Keeping people healthy far less profitable than charging sick people outrageous fees

Princeton economics professor Uwe Reinhardt asks us to imagine colleges working like our health care system:

[S]uppose universities operated… on a piece-rate compensation basis, like the current health system. They would then be merely a pastiche of different pedagogic profit centers, each with its own fee schedules and ownership patterns.

Professors would rent office space from the university and then each function as their own profit centers. They would equip their offices with computers to present graphic illustrations to students during office hours or surf the internet with them, charging not only a professional office-visit fee, but also a PC usage fee…

The for-profit University Library Inc. would be owned by jointly by the entire faculty, perhaps in a joint venture with Barnes & Noble. Each time a student used the reserve library to read the voluminous material assigned by the professors, there would be a separate charge — perhaps even a facility charge if a student read the book in the library, as many like to do…

Students would be charged a professional lecture fee for every class they attended along, of course, with another facilities fee, like an operating-room charge in a hospital. Every time a student sought out a teaching assistant during office hours a charge would be incurred…

[Parents] would be stunned not only by the sheer length of the invoice and the total amount billed, but also because so many line items would be expressed in either Latin or Greek and thus be completely incomprehensible to most parents. Upon requesting a fee schedule from the dean of the college, the latter would patiently explain that different prices had been negotiated with different parents and that all of those fees are proprietary information.

The analogy partially illustrates the insanity of our piece-rate healthcare system. But the analogy misses a key argument for government-paid “single payer” healthcare: An HMO receiving a flat fee per customer has strong incentives to pursue preventive medicine (and advocate for healthy patient behaviors) that keeps customers healthy. Keeping patients healthy lowers the HMO’s costs, thus raising their profits. Conversely, our current system leads profit-maximizing hospitals and doctors and drug companies to over-treat patients, conduct unnecessary tests and procedures, and prescribe medicines of dubious value.

Currently, colleges have reasonable incentives to provide quality education at low cost. If a college’s perceived quality does not match its sticker price, students will go elsewhere. And colleges that turn out poorly educated graduates won’t raise much from alumni for their endowments. But, if colleges were instead paid piece-rates, students would have far greater difficulty comparing colleges based on price-adjusted quality because: 1) The total price tag to attend each college would be hard to determine ex ante; and, 2) It would be hard to determine how well students attending any particular college fared because even students attending the same college might purchase very different educational experiences. Many colleges would likely exploit this greater uncertainty — and the greater market power it gives them — by charging higher fees. As high as college costs already are, costs would probably rise substantially. Even worse, educational quality would fall because: 1) Many students would reduce their educational experience to avoid paying fees; and, 2) As fees rose, students would be even more inclined to reduce their consumption of education.

That’s exactly the situation we face in healthcare today. Walk into a hospital, and you have no idea what you’ll be charged. You often can’t even find out until after the procedure has been carried out. Given that hospitals can charge whatever they want (unless you have a big insurance company that has the power to negotiate rates) and don’t have to tell you their fees until it’s too late to say “no,” hospitals charge uninsured patients exorbitant amounts. Fearing these giant bills, many Americans avoid treatment. People having emergencies are often so scared of the ambulance charge, for example, that they drive to the hospital… or tough it out, hoping they’ll feel better. And then there are the tens of millions of Americans who can’t even afford hospital treatment because it’s so expensive.

A single-payer system would be infinitely superior to and cheaper than our current situation. But there’s much less profit in keeping people healthy than in charging outrageous fees when people get sick.

Posted by James on Friday, February 05, 2010