Medicare And Medicaid's Hidden Costs

Cross-posted from The Agenda on National Review Online.

Maggie Mahar of the Century Foundation is one of my favorite liberal health care writers. While free-market types would disagree with her admiration for the welfare state, she stands out among her peer group as someone who understands how health insurance works. (In this way, she compares favorably to the President, who believes that “overhead...gets eaten up at private companies by profits,” instead of the other way around.) She is therefore clear-eyed in assessing the practical implications and limitations of Obamacare.

Another one of her qualities is that she takes the time to empirically engage criticisms of the new law. One such criticism is that the law will drive health-care inflation because it massively expands the role of Medicaid. In brief, because Medicaid pays hospitals and doctors an average of 72% of what Medicare pays (and Medicare itself pays much less than what private insurers pay), hospitals and doctors overcharge people with private insurance to make up the difference. This is called “cost-shifting.”

In a December 2008 report, Milliman, an actuarial and consulting firm, estimated that those with private insurance shoulder $90 billion per year of the real cost of Medicare and Medicaid, due to these hidden underpayments. Many Democrats attempted to dismiss the report because it was funded by America's Health Insurance Plans, the insurer trade group. But Milliman’s analysis deserves to be addressed on its merits. Maggie Mahar did so by citing a report from the Medicare Payment Advisory Commission:

This is a canard that insurance lobbyists like to perpetuate because it helps justify climbing premiums. The non-partisan Medicare Payment Advisory Commission (MedPAC) has taken on exaggerated accounts of “cost-shifting” by showing that a hospital’s relative market strength determines what a hospital is paid by private payers.

MedPac points out that from 1994 through 2000, during the heyday of “managed care,” insurers had more power than hospitals in most markets: “managed care restrained private-payer payment rates.” But “by 2000, hospitals had regained the upper hand in price negotiations due to hospital consolidations and consumer backlash against managed care.”

Private insurers no longer tried to “manage care.” Huge hospitals had the clout to perform as many tests and treatments as they wished, without having to prove that the patient needed the procedure, and newly-consolidated hospitals could charge insurers as much as they pleased. They knew that the insurers’ customers wanted those large medical centers in their networks. Insurers “in turn passed along these costs through higher premiums to enrollees and employers,” MedPAC reports. “While insurers appear to be unable or unwilling to ‘push back’ and restrain payments to providers, they have been able to pass costs on to the purchasers of insurance and maintain their profit margins.”

There is no doubt that hospital monopolies are a big driver of health-care inflation; indeed, I and others have written extensively about this problem. But Mahar's argument falls flat, insofar as one cause of health-care inflation doesn’t exclude the other. That is to say, just because hospital monopolies drive up the cost of health care doesn’t mean that government underpayments don’t also do so.

Mahar's contention does lead us to one reason why single-payer systems are less expensive than ours: in a single-payer system, the government has monopsony power to tell the hospitals to go take a hike if they try to charge more than the government is prepared to pay. The problem with single-payer, however, is that hospitals have no incentive to improve their quality: they are paid the same regardless of whether or not they invest in better care for their patients.

Indeed, in important ways, hospitals benefit from poorer quality and a sicker populace: if patients are readmitted to the hospital because they weren't optimally treated the first time around, the hospital gets paid twice. Insurers have the opposite incentive: they benefit economically when their beneficiaries are as healthy as possible.

That’s why the ideal system is free and open competition on both the payor and provider sides of the health care ledger: transitioning from the employer-sponsored system to a national individual health insurance market; and encouraging the proliferation of physician-owned specialty hospitals that can compete with the incumbent monopolies. In this way, insurers can acquire the scale that would allow them to gain the upper hand against hospitals and thereby hold down costs. At the same time, such a system creates the economic incentives for insurers to provide products that people want to buy, and for hospitals to treat patients as well as they possibly can.

Obamacare, unfortunately, moves us in exactly the opposite direction.