Why Does Healthcare Cost So Much in the United States?

Most Americans believe that we should have a healthcare system that provides care to all of us. We do not have such a system, and one of the reasons we do not is that our healthcare is too expensive. Healthcare in the United States costs far more than healthcare in other developed countries but does not deliver better results. Books have been written to answer the question of why our system is so expensive, and in this article, I have tried to summarize their findings in a useful way.

There are five fundamental reasons why our healthcare has become so expensive, and they are:

1.       The enormous advances in medicine that have taken place since World War II have pushed up the price of healthcare.

2.       Our third-party payment systems were introduced and later modified without planning or effective cost controls. They pay “fee for service” for healthcare in a fragmented and uncoordinated market. 

3.       Healthcare organizations and medical practices have come to be governed by a business ideology that gives priority to maximizing revenue and market share over all other goals.

4.       Our system does not contain incentives for patients to make good use of primary care or to adopt health lifestyles. Health care providers are paid for treating sick people rather than for keeping them healthy.

5.       Our government has intervened in the healthcare market in ways that were badly thought-out and distorted by politics.

Advances in Medicine

Healthcare is expensive in all countries because modern drugs and medical procedures are expensive. Improvements in pharmaceuticals, in anesthesia, in diagnostic techniques and in surgery that have been made since WWII have made it possible to cure diseases that we could not cure before that time, but those advances have come at a cost.  We must recognize that if we want to have the medical science of the twenty-first century, we will have to pay more for healthcare than we did in 1940.

However, not all of the cost of healthcare in the United States may be accounted for by the advances in medical science. The process of innovation in medicine has interacted with the other four causes to inflate our healthcare costs far beyond those faced by other countries.

  

The Emergence of Third Party Payment without Planning or Cost Controls

Employers began to offer health insurance during World War II because wartime wage controls prevented companies from offering higher wages to attract employees in the tight wartime labor market.  After the war, health insurance gradually became a standard part of the benefits that large companies offered to their employees, and most Americans now expect that most of their medical bills will be paid by health insurance that they obtain through their jobs. Furthermore, this became a tax-exempt form of income with the tax reform act of 1954.

Health insurance or any system of third-party payment changes fundamentally the nature of competition in the healthcare market.  If I am sick and have good health insurance, I do not care how much it costs to cure me. I want the best care delivered in the most agreeable way, and therefore, a hospital seeking my business focuses on providing all of the latest technology and on making its patients as comfortable as possible. So, we have a private room for every patient, and we have too many MRI machines or CAT scan machines in each community. These investments have to be paid for, and because the hospital’s bills are paid by insurance companies rather than by the patients, the hospitals in many communities can simply raise their prices.  The ability of hospitals to raise prices has also been enhanced by the emergence of large hospital and clinic chains that dominate local healthcare markets.

Third-party payment creates similar incentives for pharmaceutical companies. They concentrate their research on drugs that will bring high profits, and they raise prices to inflate those profits. The patients of course want the latest and greatest drugs to cure their illnesses, and they do not care about cost when they do not have to pay.

The effect of third-party payment is magnified for doctors by the “fee for service” payment model.  When doctors are paid a fee for each service that they provide, they can increase their incomes by providing more and more services, even when the services do not help the patients, and if the patients do not care how much they are charged, the opportunity to bill for unneeded services is greatly enhanced. So, we find doctors performing unnecessary tests and unnecessary surgeries.  

In addition, the doctors find ever more creative ways to bill for their services in order to maximize their incomes. For example, they use “physician extenders” like nurse practitioners or physician’s assistants, and the patient is billed both for the time of the extender and for that of the physician who “supervises” her. 

The insurance companies resist these trends, but their resistance is weak and uncoordinated. Because of anti-trust law, they do not band together to negotiate with the hospitals. Instead, each insurance company negotiates as it can, but the companies individually are often not strong enough to hold down prices. To save money in this situation, the insurance companies have adopted several strategies. First, they employ people to scrutinize each claim in order to deny any claims that they can deny. Second, they raise the price of the insurance they sell.  Finally, they sell policies with high deductibles and co-pays to encourage patients to choose the most cost-effective treatments.

As prices of both healthcare and health insurance keep rising, patients are less and less able to afford their insurance and more and more people are uninsured. Those who are insured find that as deductibles and co-pays rise, the insurance covers an ever smaller share of their medical bills.

The distorting effect of third-party payment is magnified by the fact that often neither doctors nor patients know the prices of drugs or medical services, and information about prices is very hard to obtain for several reasons. First, each insurance company negotiates separately with each health care provider. So, the price depends on the patient’s insurance.  Second, healthcare providers are very reluctant to tell either patients or doctors what the prices of specific services are.  Third, doctors are not trained to think about prices when they prescribe treatments. Thus, even in cases where a patient or a doctor might choose an inexpensive but effective treatment over a more expensive one, he or she lacks the information to make that decision. 

