By: Danielle Teitelbaum
July 12, 2021
Despite spending twice as much on healthcare than other developed nations, the U.S. performs poorly on many health outcomes. Why is U.S. healthcare so dysfunctional? The answer lies in the way we pay for it. Most healthcare spending is done through third party payers, most commonly via health insurance companies acting as intermediaries between patients and providers. This framework, based on an unbalanced power dynamic, has incentivized the commercialization of healthcare to the detriment of patient wellness. Past reforms have been insufficient to remedy these shortcomings for failure to address the underlying incentives, thus requiring a new approach that puts patient wellness and autonomy first.
I. The U.S. Framework for Financing Healthcare
Generally, insurance is a form of risk management that spreads loss across a large pool of policyholders. As such, the purpose of insurance is to protect an individual against losses with the following characteristics: they are unavoidable, unpredictable, and will be significant.
Most types of insurance follow the above framework. However, American health insurance originated in hospitals to cover the high fixed costs of emergency care. Instead of protecting against unexpected and significant costs, early plans covered all costs up to a certain limit. Health insurance continued to evolve from this actuarially flawed hospital model, which does not follow the catastrophic risk-spreading framework. Instead, coverage for medical emergencies requires paying for a more comprehensive plan which covers a mix of catastrophic and routine procedures. Some nonemergency procedures (i.e., throat cultures) are covered by these plans. Conversely, cancer treatment is not fully covered, nor are ambulance calls, although most would consider these catastrophic medical expenses.1Note that insurances offered plans labeled “catastrophic health plans.” However, these plans were not comprehensive in covering all emergency expenses and had very high deductibles. The ACA expanded the list of essential services these plans were required to cover. However, insurers responded by severely restricting access to these plans.
A. “Tying” Creates Unequal Bargaining Power
By selling coverage for both types of treatment together, insurance companies can charge inflated prices for routine, less expensive medical procedures, thereby increasing their profit margin. The Federal Trade Commission refers to this practice as “tying”, an anticompetitive strategy. “Tying” occurs when a seller uses its market power for an inelastic product (here, emergency care) to force customers who want/need the inelastic product to buy it together with a second, more elastic product (routine care). This allows sellers of both to raise the price of the elastic product and forecloses competing sellers of just the elastic product.
“Tying” appeared in the health insurance market because insurance originated in hospitals, the main providers of emergency care. Insurers pressured patients to buy routine care coverage from them by tying it to the emergency care coverage that hospital patients sought. Once patients were forced to pay their insurer for routine health care, they were under financial pressure to only see providers who are in network with that insurance.
This relationship has forced many private practitioners to go in network with a major insurance company and accept unrealistic reimbursement terms to avoid losing patients. The result is that health insurers now hold enormous power over both patients and providers. Providers are bound by one-sided contracts with insurers while patients cannot access necessary medical care (that they already paid for via premiums) unless the insurer approves treatment. Thus, rather than serving as a risk diffuser, health insurance has evolved into a gatekeeper to healthcare, a role which it leverages to maximize profits.
B. Third-Party Payers Divert Focus from Patient Wellness
Consequently, we now have a healthcare system in which incentives are skewed in a way that negatively impacts patients’ health. Doctors are reimbursed by health insurance companies based on a fee-for-service scale in which they are paid a standardized amount per billing code. This created a “box-checking”, rather than problem-solving, approach to treating patients. The financial incentive for providers to really troubleshoot patients’ symptoms no longer exists, since they can still bill the insurance whether the patient is satisfied or not. Thus, our intermediary-based system has removed patient leverage in negotiating for better care and contributed to the rise of a reactive, rather than proactive, approach to health.
1. Providers are Consolidating and Commercializing
Medical providers must now contend with multiple insurance programs, each with its own codes, policies, and procedures, in constant flux due to market changes and regulatory updates. To keep up, providers must hire extra staff to do the medical billing or outsource to a billing company such that the cost of getting paid is often more than the amount earned.
As a result, four concerning trends of consolidation and commercialization have emerged. First, providers are abandoning their private practices and moving into large group practices where they are paid a salary. This trend is leading to an increase in “healthcare deserts” in rural areas and low-income neighborhoods, further deepening persistent health disparities.
The second is “packing” providers’ schedules with brief patient visits. Packing creates a quantity over quality issue and causes “physician burnout”, doubling the risk of medical error and reducing empathy for patients. Moreover, severe burnout can force providers to leave the field, contributing to a shortage of providers.
