Health Care’s Third-Party Spending Trap

Contrary to "conventional wisdom," health insurance-private or otherwise-does not make health care more affordable.

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Many doctors—myself included— will gladly substantially discount their fees in return for up-front payments from people who pay directly for their health care. Hospitals, ambulatory surgical centers, and urgent care clinics do the same. Why shouldn't they? They don't have to pay an army of staff to fill reams of forms and wait weeks to months to collect payment from an insurance company that sometimes is lower than what they get from their direct-pay patients.

Yet most of these same providers have much higher "list prices"—the official prices they list publicly—which are used to negotiate compensation contracts with health insurance companies and other third party payers.

Examples abound of outlandish differences between the publicly posted "list prices" of providers and health care facilities and the "discounted" prices these same providers offer to uninsured patients negotiating on an individualized, "special case" basis. I recently wrote of a patient of mine who saved $17,000 by negotiating to pay directly for his hernia operation rather than using his health insurance. In Oklahoma City, the Surgery Center of Oklahoma takes no Medicare, Medicaid, or private insurance, and provides a range of surgical services to the community for a small fraction of the prices offered by other doctors and facilities that use the conventional third party system. And they list their prices proudly on their website. This and other examples of providers who have opted out of the third party game have been recently documented at Reason.

Contrary to "conventional wisdom," health insurance—private or otherwise—does not make health care more affordable. The third party payment system is the principal force behind health care price inflation. This should come as no surprise.

Nobel-winning economist Milton Friedman, in his masterpiece "Free to Choose," wrote of four ways to spend money:

Category I—You spend your money on something for yourself. Here you are very careful, because it is your money, and the good or service you are buying is for you.

Category II—You spend your money on something for someone else. Here you have the same incentive as in Category I to economize, but since you are buying something for someone else, you are not quite as meticulous when it comes to the purchase meeting the needs or values of the recipient.

Category III—You spend someone else's money on something for yourself. Here you are not concerned about how much you spend, because it is not your money. But because you are spending on yourself, you make sure you are getting what you want.

Category IV—You spend someone else's money on something for yet another person or persons. (This is what we ask our legislative representatives to do every day.) Here you are the least incentivized to economize, or to buy something that meets the needs or values of the recipient.

Like the government does, third party payers operate under the dynamic outlined in Friedman's Category IV. This becomes most obvious when it comes to the government acting as third party payer, e.g., Medicare and Medicaid. And it doesn't just pertain to health care (think of $800 toilet seats for the defense department). When the government buys goods or services for other people with other peoples' money, special interest pleading, political concerns, and cronyism run the game. And "leakage" of money through "waste, fraud, and abuse" is a given.

But private insurance companies are also spending other peoples' money—the premiums paid into a risk pool—on medical services for other people. When they negotiate compensation schedules with providers and facilities, they don't have to bargain hard enough to reach the best price possible. They just have to reach a price that is good enough—one that allows them to charge premiums that compete well with rival insurance companies. They pass on the difference between what they could have negotiated and what they actually negotiated to their customers who pay the premiums.

Meanwhile, when the third party payer is perceived as picking up most of the tab, then health care consumers and health care providers engage in Category III spending. Neither have an incentive to take cost into consideration.

People who negotiate direct payment from providers get much better deals than the insurance companies get. In the example of my patient who saved $17,000, the hospital asked for $23,000 to use its facility for a simple outpatient surgery. He got a bid for just over $2,000 at another hospital, when he offered to pay directly as a "special case." But insurance companies regularly agree to pay the hospitals thousands more for their facility charge. This makes complete sense when viewing the payment mechanism through the lens of Friedman's spending categories.

When health care providers give discounts for direct payment they don't lose money in the process. Otherwise they wouldn't do it. And, in order to keep direct-pay patients from walking away, they need to keep their prices acceptable to the patients paying the bill. Just imagine the prices providers would offer if a much greater proportion of the population paid directly for health care. My patient would have saved more than $17,000, because all of the providers involved would be openly competing with other providers for direct-pay business. Just look at the fields of cosmetic surgery, Lasik eye surgery, and dentistry, as examples of how the absence—or minimal presence—of third party payers drive prices down and quality and service up.

