Healthcare Is Like an All-You-Can-Eat Buffet & That's a Problem

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Healthcare costs have risen sharply in this country over the last few decades, and although growth rates have begun to stabilize (the most recent government data show hospital price rose 2.1 percent in the last 12 months), the national outlay on healthcare spending is expected to grow as a portion of GDP, from roughly 17 percent today 22 percent by 2038, according to a Congressional Budget Office estimate.

For comparison's sake, health spending as a portion of GDP was just 5 percent in 1960. Continued growth puts at risk our nation's ability to invest in other sectors and economically compete with other industrialized nations.

How did the U.S. go from spending just 5 percent of GDP on healthcare to 17 percent in just 15 years?

Well, that's a complicated question to answer, but a recent report from The Engelberg Center for Health Care Reform attempts to do just that. The study explores the role of technology — which has been said to drive healthcare costs — income growth and insurance coverage in the rising price of healthcare services. Various economists have proposed each as the key driver of rising health costs. However, the Engelberg report found it's actually a combination of technology and the ability to pay for that that technology through insurance coverage that has driven costs so high.

"It is clear that it the combination of technical innovation and a continued willingness to pay for that technology that has allowed health spending to rise faster than income for so long," wrote the report's author Louise Sheiner, a senior economist for the Federal Reserve Board of Governors.

Why has there been such a great increase in Americans' "willingness to pay?"

Because, over the last 50 years, payment has increasingly fallen to insurers, not patients themselves.

Out-of-pocket spending (i.e., spending by the patient directly) has fallen from 56 percent of health spending in 1960 to 14 percent in 2012 (see graph). OOPspending

This was surprising to me given all the current talk of rising patient financial responsibility resulting from the increased use of high deductible health plans.

Keep in mind, though that Medicare wasn't introduced until 1966 and Medicaid came just a year earlier. Before that, many people were on the hook for some very large healthcare costs.

According to the Engelberg report:

"Thus, there appears to be a fairly large endogenous response to changes in healthcare spending. As spending rises as a share of income, two things happen: insurance contracts change to insulate people from the risk of large expenses if they become ill, and public programs expand to help maintain access to health services for lower income. Both of these changes fuel increased adoption of health technology…

"Without the dramatic decline in the share of health expenditures paid out-of-pocket, many Americans would simply not have been able to afford the new technologies when they became ill."

The all-you-can-eat buffet
Jonathan Bush, CEO of athenahealth, likens the effect to staying at a hotel with an all-you-can-eat breakfast buffet in his new book, "Where Does It Hurt?"

To the traveler, the breakfast is free, even though the hotel's cost of providing it has been incorporated into the room rate (compare this to the effect of not paying for healthcare services directly, even though the consumer and his or her employer pays a hefty premium).

The traveler then over consumes, "because 'hey, it's free,'" writes Bush. She's already paid for it. Similarly, patients consume more healthcare services than needed (or at least don't ask their physician if a test or procedure is really necessary), because they too have already paid for it — and they might as well use it.  

Unfortunately, the negative impact of the free pay goes beyond over consumption.

Consider this scenario: I was recently in a small town visiting some family. I stayed at a small hotel that offered — you guessed it — an all-you-can-eat breakfast buffet. Typically, I have a bowl of cereal or toast and fruit. But that day, I had all of those, plus a muffin and a waffle, even though I only had a few bites of the latter. Not only did I hurt my waistline, but, Bush would argue, I also hurt the market for breakfast diners in the town. My not leaving the hotel essentially "reduced competition for new breakfast cafes," as Bush explains it.

And that's a problem because competition drives innovation and drives down prices — something healthcare desperately needs.

Putting more financial responsibility onto patients (i.e., making healthcare coverage was less comprehensive), Bush argues, would create a more competitive market for healthcare services and would drive the creation of higher-value services than available today.  

Bush drew on an airline analogy in a recent interview with me about his new book:

"If everybody had the cost of expensive airlines tickets taken from their paycheck each month, they would never choose to fly on Southwest. There would be no Southwest, and we'd have no $100 ticket on airplanes today."


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