How distortions shape expectations

I recently suffered an injury to my foot. I got in to see my doctor the next day. They took and x-ray and confirmed no broken bones, just damaged soft tissue that should heal in a few weeks. I saw the x-ray image less than 2 minutes after it was taken. I was amazed at the clarity.

I expected to pay hundreds of dollars from my HSA account for that care, since I had not reached my deductible for the year. But, I thought it was worth it to know that I had no broken bones. I was pleasantly surprised to receive the bill. The total cost for the doctor visit and x-ray: $83.

Some say, sure, that’s the rate your insurance company had negotiated. I say, that’s closer to the rate you’d see in a competitive market where more costs are paid by patients out-of-pocket and that’s similar to what we pay plumbers and HVAC repairmen for a basic service call.

But, our expectations are different for those services, shaped by decades old market distortions of tax-deductible employer plans and third-parties paying the bills.

We might grumble about paying for plumbing or HVAC repair, but we haven’t adopted the expectation that some third-party insurance company pay that cost for us.

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14 thoughts on “How distortions shape expectations

  1. Seth, I agree with you. “We” have become so accustomed and indifferent to high prices for medical care because we have come to think that somebody else – the insurance company – is paying for it. But those dollars that the insurance company paid for the services came from what could have been an increase in our hourly wages. If, instead of paying for your insurance, your employer gave you a raise equal to the insurance premiums, you would have a greater incentive to bargain with the doctor.

    When government subsidized medicine – by creating tax benefits for employer paid insurance and by subsidizing Medicare recipients with tax dollars – they created the conditions that led to higher prices.

    Most people think that the high price of medical services is due to the high cost of the inputs ( drugs, medical supplies, medical workers, professional offices, etc.). They have it entirely backwards. It is the high price of the outputs or services (which is due to government subsidization) that has enabled the providers of the inputs – the drug manufacturers, device manufacturers, professional office landlords, etc. – to raise their prices.

    As you note, the market distortions of tax-deductible employer plans and third-parties paying the bills has led us to become accustomed to prices that would not exist otherwise. Doctors were not always “rich” in comparison to the majority of their townsfolk. They did well in good times and bad because people get sick and demand their services even during recessions, but in the “old” days when the patient was paying the bill, the prices weren’t so “obscene” and bills were sometimes paid with something other than cash.

  2. I recently slammed my shin into a box, cutting myself open pretty good. I went to urgent care and got it stitched up. I also got a tetanus shot (I couldn’t remember the last time I got one so they gave me one just to be safe).

    About a month later, I got a bill for a tetanus shot. The bill was $0. Insurance covered it. I looked carefully at the bill. The stitches weren’t listed. Anywhere. Six months later I haven’t received an additional bill. I called my insurance company to check and see if there was anything gummed up in the system. Nothing.

    About six years ago I separated my shoulder. I went to the ER, to get an x-ray. No broken bones. They gave me a sling. One month later I got the bill – around $1000 (can’t recall exactly but it was over $1000). Insurance covered none of it.

    Paying for other services – like food and getting my house painted – I get to see a price tag and I know what is going on. When it comes to medical services (in my personal experience) I have never felt like I have any grasp of what is happening with the pricing.

    • Hi Wally!

      1. Box jumps?

      2. Here’s how I visualize the problem. You are correct that, unlike the market for most goods and services where you as the recipient of the service are also the buyer and you and the seller agree on a mutually satisfactory price, the government has provided incentives that have resulted in third parties being inserted between you and the service provider. But first, let’s look at the relationship between inputs and outputs so that we understand the cause for the high prices.

      While most people assume that the price of the inputs (ingredients) determines the price of the outputs (products or goods and services), it’s really the other way around. Consider your own business. A chief reason you are able to charge what you do for membership (the output) is NOT because the rent and the equipment – the inputs – are so expensive, but because of people’s desire or demand to join CrossFit.

      Translating this to what happens in medicine:

      Several factors have created the situation today where people do not feel the “pinch” of paying for medical services. For some, the government subsidizes there care – they have no restraint when it comes to seeking care. If you and I are paying out of pocket for care, we wouldn’t go to the ER for some trivial nonsense. We would weigh the pros and cons – the monetary cost versus the cost of missing a broken bone, etc. If someone isn’t paying for the trip to the ER, there are no cons to a trip to the ER when there is a low likelihood of any real injury. A similar case can be made with regards to employer sponsored health insurance when employees want more insurance because they don’t recognize that the premiums are really coming from what could have been their wages.

      The net effect is to drive up the demand for medical services which, in turn, drives up the price.

      Now, the hospital will tell you that the reason they charge so much is because there costs to purchase labor, drugs, etc. are so high, but that’s backwards. The high demand for medical services – in part created by government subsidies – drives up the price of medical services. Thus, providers of medical services are willing and able to pay high prices for their inputs (supplies). Indeed, the suppliers of these inputs see the demand in terms of multiple medical service providers ordering inputs – the demand for these inputs drives up the price for the inputs.

