The economics of managed care

Here is my latest NYT column and these are some relevant excerpts:

Conceived in its broadest form, managed care can be run by the government, as in Britain, or left in the hands of a regulated private sector. Because the United States already has substantial private-sector capacity, and because many Americans are suspicious of government controls, the private route is the most likely option. Individuals would choose among competing providers – and those providers would try to offer the most appealing bundles of services, relative to cost.

The current tax exemption for health insurance benefits could be modified to encourage more cost-effective delivery systems, including forms of managed care that meet quality standards. For the elderly, the current Medicare fee-for-service method could be transformed into voucher programs for managed care treatment. Of course, people could go outside their network for additional services, if they were willing to pay.

It’s not well advertised, but the Obama plan would move in this direction. Many people receiving new health insurance coverage would be enrolled in Medicaid, which already relies on managed care for about half of its patients.

On a national scale, effective managed care will require the right mix of reputation and regulation to enforce provider commitments, and will need some reframing and renaming to make it palatable. It could accurately be called “competitive, choice-based single-payer coverage.”

…On the other hand, for reasons of perceived fairness, some people may be more willing to accept a “no” answer on health care from a government agency than from a private company. If so, we run the risk of limiting our care choices just because we’re more squeamish about one kind of “no” than another.

You'll note that this is a proposal to come after the Obama plan (or whatever else we do), not in lieu of it.  It's not a competing idea but rather a recognition that rationing is coming in one form or another, even if some of the cost control proposals work.

There was not nearly enough space to deal with numerous points, including the following:

1. What are the pluses and minuses of competitive managed care offers vs. government-run single-payer systems?  Or compare voucher-based competitive managed care — for seniors — to a much stronger Medicare advisory board.  Under the former scenario, individuals choose, upfront, which services won't be reimbursed.  Under the latter scenario, "experts" make that choice for everyone, subject to the constraints of politics.  Which will lead to better outcomes?

2. I suspect the biggest problem with the voucher-based idea is when patients need to switch providers, say if they dissatisfied or if they are moving geographically.  To what extent would the required regulations here mimic some of what the Obama plan does to insurance companies?  Or could we just transfer how Medicaid handles managed care right now?

3. If people do not trust their managed care providers, can we expect a mutual, cooperative, or non-profit form in those markets?  If so, how many of the advantages of markets over governments do we lose?

4. What are the ethics of converting fee-for-service Medicare into vouchers for managed care?  In theory the role of government is to provide public goods, not private goods.  Which health care treatments for the elderly can be considered public goods and which not?  Is there an argument that paying more and more and more falls under this category of public goods?  I am skeptical on this point.  I think  we have been pioneering a revolution in government, namely by assigning most expenditures to private goods.  In the long run that is simply not sustainable.

Few people would think that a ne'er do well brother would be justified into taking $50,000 from you to prolong his life (with p = 0.17) for another three months.  (Bryan Caplan has made a similar point.)  So why do we approve of comparable transfers through the public sector?

5. I am struck by how many people, over the last year, claim we don't know how to make cost control work.  There is plenty of evidence that managed care lowers the rate of cost growth, we just don't want to do it.

I also should note that the ideas of Arnold Kling were an influence on this column.

Addendum: Arnold Kling comments.


The problem with private managed care is it often becomes a clerical function operated by poorly trained lightweights, and thus the chance of actually providing quality care at a reasonable cost are diminished.

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"managed care can be run by the government, as in Britain": unless you choose to pay for it yourself.

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The "we don't know how to control costs" theme is the most annoying part of this entire debate. One controls costs by not buying stuff. In life, there are tradeoffs on everything you do or buy.

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Tyler, I'm having a hard time with your analysis.

1. We are not talking about health care. We are talking about the financing of health care. Indeed, how health care is financed has important consequences for access to service and quality of service. (Yes, I know your readers know this, but as D. Henderson reminded us, Obama doesn't).

2. My definition of "managed care" is GIVEN THE PERVERSE INCENTIVES OF GOVERNMENT PROGRAMS FOR FINANCING HEALTH CARE, MANAGED CARE IS ANY ATTEMPT TO DEAL WITH ONE OF THEIR CONSEQUENCES: FINANCIERS' RELUCTANCE TO PROVIDE SERVICE AND ACCESS TO HEALTH CARE. I'm an adviser to my children's bakery company and I can tell you that they don't have a "managed bakery" problem because there are not perverse incentives for Chileans to consume baked foods. I'm sure that Mises, as a business adviser, have never ignored the perverse incentives of government programs.

