1 Evan Bennett November 16th, 2013 WRD 104. Prof.

Leeb Cost Inefficiencies of the US Health Insurance System and the Affordable Care Act In 2010, Congress passed the largest health care reform since Medicare and Medicaid were signed into law in 1965. The Affordable Care Act (ACA) presented a sweeping overhaul of how Health Insurance was administered and aimed to increase competition between private insurance companies. While the ACA does expand healthcare to the uninsured and reduces the overall cost, it fails to fix the inherent problem. Private Health Insurance will never be able to cover everyone and efficiently control healthcare prices. The issue with the high cost of healthcare is the insurance system itself. Having a third party administer the cost between the consumers and the hospitals creates a system where there is no set basis to the cost of health care. As opposed to a government run system, where the cost is universally set, and a free market system, where consumer demand dictates the cost, the exact cost of health insurance is lost in a series of zero sum competition and the additional cost of administration. At each transaction of administering healthcare, payer to patient, hospital to insurer, the cost is shifted from one party to another and no real value is created. Even though health insurance companies in the United States are for profit and operate on an open market, the nature of administering healthcare makes them different from a typical business. On average it takes 17 years for a clinical trial to become a medical practice. Consumers purchasing healthcare are completely unaware of the quality and exact cost. The Affordable Care act aims to address these issues by expanding coverage and improving the way health insurance is administered. While it does expand coverage, it fails to change the nature of competition on which health insurance runs. There are many issues with the system as a whole but none can be solved directly without sacrificing quality of care. Therefore, the purpose of this paper is to show

2 how the insurance system in the United States is structured so that the cost, while contained under the Affordable Care Act, will never be cost effective and able to insure everyone. Past/History The Healthcare system that is in place today was created around the time of World War II. To save on government costs, Healthcare was passed on to Employers to provide employees. Blue Cross and Blue shield arose to become the main dispenser of healthcare. From Post-World War II to the 1980s, these two companies where non-profit, quasi social institutions that provided healthcare based on cost set by community standards. (Fuchs 1538) In conjunction with larger firms and industries like Ford and General Motors, insurance rates remained relatively stable. With the emergence in the late seventies of large scale for-profit commercial insurance companies, a shift from community rate premiums to actuarial risk occurred. This meant that buyers where no longer looked at in broader civic terms of people who needed coverage but instead on what risk would they pose to the insurance companies. (Fuchs 1540) It is from this risk assessment that the ban on preexisting conditions and lifetime limits occurred. As these companies lowered premiums and developed new ways to gain market power, the quasi-social insurance community rated premium system could not survive. It is no coincidence since the emergence of these large scale firms, Healthcare costs have raise faster than any other country and show no signs of slowing unless a large scale change occurs. Current State and Projections As the Healthcare system stands today, nearly 43 million people are uninsured while spending on Healthcare consumes 14% of the countrys GDP. (Medicine 2) If this trend continues it is projected by 2013 that 20% of the United States GDP will be consumed by health care costs. The United States is the

3 only developed nation with this type of Health Care system. Ever since the 1980s health care rates in this country have been steadily increasing. Health Insurance companies make up for a majority of the uncontrolled costs. Since they operate on the open market, they act with relative impunity. When premiums go up, companies are not required to give a notice or reason. Since 1999, health insurance coverage has risen 139%. While some states have laws to address this issue most do not. The few who do have had very limited success in effectively reviewing rates, primarily due to legal authority and the inability to require any type of transparency. Waste A major component that stems from the insurance system is waste. In 2009, according to the Institute of Medicine, about a third, $750 billion, of health care cost was wasted. By comparison thats as much as the Pentagon spent each of the eight years on the war in Iraq. Excess administrative costs $190 billion, inflated prices $105 billion, and fraud $75 billion accounted for the greatest portion of wasted cost. While not all directly attributed to Health Insurance companies, each of those areas are completely related to cost and pricing. A report from Thomas Reuters highlighted 700 billion in waste

that could be cut from the Healthcare system Donald M. Berwick, MD, MPP; Andrew D. Hackbarth, MPhil both Physicians and the former CEOs of Healthcare analytics backs up IOMs findings, and identified six major areas where waste could be eliminated. Two of the main areas will be explained below. 1) Administrative Complexity The way cost is administered between all the separate parties is incredibly complicated. Between the hospital administration and the health insurance agencies, the rules and forms that guide payments add waiting time for patients create an added burden on physicians. In addition the