      PS – I built my own plyo boxes and topped them with pieces of rubber gym mats (horse stall mats).

  3. Yep. Box jumps. I have a wonderful scar. I like the rubber mat top idea. Smart solution.

    “Several factors have created the situation today where people do not feel the “pinch” of paying for medical services. For some, the government subsidizes there care – they have no restraint when it comes to seeking care. If you and I are paying out of pocket for care, we wouldn’t go to the ER for some trivial nonsense. We would weigh the pros and cons – the monetary cost versus the cost of missing a broken bone, etc. If someone isn’t paying for the trip to the ER, there are no cons to a trip to the ER when there is a low likelihood of any real injury. A similar case can be made with regards to employer sponsored health insurance when employees want more insurance because they don’t recognize that the premiums are really coming from what could have been their wages.”

    So regardless if it is the government or an employer subsidizing the cost, the problem is that the feedback loop is broken. So the solution is no subsidized health care costs by anyone? No insurance? Or simply all private insurance – untie it from people’s jobs and get rid of medicare/medicaid?

  4. Yep, the feedback loop is broken. That’s another way of saying that the normal incentives or disincentives have been messed with.

    Please note that “employer subsidized” is ultimately the government’s doing. Back in the WW2 era when FDR froze wages, the government gave business (perhaps their cronies – I’ll do more research on this) a way to “raise wages” by giving employer provided medical insurance a tax break, i.e. it’s a business deduction for the employer and you get the full benefit of all the dollars rather than just the after tax dollars – which also encourages you to buy “more” insurance which may mean a policy with a lower deductible which gives you less incentive to avoid treatment for a “boo boo” as opposed to a real injury.

    As far as subsidizing costs, remember that when something is subsidized, we get more of it – but someone must pay the costs. If we subsidize the supplier of the service, the supplier artificially lowers his price (because the subsidy makes up the difference) – but “someone” (taxpayers) ultimately are the ones paying the subsidy – the net being a transfer of income from those paying taxes to those not paying taxes. If we subsidize the consumers, they are willing to pay more for the service and the quantity demanded increases (as does the equilibrium price) – again “someone” gets stuck paying the subsidy.

    Here’s a nice visual:

    http://www.coyoteblog.com/coyote_blog/2012/09/how-government-interventions-affect-health-care-supply-and-demand.html

    I’m not opposed to insurance. I agree with you that it should be separated from one’s job – which would be the case if the tax favored status was removed. Note that this would have solved the problem of a person being tied to a job because of insurance. As far as Medicare goes, if you look at the premiums that seniors pay, they are far below the amount that an insurance actuary would come up with to cover the amounts paid out. In other words, younger workers are subsidizing Medicare for retirees. Like social security, this works (or worked) when there are many young workers and few retirees, but the baby boom is reversing the demographics and the SHTF scenario is approaching. The sober discussion that nobody in Washington wants to have is that the chances of incurring large costs for medical care grow exponentially with age once one reaches 60 and the true cost for an insurance policy grows in a like fashion. The average senior – especially over 65 or 70 – would be hard pressed to afford insurance (unless he was prudent enough to put away some cash as a young person or to buy a level rate insurance policy when he was younger). The hard but true fact is that we are all going to get old(er) and die of some illness or injury. We struggle with the reality of letting granny or gramps (or mom and dad) go because of a choice (trade off) of paying huge sums of money for medical care (which may only prolong their life/suffering for a few months) versus letting them go. With subsidies (Medicare) we don’t look at it as “our money” and thus we aren’t faced with the decision between “keep pops alive and spend lots of cash) versus “let pops go and save our cash”. Unfortunately, we are still affected because we do pay the costs in terms of taxes – even though we don’t always recognize them. So, I’m not opposed to keeping pops alive at 90, I just think that you shouldn’t be forced to pay to keep my dad alive anymore than I should be forced to pay to keep your dad alive at 90.

    If we want to have a “charity” program for those who are truly UNABLE (as opposed to UNWILLING) to provide for themselves, there are better options than Medicaid. First, private charity (churches, charitable organizations, free care by docs and hospitals) has traditionally filled this role. If one wishes a government “solution”, it is best done (administered) as locally as possible and with direct payments to the “needy”.

    OK, this is getting long and I have to go do my box jumps (seriously!) alt w/ stationary bike HIIT.

  5. “So the solution is no subsidized health care costs by anyone? No insurance? Or simply all private insurance – untie it from people’s jobs and get rid of medicare/medicaid?”

    The solution is to remove the incentive/feedback distortions. Removing the employer tax advantage removes one distortion. This would cause us to buy health insurance like we do auto and home insurance. We’d likely stick with one company longer, which solves a lot of the pre-existing condition problem that government has tried to solve

    There are other distortions as well. Third party payment — gov’t and insurance company — is a feedback problem where the most interested party doesn’t make the price/value judgement. When my roof was damaged, my insurance company cut me a check, gave me a list of roofer and educated me on the rates I would expect to pay.

