A large part of the welfare state, in both the United States and other wealthy countries, is devoted to paying for health care. In most wealthy countries, the government pays between 70% and 90% of all medical costs. The private sector plays a larger role in the U.S. health care system. Yet even in America, as of 2014 the government pays almost half of all health care costs; furthermore, it indirectly subsidizes private health insurance through the federal tax code.

Figure 11-4 shows who paid for U.S. health care in 2014. Only 12% of health care consumption spending (that is, all spending on health care except investment in health care buildings and facilities) was expenses “out of pocket”—that is, paid directly by individuals. Most health care spending, 77%, was paid for by some kind of insurance. Of this 77%, considerably less than half was private insurance; the rest was some kind of government insurance, mainly Medicare and Medicaid. To understand why, we need to examine the special economics of health care.

In 2014, U.S. personal health care expenses were $9,523 per person—17.5% of gross domestic product. However, this did not mean that the typical American spent nearly $9,000 on medical treatment. In fact, in any given year half the population incurs only minor medical expenses. But a small percentage of the population faces huge medical bills, with 10% of the population typically accounting for almost two-thirds of medical costs.

Is it possible to predict who will have high medical costs? To a limited extent, yes: there are broad patterns to illness. For example, the elderly are more likely to need expensive surgery and/or drugs than the young. But the fact is that anyone can suddenly find himself or herself needing very expensive medical treatment, costing many thousands of dollars in a very short time—far beyond what most families can easily afford. Yet nobody wants to be unable to afford such treatment if it becomes necessary.

329

Private Health Insurance Market economies have an answer to this problem: health insurance. Under private health insurance, each member of a large pool of individuals agrees to pay a fixed amount annually (called a premium) into a common fund that is managed by a private company, which then pays most of the medical expenses of the pool’s members. Although members must pay fees even in years in which they don’t have large medical expenses, they benefit from the reduction in risk: if they do turn out to have high medical costs, the pool will take care of those expenses.

There are, however, inherent problems with the market for private health insurance that arise from the fact that medical expenses, although basically unpredictable, aren’t completely unpredictable. People often have some idea whether or not they are likely to face large medical bills over the next few years. This creates a serious problem for private health insurance companies.

Suppose that an insurance company offers a “one-size-fits-all” health care policy, under which customers pay an annual premium equal to the average American’s annual medical expenses, plus a bit more to cover the company’s operating expenses and a normal rate of profit. In return, the insurance company pays the policyholder’s medical bills, whatever they are.

If all potential customers had an equal risk of incurring high medical expenses for the year, this might be a workable business proposition. In reality, however, people often have different risks of facing high medical expenses—and, crucially, they often know this ahead of time. This reality would quickly undermine any attempt by an insurance company to offer one-size-fits-all health insurance. The policy would be a bad deal for healthy people, who don’t face a significant risk of high medical bills: on average, they would pay much more in insurance premiums than the cost of their medical bills. But it would be a very good deal for people with chronic, costly conditions, who would on average pay less in premiums than the cost of their care.

As a result, some healthy people are likely to take their chances and go without insurance. This would make the insurance company’s average customer less healthy than the average American, raising both the medical bills the company will have to pay and its costs per customer.

The insurance company could respond by charging more—raising its premium to reflect the higher-than-average medical bills of its customers. But this would drive off even more healthy people, leaving the company with an even sicker, higher-cost clientele, forcing it to raise the premium even more, driving off even more healthy people, and so on.

This description of the problems with health insurance might lead you to believe that private health insurance can’t work. In fact, however, most Americans are covered by private health insurance. Insurance companies are able, to some extent, to overcome the problems we just outlined in two ways: by carefully screening applicants and through employment-based health insurance.

With screening, people who are likely to have high medical expenses are charged higher-than-average premiums—or in many cases, insurance companies refuse to cover them at all. The problem that screening creates is that those people who need health insurance the most are more likely to be denied coverage or charged an unaffordable price. This is yet another reason behind the support for ACA, which expanded coverage to everyone regardless of their health history. Next we explain how employment-based health insurance, a unique feature of the American workplace, also allows private health insurance to work.

330

Employment-Based Health Insurance One way insurers have overcome problems is by selling insurance indirectly, to employers rather than to individuals. The advantage of employment-based health insurance—insurance that a company provides to its employees—is that these employees are likely to contain a representative mix of healthy and less healthy people, rather than a group of people who want insurance because they expect to pay high medical bills. This is especially true if the employer is a large company. Employers require thousands of their employees to participate in the company health insurance plan because allowing employees to opt out (which healthier ones will be tempted to do) raises the cost of providing insurance for everyone else.