This isn't to say we don't need health insurance. Health insurance that covers truly unforeseen, costly catastrophic occurrences makes sense for most people. As does life insurance, property and casualty insurance, and auto insurance. But health insurance that covers routine, predictable events isn't really insurance. It's prepaid health care. And it is driving up prices for everyone with everyone else's money.

Policymakers need to understand that the key to "affordable health care" is not to increase the role of health insurance in peoples' lives, but to diminish it. We need much less Category IV spending on health care, and much more of Category I.

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67 responses to “Health Care’s Third-Party Spending Trap

  1. Did you guys mean to leave 60% of the column as a hyperlink?

    1. SugarFree must have made an outstanding donation to receive such a recognition.

    2. A good example of hyperlink inflation resulting from third party journalism.

      1. That does not logically follow. Third party journalism dominates because of hyperlink inflation.

  2. Well, yeah, health insurance (or Medicaid) only pays like 1/5 to 1/3 the list price. So to compensate, hospitals & doctors charge 5x as much.

    But ultimately, the problem with Category 1 is that many people don’t have money to pay for any health care, even at the real cost, not inflated. They aren’t going to move to another country* or die in the streets. They have to be accounted for.

    * Indeed, you have what, 20 million people here illegally who won’t pay for their own healthcare. That has to be paid for someone, which means hospitals pass on the bill to paying patient.

    Somehow in other countries, they manage to pay half of what we do and cover everyone. Yes, they have waiting lines. But they pay much less.

    1. This system does not prevent charity hospitals from operating. Or even govt run clinics or hospitals for those who can’t pay. At this point anything would be an improvement. The ACA is going to drive prices through the roof, both from the doctors’ perspective and insurers. Doctors because there will be a shortage (supply and demand) and insurers because of the people they will end up covering.

    2. Indeed, you have what, 20 million people here illegally who won’t pay for their own healthcare. That has to be paid for someone…

      No, it doesn’t have to be paid by anyone.

    3. Yes, they have waiting lines. But they pay much less.

      I’m sure that was great comfort to Margaret Hutchon, former NHS director, who died due to those waiting lines. I be her husband is just thrilled that the cost was so low.

      Fuck off.

    4. Shorter JeremyR:

      “Look at all those other people enjoying their turd sandwiches! Why can’t you just enjoy yours?”

    5. But ultimately, the problem with Category 1 is that many people don’t have money to pay for any health care, even at the real cost, not inflated. They aren’t going to move to another country* or die in the streets. They have to be accounted for.

      I would chalk a significant portion of this up to failures in the public education system. My father and his father’s generation knew how to set bones and stitch wounds before they were out of High School, mine and my kids generations graduate from High School “insufficiently qualified” to fill out and file the paperwork required to get a medical professional to treat us. Even the valedictorians need an additional certificate to be a CMAA or CMT.

      Somehow in other countries, they manage to pay half of what we do and cover everyone. Yes, they have waiting lines. But they pay much less.

      They pay half, wait longer, and the outcomes are half as good; a fantastic bargain! One simple thing that gets lost in the author’s tap-dancing to Friedman’s tune is that the more parties there are involved in the money/healthcare transaction, the less actual healthcare gets exchanged per dollar, period.

    6. Let’s not forget WHY we have such a reliance on health insurance in the first place. Wage controls forced companies to compete on the basis of better benefits packages instead of higher wages. Then those benefits got special tax treatment codified. Now it’s expected that you get health insurance subsidized by your employer.

      What if that weren’t the case? Then we’d have employers competing on salary again. I’d much rather have $10k in extra salary (if it weren’t for the special tax treatment that insurance plans get) than have my employers pay $10k for a health insurance plan which covers a ton of stuff that I don’t need or that I could easily pay for myself.

