Prescription for Reform Should Include End to Third-party Payer System

(Editor's note: This is an edited version of a commentary that ran Aug. 23, 2009, in The Oakland Press.)

The most fundamental problem with America's health care system is not one that politicians are talking about.

They discuss its symptoms, to be sure: We spend too much, costs are rapidly rising, and some patients undergo excessively expensive procedures while others can't get the treatment they need because costs are prohibitive or are not covered by their insurer.

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But the politically neglected root cause of these shortcomings is third-party payment for health care. "Third-party payment" is when insurers or government — or anyone who is not the patient — pays for services rendered. This system is an accident of history (specifically, as a way for employers to get around wage controls during World War II), under which few Americans directly foot the bill for their own medical costs.

When consumers don't pay for their own care, doctors and hospitals have fewer incentives to lower prices and increase value, and insured patients have little incentive to shop for the best deal. Patients may not even know the cost of services they receive. As a result, medical consumption increases rapidly — and with it medical costs.

In contrast, when higher deductibles and co-pays raise out-of-pocket expenses for patients — or when people purchase services not covered by insurance (like cosmetic surgery) — health care costs have risen more slowly, or even fallen.

Moreover, people who do not pay for their health care lose the financial motivation to maintain good health. An individual may find it easier to simply rely on expensive drugs and procedures than to adopt a healthier lifestyle.

Conversely, insurance companies are detached from the benefits they provide. While a policyholder might benefit a great deal from a certain procedure, the insurer experiences only the cost of the procedure, not the benefits.

These skewed incentives on both consumers and providers result in ever-higher costs, forcing insurance companies to take a greater role in making health care decisions that historically were the domain of patient and doctor. This generates frustration with insurance "gatekeepers" who, given the absence of constraints on consumption present in markets where consumers pay, restrict access to all the care doctors may want to prescribe.

That's where we're at now. It's essentially a system of prepaid health care, not really "insurance." Insurance properly understood is a means of protecting against the expense of an unlikely but potentially catastrophic event.

Auto insurance is a good example: It reimburses a car owner who has a crash, or whose car is stolen. It does not pay for oil changes and routine maintenance. If it did, we would not be surprised to see drivers getting tune-ups or new tires twice as often as needed.

In contrast, traditional health insurance policies do pay for those routine, predictable expenses. Many of the problems with the current health care system — high costs, overuse, inefficiencies and intervention in health care by insurers — can be solved by shifting toward a system where patients pay such expenses hemselves.

"Insurance" should be restored to its proper role of only paying the really big bills for unexpected and financially devastating events. Moving in this direction would restore the proper incentives on both consumers and providers and get insurance companies out of more routine matters.

In markets for other goods and services where consumers pay their own way, the norm is for costs to fall and quality to increase as providers strive to discover the most cost-efficient method of providing ever-greater value.

It's ironic, then, that in spite of their concern that the system is no longer efficient or cost-effective, congressional health care reformers would further expand the very system that allows patients to stop caring about the costs of their care. The health care reform bills being debated don't solve the problems caused by third-party payment for health care — they exacerbate them.  

If co-pays, deductibles and other out-of-pocket health care expenses are reduced, as they likely would if today's "reformers" get their way, patients will become even more detached from the costs of their care and less prudent in their consumption, driving costs higher.

In markets where consumers bear the expense, cost overruns and inefficiencies are rooted out by competition. In contrast, congressional reformers believe they can create a bureaucratic program that will do this.

Justifiably, few people trust the government to design an efficient, cost-effective program capable of staying within its budget.

How can we solve the problems generated by third-party payment in health care?

A successful alternative is already serving millions of people in the form of high-deductible insurance plans associated with tax-advantaged health savings accounts from which routine expenses are paid. These plans ensure that catastrophic costs are covered while giving patients control over how to spend their noncatastrophic health care dollars.

Expanding HSAs would also make it easier to move away from a system in which most people receive health insurance from their employer — another accident of history that locks many individuals into jobs they would like to change, while adding to the burdens of those between jobs.

It's also unfair to give preferential tax treatment to higher-paid employees who benefit from their employers' ability to buy "Cadillac" health coverage tax-free, while lower-paid and self-employed workers must buy insurance with after-tax dollars, effectively subsidizing those better off than themselves.

If reducing health care costs is a prerequisite for real health reform, we're more likely to get there by restoring the normal incentives for consumers to be frugal and providers to add value.

This can only be accomplished by moving away from "third-party payment" in the provision of routine, noncatastrophic health care services. The alternative of using government bureaucracies to contain costs inevitably will result in rationing and limiting the types of care people can get.


Janet Neilson is a health policy communications associate at the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Neilson writes a daily blog on health care at Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.

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