In the previous post on health insurance, How Health Insurance Works, I ended with the editorial comment, “Surely there is a better way.” Right now you’ll be paying $9,000-$12,000 or more per year in premiums for a family plan and $5,000-$6,000 per year in premiums for an individual plan, even if you are young and healthy. Granted, your employer might pick up two-thirds of this or more if you’re working for someone, and the government will pick up a like amount if you’re self-employed and not making that much in income, but if health insurance costs were lower you might have a higher salary or lower taxes.
Premiums also don’t tell the whole story. With deductibles of $2000-$4000, you might be paying more than $11,000 each year before insurance picks up a dime. Even then, they are only paying 60-80% of the bill. So this means that on years when you don’t have an appendicitis, you’re paying $10,000. In years when you do, you’re paying $16,000! When a family member has some sort of major illness, families need to find several thousand dollars to pay the hospital and doctor bills. This is difficult for most families, especially when they are already paying so much each year in premiums.
So obviously the insurance companies are making all sorts of money so we should just get rid of the insurance companies and healthcare would be affordable, right? Well, unfortunately health insurance companies actually aren’t keeping that much of the premiums they collect. They are actually only making maybe 5% and spending maybe 5-10% on administration and marketing, so your premium would only go from $10,000 to maybe $8500, even if the health insurance company were somehow to pay out everything they collected in premiums.
So the doctors and hospitals are overcharging, right? Well, no, at least in the case of a doctor’s office. If you consider the cost of maintaining the buildings, hiring and paying staff (many of whom spend their time filling out insurance forms), buying expensive machinery like x-ray machines, and paying for malpractice insurance (which can run from $100,000-$300,000 per year), the rates charged really don’t look that unreasonable. The rates that hospitals and doctors in emergency rooms charge are another story, and that is where the real problem is seen most clearly.
The reason medical care cost is so out of line, which causes health insurance costs to be so high, is that few people are actually paying for the services. Imagine if you ran a restaurant and sold hamburgers. Given your costs for rent, staff, food, and utilities, you might charge $6 for a hamburger and fries. Now let’s say that one-quarter of the people who came in for your hamburgers didn’t pay, and yet you were required to serve them no matter what. If you absorbed the costs, you wouldn’t be in business for very long because your profit on the burgers you did sell was nowhere near the 33% you’d need to make up for those who were not paying. So what would you do? You’d raise the price for those who were paying by 33% to cover the cost of the customers who weren’t paying, so you would now be charging $8.00 for a hamburger and fries.
Some of your customers would complain about the price hike, but many would keep paying the price if they really needed a hamburger (you are the only place in town). Some would say they couldn’t pay the new prices, however, and ask to eat for free as well. Now maybe only half of the people are paying. You’d therefore need to double your original price to make the same amount you were making when everyone was paying $6. So your hamburgers are now $12 each.
At $12 a hamburger, few people would be able to pay even though you were the only place in town. If their boss offered to pay half of the cost, however, they might keep going since now they felt they were only paying $6, even though they might have gotten a raise at work if the boss weren’t paying for their hamburgers. This is the same as medical insurance, where the price people think they are paying seems less. The issue with healthcare and hamburgers is that by making the cost seem less, or even worse, making it seem like you are losing money if you don’t purchase the item, you keep demand for the item high even though fewer people are able to afford the price. This keeps the price high and keeps people from looking for better ways to provide the service.
The emergency room is the same way. The reason seeing a doctor for 20 minutes in an emergency room, beyond the huge price he needs to pay for malpractice insurance, costs $1000 is that he wants to maybe make $100 per hour for his time. On a given 10 hour shift, however, only a couple of people will actually pay anywhere near full price for the service. You pay so much because you are paying for a lot of other people who pay little or nothing, just as the few people paying for their hamburgers were paying for all of the others who were not.
Government programs like Medicare and Medicaid just make things worse by stiffing the doctors on the amount they pay. A doctor is paid less than the cost of providing the service in most cases, causing him to charge more for those who aren’t using government health insurance. Likewise, those on insurance are getting supplemented by those without insurance who are able to pay the bills because the amount the insurance company pays is less than the full rate. The other effect of insurance is to cause people to get expensive treatments, tests, and prescriptions even if the cost is ridiculous, since for them the cost is the same or only slightly greater. No one would pay $20 for an aspirin out of their own pocket, but they’ll take them if insurance covers the bill.
The secret to reducing healthcare costs is to 1) largely get rid of health insurance except for its normal use – buying down risk, and 2) get people to pay for the services they receive. In the next post I’ll discuss ways to do this.
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