might work better if they are public rather than private? For example, for years the auto companies have complained that health care costs are so much higher in the United States. than for auto workers across the border in Canada. If so, there is a straightforward remedy.

There is nothing that the Canadian government is doing that the auto companies and the unions cannot do for themselves. As I have written before, the auto companies can form an HMO and tell it to ration medical care the same way the Canadians ration care.

That the auto companies don’t even seriously consider this option (all the while urging government to consider it) is understandable. The reason is cultural. When a Canadian doctor has to ration care, she is likely to tell the patient, “There is nothing more we can do.” The doctor almost never says, “We could save you, but the government cares more about money than it cares about you.”

An American doctor, however, might well say, “We could save you, but your employer cares more about profit that it cares about you” — thus generating a lot of employee ill will.

This is a cultural issue, though, not an economic one.

Principle 2: The few things government can uniquely do can be done without public insurance.

The advocates of socialized medicine frequently claim that government can use its position as a monopsony (single) buyer of care to negotiate lower provider fees. This is what they envision happens in Canada, for example. In fact, governments usually don’t bargain with medical providers. They simply announce a low price they intend to pay and the suppliers of care can take it or leave it. That’s what happens in the U.S. Medicaid program, for example, and almost a third of doctors decide to leave it — refusing to accept any new Medicaid patients.

However, and this is key, the government doesn’t need to pay provider fees in order to suppress them. It can simply impose price controls on all providers. In fact, if paying providers below-market fees is socially desirable, that is exactly what the government should do for all patients, not just the patients the government happens to insure. Such an act would not make health care more efficient, however, it would just shift costs from patients to the providers of care.

Remember: shifting costs is not the same thing as lowering costs.

Principle 3: Most public insurance in this country is actually administered by private insurance companies.

I can’t begin to count the number of people I have met who believe that BlueCross is evil because it is private and that Medicare is good because it is public. I usually ask, “Who do you think runs Medicare?” Following an awkward silence I usually supply the answer: “It’s BlueCross!” And other insurers.

From the beginning, Medicare and Medicaid have been mainly run by private contractors. Who else was going to do it? The government certainly had no experience doing so.

Now do you think that when BlueCross is called “Medicare” it suddenly becomes more efficient than when it is called “private insurer”? If not, then can we put this nonsense aside once and for all?

Principle 4: Most people with public insurance are in private sector health plans.

More than one out of every four Medicare beneficiaries is in a private Medicare Advantage plan and two-thirds [see here, page 13] of all Medicaid enrollees are in private plans under contract with state governments. In the future those numbers will likely rise. In fact, almost all of Medicaid will eventually be contracted out to the private sector as state governments desperately try to cope with the impact of Medicaid on state budgets. Why turn to the private sector? Because of the next principle.

Principle 5: It is only in the private sector that one finds anyone who has an incentive to lower costs without rationing care.

Most providers have an incentive to increase costs rather than lower them. Their incentive is to maximize against the payment formulas of third-party insurers — whether public or private. And surprisingly, most private insurers also have no incentive to lower costs other than by negotiating lower provider fees. BlueCross, for example, has no incentive to lower Medicare’s costs when it is administering Medicare. When its clients are private employers, BlueCross (for reasons that are historical and institutional, but ultimately because of bad government policies) rarely interferes with the practice of medicine. In Dallas, for example, virtually every hospital in the Metroplex (no matter how efficient or inefficient) is in the BlueCross network.  Similarly just about every doctor (no matter how good or how bad) can be in the BlueCross network if he or she chooses.

However, there are providers who do have an incentive to lower costs and they appear to be responding to those incentives. Surprisingly, they are using some of the techniques the Obama administration says it likes (medical homes, coordinated care, evidence-based medicine, etc.) and that appear not to work well when the government funds pilot programs to try them out. Even more surprising, where these efforts to make medical care more cost effective are most visible is in the Medicare Advantage plans — the very plans that president Obama and many Democrats in Congress seem to be hostile to.

I have previously reported on the efforts of IntegraNet, which appears to achieve good medical outcomes while holding costs down to about 70% of premium income. (Technically, that’s a 70% MLR.)

Two things are important to keep in mind when comparing what I have just said to the table in Uwe Reinhardt’s post. First, the people who are holding down costs and daily searching for new ways of doing so are not the insurance companies (the Medicare Advantage HMOs) — at least as far as I can tell. They are separate companies (e.g., independent doctors associations) operating under contract with the HMOs. Second, if what I am saying is true, the real cost of delivering care under the Medicare Advantage program is much lower than anyone realizes and it’s mainly going to the profits of the HMOs and the entities they are contracting with.

That implies that more competition (ah, more privatization!) has the potential to considerably reduce the taxpayer’s future burden.