Pre-existing Condition

Michael Rothschild

This article appeared in Upside Magazine (August 1993).

Put in context, these words were uttered in protest to my friend Jennifer when she refused to allow a pediatric nurse to administer a sonogram to her infant daughter. Unknown to the nurse, Jennifer and her husband had fallen through a crack in the health care system that all Americans dread. A job change, a paperwork glitch, and a "pre-existing condition" had left them uninsured just when they needed coverage the most.

As it turns out, in this particular medical situation, a $37 urinalysis test yields almost the same information as a $350 sonogram. And having spent months caring for their little girl while learning enough about the system to fend off financial ruin, Jennifer was savvy enough to get the physician's advance approval for the cheaper test. When she explained to the nurse that they cared about the cost of the tests, because they indeed were paying the bills themselves, the nurse reacted with shocked disbelief. Apparently, the concept of a cost-sensitive consumer of medical services was foreign to the nurse's considerable experience.

Repeated millions upon millions of times each year, small but wasteful choices add up to a health care system plagued by runaway costs. With health care now chewing up 14% of the GDP, with the competitiveness of American firms being undermined by employee health costs, and the federal government being driven into bankruptcy by Medicare costs, President Clinton claims his plan will fix the mess.

But Clinton's plan ignores the fundamental flaw in the current system. Though often called the "medical marketplace," the American system is nothing of the sort. No market can exist without price and quality conscious buyers. Without self-serving customers evaluating competing offerings and prices, there can be no market discipline, no economic feedback loop which nourishes the efficient and innovative while choking off the wasteful and hidebound.

But today, over 95% of all hospital bills and 80% of all doctors charges are paid for by "third-parties," someone other than the person being served. If this is a market, it's the first one in human history without real customers.

Tragically, under Hillary Clinton's "managed competition" plan, Americans will have even less reason to make prudent choices than they do now. If passed by Congress, all meaningful decision-making power will be consolidated into several new bureaucracies. As bad as the current system is, Clinton's plan will wreak still further havoc on the quality, availability, and cost of U.S. health care.

How did we get into this mess? Through decades of well-intentioned policy blunders. It began with World War II's wage control system, when employers found it difficult to recruit enough workers to meet production schedules. To sweeten compensation packages without running afoul of wage controls, some firms began offering health care benefits.

By the 1950s, when the Internal Revenue Service decided to go after this form of untaxed employee income, the practice had become widespread. So Congress responded to constituent protests by exempting employer provided health care from income and social security taxes. Over the years, as tax rates climbed, basic arithmetic drove millions of Americans to stop paying their own medical bills and instead take a portion of their earnings in the form of tax-free health benefits.

As usual, the numbers tell the story. At today's tax rates, the gap between an employee's value to the firm and her take home pay is considerable. With 15.3% deducted for social security, 15% for federal income tax, and about 6% for a typical state's income tax, just 64› of a firm's payroll dollar winds up in an employee's hands. For employees taxed at the 31% (soon to be 36%) federal rate, take home is just 48 cents (43 cents). Put another way, for a worker in the 31% bracket, an employer can provide $2.08 in health benefits for the same cost as $1.00 in take home pay. You don't have to be a Rhodes Scholar to figure out that most people would rather take their pay in the form of health benefits, even if the system wastes half their money.

Another unintended, though devastating, consequence of these perverse tax incentives is that Americans now run virtually all their medical bills, regardless of a how small they might be, through their insurance firms. Since most policies have $250 deductibles, it makes sense to exhaust the deductible early in the calendar year to reach the point where the 80-100% coverage kicks in. But since each claim, regardless of amount, generates about $8 in processing costs at the doctor's office and another $8 in handling costs for the insurer, huge administrative costs are generated by an enormous volume of small claims.

We'd never dream of using auto insurance to pay for predictable expenses like oil changes and tire rotations. Except for health care, we buy insurance only to protect ourselves from improbable but financially catastrophic risks. But responding to the incentives laid down by the tax code, we've turned America's health insurance companies into the world's most expensive bill paying service. It took until 1982 before the Reagan administration switched the reimbursement system to DRGs (diagnosis related groups), where the government decreed the price it would pay for a particular service, regardless of what the hospital or physician said their costs were. Hailed at the time as a brilliant reform, the government's shift to DRG-based price fixing, never dealt with the real issue_the decoupling of benefits from payment.

Instead, government price caps on Medicare/Medicaid services led hospitals to shift costs to patients covered by private insurance. This, in turn, accelerated the cost surge faced by insurers, who passed the inflation along via massive annual premium hikes. By the late Eighties, forty years of bad health care policy had created the present crisis.

Now it's Bill Clinton's turn to solve or be destroyed by the mess. With great media fanfare, Hillary Clinton's 500 master planners labored in secrecy to design a regulatory contraption that would make Rube Goldberg blush. So complicated that no one can explain it cogently, "managed competition" is a new label for more of the same bad medicine -- shifting power from consumers to bureaucrats. Though rarely mentioned by the mainstream press, a perfectly viable solution is within reach. Known as the MediSave (or Medical IRAs) plan, this system was created by John Goodman, president of the market liberal National Center for Policy Analysis in Dallas. Alone among all the plans discussed, MediSave is designed to discipline health care spending by harnessing the self-interest of American consumers. Under the MediSave system, every American would have a tax-free savings account dedicated to health care. Employers would funnel health care dollars directly to employees' MediSave accounts instead of the insurance firms. Governments could do the same with their payments. Small medical expenses would be paid with a debit card linked to each MediSave account. Funds not used in a given year would grow with tax-free interest. Funds not used during a person's working years could be spent on post-retirement health care or rolled over into a pension fund. MediSave accounts would be private property, portable with job changes, and part of an estate at the time of death. Since 80% of Americans use well under $1000 in medical services per year, most people would buy inexpensive insurance with deductibles of about $1000. The system's administrative costs, estimated at 25% of all costs, would plummet as the volume of small claims collapses. With frugality and smart shopping rewarded by growing MediSave balances, 100 million families would exert incredible market discipline on health care providers. Though the experts claim that average people don't know enough to exercise good judgment in health care, a Rand Corporation study shows that people who paid for their own care spend a 33% less than those with free care, with no measurable difference between the two groups' health outcomes. Besides, with MediSave empowering consumers, consumer guides would spring up to help health care shoppers evaluate competing services. The question is not whether MediSave accounts will work. They do. In Singapore, the first country to implement MediSave, health care quality is up and medical inflation is down. The only real mystery is why Hillary Clinton refused to even consider a MediSave strategy. Just one explanation seems plausible_ideology. Despite the worldwide triumph of markets and the ongoing decentralization of business and governmental power, America's social engineers cling to their command-and-control mindset. Instead of creating a genuine health care market, where all Americans have incentives to behave like prudent consumers, our master planners offer up more mandates, taxes, regulations and bureaucracy. Bill Clinton and millions of Americans are about to pay a terrible price for that slavish devotion to obsolete dogma.