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Health Care Is So Expensive Because You Don’t Pay For It Yourself


Almost everyone involved in health care will tell you that the greatest problem in our system is that we pay on a fee-for-service basis. Almost everyone is wrong.

The logic is obvious: paying a fee for a service encourages providers to get more fees by providing more services. Ergo, we consume too much and spend too much. Ipso facto, getting rid of fee-for-service would result in fewer services and less spending. Case closed.

Well, maybe not. In fact, almost everything we do in the course of our economic lives, we do on a fee-for-service basis. When we go to the movies, get our oil changed, have our roof replaced, buy a computer, get a haircut, hire a babysitter, buy a steak dinner, get someone to do our taxes or defend us in a suit, we do it on a fee-for-service basis. None of it is particularly inflationary.

The graph below shows the Consumer Price Index broken into components. Food, housing transportation, apparel—all are paid fee-for-service, and all have a lower rate of inflation than health care does.

Yes, the providers of these services would like to sell us more units of service. But we have good reason to resist—we don’t want to waste our money on services we don’t need. What is unique about health care is not fee-for-service, but third-party payment. Only in health care is someone else picking up the tab for our spending.

If We Applied Health-Care’s Model to Other Markets

If we applied the same third-party payment technique to any other segment of the economy, we would get the exact same inflationary spiral we see in health care. I buy donuts from time to time. If those donuts were free at the point of purchase, I would buy (and eat) a whole lot more than I do today. The stereotype of cops eating donuts came about because donut shops gave them away to the cops for free.

When I was working as a state-level lobbyist for the Blue Cross Blue Shield Association, I would attend meetings of the National Association of Insurance Commissioners (NAIC), the National Governors Association (NGA), the National Conference of State Legislators (NCSL), and a bunch of other organizations. These groups typically held their meetings in the ritziest hotel in Kansas City, New Orleans, San Diego, Boston, or some other place that was easy to get to.

Not once did I ever inquire what the room would cost. Why should I? Blue Cross was paying for it. The cost made no difference to me whatsoever. Some years later, when I went into business for myself and tried to attend the same meetings at my own expense, I became very interested in the cost of the rooms. Most of the time, I would stay at a cheap motel on the edge of town and drive to the meetings.

Ah, but health care is different, you might say. Yes it is. It is different because of third-party payment and for no other reason. The other reasons usually given are easily rebutted:

  • Information asymmetry (the providers know more than the patients). Of course, but that is also true of, say, criminal law or engineering.
  • Health care is essential to life. But it is far less essential than food or housing, which do not require third-party payment.
  • Patients are too fearful to make rational decisions. More fearful than if I were arrested and locked up at Riker’s Island?
  • Health care is complicated. As complicated as an iPad? I don’t think so.

Efforts to move away from fee-for-services or to control it never work very well. Witness capitation under managed care, or the RBRVS system of paying physicians under Medicare. Medicare’s price controls lead to absurd complexity yet do not reward physicians for the things that are most important to patients, such as kindness, patience, communication ability, friendliness—the qualities that humanize the medical transaction and would be rewarded in any other segment of the economy not dominated by bloodless third-party payers.

The recent adoption of the ICD-10 codebook has made it a whole lot worse. This offers 140,000 separate billing codes, according to The Wall Street Journal, including separate “codes for injuries in opera houses, art galleries, squash courts, and nine locations in and around a mobile home, from the bathroom to the bedroom.”

Would ‘Bundling’ Services Help?

One of the more peculiar mental twists by health academics is the notion that the answer to the problems with fee-for-service is to bundle some of these services into single packages. As we argued above, FFS is not a problem in health care or anywhere else. The problem is third-party payment. But for the moment let’s suspend our disbelief and accept that FFS is a problem. In what way does bundling solve it? Or even address it?

Proponents of bundling would go from paying a fee for a single service to paying a fee for a bundle of services. It is still fee-for-service. In fact, services are already bundled. An office visit to a doctor “bundles” many discrete services such as weighing the patient, getting a blood pressure reading, checking pulse and lungs, interviewing the patient about how she is feeling and whether she is having any reactions to the drugs prescribed during the last visit. These services are not billed separately but “bundled” into an “office visit” package.

Presumably, the advocates of bundling would want more and bigger bundles, or think they know what should be in the bundle better than the physician does. Or perhaps they have no idea what they are talking about—it is simply the latest nifty-sounding term they use to pretend they have something to say. If third-party payment encourages doctors to perform more services, would it not also encourage doctors to perform more bundles of services? Is there really any difference? Are there any examples in the real world of how bundling might actually work?

Well, yes, as the matter of fact. There is one very big sector of the economy that is all about bundling. That is higher education. When young people go off to school, they do not pay separate fees for different professors or different courses. They pay a single annual tuition that covers an entire year’s instruction. The tuition is also “community rated.” Other than a distinction between in-state and out-of-state, all students are charged the same rate. The smart ones pay the same as the dumb ones even though the two groups will require different levels of service. Everybody pays the same for a comprehensive bundle of services.

This Comparison Actually Works Perfectly

This is just perfect. It is everything an academic could hope for in health care. Surely higher education is a great example of these progressive principles in practice and a beacon for what we could do in health care. Well, maybe with one teensy exception. It doesn’t slow spending a whit—quite the opposite. Doug Short expands on the CPI chart below to include “College Tuition & Fees” as a separate item.

It turns out that college costs have risen twice as fast as even health care since 2000! It is unrelenting. Year after year, during good times and bad, it rises twice as fast as health care.

Is bundling a bad idea? Of course not. Physicians have been bundling for all eternity. They do it when it makes sense and enhances value. But today they are not allowed to create new bundles because the federal government doesn’t pay that way. It pays according to discrete ICD codes that are getting increasingly (and absurdly) specific.

But neither is bundling a panacea, especially if it is dictated by the same people who brought us the ICD-10 codebook. Two of the early advocates of bundling came to have second thoughts about it after a few years. They are James Caillouette, surgeon-in-chief at the Hoag Orthopedic Institute, and James Robinson, economics professor at UC Berkley, who write in Health Affairs that

As leaders in the Integrated Health Association (IHA) bundled payment initiative, we shared the same hopes, devoted the same energies, and share the same frustrations with the modest results. We feel it is important to emphasize what we consider to be the initiative’s most important design failure: the lack of engagement and alignment on the part of the consumer. No one will ever reform the U.S. health care system without bringing the consumer along and, indeed, placing consumer choice and accountability at the very center of the reform initiative.

They go on: “We were first and the most enthusiastic participant in IHA bundled payment initiative, sending the hospital’s entire C-suite to the founding meeting with the health insurers. We signed more contracts and treated more patients than any other participant. But we never received the volume of new patients necessary to cover our incremental expenses, much less finance a much-desired expansion.”

They conclude: “Our policy focus right now, however, is in encouraging the alignment between consumers and providers through reference pricing, travel medicine, quality reporting, and price transparency.”

Well, better late than never! These are precisely the remedies many of us have been advocating for about 20 years now. But the “health policy community” keeps getting distracted by whiz-bang new slogans like ACOs, bundled payments, case management, and the latest: Big Data! None of these are actually new ideas. They are all just repackaging of the same old ideas that have failed in the past. They all involve some smart guys (or committees of smart guys) telling everybody else what to do.

But maybe there is hope if even Health Affairs is publishing articles about the essential role of empowered and engaged consumers making good decisions.