Charlie Martin: You can’t fight arithmetic. This is a long excerpt from an even longer article so feel free to skip it (blog posts are supposed to be brief), but I think he makes some excellent points that are very much relevant to the current national discussion.
The way to interpret that is: if you sell enough insurance policies to people with the same characteristics, the insurance company can expect to pay out about R dollars for every $100,000 worth of policies sold. I just went online, and as a 58-year-old man with diabetes, the best rate I found was $495 a year. That would actually be a little more than the actual risk; insurance companies need to have some room for runs of bad luck, and they need to have some margin over that to pay for all those people running the insurance company and some profits for the stockholders. (Which, contrary to what you hear from the usual suspects, isn’t very large — Aetna, for example has profits between 2 and 6 percent.) So the real premium for a term life insurance policy is a little more than just the expectation value. How much depends on a whole bunch of things, so let’s just say x. Your total premium is going to be R+x and we know x > 0.
When we look at what we call health insurance now, though, that all breaks down, because many of the things that are covered happen — colds and flu, childhood illnesses, and so on — with probability near 1.
Guess what? If P is about 1, that premium is going to be the total cost plus x. Always. No matter what.
We got away with the current scheme for as long as we did because, dating back to Harry Truman’s administration, we let companies buy their group health insurance using pre-tax dollars. In other words, they got a pretty substantial discount for buying health care for their employees instead of paying them more.
Now, when you give people an incentive like that, they’re going to do more of it; what used to be “major medical” starts adding regular doctor visits and such. At the same time, the insurance companies want to control their costs, so they started adding more administration to the whole thing. That increases x but it doesn’t change the relationship.
What does change the relationship is that we start to run into something Milton Friedman called “Gammon’s Law,” which originated with a study of Britain’s National Health Service done by Dr. Max Gammon. Friedman called it the Theory of Bureaucratic Displacement:
In a bureaucratic system, increases in expenditure are paralleled by a corresponding decrease in production.
Translated from the economist-ese, that means in a bureaucratic system, the more you spend on something, the less you get of it.
Gammon’s original work in which he identified this found the correlation was very nearly perfect: as the number of pounds spent on the National Health System increased, the number of hospital beds declined. The correlation was -0.99.
Aside: for those of you who don’t eat and breathe statistics. Imagine you have a loaf of sliced bread. You weigh the bread, then take out a slice, then weigh it again; keep taking out slices of bread and re-weighing.
The correlation between the number of slices taken out, and the weight of the remaining bread, will be around -0.99.
Why does this happen? There are at least a couple of reasons. As more money goes into the bureaucracy, there’s more pressure to make sure it’s being spent well, which means more forms, more auditors, more independent review boards. All of that takes time and money, and that time and money are being taken away from what used to be the goal.
The second reason is that as administration develops, it becomes its own constituency. Administrators are more important that the people doing the work — they must be, right? I mean, they’re the managers. Administrators get paid more, and in a bureaucracy, administration is the route to higher pay, better offices, and more perks. What’s more, the people doing the work have to do more work to support the administrators. Doctors are seeing that now — new record-keeping requirements, from HIPAA to electronic record systems.
The upshot, though, is that once a system becomes bureaucratic, adding money makes it worse.
So, the current plaintive cry from the Left is “what have you got to replace it with?” I’ve got to admit that my instant reaction to that is “if you’re doing something stupid, then replacing it with not being stupid isn’t a bad thing.” But we can actually make some sense of the question if we instead ask “what can we do with health care where the arithmetic makes sense?”
Here are some ideas:
- Let everyone buy health care with pre-tax dollars.Right now, if you have a corporation buying your health “insurance,” they can call it an expense; it comes out of the pocket before it’s taxed. If you’re buying it as an individual, though, you buy the insurance with after-tax dollars, which means that you’re automatically paying more. Often much more.The “flexible spending account” was one solution to that — you could at least put away enough money to cover your deductibles and any expenses you expected with pre-tax dollars. It wasn’t a great deal, because you had to guess right — anything that was left at the end of the year went back to the government.So, instead, let’s do this: You can put whatever you want into a flexible spending account, which can only be spent on healthcare items, just like an FSA now. Oh, we’d let you spend it on over-the-counter drugs too, something they took away from FSAs a few years ago.If you haven’t spent it all at the end of the year, it stays in your account. You can adjust your contribution if you need to. You keep the FSA in any bank you like — and if you don’t like the bank’s policies, you can move your account any time. Yes, the account pays interest, and that’s not taxable either. (Idea: this is also a retirement account; you can start withdrawing cash at age 65 and your heirs get the leftovers if you die.)
- Let everyone buy whatever insurance they want, with one exception (that’ll be point 3.) Open market, and you pay for it with your FSA from point 1.
- Establish a minimum acceptable standard for a basic major medical plan. No daily health care, no mandated chiropractic. Everyone has to have this. Yes, a mandate. The differences: first, you pick the plan you like. If you want fancier insurance, it costs more, but everyone has to have at least the basic plan. If you don’t make enough money to afford it, okay, you get a subsidy. You still pick the plan you like on an open market.
So now, what does this scheme do? First of all, it restores something like competition, and removes insurance companies from the day to day payments to medical providers. You pay them out of your FSA using a debit card. If you want to see a “concierge doc,” you can, and you pay them effectively in cash. If you don’t use up all the money this year, you can cut your contribution next year — that’s more cash in your pocket and an incentive not to spend more than you have to. There’s no insurance company doing the paperwork, just a bank making sure you’re charging an authorized item.
If the insurance companies want to stay in the loop, then they have to provide some useful service — helping you find better docs, or negotiated discounts, or something. As it stands right now, they have almost no incentive whatsoever to try to provide better service.
Second, it means freelancers and small businesses are now on a level playing field with big companies. Everyone is using pre-tax dollars, and if a union or whatever wants to negotiate a subsidy to be added to your pretax account, then it can. Maybe there’s a limit on the amount, maybe not.
Whatever solution we look for though, the really important point is this: the whole basis of Obamacare, the notion that we can have more people, getting more benefits, and pay less, is just impossible. The arithmetic doesn’t work. And if you think that’s “unfair,” I’m sorry.
But arithmetic isn’t sorry. Arithmetic doesn’t listen. Arithmetic doesn’t care.