The Four Components of Healthcare Spending: Thoughts on Healthcare Reform

Yesterday Darshak Sanghavi has a great Slate article about the Massachusetts Health Reform Experiment. Dr. Sanghavi found that people had medical coverage, but the deductible [the part that you pay before insurance kicks in] was so high that the working poor, who are the target of the healthcare reform movement today, ended up right where they were, skipping and skimping on expensive medical services. He fears that we Americans will end up with the same result, lots of money spent with no change in outcome.

The American medical system is state of the art, yet we have many systemic problems: MediCare, that legacy of the Great Society, is driving our Federal government into bankruptcy. Healthcare spending is going higher and higher, yet our physical wellness ranking is at the Third-World level. The poor and rich are covered, but the middle class is finding medical care increasingly unaffordable. The United States is facing severe pressures, but we are not alone. Other public health care countries are experiencing greater-than-inflation healthcare increase as well, as a result of an aging, diabetic population.

To clarify our thinking and understand our objectives in healthcare reform, I will break up our healthcare spending into four different categories. Each of these four categories have different economic characteristics, which means that we really should devise four different policies to target each of the four sectors.

The four sectors are:
1.) Preventive and Maintenance Cost
2.) Accidents & Infectious Diseases
3.) Chronic Conditions
4.) Pharmaceutical Cost

1.) Preventive and Maintenance Cost: This category covers the general prevention and maintenance treatments we all are supposed to have: Annual Physicals, Vaccinations, Physical Exercises, etc. An ounce of prevention, and all that. This sector is fairly low cost and foreseeable. Public health science has figured out a schedule of vaccinations everyone should get. Everyone should get annual physicals to catch problems while they are cheap to treat. Inexpensive physical exercises will minimize expensive Type II diabetes down the road. This category is where we can group together to exploit monopsonic leverage. We know exactly what we need. Doctors know exactly how to provide the services. We can put primary care providers on a salary to meet this need. This cost category is amenable to a government solution.

2.) Accidents & Infectious Diseases: This category covers trauma medicine/surgery and infectious diseases. Sometimes we catch the flu. Some of us get into car accidents. We cannot drive these probabilities to zero, but actuarial modelling allows us to budget for this cost category well in advance. This category is the "Insurance" part of health insurance. At the same time, we can use risk management techniques to control this cost. For example, enforcing handwashing in schools and airports can vastly decrease the severity of our annual flu outbreaks. The individuals and families opposed to vaccinations can opt out of vaccines, but they should have to pay more money for increasing disease transmission, and hence, our overall financial burden in treating infectious diseases. People who have a history of STDs, for example, should have to pay a higher insurance premium for engaging in risky behavior. Same thing goes for speeding and drunk driving: Reckless driving is the 6th killer in the United States, ahead of firearms and STDs. In addition to stiff traffic tickets, higher insurance premium for risky drivers is only right to responsible drivers everywhere.

This cost sector is not exactly suited to a government solution, because there would be too much political pressure to lower the insurance premiums for the speeding drivers and irresponsible vaccine opponents. A regulated insurance industry is best in this case: You get sick or in an accident, you get paid for the treatment, depending on your insurance coverage. The more responsible you are, the cheaper your premiums. The ones with the Need for Speed and vaccine opponents can opt out of insurance. It is their choice to engage in risky behavior, but we do not have to pay for their resulting medical needs. Actuarial incentives might even encourage responsible behavior, just like car insurance. Universal coverage is not a good policy for this cost category.

3.) Chronic Conditions: This category covers chronic, non-infectious diseases like cardiovascular diseases and diabetes. This cost category is one of the two main drivers for our runaway medical spending in the US [the other being drugs]. I will limit my discussion here to the non-pharmaceutical treatments, because drug is so big it needs its own cost category. So MRI, dialysis, specialty surgeries, etc, fit into this category.

