Buffett Is Right, The U.S. Pays A Huge Economic Price For Its Wasteful Healthcare

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by: Shareholders Unite

Summary

The US healthcare system is rife with inefficiencies; as a consequence, it's much more expensive compared to other advanced nations.

This would be tolerable if it produced better health outcomes as these other nations, but it doesn't.

These high healthcare costs put America at a competitive disadvantage.

The proposed healthcare law does nothing to address the problems.

The US healthcare system is by far the most expensive in the world:

The US spends twice as much per capita on healthcare as the OECD average. This puts the US economy at a competitive disadvantage, because healthcare is a cost that has to be paid, it is similar to a tax.

It is paid either by companies directly, when they pay the premiums for their employees, or it is paid by consumers in the form of premiums and out of pocket expenses, or it is paid in the form of taxation to fund Medicare, Medicaid and some other programs.

From an economic perspective, it doesn't matter a great deal how it is paid, or who pays it, the net effect is (as among others Warren Buffett claims) it puts the US at a disadvantage versus other developed nations. It is a taxation, but a tax that is much higher than everywhere else.

That would perhaps be tolerable if it delivered comparable results, but it doesn't, quite the opposite. Life expectancy in the US has increased way less than those of almost all other advanced nations. In fact, in an already famous paper, Nobel prize winner Angus Daeton showed that middle-age white people without a college degree have seen an increase in mortality, unprecedented in the Western world:

The following graph brings home the blatant inefficiency of US healthcare, and how much of an outlier it is in the world.

What is also striking is that the US, despite pretty dramatic improvement under the ACA (Obamacare), is still far from universal coverage, leaving some 9% of its population uninsured (7% in states that accepted the Medicaid expansion). In this it stands alone in the developed world.

So basically the US has by far the most expensive healthcare system in the world, without anything to show for it. It doesn't provide value for money, in fact, quite the opposite. Yes, there are some pockets of excellence, but on the aggregate, it's no match for the best systems in other advanced nations, and it leaves whole swaths of people uninsured.

So an innocent outsider might think that now that there is a unified government (one party dominating White House, Senate and House), and being business friendly, and having made healthcare overhaul perhaps the biggest campaign theme, something will be done about this.

Something that will have an impact on the healthcare cost, or something that perhaps expands coverage, like the President promised on many occasions during the campaign.

You couldn't be further from the truth. The new bill, at least in its House of Representatives incarnation, the AHCA or American Health Care Act, does actually nothing to contain overall healthcare cost (it might lead to some premiums declining but that's not the same). Per the CBO, it's also likely to produce 23M more uninsured people and imperil healthcare affordability or even access to many with pre-existing conditions.

A missed opportunity

This is a missed opportunity plain and simple. The two overriding issues for US healthcare are containing its cost and expanding its coverage. Both put the US at a competitive disadvantage versus other advanced nations, probably more so than its (nominally) higher corporate tax rate.

Healthcare costs are a deadweight on society, and whoever pays for them doesn't really matter a great deal in relation to US competitiveness. One might think that the rate of people that have no insurance doesn't matter, but one would be wrong.

For starters, uninsured people still get sick, but they are much more likely to seek medical attention much later, which can be too late. Prevention or early intervention not only produces much better outcomes in terms of personal health, but also in terms of costs. Costs that often fall on society at large, that is, the tax payer.

Not having health insurance also has other economic disadvantages. It saddles a lot of people with such enormous medical debts that it is the single biggest reason for personal bankruptcies, from Demos:

The result is that in 2014, 64 million people were struggling with medical debt, the leading cause of bankruptcy in the United States. One study estimates that medical debt accounted for 62 percent of bankruptcies in 2007, an increase from 46 percent in 2001.7 A cross-national study finds that Americans are more likely than residents of other high-income nations to skip necessary healthcare to save costs. For example, 37 percent of Americans went without care to save costs, compared to just 4 percent of those living in the United Kingdom.

Fear of losing healthcare coverage is also a barrier for people to change jobs or start their own companies, hobbling efficient labor allocation and entrepreneurship. Obamacare made some progress on these fronts, but we might move backwards again with the AHCA.

Top priority

It should be a top priority for a business-friendly government to try to bend the cost curve, but the proposed AHCA does little to nothing of the sorts. In fact, when asked what the purpose of the proposed AHCA was, most senators involved in the process seem remarkably clueless. Perhaps that's why the law is prepared in such absolute secrecy.

If there is an explicit aim, it is to reduce premiums. ACA premiums in the individual market have indeed gone up a lot, but what we are forgetting here is that in the first year, they came in way lower than was expected:

Probably insurance companies wanted to establish themselves and/or had too optimistic expectations about the conditions of the people signing on. This advantage is now being eroded, but premiums are comparable to plans provided by employers.

It's also not terribly hard to reduce premiums, simply allow insurers (as the AHCA does) to cover less and by making it more expensive for older people.

But from a business perspective, it's paramount to realize that premium cost is not the same as healthcare cost. For instance, by allowing insurance companies to introduce more stingy policies, premiums could fall but out of pocket expenses will rise, per the CBO (and in extremis, the tax payer might be liable for some of these).