The third, “delegating”, occurs when a practice employs few top tier care providers (e.g. doctors and dentists) and many lower tier healthcare providers (e.g. nurses, physician’s assistants, dental hygienists, etc.). The insurance is billed under the higher-tier providers while patients are primarily treated by lower-tier providers. Patients are seen by different providers every time (turnover for lower-tier care providers is double that of top tier providers), disrupting continuity of care, making patients less likely to confide in providers and consequently letting health issues go unaddressed.
The fourth is “upcoding”, when a practice orders unnecessary tests or procedures simply for the purpose of milking the visit for as many billable services as possible, or bills for tests or procedures that were never done. Upcoding creates tremendous waste in our healthcare system and can undermine medical studies that use testing data. Furthermore, unnecessary procedures (i.e., tooth extractions, mastectomies) can be harmful to patients’ quality of life.
2. Administrative Bloat Increases Costs and Reduces Accountability
The current financial structure generates administrative bloat. Insurance companies employ a complex code-based billing system which necessitates the operation of extensive administrative processes by insurers, hospitals, and providers, all of whom pass the costs on to patients. The current ratio of administrators to providers is 10:1, meaning patients need to pay ten administrators for each provider they use. This disparity widens as administrative layers are added.
Some of this bloat is driven by government regulation. For example, Medicaid is designated the “payer of last resort,” meaning claims from patients who are eligible for both Medicare and Medicaid coverage are supposed to be submitted to Medicare first. Under the so-called Medicaid Maximization program (MedMax) many states contract with private third-party agencies to review Medicaid claim submissions to determine whether any portion is Medicare reimbursable.2Visiting Nurse Serv. of New York Home Care v. New York State Dep’t of Health, 13 A.D.3d 745 (N.Y. App. Div. 2004), aff’d, 5 N.Y.3d 499 (N.Y. 2005) (explaining the role of MedMax programs).
Otherwise, it is the result of insurers outsourcing administrative obligations to third parties. For example, Pharmacy Benefit Managers (PBMs) serve as middlemen between pharmaceutical companies and health insurers. PBMs contract with insurance companies to negotiate drug prices, saving money for insurers and shaping patients’ access to medications.
One immediate result of this bloat is that by adding more administrative layers to the healthcare system, the overall cost of healthcare increases. An increasingly large proportion of the money available for healthcare is already being spent on administration, rather than patient care. One can infer a direct connection between this budget trend and the high spending and poor outcomes paradox of U.S. healthcare.
Another danger is the use of unregulated third parties to undermine government regulatory efforts and serve as a liability shield for bad faith practices. For example, health insurers employ utilization review providers (independent reviewers which prevent overconsumption of healthcare) to review and approve treatments prescribed by providers. In Corcoran v. United Healthcare, Inc., the patient plaintiff had no viable claim against their doctor, insurer, or third-party reviewer because the doctor prescribed appropriate treatment, insurance outsourced the coverage decision, and the reviewer did not examine the patient. Accountability for the patient’s harms was diffused among these responsible actors by the complex administrative labyrinth, barring any recovery for their losses.
Finally, an increasingly complex system is undeniably more difficult to control. Market influence is no use where consumers cannot shop among insurers and providers because their prices are either not public or too difficult to calculate given the procedural obscurity.
II. Where Previous Reforms Have Fallen Short
The trends described above have led to the high spending and poor outcomes U.S. healthcare suffers from today. The Federal government has made several attempts to check the health insurance industry and reign in its ballooning costs. However, all of these initiatives addressed the symptoms of the problem rather than the underlying cause. Our government has repeatedly propped up the current system, adding and expanding public programs to patch the recurring holes.
A. Building on the Legacy of the Internal Revenue Act of 1954
Medicare and Medicaid were created to cover those who were unable to access employer sponsored coverage but were largely inadequate due to rising costs, difficulty accessing coverage, and the growth of “Medigap” plans. The government tried to address growing calls for reform by encouraging employer sponsored health insurance with a carrot and stick tax benefit scheme.
Employers originally used health insurance benefits as an incentive to recruit employees at a time when wages were frozen. The government has supported this initiative through tax breaks and more recently, through tax penalties for larger employers whose employees do not have coverage. This seemed to work while unemployment was low, but less so during grueling recessions with high unemployment. Following the pandemic and subsequent economic paralysis, many who relied on employer sponsored coverage were laid off and suddenly left without coverage.
Employer sponsored insurance also disincentivizes smaller businesses from hiring new employees, because growth comes with a hefty price tag: provide coverage or pay a penalty. This health benefit burden has greatly contributed to the rise of the gig economy, which allows employers to get around providing benefits (although courts may be starting to crack down on this). It also keeps employees ‘locked’ into suboptimal jobs (known as “job-lock”), keeping them from entrepreneurship or a job where they would create more value.
