Optimizing the Healthcare System

One of the basic ideas in the theory of optimization is that the strategy of optimization should itself be optimized. You can do that by applying various different measurements to prospective optimization targets and comparing them according to some evaluation process. The general rule is that your best selection for an optimization target is where there’s something to optimize.

The pie chart you generally see for measuring costs in our healthcare system attributes the costs in our system to insurance, hospitals, professional salaries, pharmaceuticals, and litigation costs, pretty much in that order, with insurance at roughly 30% of the total and growing fast, hospitals and professional salaries at roughly 20% each and growing a little less fast, and other costs accounting for substantially lower percentages of the whole.

Even divvying up the pie this way is a political judgment. One could also aggregate the costs of hospitals with professional salaries as “healthcare providers”. That slice would then be the largest in the pie and, consequently, would attract additional scrutiny.

However you cut the pie both because of its size and its rate of growth it’s pretty clear that something should be done to reduce insurance costs and there have, basically, been two proposals for doing that from two different camps, the “adverse selection” camp and the “moral hazard” camp.

The “adverse selection” camp attributes the rising costs of health insurance to the increasing efforts on the part of the insurance industry at controlling its costs by denying insurance for a variety of reasons to different groups. Their preferred solution is mandatory universal coverage. The “moral hazard” camp sees the rise in the cost of health insurance as being due to excessive consumption due to the isolation of the consumer from the costs of healthcare. Their preferred solution is elimination of what we think of as healthcare insurance today in favor of high-deductible catastrophic care insurance and some form of health savings accounts.

Each of these camps has its problems. I think those in the “adverse selection” camp suffer somewhat from a lack of understanding of how insurance actually works. Basically, there are two ways of making money in the insurance business. The first method is you can take the premiums, invest them, and make money from your investments. This method worked beautifully in the 1990’s and, unfortunately, many insurers thought that would last forever. As should have been foreseen it didn’t. The other method is the plain, old-fashioned insurance business: you charge more for premiums than you pay out in benefits. Under that scheme as healthcare costs rise, insurance costs rise just a little faster and, indeed, that’s what we’re seeing.

The “moral hazard” camp has its problems, too. Although they’re more in the right of it for tying rising insurance costs to rising healthcare costs, their prescription has a small problem. When people bear the costs of their own healthcare, they reduce their spending on both necessary and unnecessary treatment. Consequently, public health suffers and it’s possible that there won’t be much in the way of savings if people unwittingly trade expensive emergency or critical care for relatively less expensive preventive or routine care.

I’ve supported some form of single-payer solution for decades out of a simple desire to reduce the costs of claims administration but I haven’t cared for the form that most proposals take. I’m practically alone in suggesting that no market-based solution can succeed under our current situation of a supply that’s severely constrained. I don’t think that universal coverage does enough to control costs to be affordable and, indeed, without some form of fiat pricing would quickly be overwhelmed by increasing costs. That gives weight to the concern that many critics of both single-payer and universal coverage have that either system is just a stalking horse for some sort of fiat system. I’m reminded of something one of my old economics professors said—that we don’t know how to create abundance but we have a pretty good idea of how to create scarcity and it’s through fiat pricing.

While insurance costs are the most tempting target, for reasons I outlined in a prior post I don’t think we can get the entire distance we need to go by that route. We also need to optimize costs in the hospital and professional salaries components of the cost equation and I honestly don’t see any way to do that without dramatic increases in the supply of health care including the way healthcare services are provided. But that’s fodder for another post.

4 comments… add one
  • PD Shaw Link

    The main problem with the “moral hazard” camp is the low savings rate among Americans. They need to go to an average earner and explain to them that you’ll just need to pay the first $2,000, $3,000 or $5,000 (or more) of your health care. Where will that come from? If it comes from anybody else, you have the moral hazard problem. If it comes from a raise the employer is expected to give him, good luck with that. And I thought the “moral hazard” camp was aligned with those seeking to de-link health care insurance from employment?

  • Phil Link

    I think the entire “moral hazard” argument is specious, for a few simple reasons. First off, do you know anyone who actually wants to “consume” healthcare? Does anyone actually enjoy going to the doctor, let alone the hospital? Are patients the ones who specify what tests and procedures they receive in the health care system? The entire idea of people driving up health care costs by excessive consumption is ludicrous, when you don’t have to look beyond the fee-for-service payment model to see where the demand comes from.

    The other reason that forcing people to become health care “consumers” doesn’t make sense is that it’s unrealistic to expect the average person to be a competent “healthcare consumer” when we send doctors to school for 8+ years. Beyond the most basic measures of comparing hospitals, how are people supposed to know what’s necessary and unnecessary when their physician recommends something?

  • I think the entire “moral hazard” argument is specious, for a few simple reasons. First off, do you know anyone who actually wants to “consume” healthcare?

    I’ve made a similar argument myself, Phil. We don’t have both legs put in casts if they’re cheaper or have two heart valves replaced rather than one.

    I don’t this of this as specious so much as true only on the margins.

    In my view the reason for this is that although what we’re buying is health care what we want is health. More health care does not necessary translate to more health.

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