There’s another reason employment-based insurance is widespread in the United States: it gets special, favorable tax treatment. Workers pay taxes on their paychecks, but workers who receive health insurance from their employers don’t pay taxes on the value of the benefit. So employment-based health insurance is, in effect, subsidized by the U.S. tax system. Economists estimate the value of this subsidy at about $150 billion each year.

However, many working Americans don’t receive employment-based health insurance. Those without coverage include most older Americans (relatively few employers offer insurance that continues in retirement); the many workers whose employers don’t offer coverage (especially part-time workers); and the unemployed.

Table 11-5 shows the breakdown of health insurance coverage across the U.S. population in 2014. A majority of Americans, nearly 175 million people, received health insurance through their employers. The majority of those who didn’t have private insurance were covered by two government programs, Medicare and Medicaid. (The numbers don’t add up because some people have more than one form of coverage. For example, many recipients of Medicare also have supplemental coverage through Medicaid or private policies.)

Medicare, like Social Security, is financed by payroll taxes, and is available to all Americans 65 and older, regardless of their income and wealth. It began in 1966 as a program to cover the cost of hospitalization but has since been expanded to cover a number of other medical expenses. You can get an idea of how much difference Medicare makes to the finances of elderly Americans by comparing the median income per person of Americans 65 and older—$23,569—with average annual Medicare payments per recipient, which were more than $10,000 in 2014. As with health care spending in general, however, the average can be misleading: in a given year, about 7% of Medicare recipients account for 50% of the costs.

Unlike Medicare, Medicaid is a means-tested program, paid for with federal and state government revenues. There’s no simple way to summarize the criteria for eligibility because it is partly paid for by state governments and each state sets its own rules. Of the nearly 51 million Americans covered by Medicaid in 2014, 29 million were children under 18 and many of the rest were parents of children under 18. Most of the cost of Medicaid, however, is accounted for by a small number of older Americans, especially those needing long-term care.

331

Nearly 14 million Americans receive health insurance as a consequence of military service. Unlike Medicare and Medicaid, which pay medical bills but don’t deliver health care directly, the Veterans Health Administration, which has more than 8 million clients, runs hospitals and clinics around the country.

The U.S. health care system, then, offers a mix of private insurance, mainly from employers, and public insurance of various forms. Most Americans have health insurance from either private insurance companies or through various forms of government insurance.

Health care is one area in which the United States is very different from other wealthy countries, including European nations and Canada. In fact, we’re distinctive in three ways.

Table 11-6 compares the United States with three other wealthy countries: Canada, France, and Britain. The United States is the only one of the four countries that relies on private health insurance to cover most people; as a result, it’s the only one in which private spending on health care is (slightly) larger than public spending on health care.

Canada has a single-payer system: a health care system in which the government acts as the principal payer of medical bills funded through taxes. For comparison, Medicare is essentially a single-payer system for older Americans. The British system is extended to everyone: a government agency, the British National Health Service, employs health care workers and runs hospitals and clinics that are available free of charge to the public. France is somewhere in between the Canadian and British systems. In France, the government acts as a single-payer, providing health insurance to everyone, from a sizable government-run health care system. French citizens can also receive treatment from private doctors and hospitals.

Canada, Britain, and France provide health insurance to all their citizens; the United States does not. Yet all three spend much less on health care per person than we do. Many Americans assume this must mean that foreign health care is inferior in quality. But many health care experts disagree, pointing out that Britain, Canada, and France generally match or exceed the United States in terms of many measures of health care provision, such as the number of doctors, nurses, and hospital beds per 100,000 people. Although it’s true that U.S. medical care includes more advanced technology in some areas, many more expensive surgical procedures, and shorter waiting times for elective surgery, surveys of patients seem to suggest that there are no significant differences in the quality of care in Canada, Europe, and the United States.

332

So why does the United States spend so much more on health care than other wealthy countries? Some of the disparity is the result of higher doctors’ salaries, but most studies suggest that this is a secondary factor. One possibility is that Americans are getting better care than their counterparts abroad, but in ways that don’t show up in either patient surveys or statistics on health performance.

