Code Red: Two Economists Examine the U.S. Healthcare System

August 24, 2012

A Tale of Two Systems

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 8:44 am

It was the worst of systems. It was the worst of systems.

For decades, policy analysts have debated how we to strike a proper balance among access, quality and cost in our healthcare system. This debate has missed a crucial point: we do not have one healthcare system, we have two. And both are broken. Fortunately, if we fix one the other may heal itself.

The first system is the one that we encounter when we seek treatment for an illness. This system defines how much we pay out of pocket, which depends which providers we seek and what treatments they deliver. This system also defines how much our providers are paid, including rewards for exceptional quality and penalties for substandard quality. Historically, patients have relied on their physicians to guide them through the complexities of this system. In recent years, supporters of consumer-driven healthcare have argued for a bigger role for patients. They make the important point that patients will never make a serious effort to balance access and quality against cost unless they are responsible for all three.

In the previous two blogs I described the vast inefficiencies in the first system. Demand inducement, the imperative to use any and all medical technologies, and the absence of any competitive pressures for process innovation, have combined to give us decades of runaway costs. Patients pay such a small percentage of the medical bill that they do not seem to care. Some policy analysts would force patients to pay a larger share of the medical bill, but there are limits to how much we can experiment with patient cost sharing without exposing some patients to excessive financial risk. Within the first system, patients will never feel equally responsible for access, quality and cost. Cost will always take the back seat. And so unless we take a top down approach (i.e., a single payer system), we can never hope to control costs in the first system.

Our efforts to contain costs must address the second system. This is the system we encounter once a year when we choose our healthcare plan, and in doing so choose the rules that govern the first system. If we want wide access to providers, fee-for-service payments, and minimal oversight of physician decision making, we choose a large network PPO and pay a high premium. If we want to join a system where moral hazard is mitigated by big deductibles, we choose a consumer driven health plan. If we want a system that reverses the perverse economic incentives of fee-for-service medicine (perhaps introducing a different set of incentives), we join an HMO. We can choose plans that include the top-ranked providers as listed by U.S. News, Healthgrades, or some other ranking, and we can choose plans that have strong pay-for-performance incentives.

In the second system, we as consumers get to decide how the first system will work for us as patients. The second system provides consumers patients with an opportunity to make explicit tradeoffs between access, quality, and cost. If consumers really want less costly healthcare, we can vote with our wallets in the second system.

Unfortunately, as things stand even the second system does not force a full reckoning of costs, as this would require breaking down some institutional barriers. The most obvious is tax subsidy for health insurance. If consumers consider the tradeoff among cost, quality, and access and opt for lower cost, the federal government shares in the savings. What consumer wouldn’t put less weight on costs in this situation? Employer-sponsored health insurance also corrupts this second system. Most employers offer their employees just one health plan, in effect forcing all employees to accept the same balance of cost, quality and access. We can debate whether employers take their employees’ point of view when seeking this balance, or whether they put too much weight on costs. Either way, this one-size-fits-all approach doesn’t make sense. When employers do offer a choice of plans, they usually do not require employees to bear the full additional cost of the more expensive plans. Again, cost takes a back seat.

We can easily address these problems. Limit the tax deduction to the value of a low cost plan. Implement exchanges for all Americans and extend them to Medicare. Alain Enthoven promoted these ideas in the 1970s. Health economists have embraced variants of Enthoven’s plan ever since. Nearly 40 years later, hasn’t the time come for these sensible reforms?
Republicans are on the defensive right now thanks to the recent spotlight thrown on the Neanderthal wing of the party. But Romney and Ryan have a chance to steal the healthcare momentum from Obama. The health insurance exchanges in the Affordable Care Act takes some steps to fix the second system, at least for the ten or twenty million Americans expected to use them. But the ACA keeps the tax deduction for employer-sponsored insurance and keeps the top-down system for Medicare. Ryan has given serious thought to the Enthoven reforms. He has proposed a version of exchanges for Medicare and should state that if President Obama believes that exchanges are good enough for 20 million Americans, then surely exchanges should be good enough for all Americans. Ryan has also said that he will balance the budget by limiting several tax deductions and I suspect he means to include the deduction for health insurance. Make this explicit. Limiting the deduction for health insurance fits with the argument that Republicans are taking the long view.

As far as I can tell, Romney has given no thought to any of this; if ever he was going to show that he is a serious candidate, now is the time to do. He should make reform of the second healthcare system a central theme of his acceptance speech at the Republican National Convention.

If we can reform the second system, consumers will face the proper balance of incentives. For the first time, cost will matter as much as access and quality. But it will not be sufficient to get the incentives right. Cost sensitivity without quality control will create a race to the bottom. Insurers and Medicare are already making limited use of quality metrics in the first system. But consumers have so little skin in the game that the amount of money involved in pay-for-performance incentives has been very limited. Even so, providers have complained about even the skimpiest of incentives. (Witness the uproar about Medicare’s proposal to reduce payments by one percent to hospitals with excessive readmission rates. One percent!) Consumers tend to take the side of their providers in these arguments, but might not do so if it was their own money at stake, which will happen if we reform the second system. Fortunately, we have made sufficient strides in quality measurement and risk adjustment that we can credibly measure the quality of our alternatives in the second system. We are finally ready to truly reform our two healthcare systems.

When I return from a short vacation, I hope to finish this series of blogs about health reform. The title of my last blog: Great Expectations!

Blog at

%d bloggers like this: