Featured Discussion: Understanding American Health Care: A Conversation with Christopher J. Conover

NOTE: discussion edited and revised for clarity and accuracy.

MR. PAUL HOWARD: Today, I'm talking with Christopher J. Conover, a Scholar at Duke University's Center for Health Policy and Inequalities Research and an Adjunct Scholar at the American Enterprise Institute. He's also News and Notes Editor for the Journal of Health Politics, Policy and Law and the U.S. Health Policy Gateway. We're going to be talking about recently published and extraordinarily informative book, American Health Economy Illustrated. If you're looking for a single, easy to understand compendium of facts on the American health care system, look no further. For a health policy wonk, it's a real joy to read. Chris, thanks for joining us today.


PH: Chris, I'd like to talk about a few of the more interesting tables in your book, and how they debunk some of the common myths that both the public and policymakers often repeat about the U.S. health care system.
To start with, I think that one of biggest myths or misunderstanding is that if the U.S. was just to become more like our European cousins in terms of how the government pays for health care, many of the woes of our current system would just go away.
It is certainly true that there is a lot of waste in the U.S. system. But when you look at the U.S. system compared to our OECD competitors, there's a very interesting wrinkle in terms of how the U.S. compares in terms of out of pocket spending Could you talk about that for a moment?

CC: Well there is a concern that the U.S. health system leaves people to the wolves, by exposing them to very high health care costs. But, surprisingly, among the 20 largest economies in the industrialized world, the U.S. actually has the fourth lowest share of health spending that is paid for out of pocket, at just over 10% of all health spending. Now this is in spite of our having 50 million uninsured. In reality, even among people who are uninsured the entire year about two-thirds of their health spending is actually paid for by someone else whether it be government programs coming in to backfill the difference, or providers who simply write off their expenses as charity care, and that sort of thing.
That's much different than in Switzerland which has universal coverage but where the average citizen pays more than 30% of their health spending out of pocket. And I think that Obamacare's framers mistakenly thought that the problem was not enough insurance, but in reality most Americans have too much health insurance and that is the principal reason we have excess health spending in this country.
From my point of view we could replicate the pathologies of the American health care system in any other industry simply by introducing third party coverage. So for example if I offered to pay 90% of whatever you put into your grocery cart, what do you think would happen? You know what you bought would change. You'd be buying more steak and less tuna presumably.

PH: Filet mignon every night.

CC: Exactly, but the prices that you paid for would also be that much higher because you'd be price insensitive. And if most people had food insurance of this sort, then grocery stores would soon begin to offer more expensive food and would end up competing on the quality of their service rather than price and that's exactly what we see in U.S. healthcare system.

PH: So there's this perception that in a lot of other healthcare systems, that are at least a single payer or that have universal coverage schemes, that consumers don't pay anything out of pocket but you show that just the opposite. Consumers still pay very significant amounts of money; as in the case of Switzerland, 30% of out of pocket spending, which creates another check on healthcare's utilization. Is that fair?

CC: Right. Having some higher out of pocket exposure actually is a good thing as long as we're covering catastrophic costs with insurance. That's what insurance is really for, not paying for routine expenses that consumers can afford to pay themselves.
Ironically, we're making the same mistake in higher education. College tuition actually has increased at twice the rate of healthcare costs over the past 25 years and we think the solution - in terms of affordability - is greater government subsidies rather than relying on competition to hold down prices and costs.
In the few places of the healthcare system where we do allow market forces to operate and there's very little insurance, things work much more like normal markets. For instance, we see fierce price competition for services like Lasik eye surgery, resulting in lower average prices and much higher quality over the past decade.

PH: People assume that healthcare is inherently different from other sectors of the economy, at least in terms of complexity. But in other sectors of the economy you do have extraordinary complexity. You mentioned the example of Lasik. We could also talk about automobiles. I have only the faintest idea of how modern cars work, but that doesn't mean I can't be a good consumer in that market.

CC: Computers or consumer electronics would be another good example. Those are very complicated products, and yet people buy them easily every day.

PH: The nuance, I think, is that having consumers in the market creates competition among sellers to drive costs down and compete for market share. You don't have to be an electrical engineer to buy a good computer because Dell or Apple will market and sell a bundled product that's affordable based on a few key features that consumers can understand.

CC: In health care we see the opposite forces at work. At the end of the day, Obamacare not only extended coverage to the uninsured but it also made coverage more lavish for everyone else who already had too much insurance to begin with. So now we've got free preventive healthcare services, including contraceptives. That makes as much sense as requiring auto insurers to cover the cost of putting gas in your car. If we did that it would make consumers less cost conscious about buying things like gasoline and it would add a completely avoidable administrative cost of maybe $10 or $15 per claim that simply drives up the costs of insurance. That really doesn't make sense but that's the direction Obamacare took us.