The Rise of the Ideology of Maximizing Revenue and Market Share

American health care providers have come to accept a variation of an idea famously expressed by the economist Milton Friedman in an article in The New York Times Magazine, where he said,

… there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.

Most health care providers are at least nominally non-profit organizations. So, they don’t strive to maximize profit, but they do strive to maximize revenue and market share. This approach is in direct conflict with the traditional ideology of medicine, which stresses the physician’s duty to care for patients and with the traditional mission of hospitals, which were charitable institutions designed to provide beds and nursing care to patients.

The idea that the main  responsibility of a health care provider is to maximize its revenue and market share has become widely accepted as we can see by the fact that the CEO’s of such organizations are rewarded mainly for advancing those goals, although measures of the quality of care are also considered in some healthcare organizations. Since the health care providers are non-profit organizations, their administrators use the revenue to raise their salaries and to build luxurious facilities.

Many doctors are bothered by the idea that maximizing their incomes is their only responsibility, but they have little choice but to go along. If they join a large healthcare organization, they are pressured to maximize the money they bring into it. If they stay outside of large organizations, the doctors in many markets find that their costs go up and their incomes go down because they are “outside of the networks” within which patients covered by insurance must often seek their care

The idea that the only goal is to maximize revenue and market share  magnifies the effects of third-party payments. The idea justifies the use of any charges that are not actually fraudulent or illegal, and it justifies raising prices to levels that cannot be justified by the need to cover costs. A recent case that illustrates the problem concerns the AIDS drug Daraprim. The rights to Daraprim were purchased by Turing Pharmaceuticals, which had been founded by a hedge fund manager named Martin Shkreli. After purchasing the rights to the drug, the company raised the price of a dose from $13.50 to $750.00, and if a company’s only responsibility is to maximize its revenues, it was fully justified in doing so. This is a particularly egregious example, but it is not atypical. In her book, An American Sickness, Dr. Rosenthal tells us about the many strategies used by doctors and hospitals to maximize their incomes.

They invent charges in order to inflate their bills. For example, a hospital may charge a “facility fee” for the use of an operating room in addition to the charges for all of the materials that are used in an operation. This is as if an automobile dealer were to add a facility fee to the price of a new car in order to cover the use of his showroom. Doctors have been quick to follow suit. A surgeon may establish an ambulatory surgery center where she, too, may charge a facility fee.  

Insufficient Incentives to Use Primary Care or to Choose Healthy Lifestyles

Our healthcare system does not do enough to encourage people to use primary care. Good primary care is very inexpensive. It can help people to avoid getting sick, and it can catch illnesses before they require hospitalization. Often, health insurance does not cover primary care, and this is especially true for policies with high deductibles or co-pays.  Moreover, this country has many people who have no health insurance at all, and they can receive free care mainly in hospital emergency rooms.  Consequently, we rely too much on emergency rooms and hospitalization, which are the most expensive parts of our healthcare system.

Our system also does too little to encourage people to live in healthy ways. A large part of the cost of healthcare in the United States is due to the need to care for people with chronic conditions like diabetes or obesity.  We can reduce the frequency of such conditions by encouraging people to live in healthy ways, but our health care providers are incentivized to treat sick people rather than to keep them well. That, too, raises the cost of healthcare in our country.

Poorly Thought Out and Politically Distorted Government Intervention

The increased cost of healthcare has created hardships for people who cannot afford insurance that really covers the cost of the care they need. This problem has become so serious that the inability to pay inflated medical bills has become the principal cause of personal bankruptcy in the United States. To alleviate the hardships experienced by our citizens, the federal government has stepped in with programs designed to pay for care for people who cannot afford it.

The most important of these is Medicare, which pays for care for old people.  It doesn’t cover the whole cost, but people may buy reasonably priced Medicare supplement insurance that covers most of the part not covered. Medicare has been extremely successful in providing care, but it has been much less successful in controlling the cost of care. In fact, in some ways, it has contributed to the problem.

Medicare has enough market power to set the amount that it will pay for any particular service, and any doctor or hospital that wants to treat Medicare patients must accept what Medicare pays. So, the program is able to control its own costs to some degree, but Medicare pays “fee-for-service.” So, the program is still vulnerable to bills that are inflated by charges for unnecessary services. In addition, it cannot control what the doctors and hospitals do to recover the income that they lose by treating Medicare patients.  That income is recovered through inflated charges that are paid by non-Medicare patients. As we have seen, the healthcare market places few constraints on the ability of healthcare providers to inflate their prices or to invent new ways to bill for their services, and the use of such methods drives up the cost of care in the system as a whole.

Medicare has also been unable to control the cost of drugs but in this case, the reason is political. When Medicare Part D, which pays for prescription drugs, was created, the drug companies lobbied successfully for a provision in the law that prohibited Medicare from bargaining with them over drug prices. Medicare had to accept whatever prices the companies set. Some patients may choose a Medicare Advantage Plan or a private drug coverage plan that is permitted to bargain with the drug companies, but no such plan has the bargaining power that Medicare is prohibited from having. Of course, that means that the drug companies are able inflate their prices at will as we have seen in the case of Daraprim.