      Somehow, I think that if people didn’t have the health insurance crutch and had thousands more in salary, they’d manage to pay their medical bills.

      1. What else? Hmm…the European systems have much longer wait times and much worse health outcomes. Moreover, the medical research climate in Europe is all but stagnant (with the exception of some government grants). Great outcome. Equal bad results for all.

    7. Shorter everyone else: Fuck off slaver.

    8. “Yes, they have waiting lines. But they pay much less.”
      So they get what they pay for. Interesting.

    9. New Jersey medicaid reimburses a general physician $25 for a consult. Colorado is a whopping $45. Doctors are able to take in some of these patients because private insurance pays multiples more, enabling them to cover the medicaid losses (yes, they lose money.)
      Hmm, I wonder whats going to happen when the estimates of people on medicaid doubling prove to be low-ball?
      According to a GP in NJ that I know, the only solution will be to hire NPs/PAs and crank though 10 patients an hour. Oh, he also has to write a check every Jan 1st of 100k for his annual malpractice insurance (despite having a stellar practice for 30+ years.)

  3. Single-payer legal care.

  4. Hate to defend the DoD, but the $800 toilet seats made perfect sense. New machinery had to be created.

    1. Wha? They couldn’t buy toilet seats that didn’t need new machinery to be made?

      1. The seats were for the P-3 Orion, like everything on the plane, it had to be custom designed. They had been out of production for years so the machinery was gone when they wanted them refurbished. So you couldn’t just go to the store and buy them (like so many reporters said when this story came out).

        1. The seats were for the P-3 Orion, like everything on the plane, it had to be custom designed.

          That explains the square wheels

          1. Now, now. I never said they were particularly good at design.

        2. Well that and the fact that black ops funding has to come from somewhere.

          I have a $50 portable toilet on my boat for my wife. Couldn’t a P-3 Orion hunt submarines with a portable toilet ?

    2. From what I understand, the toilet seats really *did* make sense.

      As I recall, the situation was something like this: a company had a contract for $100 million to build something big – say, a bunch of new buildings on a military base. In the interests of accounting, the final cost of the project had to add up to $100 million. The contractor found ways to save money on a lot of line items – the plumbing, wiring or whatever came in below the budgeted cost. So to make the final numbers come out to $100 million, they needed to put in really big numbers for whatever line items they had left. Hence, toilet seats that looked ridiculously expensive if you just looked at one line item. However, viewed in the context of getting the entire project for the $100 million cost that was bid up front, the only “scandal” was that they didn’t list “contractor profit” on a separate line in the spreadsheet.

  5. This isn’t to say we don’t need health insurance. Health insurance that covers truly unforeseen, costly catastrophic occurrences makes sense for most people. As does life insurance, property and casualty insurance, and auto insurance. But health insurance that covers routine, predictable events isn’t really insurance. It’s prepaid health care. And it is driving up prices for everyone with everyone else’s money.

    This probably should have been the first or second paragraph. But even then, sentences like this one

    They just have to reach a price that is good enough?one that allows them to charge premiums that compete well with rival insurance companies.

    strike me as really odd. How do you think they compete with rival insurance companies? Lower premiums are one way. How would they lower premiums? Well for starters, they could negotiate lower prices with healthcare providers! If that isn’t currently happening, then you may want to go back and check your assumption that they are competing in a truly open and free marketplace.

    1. Also, in a free market some insurance companies might want to compete for customers by offering to defray the cost of some number of routine services. I’m not saying that would definitely happen, but it could. The point is that in a free market, insurance companies would only offer such services if it truly made sense for them to do so.

    2. Well for starters, they could negotiate lower prices with healthcare providers! If that isn’t currently happening, then you may want to go back and check your assumption that they are competing in a truly open and free marketplace.

      Market mechanisms provide only an advisory role in pricing health insurance. Most healthcare, is distributed by political means, rather than economic ones. Whether it’s government programs or hyperregulation or good ole fashioned price fixing, most healthcare is distributed politically and won’t necessarily make any economic sense when it’s presented as a product of the marketplace.

