TCS Daily

Taking Kuttner's Health Care Challenge

By Arnold Kling - October 14, 2004 12:00 AM

"The hardest job for a liberal is to defend the D.C. public school system.
The hardest job for a conservative is to defend free-market health care."

-- Robert Kuttner

"Yes, but the D.C. public school system actually exists."
-- Alex Tabarrok

Alex Tabarrok gave the short answer to The American Prospect editor Robert Kuttner's challenge. I want to give the long answer. I want to propose two market-oriented reforms for health care. On the demand side, I propose event reimbursement in health insurance instead of procedure reimbursement. On the supply side, I propose reputation systems instead of credential-based regulation.

I heard Kuttner speak at a forum on health care, and I was disappointed that the two sides tended to talk past one another. I found myself sympathizing with Jeff Lemeiux, of, who wants those of us on the right try to speak to the fears of those on the left.

According to Kuttner and Lemeiux, what the left fears about free-market health care is:

  • 1) Neglect of public health issues.
  • 2) Unequal access to health care.
  • 3) Inability of the private market to provide health insurance to those who need it most.
  • 4) Private health care is too expensive, and there is seemingly no limit to cost increases.

I discussed the first point -- public health -- in the TCS piece "Getting to Health Care for Tomorrow." I believe we can agree that government has a role in providing health care to those in poverty, and that low-cost clinics in poor neighborhoods and towns are the best approach. In that case, any remaining ideological differences concern the role of government when people might make bad health care choices. Liberals might be more inclined to try to prevent people from making bad choices. I would be more inclined to let them live with the consequences. Overall, though, I do not think that the health care debate hinges on how we approach public health issues.

I also think that we can take the second issue off the table. Suppose we define "reasonable access to health care" as "no one will be denied access to a high-value medical procedure because of lack of funds." A high-value medical procedure is one with a high ratio of benefits to costs. Benefits are defined in terms of longevity, reduction in pain, or correcting a serious disability. In that case, I think that we could agree that "reasonable access to health care" should be a goal, and that government has to help the poorest in society attain such access.

I would note, however, that "reasonable access" is not the same as "equal access," because there are many medical procedures that do not offer a high value relative to costs. To take extreme examples, consider undertaking a heart transplant on someone in an irrecoverable vegetative state, or consider Michael Jackson's facial reconstruction. If private individuals want to pay for such procedures, that is fine. But we do not need public funds to insure equal access for the rest of us.

That leaves two more areas of concern -- health insurance and health care costs. The remainder of this essay looks at those.

Insurance That Reimburses Events

Event reimbursement insurance would give you a lump sum if you become injured or seriously ill. The lump sums might be in multiples of $5000. You might get $5000 for a broken wrist that requires surgery, $25,000 if you are diagnosed with stage one breast cancer, etc. The insurance contract would spell out which events result in which dollar amounts.

The money the insured person receives will not necessarily cover the cost of procedures. The goal would be to specify sums that would pay the cost of standard treatments, but some discrepancies are to be expected. It would be satisfactory to have decent approximations. The actual cost of treatment might be more, and it might be less. In fact, the consumer could choose to have no procedures done, and spend the money on other things.

Some conditions not only are costly to treat by themselves, but they also often imply other complications. A diagnosis of diabetes might carry with it a higher risk for heart disease, and this would have to be factored into the reimbursement amount for the diabetes diagnosis. You would get a lump sum now because of the heart risk, but you would have to pay more for insurance for heart events going forward.

Insurance contracts could turn out to be rather complicated. For example, a torn knee ligament might be covered if you injured yourself walking down the steps, but not if you injured yourself skiing.

As with any insurance, the company would have to be vigilant for fraud. If you injured your knee in Aspen, the insurance company would have to verify your claim that you fell down the steps. In fact, the contract might include all sorts of riders, such as requiring that you obtain a regular medical checkup, if the insurance company believes that this will serve to reduce its incidence of unnecessary claims.

Any insurance reform will have to deal with pre-existing conditions diagnosed under the current system. If you are healthy now, then an event reimbursement system will be able to reimburse you should you come down with diabetes. Once event reimbursement is in place, it will not have a problem with pre-existing conditions.

However, if you have diabetes today, you cannot get new insurance without some sort of transition plan, because the event reimbursement concept assumes that you already have been reimbursed for your diagnosis. Once a transition plan can be developed to handle pre-existing conditions as of now (under current insurance), then the new system can handle any new developments going forward. Under event reimbursement, when you get a lump sum at the time you are diagnosed with diabetes, you are still insurable at that point, because you already have been paid.

One advantage of event reimbursement compared with procedure reimbursement is that it gives patients and providers the incentive to control costs. It also gets insurance companies out of the business of setting fees for services. Providers set fees, and consumers decide either to accept those fees or go somewhere else for service. Relative to current practice, this is a radical concept, and it would take some learning on the part of both consumers and health care providers to adapt. We seem to be able to handle this aspect of markets in other goods and services, so I am optimistic that this would work.

However, the primary advantage of event reimbursement insurance is that it is true insurance. As I pointed out in "You Call This Health Insurance," the traditional "health insurance" that we have today is really something quite different. The current system cannot deal with someone who develops a disease that puts him or her at risk for expensive procedures going forward. The competitive market breaks down at that point.