3. Only a naive economist may think that managed care can work. Indeed, my statement depends on how large the perverse incentives are. But we are talking about your country, and I'm sure you agree with me that AT LEAST TODAY they are large enough to justify their elimination. Now "managed care" pretends to be a second best solution--given the government programs, how we can mitigate/eliminate some of their negative effects. Let me tell you what happened in Chile. In the mid 1980s, the Pinochet government reformed health care financing and introduced a mandatory contribution to be managed by special insurance companies (the ISAPRES). It didn't take long for politicians to promise that the new system was going to provide low cost access to high quality service, but the political competition for promising "heaven on earth" and the aging of population quickly created a perverse incentive to demand too much service that the ISAPRES could not finance with the mandatory contribution. To make the story short, all kinds of measures have been introduced to mitigate this negative effect but with no success: the ISAPRES are still very stingy with access to service and quality of service (I can tell you many stories about how absurd the system has become).

4. I look forward to what you'll say about your country's health financing system ten years from now. My bet: because of your political system, health financing will not be significantly different from today's and therefore government spending will continue to grow but at a lower rate than total health costs and quality of service will be lower.

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In theory the role of government is to provide public goods, not private goods.

What theory is that? It seems to me that law courts, for example, are rivalrous. Is GMU a public good?

Perhaps the theory you cite is the libertarian view, but I don't think it deserves to be enshrined as a standard for all political decision-making.

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Perhaps you could bundle managed care with life insurance, some kind of quality of life insurance and disability insurance.

But really I think that what needs to happen is more people taking care of themselves more, through savings and so making more of the money saving decisions themselves. BTW I think this is happening as more employers drop insurance and raise the deductibles.

At least half of people would be better off with the money rather than insurance, paying in the rears.

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There is no doubt that there has to be some way of reducing health care utilization. Some people think that the way to do this is by getting patients to pay for more things out-of-pocket and making their own judgments about what is or is not worth paying for. The alternative is to give people an incentive to sign up for some kind of managed care, and have the managed care plan make those judgments. The latter idea, which is being pushed by Jonathan Gruber,


has a lot going for it. But this is true *only* if people trust the entity making those judgments. So it is absolutely essential that these entities at least be heavily regulated (and ideally they should compete with a public option). You can't get the benefits of limiting supply if everyone hates and fears the one doing the limiting.

The good news in all this is that there seems to be a huge amount of low-hanging fruit in terms of stuff that could be cut with little or no harm to health. So if this is done right there will be a pretty big free lunch for all of us.

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I second Scott Jenkins' comment, which blows a giant hole in the question.

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The idea that "people" are not emotionally capable of taking care of end-of-life decisions has nothing to do with me. That line of reasoning from people like the doctor who commented at Arnold's blog really irritates me. Do the doctors believe they bear any responsibility for people yielding to authority in medical matters. "Surely not!" Secondly, I think people will become emotionally capable really quickly once granddad realizes he is taking potential care away from grandmom or preventive care away from the grandkids for his long-shot Hail Mary

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Tyler, reading the many comments to your post I conclude that your framing of "managed care" is wrong. Rather than addressing directly the issues that have led to the perverse incentives underlying the demands for "free" and "unrestricted" access to service and for high quality of service, you --as Obama and his parade of partisan economists-- prefer to focus on the financiers that must ration access to service and reduce quality of service. To justify such a position Obama and company rely on all sorts of "moral" arguments that you prefer not to confront directly but to weaken with "sophisticated" but irrelevant ideas.
Sometimes it's better to argue from a clear-cut, well-defined position, even if it's politically incorrect and unfeasible.

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I have a pretty good idea of where I'd like us to go:

I'm for a version of the plan above put forward by Milton Friedman. I understand it, and I feel on firm ground arguing for it.

Normally, I would judge the current realistic alternatives being presented based about how far they get us towards my favored position. In this case, I haven't a clue. I am for Universal Health Care, which is one reason I'm a Democrat. Consequently, I can support the current plan on moral reasons and again, on my support for a universal plan, which is what I'm doing. It's the only clear argument I can grab onto in the current debate. I'd like to think that other people have a handle on where we're headed on this issue, but I don't.

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It occurs to me that Frakt's recent posts on administrative costs are particularly germane to managed care. At the height of managed care, when costs did come down, physicians were beset with very large administrative costs, especially with pre-certification. people tend to look at admin costs only from the POV of the insurance companies. There are also significant admin costs on the provider side. If managed care is to emerge as a real force again, it needs to do so in a form that does not impart such large costs.


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It seems to me that we have to properly define the terms used in the healthcare dialogue. What we are discussing is not "insurance" because it covers both reasonably foreseeable as well as unexpected health situations. So I think we have to make sure that everyone is insured against catastrophe but I think only the most destitute should have their regular health "maintenance" paid for by the government.