  6. …check your assumption that they are competing in a truly open and free marketplace.

    I think we are on to something here…

    1. It’s as if the answer has been right in front of us this whole time.

  7. A minor nitpick:

    “Meanwhile, when the third party payer is perceived as picking up most of the tab, then health care consumers and health care providers also engage in Category IV spending.”

    Actually that would be Category III spending for the health care consumers.

  8. “This isn’t to say we don’t need health insurance. Health insurance that covers truly unforeseen, costly catastrophic occurrences makes sense for most people. ”

    Republicans should just pitch a healthcare insurance reform that’s primarily a mandatory catastrophic healthcare insurance (similar to the idea of mandatory liability car insurance). I know that’s not a Libertarian idea, but it’s still better than the pig shit we are currently wallowing in and it would minimize that “But the Republican’s don’t have a plan” Left wing meme.

    A very high deductible healthcare insurance plan would reduce the burden on health care providers who are required to provide emergency room services and mitigate healthcare bankruptcies.

    1. I agree it would be smart politics for Republicans to propose something along these lines. The GOP could could also offer to revise the bankruptcy laws. The Dems would never accept either proposal, so neither idea would be enacted, but some moderate voters might be swayed.

      1. “I agree it would be smart politics for Republicans to propose something..”

        And that’s the part where the Stupid party earns their appellation.

  9. 3rd party payor itself is not the reason healthcare costs are ballooning. Aside from individuals, no one is better at mitigating costs than insurance companies. Most auto body repairs are facilitated by auto insurance, so if the premise were true, why aren’t auto body shops completely unaffordable to the average Joe?

    It’s not the insurance system at fault. It’s the policies that limits the number health insurers to a select group of government approved insurers that have formed a non-competitive cartel.

    Secondly, it’s the American Medical Association/Medicare/Medicaid price fixing powers. The market mechanisms of supply and demand only play an advisory role in determining pricing, where the Special Relative Valuation Committee in the AMA gets legal authority to dictate Medicare/Medicaid compensation rates who in turn dictate the compensation paid out by insurance companies.

    Chicken before the egg. If it weren’t for the skyrocketing costs of healthcare, we wouldn’t be so reliant on 3rd party payouts for medical expenses. It doesn’t logically follow that the existence of 3rd party payors creates skyrocketing costs because we wouldn’t need 3rd party payors in the first place, were it not for those skyrocketing costs. That’s not to say they haven’t contributed to the problem, but their contributions to the problem is a feature of the cartelization of the industry, not their mere existence as 3rd parties.

    1. plenty of other cost drivers… malpractice insurance, fraud, fda compliance (increasing drug costs,) everything under the sun requiring a prescription (thanks AMA.)
      ACA failed to address any of these.

      1. Malpracitice insurance as a factor of the increasing cost of healthcare, is rather small. It’s a big ticket item in the litigation industry but pales in comparison to other costs in the insurance industry. From the Insurance Information Institute:

        Costs to the Public:[of malpractice insurance] According to a 2011 report by Towers Watson, since 1975, when medical malpractice insurance data were first separated out from other types of liability, medical malpractice cost increases have outpaced other tort areas, rising at an average of 10.0 percent a year, compared with 7.5 percent for all other tort costs. However, growth in medical malpractice costs since 2005 have averaged less than 0.5 percent annually. Regardless of whether a case is won or lost, going to court is expensive.

        1. This does not take into account the CYA aspects of medical practices which includes multiple and unnecessary tests and treatments and medications to avoid any legal exposure for the provider.

          1. Neither do malpractice insurance rates. And unnecessary medical procedures happen for more reasons than that. First and foremost it’s to up their compensation from insurance carriers and government agencies.

  10. In 2006, I “rolled” my auto three times at 65 MPH.

    Among my injuries were –

    a compressed vertebrae in my neck(the roof of my car was compressed almost to door level- my neck was stronger than the reclining seat mechanism).

    three cracked ribs (seat belts work… sub-optimally).

    and a compounded Monteggia fracture of the ulna of my left arm (during one of the rolls, the car landed on my arm hanging out the window).