PH: Or take the rule that insurance companies had to cover children under 26 as dependents on their parents' policies. As a rule, insurers are happy to cover that population because they are very healthy and cheap to cover. So they have a higher profit margin for that population. They weren't covered before because consumers didn't want to pay for the added cost of covering a very healthy population. And because they wouldn't pay, the insurers didn't routinely offer that type of coverage.

CC: I would say that everyone needs catastrophic coverage, including young people. But the problem is Obamacare is encouraging very, very comprehensive coverage. That's going to end up increasing the cost of healthcare in the U.S. In that sense, the Affordable Care Act is very false advertising. It's really the Unaffordable Care Act.

PH: There seems to be a growing consensus on that point, at least from the data that I've seen from places like the Congressional Budget Office. Obamacare is going to increase the cost of insurance for many people. Subsidies will also increase, but this is just shifting costs in the market in terms of the premiums (from older to younger insured), or from policyholders to taxpayers.

CC: Absolutely, right.

PH: The other myth that I'd like to talk about is the idea that runaway health care costs in the U.S. are driven by greedy, for-profit companies. One day the villain is the greedy insurance industry, another day it's the pharmaceutical companies. And so if the problem is profits or greed, if we could just reduce or eliminate the profit margins for these companies, health care costs would decline. And Obamacare actually tries to do this through something called the "medical loss ratio" which limits the profits that insurance companies can make on their policies.
In your book, you look at profit margins for health insurance companies compared to other industries. How do they really compare?

CC: It turns out that no matter how you measure profits, (return on revenue, return on assets, or return on equity) the profits of health facilities and even health insurers are basically in the middle of the road among all industries in the U.S. So the return on revenues for health insurers, for example, typically ranges from 3% to 6% and that puts the industry in the lower half of earnings among all industries across the country.
Now admittedly the earnings for pharmaceutical companies typically put them in the top five industries in the country, but you need to remember that the patent system deliberately gives them a time limited monopoly over brand name drugs to encourage them to invest in R&D which they do to the tune of tens of billions of dollars a year.
And the CBO has looked at the profits in the pharmaceutical industry and they've concluded that once you take into account the riskiness of that businessbecause the cost to bring an average drug to market is in excess of a billion dollars--the profits in the pharmaceutical sector turn out to be comparable to the rest of industries in the U.S.
The really silly part is that policymakers are obsessed with non-profit insurers and health systems. More than half of the revenues in the health services industry are already from public or non-profit facilities.
All told, health insurance company profits account for about 1% of U.S. healthcare spending. This means we could wipe out profits and we'd end up saving one cent out of every dollar we spend.

PH: If you took this to its logical conclusion, you'd assume that Wal-Mart shouldn't exist. Profits don't drive higher prices per se. Firms maximize profits through a variety of strategies including offering lower prices or better services. Profit maximizing behavior in a competitive market actually increases consumer welfare, right? That's what we see with Lasik, where there is a true consumer market for the product.

CC: Yes, right. Obamacare was designed by people who mistakenly believe there is too much profit in medicine and it needs to get squeezed out. So there was this fierce fight over offering a public insurance option, and implementing the medical loss ratio restrictions on insurers, which are basically price controls. And like most price controls, they've already had an adverse effect on the market by encouraging some small insurers to exit the market entirely. On the other side, the law is encouraging accountable healthcare organizations (ACOs), which have been designed largely to bypass those health insurers, which you will remember the President vilified repeatedly during the debate over passing the Affordable Care Act.
But limiting profits and dictating firm organization is likely to decrease innovation and competition. As my AEI colleague, Scott Gottlieb, has pointed out, ACOs likely are going to end up being local hospital monopolies that drive up prices and may jeopardize quality.
We've got very solid empirical evidence that competition among hospitals is welfare enhancing up to about four facilities in a given geographic area. And when I say welfare enhancing I mean that it produces lower prices and/or better quality of care.
Yet ACOs move the system in the opposite direction by encouraging consolidation into more local monopolies. Moreover, the ACOs are designed to favor hospitals which don't exactly have an inspiring track record of promoting innovations and improving patient care. For instance, they've had an abysmal record on preventing hospital acquired infections.

PH: Some firms, however, do seem to have solved the riddle of offering high quality care more efficiently.

CC: Right and then the real irony is that the organizations you're referring to, like the Geisinger hospital system, the Mayo Clinic, and Kaiser were the models for Obamacare's ACOs.
But the regulations for ACOs are so complicated that these organizations weren't interested in becoming an official ACO. Obamacare's architects were well intentioned, but you can't mandate a firm's culture or management any more than you can mandate that every software company become Google.
Once government gets involved in healthcare markets it has a great propensity to draw the wrong lessons from the right examples.