B. The Affordable Care Act
The most recent attempt at sweeping healthcare reform is the Affordable Care Act (ACA). The ACA was a highly ambitious piece of legislation that tackled costs, quality, and access to coverage. Despite that, the ACA was insufficient because it addressed problems in isolation, rather than deal with the underlying power disparities and skewed incentives. Insurers, experts at finding loopholes, simply restructured by increasing premiums and out-of-pocket maximums in order to protect their bottom line. United Healthcare made $1.9 billion in profit during the last quarter of 2016 despite increased regulation from the ACA.
One of the main objectives of the ACA was to move healthcare from the fee-for service model to a value-based method of payment. It did so by establishing Accountable Care Organizations (ACOs) to cut down on duplication of services and link hospital reimbursements to health outcome metrics (like readmission rates).
However, this strategy has several flaws. One is that ACOs are only available to those with original Medicare, so their services have a limited reach. Another is that the metrics used to evaluate quality of care apply mainly to hospitals, which does not do much to advance the sort of preventative care that is more likely to take place at primary providers.
Furthermore, the “value” in a value-based healthcare system is good health. It is difficult to assign metrics to health; sickness can be pinned down to evidence from tests and cultures but healthiness is more abstract and thus not well suited to a scoring system. This can perhaps be offset by incorporating patient feedback. However, patients may not be motivated to provide feedback if they are not the ones paying. Even if they could be pushed to provide feedback, it would need to be collected, evaluated, and included in decision-making somehow, most likely by the addition of even more intermediaries. Therefore, it is unlikely ACO’s would have efficiently shifted healthcare to a value-based approach. We can only speculate what the long-term effect of the ACA would have been, as its impact was interrupted by the Trump administration’s attempt to repeal and replace it.
Medicare-For-All gained widespread recognition in recent debates over healthcare. However, it remains a mere proposal because it is extravagantly expensive. Economists estimate it costing a staggering $34 trillion to implement, and the tax schemes needed to fund it would disproportionately burden the middle class, making it difficult to get the support needed to pass it.
Furthermore, Americans are wary of socialized medicine. Many worry about losing autonomy in health care decisions and having fewer choices of providers and procedures, or that there will be long waits for elective procedures like in Canada. Given that Medicare-for-All will presumably cover all medical procedures, it could also conflict with personal values. Medicare-for-All would force some taxpayers to fund procedures they oppose on moral grounds, making it difficult to reach a consensus among voters. It is difficult to pinpoint exactly how much support exists for the bill, although it tends to drop when people are made to understand that private insurance would be eliminated under this system.
III. Reinventing U.S. Healthcare with an Incentive-Based Approach
To create a new system, one must first define its goals and work backwards to explore what incentives would advance those goals and what mechanisms would create those incentives. The goals of a healthcare system should be affordability, quality, efficiency, and accessibility. For most industries, the market is the best tool to keep prices and waste low, quality high, and ensure that supply and demand will meet efficiently. As applied to healthcare, this translates into providers being paid without intermediaries. However, providers of emergency care would have grossly disproportionate bargaining power if healthcare were left to market forces and the American hospital health insurance experiment has shown that it is not advisable to leave this up to the market.
Based on the above assessment, the key to the new plan is to do the opposite of what the hospital insurance industry did. To realign incentives in healthcare, the new system needs to “untie” catastrophic and routine care. The government can accomplish this by combining tax-based, single-payer catastrophic coverage with universal access to Health Savings Accounts (HSAs).
A. Separate and Socialize Emergency Medical Care
Compartmentalizing healthcare in this way would resolve a number of issues. First, universal coverage for emergency care will restore insurance to its proper role by covering medical expenses that are difficult to prevent, predict, or save for. Having everyone contribute to a national emergency medical fund makes sense, as anyone could potentially experience an emergency. This brings insurance back to its goal of diversifying risk by spreading it out over a large pool and preempts a death spiral, as everyone would automatically participate via taxes.
Second, this would prevent providers from taking advantage and overcharging for emergency care. The reality is that in an emergency, a patient has no negotiating power regarding price or choosing a provider. Therefore, allowing market forces to determine prices in such situations is inviting abuse of grossly unequal leverage. Furthermore, autonomy does not come in to play here. Someone experiencing a medical emergency does not have the luxury of choice but must take the first available provider. Therefore, a single-payer system in this context does not reduce patient choice or autonomy in any way.
Third, this preemptively addresses the greatest shortcoming of the Emergency Medical Treatment and Labor Act of 1986 (EMTALA): uncompensated care. EMTALA was passed to provide a safety net for those in need of emergency care regardless of coverage, but it did not address how hospitals would be compensated for treating uninsured patients. The cost is immense; it is estimated that U.S. hospitals provided $38 billion in uncompensated care in 2017.3While uncompensated care was reduced by Medicaid coverage expansion under the ACA, not all states participated.