The most likely explanation is that the U.S. system suffers from serious inefficiencies that other countries manage to avoid. Critics of the U.S. system emphasize the fact that our system’s reliance on private insurance companies makes it highly fragmented and very expensive to operate. Each insurance company expends resources on overhead and on such activities as marketing and trying to identify and weed out high-risk patients. On average, the operating costs of private health insurers consume 14% of the premiums clients pay, leaving only 86% to spend on providing health care.

Americans also pay higher prices for prescription drugs because, in other countries, government agencies bargain with pharmaceutical companies to get lower drug prices.

However one rates the past performance of the U.S. health care system, by 2009 it was clearly in trouble, on two fronts.

Lying behind the growing number of uninsured, in turn, were sharply rising premiums for health insurance, reflecting rapid growth in overall health care costs. Figure 11-6 shows overall U.S. spending on health care as a percentage of GDP, a measure of the nation’s total income, since the 1960s. As you can see, health spending has tripled as a share of income since 1965; this increase in spending explains why health insurance has become more expensive. Similar trends can be observed in other countries.

The consensus of health experts is that the rise in health care spending is a result of medical progress. As medical science advances, once untreatable conditions become treatable—but often only at great expense. These higher costs have to be passed on in the form of higher insurance premiums or require larger commitments of taxpayer funds.

333

The combination of a rising number of uninsured and rising costs led to many calls for health care reform in the United States. And in 2010, Congress passed the Affordable Care Act (ACA) which took full effect in 2014. It was the largest expansion of the American welfare state since the creation of Medicare and Medicaid in 1965. It had two major objectives: covering the uninsured and cost control.

Covering the Uninsured To understand the logic of the ACA, consider the problem facing one major category of uninsured Americans: the many people who seek coverage in the individual insurance market but are turned down because they have preexisting medical conditions, which insurance companies fear could lead to large future expenses. Lou Vincent, from this chapter’s opening story, was one of those people. He was denied coverage for years because he had Type II diabetes. How could insurance be made available to such people?

One answer would be regulations requiring that insurance companies offer the same policies to everyone, regardless of medical history—a rule known as community rating. It can lead to problems as healthy individuals don’t buy insurance until they get sick, and because only people with health problems are getting coverage, insurance becomes very expensive.

To make community rating work, sick and healthy alike need to buy health insurance—a requirement known as the individual mandate. In addition, government subsidies need to be available to make the required insurance affordable for lower- and lower-middle income families.

It’s important to realize that this system is like a three-legged stool: all three components must be present in order for it to work. Take away community rating, and those with preexisting conditions won’t get coverage. Take away the individual mandate and many healthy people won’t buy insurance. As a result, only those who are sick buy insurance, which in turn drives up costs and premiums. And you can’t require that people buy insurance without providing subsidies to those with lower incomes.

Cost Control But will the ACA control costs? In itself, the expansion of coverage will raise health care spending, although not by as much as you might think. The uninsured are by and large relatively young, and the young have relatively low health care costs. (The elderly are already covered by Medicare.) The question is whether the reform can succeed in reducing the rate of growth of health costs over time.

The ACA’s promise to control costs starts from the premise that the U.S. medical system, as currently constituted, has skewed incentives that waste resources. Because most care is paid for by insurance, doctors and patients have little incentive to worry about costs. In fact, because health care providers are generally paid for each procedure they perform, there’s a financial incentive to provide additional care—do more tests and, in some cases, perform more operations—even when there are little or no medical benefits.

The ACA attempts to correct these skewed incentives in a variety of ways, from stricter oversight of reimbursements, to linking payments to a procedure’s medical value, to paying health care providers for improved health outcomes rather than the number of procedures, and by limiting the tax deductibility of employment-based plans.

334

Results So Far Important provisions of the Affordable Care Act took effect at the beginning of 2014 and by 2015 it was possible to get an initial view of its results.

These include a drop in the unemployed percentage of the working-age population that began after 2010. The drop can be explained partly by the recovering economy, but also because some provisions of the ACA went into effect, notably a rule allowing Americans under 26 to remain on their parents’ policies. And after 2014, with the law in full effect, the number of uninsured fell sharply, as we can see in Figure 11-5.

In terms of costs, several measures of health cost growth slowed substantially after 2010. Most notably, Medicare spending per beneficiary, which grew 7% a year from 2000 to 2010, grew only 1% per year from 2010 to 2014. Growth in premiums for employer-based coverage also slowed down, from 8% to 5% annually. Nobody knows how much of this slowdown was the result of the Affordable Care Act, but the results seemed encouraging.

Overall, as of 2015 health reform seemed to be working more or less as intended. It remains to be seen how it will perform over the longer term.