PH: Speaking of which, even in a best case scenario, even if the health law reform works exactly as intended with no perverse consequences, the financial scenario for the country is still pretty grim, right?
CC: That is what's so scary. CBO has projected that even under Obamacare the federal government is going to grow 41% over the next 75 years relative to its current share of the economy. Every penny of that increase is going to be related to growth in health entitlements, i.e., Medicare, Medicaid and new exchange subsidies. This is par for the course.
From 1967 to 2007, as I show in my book, every penny of the increase in the size of federal, state and local governments as a share of the economy also could be attributed to growth in tax financed healthcare spending. Now I calculated that within 75 years the unfunded liabilities for entitlements will end up amounting to about one-third of payroll. That means we'd have to triple current payroll taxes or get the revenue equivalent from other taxes in order to finance this shortfall.
Now upper income earners already make up the lion's share of federal taxes, so there's no way to load all of even most of this added burden onto them.
We're either going to have to cut healthcare costs really dramatically or we're going to have to impose very damaging levels of taxes on all Americans. Forget about protecting the middle class, that's just impossible under the current scenario.
And economists also recognize that taxes can be very damaging to the economy. According to Obama's former economic advisor, Christina Romer, every 1% increase in taxes as a share of the economy results in a 2% to 3% decline in GDP.
So when the CBO says that the absolute size of the federal government is going to grow as a share of the economy by 9 percentage points over 75 years, that is very, very scary to contemplate, because it implies close to a 30% loss of potential GDP.

PH: The President launched health care reform by way of saying that we've got to bend the curve of U.S. healthcare spending. It's just unsustainable.

CC: Right.

PH: But even if we could shift enough tax revenue to fund current entitlement spending, all you're doing is taking money out of more efficient and productive U.S. industries to fund what everyone - on both the left and the right - agrees is a deeply dysfunctional health care industry. And the President has only proposed very modest Medicare reforms and basically said he's taking any Medicaid reforms off of the table. Presumably Obamacare is untouchable too. Where does that leave us?
CC: Not in a very good place economically speaking. Historically, we have had a huge advantage over our competitors in Europe because we have had relatively low levels of taxes - i.e., government took a much smaller share of GDP.

Progressives will argue that the U.S. is severely undertaxed. But high levels of taxation, at the margins, are very damaging economic growth. That's just the tradeoff you face. Unfortunately, projected increases in tax financed health spending over the next 50 years is going to be so large relative to our competitors that the U.S.'s comparative advantage is going to largely disappear.

Now, other advanced economies are going to have to increase their tax financed health spending to keep up with demographic changes from aging populations. That's true. But the U.S. is going to have a much bigger relative problem because we're starting from much lower level of tax financed health spending to begin with.

In my book, I show that the growth in tax financed spending as a share of the economy is going to more than wipe out our current margin of advantage over these other countries in terms of our having a low relative level of taxes compared to GDP. So that means that in the future we can't count on faster growth to keep ahead of our competitors. We're going to be just in the same boat as they are with slower growth and fewer economic opportunities for all Americans, but particularly for lower-income Americans. I think that's a problem that progressives should be more worried about than they appear to be today.

PH: Another interesting thing I learned from your book is that between 1993 and 2010 the relative burden of government in several of our key competitors went down, for instance in Canada and Germany. For the U.S., the burden is going up.

CC: We're moving in the opposite direction.

PH: Let's wrap up where we started. Most Americans think that more insurance is better insurance. They think health care spending is, or should be, a free lunch that someone else pays for. But that money is coming from somewhere: from lower salaries, lost job creation, future economic growth. How do you change that perception? Until we change that perception the prospects for fundamental change in policy look very, very poor, right?

CC: Honestly, I'm not sure how to change that perception. What I do know that if we want to contain the size of government, and continue to have robust economic growth, the only way to do that is to contain growth in health care costs. President Obama is basically taking us in the opposite direction. Politically, my view lies with analysts like with Jim Capretta and Jeffrey Anderson, who have recently put out a great article saying Delay, Repeal, Replace. Delaying Obamacare's implementation might give us enough political breathing room to repeal most or all of the law and then implement a much more market oriented vision, where we put power into the hands of patients to make choices instead of centralizing all of that decision making power in Washington. We've got plenty of evidence that when Washington centralizes control of markets we get lots of unintended consequences. Health care is just the latest case in a long procession.

PH: That's a good place to wrap up, I think. Chris, it's been terrific talking with you, and I highly recommend, American Health Economy Illustrated. Whether you're on the left or the right, it's an indispensable resource for understanding the American health care system.

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