The shortcoming of EMTALA is not limited to the uninsured, as even insured patients contribute to uncompensated emergency care. For example, if a patient mistakenly thinks they are having an emergency, insurance may not cover the bill. Or, if the patient went to an in-network hospital, but later discover than one of the doctors was not in network, they are left holding the bag. These “surprise medical bills” are a significant driver of medical debt, which affects 20% of working-age Americans with health insurance, and is the top reason why people in the U.S. file for bankruptcy. Eliminating the need to pay for emergency care would lift a crippling financial burden off of 79 million Americans.
B. Extend Universal HSA Access to Nonemergency Medical Expenses
The second element of the plan requires universal HSA access to allow patients to save money exclusively for healthcare spending in tax-exempt bank accounts. The concept of universal HSA access is not new. HSAs originated during the Clinton administration as part of early healthcare reform efforts, but have been narrowly applied to insurance plans with high out-of-pocket costs, excluding many from the benefits. Furthermore, while HSAs allow for budgeting for ordinary medical expenses, it is unlikely that they could help the average American to pay for catastrophic medical expenses. Thus, they only become viable as a national solution when paired with catastrophic coverage.
HSAs allow patients to save money for healthcare expenses in tax exempt savings accounts, and present benefits to all parties involved. For patients, HSAs give them the power to spend their money in a way that maximizes their health outcomes. Any savings will accumulate over time, unlike insurance where unused premiums are forfeited. For providers, HSAs would reduce the “cost of getting paid” to almost $0, making smaller and patient-focused practices feasible again. Together, these benefits can bring competition back to healthcare, allowing market forces to bring down costs and match supply and demand to create a more efficient system.
A salient concern is that some do not earn enough to contribute to an HSA. This does not invalidate the benefits of adopting universal HSAs but rather, it suggests that Medicaid may still be necessary for the unemployed and minimum wage earners.
Another potential argument against universal HSAs is that people will consume less healthcare as a result of paying per procedure. This line of thinking conflates more healthcare consumption with better health, which is untrue. As the prescription opioids crisis and unnecessary mastectomy rates demonstrate, overconsumption of healthcare can actually harm patients as much as underconsumption. Since the HSA framework provides an incentive to budget and invest in healthcare spending to produce long-term savings, there is sufficient financial incentive for patients to spend on preventative care. Therefore, any reduction in healthcare consumption will likely reflect the reversal of the upcoding normalized by the health insurance system.
One might argue that the sheer size of the health insurance industry is an obstacle to fundamental reform. However, the current size of the industry inflated, so its size far exceeds its value. It is a bubble that if preemptively deflated can be reformed with minimal instability. Its elimination would cause significant, but temporary unemployment because consumers seeing healthcare savings will be able to spend more across the economy and employers relieved of the health benefit burden may be able to expand hiring.
A national emergency health infrastructure would also help the government address national emergencies more efficiently. The advantages of this are especially apparent after the COVID-19 pandemic and the disruption it wreaked on health insurance coverage (it is estimated that 29% of Americans lost their health insurance in 2020). In addition, the pandemic was an eye opener for many regarding the deeply ingrained structural flaws in our healthcare system making more people open to reform.
Some might prefer incremental reform over sweeping restructuring. Past reform attempts avoided fundamental change, perhaps because the system was so entrenched that uprooting it presented a messy prospect. However, the pandemic has already disrupted our social infrastructure on many levels. Disruption, while unsettling, also lowers the transition costs of fundamental change. Thus, the transition costs of making fundamental changes in our healthcare system are much lower than they used to be. This pandemic presents us with a historic opportunity to make fundamental changes in our healthcare system. The silver lining of our recent tragedy could be our long overdue national health revolution.
Danielle Teitelbaum, J.D. Class of 2022, N.Y.U. School of Law.
Suggested Citation: Danielle Teitelbaum, An Incentive Perspective on U.S. Healthcare, N.Y.U. J. Legis. & Pub. Pol’y Quorum (2021).
- 1Note that insurances offered plans labeled “catastrophic health plans.” However, these plans were not comprehensive in covering all emergency expenses and had very high deductibles. The ACA expanded the list of essential services these plans were required to cover. However, insurers responded by severely restricting access to these plans.
- 2Visiting Nurse Serv. of New York Home Care v. New York State Dep’t of Health, 13 A.D.3d 745 (N.Y. App. Div. 2004), aff’d, 5 N.Y.3d 499 (N.Y. 2005) (explaining the role of MedMax programs).
- 3While uncompensated care was reduced by Medicaid coverage expansion under the ACA, not all states participated.