That being said, I am curious what to make of the current insurance contracts. To me, the way it should work is I should contract for health insurance in my young healthy years when I under-use the service so that it is available at a future date when I over-use the service. Presumably I am financing my over-use with my under-use. But if I am insuring against catastrophe and every year without a catastrophe is going into the P&L of the insurance Co, shouldn't the eventually catastrophe (say cancer at the age of 70) trigger a payout to address that specific event. That is to say, if I pay for insurance up until the day I get diagnosed with cancer shouldn't treatment for that cancer be funded by my insurance company even if I no longer pay premiums from that day forward? I presume Larry Silverstein stopped paying insurance premiums on the WTC after they fell but the insurance company will still pay for the event that happened when the coverage was in place.

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Ryan S wrote: I think the article is really good in assessing the inevitability of rationing of care by cost, but a bit light on discussing why some managed care organizations, such as Kaiser Permanente, are popular, while the managed care organizations on the whole are generally unpopular. Kaiser Permanente is not just an insurer, but also a provider network.

Managed care was known as HMO with Kaiser being one of the organizations that pioneered them, but there were others as well, The spread widely when Nixon pushed them and they were required to be included as options if HMO organizations existed in the Federal covered benefit plans.

All were not for profit, and were more properly prepaid health plans, not insurance. The monthly payments paid for a staff of employees including doctors and nurses, facilities, and for contracted out services like hospital care because most could not afford a captive hospital.

And that became one place they controlled costs. The Blues were also prepaid health care, but it was in two parts, hospital care (the original Blue, and prepaid doctor. Both hospitals and doctors did fee for service, but for Blue members they provided covered services with copays or deeply discounted fee schedules, but from separate funds. With in a State, a hospital got access to the Blue Cross funds only if doctors sent patients, and doctors got paid for patients in a hospital if he had hospital privileges. So, a doctor had an incentive to admit his patient to the hospital where he had privileges.

In contrast, the HMOs started out with a doctor group practice, and then the HMO paid fee for service to have a member cared for in the hospital. Even with contracts which gave the HMO reduced fees, and patient sent to a hospital meant cash out the door. So, HMOs had every reason to provide out patient surgery.

In contrast, the Blues partitioning worked against it. Out patient surgery by a doctor meant the doctor fund got hit with the cost of surgery, which while lower than hospital care, still came out of the doctor prepaid fund. Hospitals didn't like outpatient because they billed far less, getting less out of the prepaid fund which was setup to fund the full hospital.

I was with an HMO in the 80s and 90s when it failed, and at first we went to the hospital for emergency or weekend care, usually with a call to someone to screen. This resulted in the HMO opening up one of its clinics for night and weekend walk-in care, with appointments for limited routine care. Normally you called the HMO line, and they would direct you to the clinic or ER. Then they added outpatient surgery and care for those cases where they could keep at least one specialist full time. They had doctors with privileges at the hospital, arranged for outpatient care, and accelerated discharges.

The result was this put the squeeze on hospitals and the Blues. The HMOs tried all the could to cut back on hospital use because that was cash out of the HMOs, for lots of patients, the HMOs were easier than the Blues where you were dealing with two plans, one for hospitals, and one for doctors, with no clear rational for the difference.

So, while the not-for-profit Blues and HMOs were in conflict on models, both did community rating without denying preexisting conditions for the most part. The for-profit insurers cherry picked by offering low rates to small businesses without health problems, then raised rates when someone got sick, with the business switch to either the Blues or the HMO. The healthy employees were more often at for-profit insurers, and the sick at the Blues and HMOs.

In NH, the HMO kept running into financial problems, so it was married eventually to the Blues, switching from an HMO to a group practice and insurer. The group practice split off, and now the Blue ran into financial problems, so it was split into its not-for-profit safety net and a for-profit segment owned by Anthem, the same one mentioned in California.

Now insurers offer "HMO" plans, but these plans have nothing to do with HMO as an integrated prepaid health care plan. They are HMO only in they don't have a dividing line between doctor and hospital benefits in the policy, as the traditional Blues did, and the competing for-profit insurers.

The phrase used today for the HMOs that Nixon pushed is "integrated health delivery" or "integrated health management" or some other "integrated".

The thing I've most noted since the group practice of salaried employees has been separated from the prepayment and is now paid by the for-profit insurers and patients is they no longer actively seek to reduce costs. First, some of the in-house outpatient services aren't covered by the insurer, even the insurer that took over the HMO - that capability was limited to just the one group practice. Second, the group isn't funded by the insurer to do development of cost reducing practices because insurers are dealing with lots of group practices, so how can R&D at a group be billed to the insurer and attributed to insured individuals. As a group is no longer captive to one prepaid fund, getting paid by half a dozen insurers, no one insurer is going to pay to reduce costs to competitors.

