The Alternative to Regulating Health Care Prices

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There are two ways to discipline medical expenses: through government-enforced regulations, or with effective market competition. U.S. officials have never fully embraced either, which is why health spending has become an immense financial burden.

The Biden administration’s preferred method is clear but controversial. Its support of a new public option is aimed at extending the reach of Medicare’s price regulations. Consumers buying insurance through the Affordable Care Act (ACA) exchanges could enroll in a new government-run plan that uses Medicare’s rates as a starting point for paying hospitals, physicians, and others.

The nation’s vast medical care network will balk at displacing some commercial insurance with expanded public plan enrollment. It argues that Medicare already underpays for its services, and a new public option, also with regulated pricing, would make matters worse, not better.

Market advocates agree that Medicare is the wrong template but have never offered a practical alternative. That needs to change if the nation’s steady march toward single-payer, or something similar, is to be slowed.

The political fight over the fate of the ACA confused rather than clarified the debate. ACA opponents wanted to repeal the law in large part because it imposed new federally-mandated regulations on the health insurance market, which previously had been overseen mainly by the states (except in cases of self-insured employer coverage). These regulations established a minimum national insurance benefit and prohibited the use of a consumer’s health status in setting premiums or in establishing eligibility for purchasing coverage. The overall effect was to lower costs for millions of Americans with pre-existing medical conditions while raising them (modestly) for everyone else.

ACA opponents confused rolling back the new insurance requirements with advancing market discipline. In their view, allowing insurers to charge whatever they want, and to retain discretion over covered services, would foster competition and lower costs.

That’s a misreading of how this market works. Even if all of the ACA’s insurance rules were repealed, competition would not discipline medical care expenses, for reasons  Kenneth Arrow explained more than a half century ago. Medical care has characteristics that impair price discipline when there are no guardrails. The high expenses associated with many effective treatments lead consumers to seek out insurance protection, and insurance severs consumption from point-of-care pricing. Insurers, meanwhile, can segment the market by identifying customers likely to incur significant expenses and charge them higher premiums. The premiums for high-risk customers can be so high as to price them out of the market.

Further, the concentration of expenses in a small number of high-cost cases makes it difficult to use patient cost-sharing to lower overall expenses. The average expenditure for the top 5 percent of cases in 2016 was $50,000. Insurance deductibles will never be high enough to meaningfully influence such expenses.

Patients also rely on the recommendations of their physicians when they face health challenges, and physicians are expected to steer patients toward beneficial care based strictly on considerations of improving their health. The result is consumption of services without much regard for pricing.

Despite the limitations of an unregulated market, full government control is not the only option. Market competition can discipline medical care expenses, but only if government policy helps consumers play their necessary role. Regulation can facilitate competition, rather than supercede it, by forcing market participants to disclose meaningful price information that allows value comparisons. With the right incentives, consumers would use this information to lower their out-of-pocket costs (including for premiums).

Two conceptions of market discipline have been embraced by factions opposed to full governmental control. One envisions consumers hiring agents -- HMOs and other managed care health plans -- to control medical expenses on their behalf. The other sees consumers playing an enhanced role in shopping directly for high-volume care. Both have validity. They share in common a need for regulations that standardize (and thus simplify) consumer options and reward the selection of those with lower-prices.

The consumers-hiring-agents model was advanced under the banner of “managed competition” for decades by Paul Ellwood and Alain Enthoven. Their ideas helped shape the ACA and the private option in Medicare (called Medicare Advantage). Under managed competition, consumers are given financial support to enroll in coverage but must pay more themselves if they opt for higher-premium plans. The insurance benefits are standardized so that premium differences reflect only varying levels of effectiveness in managing expenses.

The alternative -- consumers directly price shopping for some services -- also requires standardized options and improved incentives. As an example, surgeons could be asked to disclose their “all in” prices for joint replacement procedures, with regulations requiring all competing practitioners to offer the same package of clinical services within their disclosed prices. This would allow patients to comparison shop on an apples-to-apples basis. When they choose lower-priced providers, insurers should share the resulting savings with them.

Market advocates do not need to pick one version of market-based reform over the other; both can be pursued simultaneously. However, neither will be easy to implement. They require controversial changes in existing policies: in Medicare; in the tax subsidization of employer-sponsored coverage; and in regulations governing medical service suppliers and the insurance industry. The political and substantive challenges are significant, which is why they have never been adopted.

Elected officials shy away from politically-sensitive reforms, for understandable reasons.  Unfortunately, with medical care, implementing market-based reform will require placing consumers into a role they perform in other sectors but which they may be reluctant to assume in medical care, which is to steer limited resources toward high-value and away from inefficiency. Regulation is needed to assure them they can make these decisions without fear of excessive financial or health risks. The payoff from such changes would be substantial, not least for patients themselves, and is therefore well worth the effort that will be required.

James C. Capretta is a Contributor at RealClearPolicy and holds the Milton Friedman Chair at the American Enterprise Institute. He is the author of the monograph “Structured Markets: Disciplining Medical Care with Regulated Competition,” published by AEI in March, from which this essay is drawn



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