While trying to reduce premiums, the AHCA does nothing to contain healthcare cost. While woefully inadequate, the ACA at least made an effort to do that, and might even have succeeded to some extent, per the CBO, a variety of cost containment measures might have contributed to the following (from the Economist):

Overall the CBO projects that, if the law is unchanged, net federal spending for the government's main health-care programmes in 2039 will be 8% of GDP, about 15% less than had been projected in 2010. Projections for Medicare and Medicaid spending between 2011-2020 have been revised downwards by $1.1 trillion. The government also claims that since 2011 some 50,000 fewer patients died in hospitals as a result of Obamacare.

So while ACA can probably take some credit for some slowing down of healthcare cost, it can take much credit for a steep fall in the rate of uninsured (its biggest achievement), and it has also helped reduce medical bankruptcies and make it easier to change jobs or start companies without risking coverage loss.

But it is a halfway house that lacks critical support (at the state and now national level). The ACHA that is shaping up to propose it doesn't actually alter its basic structure by much.

That basic structure of the ACA is simple:

  • Community rating (the end of discrimination on the basis of prior history)
  • A personal mandate
  • Subsidies

These three work together, take one away and the whole thing tumbles. In order to end discrimination against people with pre-existing conditions (rife before the ACA), a personal mandate is necessary. Without it, only the sick and old would sign up (a well-known market failure of insurance markets called adverse selection), leading to a death spiral.

In fact, one could very well conclude that under the ACA, the personal mandate wasn't strong enough. Most of the problems with some of the exchanges is that the signed up people have been, on average, older and less healthy than what the insurance companies expected, leading to losses and premium hikes, or insurance companies throwing in the towel.

The subsidies were also necessary as without these many poor people simply could not afford to sign up.

The really curious thing is that the proposed AHCA doesn't really change all that much. The exchanges are still in place. The individual mandate disappears, but instead, there will be a premium penalty for interrupted coverage. A substantial part of the subsidies for the poor will be scaled back (in favor of tax reductions, for the wealthy).

The community rating will not disappear entirely but will be compromised, allowing insurance companies to increase premiums and/or reduce coverage for older people and people with bad health.

Apart from these changes that affect the ACA exchanges, the AHCA will also limit the Medicaid expansion and introduce a per capita cap, which over time leads to a big increase in the uninsurance rate.

A later addition, the McArthur amendment allows states to (per Quartz):

waive many of the constraints Obamacare placed on insurers, such as its ban on discriminating against people with pre-existing conditions, or its list of essential benefits that must be included in any plan, including pregnancy and emergency care.

It remains to be seen how the Senate will reshape all of this, but the extreme secrecy of that process doesn't suggest it will suddenly become more generous for poorer and older people and those suffering from bad health.

Basically, all these changes are redistribution. In general, these are from the poor, old and sick to the healthy, young and wealthy. Or reducing Federal spending at the expense of state spending. But overall healthcare costs aren't really affected.

This is a huge missed opportunity and it's curious for a government that claims to be business friendly.

Healthcare cost

What are causing these cost problems?

  • The US stands virtually alone in not regulating healthcare cost.
  • Perverse incentives, providers paid per intervention.
  • Balkanization and market power.
  • Almost complete lack of transparency, preventing competition and shopping around.
  • High administrative cost.

Prices are regulated for parts of the market, like Medicare (covering about 16% of the population), but the private insurance market, which is much larger, doesn't. And the latter vary tremendously, according to a study, which had access to a large database of anonymous data (prices paid by private insurance companies to healthcare providers have been treated as commercially sensitive data), from Insights from Yale:

We looked at seven different procedures and found that prices vary tremendously across the U.S. and within geographic areas. Across the country, the price of a knee replacement can vary by up to a factor of 17-the most expensive hospital is 17 times as expensive as the least expensive hospital.

Even more depressingly, there is virtually no relationship between price and quality. There are two fundamental problems here:

  • The market is not transparent (prices paid by private insurance companies to healthcare providers have been treated as commercially sensitive data).
  • Providers often have a lot of market power.

Both of these conspire to create wildly inflated prices in many cases, prices that bearing no relation to costs. We could fill the entire SA website with stories like (from Vox):

Last summer, Matt Anderson cut his finger on a knife while doing dishes. He's a college student, and his roommate, a biology major, suggested that he go to the emergency room. He had recently used the same knife to cut raw meat and thought Anderson's finger might get infected. Anderson estimates he got to the emergency room around 11 pm. A nurse saw him shortly after midnight and cleaned his wound. A doctor came by a little later to apply liquid stitches to his finger. Anderson went home around 1 am. "I saw a nurse for maybe five to 10 minutes and a doctor for maybe five minutes tops," he says. A few months later, the bills arrived at his parents' house: $2,782 in total.

Or the $39.95 charged to a mother for holding her newborn to her chest (charged as "skin to skin after C-sec,"). Or the baby with a cut in his finger whose parents faced a $629 bill for a band-aid and its placement on the finger. The parents thought a mistake was made and sent a letter, expecting redress:

That didn't happen. The hospital sent him back a long letter explaining why it would stick with the price. The fees, the hospital's leadership responded, were justified - and it ultimately sent his unpaid bill to a debt collection agency.