This category is fairly predictable for the ones who suffer from these conditions. The treatment options are fairly standardized; doctors and hospitals are always sharing their best practices. However, our aging population have increased the input into this cost category: old people. Ironically, our success in anti-smoking campaigns have increased our spending on chronic conditions.

Here our course of action is more nebulous. Insurance is not exactly the right model here, because all of us will end up with cancer if we live long enough. Some government subsidy will help people to afford this care: MediCare, for example. Personal savings will help some people to get treatment. We can have government pay for everything here, but we know for sure that Medicare will exceed our federal budget by 2075, if we keep on the current course.

One option is to increase our use of hospice care. For example, this study found that last-year-of-life expenses constitute 22 percent of all our medical expenditures. If we can minimize expenses for terminal patients, we will have that much more money to improve infant mortality. Given the AARP, I don't expect we can take money from old people to give to babies, but that is an option.

4.) Pharmaceutical Cost: Drugs are getting more expensive everyday. We've all received those internet pharmacy emails promising cheap drugs from Canada and Mexico. Here the problem is based on the business model of the pharmaceutical industry: The companies spend years and millions of dollars to shepherd a drug through our regulatory gauntlet. They recoup their investment by holding a high price here during their patent years. In other countries they sell the drug at a lower price to compete with copy-cat drugs and to generate demand.

The pharmaceutical industry raises the valid concern that, if we mess with their business model, we will have many fewer drugs reaching market. The drug companies have been responsible for much of our medical innovations this past century. Despite occassional safety concerns, these drugs have been effective in treating their target conditions.

For this cost category, a combination of practices may help control the cost without the unwieldy clubs of government regulation. For example, universal physical training will reduce the incidences of diabetes and cardiovascular diseases, reducing demand for the currently profitable blockbuster drugs. The expansion of hospice care will reduce demand for these drugs as well by decreasing life expectancy. Patients can encourage doctors to prescribe generics where possible [coinsurance would maintain the generics incentive for the patients] .

Some people have pushed for universal drug coverage as part of the universal healthcare reform. However, I fear that the pharmaceutical industry will band up with the AARP and push for ever greater drug subsidies, distorting market incentives and bankrupt the Federal government.

Ob/Gyn & Reproductive Care
The OB/GYN sector has experienced tremendous cost growth this past century, with the increased maternal age causing more complications(twins, etc), spreading popularity of c-sections driving up expenses, and declining fertility (from maternal/paternal aging) demanding more reproductive assistance. This growth in cost has come with an unfortunate increase in infant mortality, due to increased premature births. [Twins and triplets are more likely to be born prematurely. Maternal complications also increase premature births.]

It is important to control our OB/GYN cost because babies are our future. Their productive potential is much higher than the potential of our Retired Persons. At the same time, the OB/GYN cost growth is in part driven by societal changes, not medical advances. Therefore, healthcare reform is not the whole answer to fixing our OB/GYN sector.

If families are postponing births due to career plans, they should increase their savings to account for the cost increase from advanced maternal age. For this particular segment, perhaps a tax-deferred savings plan is the answer. For example, mothers and fathers can draw on their IRAs and 401K's tax-free and penalty free, to pay for birth/reproductive expenses. This will give young men and women a concrete reason to save money, as opposed to that nebulous retirement 40 years away.

The recent rise in twins, triplets, and beyond, is linked to increased maternal age, and correspondingly, IVF practice of multiple implantation. IVF multiple implantation is risky to the mother and disproportionately stressing the OB/GYN sector. Correspondingly, a national healthcare system should not cover multiple implantation on cost concerns. This is a scenario where personal finances, rightly, should be the driver.

Conclusion:
Given the above analysis, the AARP is emerging as a grave threat to our fiscal health. As I am counting on that Army pension to finance my retirement life, I cannot support healthcare reform when the Federal government is already wasting 30% of its Medicare money. I hope that my four categories have helped you understand better our current healthcare reform debate. Please let me know of any improvements we can make to this four component cost model.

PS: See my following post about expanding healthcare access through public financing.