The fact that procedure-reimbursement insurance breaks down in the private market is not an indictment of the private market. It is an indictment of procedure reimbursement. Event reimbursement would solve the pre-existing condition problem that plagues the current system, although it would require a transition plan for people with pre-existing conditions as of now.

Event reimbursement insurance would resemble other workable forms of insurance. People would pay fair rates based on actuarial tables. I am confident that the private market could provide event-reimbursement insurance. It would be far from perfect, but it would not break down completely as all existing systems, private and public, appear to be doing.

Today, state and Federal governments foster what I call "split the check" and "pass the buck" schemes under the guise of health insurance. If government got out of the way, then we could see whether the market would tend toward event-reimbursement insurance. I think that is where things might head in a free market, but I could be wrong. Even if the private market fails for some reason, and government ends up being involved in providing health insurance, then I would rather it be event reimbursement insurance than procedure reimbursement.

Reputation Systems

How would consumers be able to figure out which event insurance plan is best? My guess is that third parties, such as Kiplinger's, would evaluate competing plans. That is an example of a reputation system. Leaving aside medical insurance, for the medical field as a whole I believe that reputation systems would work better than our current system of credential-based regulation.

A friend who is an optometrist puts a lot of time into lobbying the state legislature. That is because the boundaries between what he can do relative to an optician or an ophthalmologist are determined by state laws. One group is constantly trying to use the legislative process to take territory away from the others.

These sorts of regulatory boundaries impose tremendous costs on consumers, without our realizing it. Like fish unaware that they are swimming in water, most of us go through life without ever thinking about the pervasive, murky regulatory swamp through which we swim when we seek medical care.

In most industries, government does not get involved in defining work rules. If a company decides to have a financial analyst do computer programming or a computer programmer do financial analysis, that is none of the government's business. In the medical industry, however, the government does dictate such work rules. This creates all sorts of supply bottlenecks. For example, if there is an increase in the number of patients needing help with starting exercise programs to recover from orthopedic injuries, the result is a shortage of "physical therapists." Any other market would adapt by coming up with a close substitute. In medicine, that is not allowed.

Another example is the rule that only a physician may write prescriptions. This protects the income of physicians, but by the same token it prevents lower-cost alternative health delivery systems from emerging.

Medical work rules mean that the benefits of what I call The Elastic Economy (chapter 12 in Learning Economics) are not felt in the medical sector. In medical care, supply is rigid, inelastic, and slow to adapt, rather than dynamic and rapidly improving as are other sectors of the economy.

Although medical work rules serve primarily to carve out economic rents for health care providers, they are not sold that way to the public. Instead, these regulations ride in under the banner of "consumer protection."

The free market principle is that as consumers we should protect ourselves. The key to protecting ourselves in a deregulated environment for medical care would be reputation systems. As Howard Rheingold discusses in his book Smart Mobs, the concept of reputation systems receives increasing attention in our information-rich, networked society.

There are reputation systems all around us. Consumer Reports ratings are a reputation system. eBay uses a reputation system to keep buyers and sellers honest. Mortgage lenders and other suppliers of consumer credit rely on a reputation system known as credit scoring.

In medicine, we already use reputation systems. The diploma on the doctor's wall is one. The referral that is made by friends or other doctors is another. All sorts of private systems are springing up to evaluate data on hospitals, doctors, and so on.

Reputation systems could provide us with an alternative to the strict, credential-driven structure that we have today. Someone could earn a reputation as capable of training you to do certain exercises without earning a license as a physical therapist. Someone could earn a reputation as a reliable prescriber for certain types of medications in certain types of situations without getting a full-fledged MD. In fact, the drug industry could be deregulated, with reputation systems for medicines replacing "FDA approval."

If you took away the centrally-planned regulatory system for medical care, my conjecture is that reputation systems would emerge as a more efficient Hayekian market response. In some cases, such as medicines, I would want to see a gradual deregulatory process, rather than lose consumer protection completely and suddenly.

Some of the expense of operating reputations systems could be offset by lower costs elsewhere. If bad doctors (and incompetent technicians as well) were dealt with by reputation systems, malpractice lawsuits would be needed much less, if at all.

If we took away the regulatory swamp, the changes would be dramatic. You could have your gall bladder surgery done by a dental assistant. That would not be a good idea, but it would be your responsibility as a consumer to make that decision. Your protection against making bad decisions would be common sense, information, and effective reputation systems.

My guess is that a lot of business process re-engineering would take place spontaneously if the regulatory swamp were replaced by consumer choice and reputation systems. I think that this is the best hope for allowing medical care to become as efficient as possible by taking advantage of the best technologies and practices our economy has to offer.

According to Robert Kuttner, addressing the problems with today's health insurance system and rising medical care costs requires more central planning and less market freedom. My guess is that it's the other way around.


1 Comment

The most amazing is that Dems believe that private health care can deliver the care to those who need it most while it has been proven that in every country with national health care, socialized health care, services are scarce, waiting lists long so long and untimely that people die while waiting.

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