Medical bills are usually so terribly complex that even experts struggle to make sense of them, from the NYT:

Bills variously use CPT, HCPCS or ICD-9 codes (more about those later). Some have abbreviations and scientific terms that you need a medical dictionary or a graduate degree to comprehend. Some have no information at all. Heather Pearce of Seattle told me how she'd recently received a $45,000 hospital bill with the explanation "miscellaneous."

And of course these bills come after the fact, while people in acute need do not have much time to shop around, but if even with hindsight no sense can be made.

Drugs

Drug companies can raise prices, often with impunity as well, not seldom to absurd levels bearing no relation to cost, simply because of lack of transparency, market power and a captive buyer.

We know of companies that build business models of buying old drugs and jacking them up stratospherically, like Valeant (NYSE:VRX) and Mylan (NASDAQ:MYL) (with their notorious EpiPen) and Turing Pharmaceuticals, the former company of the notorious Pharma Boy Martin Shkreli.

While these (and some other) companies are extreme, in general, medicines are much more expensive in the US, from The Fiscal Times:

In the case of Norway, The Journal found U.S. prices were much higher for 93 percent of top branded drugs available in both countries during the third quarter of 2015, with a similar pattern of price disparity in England and Canada's Ontario province. Depending on the drug being purchased, those countries were paying only 28 percent to 60 percent of the cost incurred by the U.S.

It's not only hospitals and pharma, there are a host of rather obscure middleman that can exert enormous market power, like "pharmacy benefit managers," from Prospect:

According to data from the Centers for Medicare and Medicaid Services, between 1987 and 2014, expenditures on prescription drugs have jumped 1,100 percent. Numerous factors can explain that-increased volume of medications, more usage of brand-name drugs, price-gouging by drug companies. But PBM profit margins have been growing as well. For example, according to one report, Express Scripts' adjusted profit per prescription has increased 500 percent since 2003, and earnings per adjusted claim for the nation's largest PBM went from $3.87 in 2012 to $5.16 in 2016. That translates into billions of dollars skimmed into Express Scripts' coffers, coming not out of the pockets of big drug companies or insurers, but of the remaining independent retail druggists-and consumers.

These pharmacy benefit managers work magic; they can turn a simple over-the-counter medicine costing $25 or $50 into a $700 prescription drug for Medicare part D. Of course, they're pocketing a substantial part of that windfall themselves.

Basically, drug pricing and distribution is a black box, and one that could even produce astronomical profits for drugs of dubious efficacy, like Mallinckrodt Pharmaceuticals' (NYSE:MNK) Acthar. its $38,000 blockbuster drug. But the black box might be about to be priced open, from Business Insider:

What happens to the price of a drug from the time it is made to the time it gets to a patient - who gets paid and how much - is something of a mystery. It's something, it seems, the pharmaceutical industry would rather not share. Maris' Wall Street huddle call opened that black box just a crack, and what it revealed is just the tip of everything Washington is worried about.

Or the obscure monopsony buyer associations that for instance kept life-saving retracting needles out of hospitals (made famous in a film by the Kassen brothers). Medicare is the single biggest customer for medicines, but it's not allowed to negotiate prices.

According to research by Ryan Gamlin, the US spends more on administrative cost than virtually any other developed nation and there is a clear negative correlation between the percentage of administrative cost and the quality of healthcare.

Markets

In theory, they lead to competition, choice, efficiency, but in US healthcare, they seem to produce almost the exact opposite:

  • Competition is greatly hampered because shopping around isn't feasible in many emergency situations, and prices and quality are almost universally very difficult to assess in advance. Even with hindsight this is very difficult as bills are often indecipherable. Markets for healthcare services are simply terribly opaque, worsened further by the balkanization of the system where patients have to deal with numerous organizations, each protecting their own turf and optimizing their private gains, often at the expense of the overall efficiency and effectiveness of the process.
  • Providers and third party middlemen often have a great deal of market power, allowing them to almost charge what they want, enabling providers to charge 17x more for comparable interventions as others, without much, if any quality benefit.
  • Incentives are all wrong (or 'perverse,' as economists have it). Providers get paid for interventions, which drives many of them to perform or subscribe numerous interventions that are not needed.
  • Insurance markets (in general, not just in the US) suffer from two fundamental market failures, adverse selection and the fact that premiums decline with the number of insured. With insufficient countervailing power, these tend to produce death spirals.

Conclusion

It is high time healthcare reform addresses the real problems of US healthcare, its exorbitant costs, balkanization, almost complete lack of transparency and pervasive presence of perverse incentives.

These issues put the US economy at a substantial competitive disadvantage. That would perhaps be acceptable if the US produced comparably better health outcomes, but in general, the exact opposite is the case. Alone in the developed world, the US cannot even insure all its citizens.

Reform should tackle vested interest, by altering the perverse incentives, reducing market power and increasing transparency. There are a good many other advanced economies in the world, which have managed to do that, the US should learn from their experience.

From what we know about the proposed AHCA, it does nothing of the sort, and that is a wasted opportunity.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.