4 rules and forms that need to be filled out make it difficult to identify how much a procedure or hospital visit should cost, which adds to overestimated costs. Further on in the paper, the coding system that insurers have hospitals determine costs by will be examined closer and shown how incredibly subjective and arcane the process is. 2) Pricing Failures Largely due to the non-competitive nature of health insurance, the pricing system to determine healthcare cost is vastly overstated. Without a set market price to determine profitability, consumers are paying more and receiving less coverage. At the same time, doctors arent getting paid any higher and the quality of care has remained the same. The cost of a simple IV fluid, or sterile salt water can cost anywhere from a 44 cents to $546Neither hospital doctors or insurance agencies can explain the discrepancies in price. It has also been reported frequently how the cost of an MRI or CAT scan procedure in the United States costs many times more than in other developed countries like Great Britain and Canada. Once again, the differences in price are lost in the complicated bureaucratic system of zero sum competition. Zero Sum Competition The waste in Americas Health Care inherently stems from the zero sum nature of competition between insurers. (Michael E. Porter 34) In a regular market place, competition produces a value. Consumers decide which products to purchase based on quality and affordability. This creates a system where providers are constantly refining and improving products. The outcome is optimization of both quality and affordability. This traditional model, spurred by innovation which creates different approaches constantly expanding and improving markets. Companies and business that dont meet this standard of competition quickly go out of business.

5 Health care and the private insurers that administer it are completely different. While Health Insurers operate on an open market, it is clear that competition has done nothing to control cost. Economists have argued that this is because there is both too much and too little competition, but regardless of the specifics, it is clear that competition is the problem. (Michael E. Porter 35) As it stands, Health Insurers operate with relative impunity because consumers have very little understanding of what they are paying for. The complexity of the medical field makes it difficult to differentiate what constitutes affordability and quality. The six different types of approaches to prostate exams are much different than choosing a common household object like a computer processor. Patients receiving care are generally unable to determine whether the type of value they received primarily because having a point of comparison is very difficult. The greatest issue with the competition is that it operates on the wrong level. Instead of dealing with medical conditions and the care that patients receive, insurance companies and providers focus entirely on costs. Value is derived when patients receive care not when their choices are restricted based on insurance network their a part of. Since each person operating in the system has no way to improve healthcare, the value is divided among each participant. To exacerbate the issue, the inefficient nature of the system many times erodes the value by creating unnecessary costs. There are four main ways in which zero sum competition is created. Cost Shifting Cost reduction is found in normal competitive markets. However, with zero sum competition, the cost is simply shifted from one party to the next. Costs are shifted from the payer to the patient, from the health plan to the hospital, from the health plan to the hospital, from the hospital to the physician, from the insured to the uninsured and so on. When this occurs the gains that do occur for one participant happen at the expense of another. (Michael E. Porter 35) Patients may get adequate

6 care, but the doctors are burdened with unnecessary costs. With each step, a similar situation occurs. Cost shifting doesnt just add no value it does the opposite by detracting the value.