So, the prepaid fund needs to be "owned" by the doctors in their group practice to create the incentives to reduce costs. If the group gives the doctors bonuses based on innovations that saved costs, on overall group cost reductions, and most important, increased prepaid indicating the service sells itself, the costs and quality will be driven toward increasing efficiency.

And an individual patient paying out of pocket can't change the system. If you need a minor surgical procedure, even if the doctor said he could do it without you being admitted and in his office, he won't bring in the equipment, staff, and create operating conditions just for you - it would cost too much. If insurers pay for it only in the hospital, that's where you will have it done, unless the doctor can change all the insurers his patients have.

Insurers can't handle paying for things done differently by every practice and hospital, they need standard procedures. This is the medical equivalent of interchangeable parts. Only the integrated prepaid group practice has the incentives and flexibility to innovate to cut costs, it it will vary from place to place. And HMO with lots of fitness and recreational members will have sports medicine specialist on staff and in weekend clinics, while an HMO in a retirement community will have geriatricians.

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Mulp, thanks for your interesting comment. The problem, however, is not in the supply side of health care. It's in the demand side --there is no way any set of suppliers can meet huge demands for "free" and "unrestricted" access to health care and for "high" quality of service. The service demanded must allow every American to enjoy "Ferrari Testarossa" physical and mental capacities for 90/100 years. Some politicians think that they can meet that demand. Think of Nancy Pelosi --she is so good and enjoy herself so much that she wants all American women to be like her and to live as long as her. Isn't that nice and great? Read this about Nancy (with picture)

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"that a ne'er do well brother would be justified into taking $50,000 from you to prolong his life"

The framing of this question reveals significant bias, and is a completely faulty view of the economics of health. A more appropriate question would be something like "is it worth spending $500 on the brother this next few years to prevent a disease that would cost $50,000 five years from now, along with the collapse of said brother's role in his family, society, and the economy, including the $500,000 we've already invested in him?" The rational individual will recognize that comprehensive preventative medicine (health care for all) is a no-brainer, and a massive public good. Just remember how much more ER treatment costs than regular clinics (about five times), and that huge parts of the ER services can be tied up with chronic patients with no coverage (upto 80%).

Of course, if you believe that the "weakest links" in our society should be left to bleed to death in the ER waiting room if they don't have the requisite cash, then maybe you'll find more traction. Even then, it's hard to disregard the significant monetary cost to society if these brothers are allowed to die.

Incidentally, strict free market believers will tell you that roads are also not a public good.

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1. Higher quality, organized care which allows patient to share in the decision making is cheaper and better than the way most people get their care today. If you want to lower costs then you have to re-engineer a health care system to provide care efficiently. How we finance care can help but it is not the heart of the problem.
2. The people with the most need for organized integrated care are those with chronic illnesses who will account for the largest share of health care spending.

I suggest anyone who cares about this issue might want to take some time and understand what makes integrated, organized health care systems like Mayo Clinic, Kaiser, Cleveland Clinic, Intermountain Healthcare, Geisinger Clinic, Scott and White Clinic, Billings Clinic, Marshfield Clinic, Denver Health, etc... much better at providing high quality care than the disorganized, uncoordinated patchwork of doctors, specialists and hospitals that most of us rely on.

It's like we are debating the relative merits of systems of capital allocation in japan and the US in the 1970's to explain the difference in the quality of automobiles being produced in each country rather than understanding their different approaches to production and quality control.

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Joe Fox,

I think there's a lot to what you say. Why do you suppose the approach used by the places you name is not more widespread?

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Roads have clear benefits in numerous ways, including the delivery of health care. Health care is a nice idea, but I fail to see a public benefit beyond the point we're at now.

If a worker can't work or dies and thus can't support his family for lack of health care because he can't afford health insurance and his employer doesn't provide it, either you are suggesting his family should likewise die, or the cost of supporting his family is cheaper than treating his health problem.

But your argument is presumably that those over 65 should get no Medicare coverage because they are dispensable and might as well die if they don't have the resources. Are you at the Tea Party demonstrations calling for terminating Medicare because it is welfare for worthless people?

We have the odd case of conservatives and Tea Party activists defending socialized medicine for those over 65 from the liberals who are seeking to cut the subsidies to the insurers who provide Medicare Advantage at 114% of government run Medicare direct spending.

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Sorry, Mulp, but I won't be your straw man. Don't presume anything. The defense of "healthcare as public good" you offered up is basically a sob story. Your argument is weak and weaken it further by resorting to unfounded personal attacks rather than reason.

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