    State mandates also cause incentive distortions, as does the right to endlessly not pay for emergency medical treatment.

    I don’t have a problem with subsidies, if the incentives are done well. I’d much rather have the subsidy go into an HSA that can be used to buy medical care and a high-deductible policy. This is similar to a voucher for education.

    • Hi Seth –

      I recognize that many people favor subsidies like an HSA plan and I would like to give it some more thought. The pro is that it gives people an incentive to put something away for medical expenses. However, it’s still a subsidy and has two results” (1) it raises the equilibrium price (the price for medical services) – albeit, it raises them disproportionately for those who didn’t contribute to an HSA (they are paying after tax rather than pre-tax dollars), and (2) it forces the government to seek revenue elsewhere (they can just raise the tax rate to adjust for the income sheltered by the HSA deduction).

      That said, the mess that the government has gotten us into with regards to healthcare insurance and prices is not an easy one to untangle politically and HSAs may be one of the less bad of a variety of not good solutions. With regards to paying for healthcare, the US is like the guy who has put on weight over 30 years and wants to lose it overnight – it can be done, but it would be drastic and painful.

      I think that in my ideal world, we would replace the income tax with excise taxes. One effect is that every consumer – which is to say every American – would feel the effects of government spending and put a stop to excessive government spending.

      There would be no subsidies for medical insurance and no government subsidies for medical care. In an unfettered free market, a person wanting a policy with a low deductible could expect to pay a larger price than he would for a similar policy with a high deductible. This would encourage people to select the “proper” policy options for their situation. An overweight cigarette smoker with a poor diet would expect to pay more than a someone who exercised, ate properly and avoided tobacco – this would allow people to choose and would discourage an unhealthy lifestyle, a major contributor to our health care costs.

      The courts would enforce judgements against deadbeats who try to skip out on medical bills (or any other debts). This would bring down costs for those of us who honor our contracts

      With the ushering in of LBJ’s Great Society and its entitlement programs (including Medicare/Medicaid), one thing has remained constant – there is no such thing as a free lunch, somebody always has to pay the bill. This has resulting in spiraling costs as it’s always easy to spend OPM. These programs always were about one thing – redistribution of wealth for the purpose of keeping leftist politicians in power. ObamaCare is just more – much more – of the same. It doesn’t fix any health care (or health insurance) problem. It merely accelerates us on our course to fiscal insolvency.

      I remember when these debates started out. The cries from the left were that we -as a nation – spend too much of our GDP on health care. When Obama said that his plan would cut health care costs, what he really meant was that it would lower prices for a few people. However, it will increase the total amount that we as a nation spend on health care – and a byproduct of its revenue collection methods will serve as a disincentive for US production. We will simultaneously increase our spending and decrease our income – a recipe for default, inflation and/or tax increases, any one of which is unsustainable.

      Will the last one out please turn off the lights!

      • The main reason I like HSA’s is that it converts third party spending into first party spending, which I think is a key feedback improvement that helps drive price transparency, innovation and cost reductions.

        The 2nd reason is that, if made available outside workplaces, it can help equalize the tax deductible advantage employer-provided insurance has. I’m not sure I care whether this is equalized by removing the tax deductibility from everything or giving it to everything.

  6. Wally — I’ve had similar price transparency issues, but I believe that is part and parcel with the third-party paid system that we have. If more people were paying directly for services, out-of-pocket or from HSA accounts, that would improve quickly.

  7. The system is distorting pricing, for sure.

    The link below isn’t related to pricing at all – I simply found all the charts and grades fascinating. It’s a report on heath outcomes of 17 industrial nations around the world – told from the Canadian viewpoint. It’s neat because it looks like they’ve been keeping statistics for 50 years. Thought you guys might find it interesting. Not trying to sidetrack the discussion or make any sort of point with it at all… just interesting stuff.

    http://www.conferenceboard.ca/hcp/details/health.aspx

    • That is interesting. International health stats provide good examples of apples-and-oranges comparisons and mistaken cause-and-effect.

      An example of apples-to-oranges comparison is the infant mortality rate, which is not tabulated consistently from country to country. The U.S., for instance, includes mortality of births after 26 weeks and countries with better infant mortality only include births after 32 weeks.

      Life expectancy is an example of mistaken cause and effect. Lifestyle and demographics have much large influences on life expectancy than medical care.

      For me, health care is one of those areas where you can’t rely on such stats. They aren’t what I call ‘true measures’. A truer measure is looking at where people choose to receive medical when they have a choice. Though I don’t have stats on that, my guess is that more people who live in countries with socialized medicine choose to come to US for treatments than the other way around.

    • Don’t forget, “health”, “health care” and “health care insurance” are three separate and distinct things. That the US ranks high or low in “health” has virtually nothing to do with our “health care” or with our “health care insurance.” When people claim that the poor or those with pre-existing conditions don’t have access to health care, they are not telling the truth. Some people may not be able to afford health care insurance, but it is the unusually rare exception that someone is denied necessary health care.

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