Bargaining Power With no value gained due to cost shifting, the different participants vie for bargaining power. To amass power, the different parties consolidate to gather more market clout. The effects of this can be seen in the large insurance companies that have dominated the market. For instance, Blue Cross and Blue Shield have risen in the past decade to become two of the largest health care providers in the country. Bargaining power however not only adds no value to healthcare, but instead severely contracts from it. With the ability to control the cost of healthcare, Insurers have made exclusive deals with only the providers that are willing to provide discounts. This did trigger competition, but only for the hospitals and providers who fought to be part of the network plans. The incentives they did offer came in discounts for employers who had large numbers of patients being insured. Additional discounts were given to companies that were providing coverage for large groups of people. (Michael E. Porter 37) While this practice did slow down the rise of cost, it was only temporary. The greatest issue with these discounts is that it has no rational economic argument. (Michael E. Porter 38) Regardless if providers take on more patients, the average cost for each is going to remain the same. Patients working for large companies arent going to be cheaper than those self-employed. In addition, doctors can only see one patient at a time and by increasing the volume of patients it adds pressure. Wrong Level of Competition

7 The fundamental problem with health insurance in the United States is that it operates on the wrong level of competition. Instead of dealing with value and specific practices and medical conditions, the competition is focused entirely on cost. The competition should occur at the physician and patient level where the value of healthcare is created. Instead it occurs almost exclusively with health insurance plans, network groups, hospital groups and physician groups. (Michael E. Porter 44) The issue is that there is a disconnect between what is being paid for and the value of care that is actually received. At this level of healthcare, the focus is on profits not on patient coverage. Value in healthcare is produced at the medical condition and not at the physician or hospital care level where competition currently happens . A medical condition (asthma, highblood pressure) is any patient circumstance that requires direct and effective care. By addressing patients concerns and needs, a value is created. (Michael E. Porter 44) This level however is very broad and currently incurs a broad range of costs. With the lack of competition, providers with worse outcomes and higher prices are allowed to remain in practice. A complex network system stifles competition at this level by restricting access to information and assigning patients to certain doctors. As previously mentioned, insurance companies use their bargaining power to control market clout and gather influence. The care patients receive is largely dictated by their healthcare plans. When out-of-network-care is allowed, it is severely restricted by large copays and the requirement to buy list fees. This type of system has been in place for so long that even physicians are unaware of the quality of care of out-of-network specialists which makes referring patients very unlikely. Therefore, the networks that insurers provide dictates the type of care patients receive. (Michael E. Porter 45) Clearly this system stifles innovation at the medical condition level and creates the high costs that have plagued the American Health Care System. Health insurance companies treat healthcare as a commodity The Affordable Care Act

8 To address the issues of rising health care costs and faulty competition, Congress passed the Affordable Care Act and the Patient Protection Act. Both laws were meant to change the way health insurance was administered primarily by making it more competitive but also by placing governmental financial restraints on the insurance industries. The primary way it does this is through accountability. If an insurer pays to much on administration costs and not enough on actual healthcare, the government requires it give back part of the money in rebates. This is called the Medical Loss Ratio. Another goal of the ACA is to extend coverage. Whereas before insurance was optional, the law now requires that each person financially able buys insurance. (Henry J. Kaiser Foundation 1) The unwillingness to have insurance however, isnt the only reason people arent covered. As previously stated, the nature of private health insurance divides buyers by the amount of risk. Therefore people with pre-existing conditions, such as asthma, are not covered. The same applies to lifetime coverage. Under the ACA, people in both these categories enter what is called a high risk pool. Since it is a greater financial liability for health insurers to cover these types of patients, the government pays a certain amount to subsidize the risk. The ACA will take effect on January 1st 2014. Employers will still be providing the majority of the insurance coverage but for those who are uninsured, a health insurance tax credit will be given as well as the possibility to buy insurance from The Exchange. Central to ACAs goal of increasing competition, the exchange is an open market where health insurance companies compete for peoples business. The idea is that by provided good information, with multiple choices on an even playing field, consumers will be able to purchase the best product at the most reasonable price. This will drive down costs and improve quality. It is projected that by 2019, 32 million people will be newly insured. (Henry J. Kaiser Foundation 3)