The political resistance to practical measures to control the cost of care has also affected the Affordable Care Act otherwise known as Obamacare. President Obama’s proposal originally included national negotiation of drug prices along with other provisions to control costs, but most such provisions were stripped from the bill in order to get it passed with the support of powerful organizations like PhrMA, the AMA and the American Hospital Association. 

Thinking about a Solution

How can we solve the problem of the ever increasing cost of healthcare? How can we create a system that provides care for all of us at a cost we can afford to pay?  I will not attempt to offer a detailed prescription for a solution, but I can suggest some principles that can form its basis.

First, we must accept the need for non-market methods to control costs. We cannot provide care for all citizens without such methods. The cost of modern healthcare would be too high for most of us to afford without health insurance, and so, we must find ways to counter the price inflation that third-party payment systems introduce into the market.  Every country with a successful system of universal healthcare has had to use non-market methods for controlling costs, and there is no reason to believe that we can be an exception.

Non-market methods might include dictation of prices by government in the way that Medicare dictates prices now, or the methods might include national or perhaps state-level negotiations of common prices for drugs or for “bundled prices” for medical or surgical treatments. (A “bundled price” is a single price for – say – removing a gall bladder, and that single price would replace the detailed list of charges for individual services that now appear on a bill for gall bladder removal.) National negotiations and bundled prices are used in several countries.  Effective managed competition could also be part of a solution.

Second, our system must encourage hospitals and doctors to strive for high quality care rather than for maximum revenue and market share.  Some incentives of this kind are already included in the Affordable Care Act. For example, a hospital may be penalized if it has too high a readmission rate.

Third, we need a system that encourages people to make good use of primary care. Good primary care reduces the need for emergency care and for hospitalization, which are the most expensive parts of our healthcare system.  Some encouragement for people to use primary care is already included in the Affordable Care Act. For example, the act requires that certain kinds of screening tests – like colonoscopies - be offered free to patients.  We might also reduce costs by requiring primary care physicians to act as gatekeepers to the rest of the healthcare system as is done today in the United Kingdom.

Fourth, we need a system that encourages people to live in ways that promote health.  Much of the cost of healthcare in the United States is due to the cost of caring for people with chronic conditions like diabetes or obesity, and the frequency of such conditions can be reduced by encouraging people to adopt healthy lifestyles.  Ways to do this are not hard to find. For example, my Medicare supplement insurance pays for membership at a gym on the theory that regular exercise will make me less likely to need expensive medical care.

Finally, the system must provide patients and doctors with accurate information about prices in order to enable them to make decisions based on costs.

For more specific ideas about how we can build a better healthcare system, you can look at the books by T. R. Reid and Elisabeth Rosenthal in the list of sources. Mr. Reid’s book is a survey of the healthcare systems that are used in several countries around the world. A briefer version of the survey may be found in a video called “Sick around the World” that was originally presented in the "Frontline” program on PBS. You can watch the video on YouTube at https://www.youtube.com/watch?v=NSpnpexPN5k. 

Dr. Rosenthal’s book is a comprehensive review of the way that our current healthcare system has evolved over the last several decades. The book also contains her detailed prescriptions for turning it into a system that provides good care at prices that we can afford.

Sources

1.       T.R. Reid, The Healing of America, Penguin Books, London, 2009

2.       Elisabeth Rosenthal, An American Sickness, Penguin Press, New York, 2017

3.      Milton Friedman, “The Social Responsibility of Business is to Increase its Profits” The New York Times Magazine, September 13, 1970. http://umich.edu/~thecore/doc/Friedman.pdf

4.       Andrew Pollack, “Drug Goes From $13.50 to $750, Overnight,” New York Times, September 20, 2015, https://www.nytimes.com/2015/09/21/business/a-huge-overnight-increase-in-a-drugs-price-raises-protests.html

5.       [Author not known], “More Americans Say Government Should Ensure Health Care Coverage,” Pew Research Center, http://www.pewresearch.org/fact-tank/2017/01/13/more-americans-say-government-should-ensure-health-care-coverage/

6.       Melanie Evans, “Bonuses Still Tied to Better Financials,” Modern Healthcare, April 26, 2014, http://www.modernhealthcare.com/article/20140426/MAGAZINE/304269985

7.       [Author not known], “Medical Bills Leading Cause of Bankruptcy Harvard Study Finds,” Consumer Affairs, February 2, 2005, https://www.consumeraffairs.com/news04/2005/bankruptcy_study.html

8.       Alain Enthoven, “History and Principles of Managed Competition,” Health Affairs, Vol. 12, Issue 1,   https://www.gsb.stanford.edu/faculty-research/publications/history-principles-managed-competition