    My bills included–

    Hospitalization(55 hours)- ER and recovery. List price $34,000.00
    Radiology- (Full CT, x-rays for the arm). List price $3700.00
    Surgery- ORIF– staples for the surgical cut, stitches where the bone broke the skin, follow-up exams). List price $9200.00
    Anesthesiology- List price $2,200.00
    Physical Therapy- List price $2,700.00

    I was uninsured.

    After negotiations(and saying I’d pay cash now for a better price), I actually paid the following–

    Hospital- $0.00 (they wouldn’t negotiate, so insured people/taxpayers paid).
    Radiology- $2,200.00
    Surgery- $4,200.00
    Anesthesiology- $1,200
    PT- $1,100.00

    1. (seat belts work… sub-optimally).

      They worked. You’ve mysteriously developed a popular misconception about how and why.

    2. Classic, so you passed the cost of the hospital stay on to other taxpayers. Nice work.

  11. This article would be much improved if you added a couple sentences at the end, pointing out that there are ways to structure medical subsidies for poor people so that they effectively move into category 1, or at least into category 3.

    You and I may know that already, but I like posting links to reason articles for my friends. Some of my left-leaning friends are, shall we say, not as economically literate as the average reason reader. Spelling things out would help.

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  13. There is a pervasive equivocation in the health care discussion, the error of equating health insurance with health care. Health insurance is discussed as if it were supposed to be some magic key which guarantees free health care services.

    Similarly, the leftoids use the weasel word “access” to frame their normative goals of interventionism in health care, as if health care were some secret club to which “access” is arbitrarily granted or withheld, and this ties right in with the “health insurance = health care” equivocation.

    Health care services are goods provided by professionals who devote decades of their lives to the excruciating task of becoming competent doctors and surgeons; you cannot arbitrarily grant “access” to their work without making slaves out of them. Government guns cannot replace human intelligence and ability, and when you propose to construct a medical system wherein the providers have no rights, it is intelligence and ability which flees the medical field, and in the former place of competent doctors you now have an army of paper-pushing bureaucrats and incompetent political hacks.

    Get the government out of health care, period.

    1. Dr. Nick: “Hello everybody!”

  14. Before Wall Street successfully turned most Insurance companies into publicly traded for profit ‘stock holder corporations’ the premium purchasers were in fact the owners of the company. If the annual cost of the Insurance company’s payout for the premium holders was not as much as the total premiums paid…the members paying premiums received a dividend return for that year. Now speculative ‘stock traders’, many corporations and Investment banks invest in what used to be ‘mutually owned by the insured’…for speculative and stock dividend profit. No wonder the cost and expense of both healthcare and health insurance has been climbing since this transformation from ‘non-profit mutually owned companies’…to Wall Street speculative ‘for profit’ stock owned ‘corporations’!!

    1. “Evil profits…blah blah evil Wall Street…blah blah speculative”

      How many played-out leftoid talking points can you stuff into one moronic post? Insurance companies have never been non-profit, “socially conscious” unicorns, fuck off.

      1. This is precisely how my automobile and house insurance company–USAA–works. Every year I get a dividend payout if they took in more in premiums than they paid out in claims.

        So, you might want to check your premises.

        1. Yes there are still quite a few “Mutual Insurance” companies around.

          So really both the first two posters are letting mood affiliation lead them astray.

          If emily jane wants to buy insurance from a mutual insurance company, she certainly can, safe in the knowledge that no one on Wall Street is touching her premiums.

          And Libertarius is welcome to look for a firm with publicly traded stock. To each their own.

