The insurance industry relies on two factors to sustain operation: market size and stable costs. Although market size is important to begin with, fast rising costs will induce many people to drop out, thereby reducing the market size. This essay examines the destructive effects of relentless cost inflation in the health care industry, which may render health insurance a non-viable operation.
The nature of risk dictates that an insurance operation must be big enough to survive. The risk exposure diminishes when a large number of people are insured. The reason is that accident or bad luck seldom happens to everybody at the same time, but to a small percentage only. Thus the great majority pays for the minority who incurs loss or damage. This results in a surplus cash flow for the operation, which can be used to invest in other business ventures to generate extra money.
All types of insurance are governed by the same basic operating principle described above regardless being run by a company or by the government. If the cash flow turns negative and increasing, private insurance will collapse for lack of profit, while public insurance will cause the government deficit to soar.
Let’s now focus on health insurance. It is uniquely different because health is much more complicated. Consequently, the problems are tremendously hard to solve. The present health care mess in the United States will illustrate.
In the US, health insurance is mainly operated by private companies. If you are employed, your employer normally pays the premium. This contrasts with other developed countries where the government has taken over control. Nevertheless, the US has an enormous federal health insurance program in the form of Medicare (for senior citizens), Medicaid (federal subsidy to states to assist the poor), and VA Health Care (for veterans).
Health insurance had worked out well in the US through the postwar period up to the mid 1980s. It was not uncommon to see doctors visit your home and administer treatment. This golden era has degenerated to the present condition where the US spends more but gets less quality, while over 50 million citizens carry no health insurance at all. What has happened?
The single most destructive force is cost inflation. Many factors contribute to this: high profits going to drug and insurance companies, high fees charged by doctors and hospitals, high costs for new specialized procedures, and many others. For whatever reason, when cost rises to a certain threshold level, people will find they cannot afford health insurance anymore. They will drop out and hope for the best, especially the young and healthy. This presents a big problem for society. For the consumers and government, it becomes a moral question when millions of people cannot afford health insurance. For the insurance companies, although prospering in the short run by continuously raising premiums, their market is shrinking, leaving the old and sick in the insurance pool, or the minority rich who can afford high premiums. This is a prescription for negative profits and eventual demise for the industry.
Besides raising premiums to improve profit, insurance companies like to adopt the following practices: shut out other competitors, attract more people with low risk, refuse to insure people with high risk, delay paying for services as long as possible, and invent all kinds of policy and procedure to make it difficult for the consumers to claim payments. Due to this kind of unscrupulous practice, insurance companies earn the reputation of being evil especially in the health care area.
The cost inflation does not go away easily even when the government takes over, unless the government clamps down on the powerful drug companies and the medical profession. The only difference is that the government covers every citizen, but it has to pay for universal coverage with higher taxes. Absent any profit motive, government lacks the incentive to cut costs unless facing insufficient tax revenues. When cost increases, government faces three choices: bigger deficit, tax hike, or lower the quality of service. The last choice means longer wait time for medical help, reduction of insurance coverage, and raising fees for all patients. In those European countries where the government has taken over health insurance, the imperfections are usually reflected in the third choice.
How to fight cost inflation? The easiest approach is for the government to impose price control. It has worked in some countries especially Japan where the prices for all health services are published by the government in a book as thick as the dictionary. In most cases, artificial price controls can easily lead to deterioration of quality although prices are kept stable.
Another approach is to increase efficiency throughout the whole health care industry. This can hardly save more than 20% of total cost unless it’s done in a drastic manner that angers the entire health profession. This approach includes: reorganize operations, streamline paperwork, digitalize medical records, reduce wastes, solar energy for hospitals, even hire doctors and nurses from developing countries to save cost.
As far as the US is concerned, price control is almost out of the question. Increasing efficiency only benefits the companies because they will not pass on the savings to the consumers. The main problem has less to do with management but much more to do with politics, corporate power, and culture.
It is not hard to see how much power drug and insurance companies have over the US government. The following facts illustrate:
Most US lawmakers depend on the drug and insurance industries for campaign donations. They owe the industries plenty of favors once being elected to office.
Both industries routinely make tremendous profits while health care costs skyrocket. While consumers complain, the lawmakers remain silent because they are with the other side.
The so-called Prescription Drugs for Seniors introduced by President Bush in 2005 costs over one trillion dollars. Despite its benevolent name, it is a favor extended to the pharmaceutical industry where the government subsidizes prescription drugs for seniors at whatever prices the companies want to charge.
In the health care reform bill introduced by President Obama in 2010, the Public Option was dropped. The Public Option would have enabled the government to operate an insurance program to compete with private insurance companies to drive down costs. But the powerful industry has mustered enough opposition in Congress to shoot it down.
Regarding the cultural problems, the following facts illustrate:
Americans are accustomed to fix and cure more than prevention and wellness. If the opposite is true, tremendous health savings will materialize because prevention means seeing the doctors less.
The health profession operates on the wrong incentives. Doctors are paid by quantity of work rather than quality. Nurses are paid by the hours. Hospitals charge fees by the day and how much materials being consumed during stay. Drug companies urge doctors and patients to use more drugs. As a result, too much unnecessary work is performed regardless of benefits to the patients. The patients do not care how much is charged because insurance will pay for it. But they do not realize that the insurance companies will come around and demand higher premiums.
The lawyers play a part in cost inflation, too. They help those patients who happen to suffer from medical mistakes to sue for tens of millions of dollars in compensation. As a result, few doctors can afford to practice on their own because the malpractice insurance is so high. In addition, doctors are encouraged to practice defensive medicine to protect them against a possible lawsuit. For instance, when a patient has a cough or skin itch, the doctor tends to order an X-ray, a biopsy, a blood test, maybe some other tests too, just in case he may misdiagnose and invite a lawsuit. This unnecessarily raises laboratory cost. Some legislators have proposed setting a maximum for malpractice compensation to reign in cost, but the proposal was shot down due to opposition from the law profession.
It looks like these deeply entrenched political and cultural problems cannot be solved. The consequence is more and more people unable to afford health insurance. At the same time, the insurance companies are losing market share because of people dropping out due to high cost. The insurers will respond by raising premiums again, which will in turn cause more dropouts. The government is paralyzed due to opposing forces coming from all sides when it tries to do something. The situation is expected to worsen until a new threshold is reached. Perhaps by that time, something drastic will happen.