9 The Congressional Budget Office, the nonpartisan group that mediates issues like this, projects that 938 billion will be the total cost of Health Reform over the next 10 years. To put it in perspective, thats 2% the national budget and 3% of what would have been spent on health care if the current rise in cost is continued. (Henry J. Kaiser Foundation 2) In addition Congress and the White House claim that these costs would be completely paid. The majority of the savings will come from Hospitals and Insurers in the Medicare program along with the fees that will be gathered from both these parties. Taxes on Medicare users will increase as well as the ones for Health Insurance Companies and hospitals. When all these measures are put into place, it is actually projected that the law will provide 124 billion in savings over the next 10 years. (Henry J. Kaiser Foundation) Of course all of these numbers and plans are just projections. As we approach 2014, a clearer picture of the law will unfold but it wont be until all the measures are in place that the success or failure of the law will be known. Rebates and Medical Loss Ratio The White House claimed that 8.5 million people would receive rebates from insurers that failed to spend at least 80% on health care. While 2.7 million people would receive a check of $100 or more, 5.7 million would not receive direct financial reimbursements, instead future premiums would be lower. (Harrington 10) Officially the percentage is known as the Medical Loss Ratio. Under the law it states The Affordable Care Act requires health insurance issuers to submit data on the proportion of premium revenues spent on clinical services and quality improvement. (Services 1) The primary purpose is to establish transparency in the health insurance market. Whereas before consumers were left unaware of the percent actually being spent on care., Now regular reporting is required that include: reporting on premiums, reimbursement for clinical services, spending on measures to improve quality, and spending on non-claim issues. Insurance Mandate

10 Another central part of the law that became controversial, was the insurance mandate. Going into effect in 2014, all Americans who are required to file a tax return, making above 20,000 a year, are required to purchase insurance. Multiple exceptions are included but for those unable to pay, a tax penalty is given depending on percent of income and family size. Graph 1.2 gives specific details on what the requirements are and who exactly is mandated to buy insurance Generally, the penalty for not having Health Insurance will be up to $95 per adult and $47.50 per child or 1% of each persons taxable income, whichever is greater. In the next couple years however, this number is going to rise based on how many months without coverage. In June of 2012 the Supreme Court ruled on the constitutionality of the ACA and the Patient Care Act, particularly on whether the insurance mandate was constitutional in a 5-4 decision. (Department of Health and Human Services, et al., Petitioners)

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Pre-existing Conditions and Lifetime Limits Before the ACA, Insurance Companies were able to deny people based of Pre-Existing conditions. Health Insurers, being private for profit companies, looked at potential buyers in terms of risk. Based on past medical history, companies raise and lower premiums. Therefore, from a profit standpoint, accepting a customer with a pre-existing condition is taking on an unnecessary risk because it is almost guaranteed to accrue higher expenses. While it may be beneficial financially, the practice has left millions of Americans uninsured. Pre-existing conditions can range anywhere from a history of heart conditions or cancer to acne and even pregnancies. ACAs Effect on Competition

12 A central part of the Affordable Care Act is to increase the level of completion in healthcare and move health insurance companies away from risk assessment. As previously mentioned, the first measure this is achieved through is the Medical Loss Ratio. By providing standards and regulation on private insurance companies, the Affordable Care Act plans on changing how competition operates. Instead of Insurers controlling the rate of premiums through strict networking choices, the Affordable Care increases the option of out of network providers by lowering copays and limiting fees. (Custer 25) Although a majority of people have healthcare plans through their employers, for the buyers that dont have health insurance, the Affordable Care Act sets up system to purchase health insurance called The Exchange. The concept is similar to a virtual mall, where health insurance companies openly compete for business through fair and equal competition. By providing honest information, affordable rates, the ACA creates a system were buying healthcare is not just based on affordable prices but also quality of care. Problems with the Affordable Care Act The Affordable Care Act does take measures to expand coverage and reduce costs but the fundamental problem is it fails to fix the nature of the system itself. As long as there are private insurers the focus will always be on deriving profits and not on administering affordable care to everyone. Limiting the way private companies act may be beneficial to buyers and increase coverage but it is also a liability for the insurers. (Silvers 402) Taking on patients with a higher risk means companies are going to take on more costs. The inevitable outcome is that when you have change the structure of a business to run less profitably, the level of efficiency goes down. Healthcare cannot be treated as a regular commodity because business and healthcare are structured completely different. Business aims to reduce cost while healthcare are structured to accrue it. With health insurance, the focus is entirely on controlling cost and creating a profit instead of dealing

13 with the quality of care. The Affordable Care Act aims for insurance agencies to incorporate the two but the nature of them will never allow it. Instead of leaving controlling costs to regulation and competition, the ACA needs an independent party to set a standard measure for care and cost. Maryland has proved this is effect by using the Maryland Health Services Cost Review Commission which has effectively maintained cost since 1977. (Affairs 2) Without this type of measure in place, cost will not be as affordable and the quality of care will be less than it could be. Conclusion The United States Healthcare System spends more on healthcare than any other country in the world. At the same time, however over 80 million citizens are left uninsured and the infant mortality rate is ranked 44th in the world. Although there are reasons contributing to the high cost in every part of the system, the area that is addressed in the paper is the private health care system. While insurers are private companies, the root of the issue is because of zero sum competition. Instead of competing for coverage at the medical condition level, insurers and hospitals focus almost exclusively at the physician levels. This means instead of having the actual treatment of patients be the means to derive value, insurers and providers compete solely for cost in a complex system of networks, fees and copays. Without a way to increase the value, competition is zero sum. At each healthcare transaction, the value is divided between each party and no benefit is gained. To make the system more competitive and expand coverage, Congress passed the Affordable Care Act. Set to take effect in 2013, the law puts regulations on insurance companies and mandates all citizens who are financially able purchase insurance. While the system does expand coverage through these different measures, it fails to fix the root of the problem. As long as health insurance is based on deriving profits, the focus will never be on administering quality of care at a competitive affordable price.

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Works Cited
Affairs, U.S. Depart of Veteran. "VA Maryland Health Care System." n.d. U.S. Depart of Veteran Affairs. 10 November 2013 <http://www.maryland.va.gov/about/statistics.asp>. Custer, William S. "Risk Adjustment And The Affordable Care Act." Journal of Financial Service Professionals (2013): 25-26. Department of Health and Human Services, et al., Petitioners. No. 11-11021, 11-11067. United States Court of Appeals for the Eleventh Circuit. 12 August 2012. Fuchs, Alain C. Enthoven and Victor R. "Employment-Based Health Insurance: Past, Present, And Future." Health Affairs (2006): 1538-1547. Harrington, Scott, E. "Medical Loss Ratio Regulation Under The Affordable Care Act." Inquery (2013): 926. Henry J. Kaiser Foundation. Summary of the Affordable Care Act. Medical Summary. Washington D.C.: Henry J. Kaiser Foundation Press, 2013. Medicine, Institute of. Americas Uninsured Crisis: . Medical. Washington, DC: National Academic Press, 2009. Michael E. Porter, Elizabeth Olmsted. Redifining Health Care . Boston: Harvard Business Review Press, 2006. Porter, Michael E. and Elizabeth Olmstead Teisberg. "Redefining Competition in Health Care." Harvard Business Review (2004): 64-76. Services, Centers for Medicare & Medicaid. "The Center for Consumer Information & Insurance Oversight." n.d. Center for Medicare and Medicaid Services. 14 November 2013 <http://www.cms.gov/CCIIO/Programs-and-Initiatives/Health-Insurance-MarketReforms/Medical-Loss-Ratio.html>. Shaffer, Ellen R. "The Affordable Care Act: The Value Of Systemic Disruption." American Journal Of Public Health (2013): 969-972. Silvers, J B. "The Affordable Care Act: Objectives and Likely Results in an Imperfect World." Annals of Family Medicine (2013): 402-405.