  15. I have a neighbor who is a dentist. I have no dental insurance and asked if he charges me less than clients that have insurance… his answer was “no”. I may be able to negotiate a lower price – I’ve only gone to him once so far – but if he changed his price it would likely be because I am his neighbor. He said that he has a set price and it doesn’t matter whether the person is insured or not. The accounting of all the transactions goes through a computer system and they naturally treat each client the same regardless of insurance. I imagine that the higher the cost then the more likely a doctor/dentist would be open to negotiations. Just like all negotiations, unless you are willing to walk away then you are unlikely to get significant gain – and if you do walk away then you must accept the wasted time you spent and the possibility of losing the specialist you wanted to work on you. I don’t like the idea of a doctor bumping his rates for insurance, but you need to assume they don’t lower them for the uninsured and articles that say different should be of suspect until actual research has been presented.

    1. Dental insurance is different.

      I know if you go to a GP or internal medicine doctor, they themselves have no idea how much their services costs. They have a different price for each plan, group, insurance, etc.

      As far as negotiations go, they rob peter to pay paul. So, they generally charge people that can pay more.

      That’s what happened to me in the hospital when my 1yo needed stitches about five years ago. I had a High deductible and they tried to rape for for $7,000. And that didn’t include the Doctor or the procedure. That was the ER. I never ever paid and never heard from them. Nor did it make my credit report. Had i had regular insurance, I probably would had pad $100 and the insurance would had negotiated for $2000.

  16. I won’t hold my breath for most practicing physicians or health care providers to start giving reasonable cash prices. They’re just as motivated to get the most money they can from you. If this worked it would be far more widespread in 2013 than it probably is. Once the government starts backing everyone’s healthcare bill doctors will take a seat on the gravy train. If economic teaches us anything it’s that – for the most part – people act in their self interest – not the self interest of other.

    1. Very true. Third Party payment, regardless of the fact that it is called AETNA, MetLife, Medicare, Medicaid, etc. is the problem.

      The consumer/patient doesn’t pay the provider. As a result, the provider milks the shit out of it.

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  18. Obamacare does nothing to increase the supply of healthcare, it just subsidizes more demand. Guess what will happen to prices? Then the state artificially restricts price levels so guess what happens to availability?

    The net result is that we get less healthcare for more money.

    If the government was in charge of Death Valley we’d end up with a sand shortage.

  19. Single payer. Just do it. Now.

    1. Didn’t read the previous comments did you? Single payer sucks. The countries that use it have longer wait times, less access and worse outcomes. In this country most healthcare is a form of single payer now (medicare, medicaid, CHIP). Not working out very well.

  20. This sums the situation up pretty well – third party payment of healthcare directly drives an insane pricing policy. There are plenty of options for self-pay patients and ways to opt out of bureaucratic medicine, including cash-only doctors, medical tourism, and telemedicine. To cite just one example, here’s a doctor in Texas that sees people for $30, less than many co-pays charged to the insured: http://theselfpaypatient.com/2…..l-see-you/

    There are a growing number of doctors, companies, web sites, and organizations that connect people with the free market in health care that currently exists, expect Obamacare to push this trend even further.

  21. Health Care should be pure.

  22. its alot like what happened with collision insurance on cars- suddenly the price of the repair goes from $300 to $1000 because the shop knows that its not the car owner who is paying for the repair.
    The farther you get from a principal to principal exchange the higher the costs get. (The two principals being the shop owner and the car owner).
    In medicine its the same with doctors and patients. If the doctor or hospital had to deal directly with the patients then the costs would be less because they would be subject to market forces. Insurance and (even worse) government programs manipulate the market forces and drive up the costs. Not only do they add to the overhead involved they make it possible for the health care industry to overcharge for service.

  23. If they would do exactly that–catastrophic insurance at much reduced rates for the unforeseen and return everything else to fee for service we could solve this debacle of healthcare in this country. Dr. Singer is correct. I know he is correct as I am also a provider– former physical therapist. We could severely reduce rates if we implemented fee for service and the abuse of the system would disappear.

    Health care for Obama was nothing but a tool to implement Marxist governmental control. NO one should have complied. I still will not no matter what.

    Deception, oh let’s just call it lying through teeth, is the tactic
    propagated by Karl himself–he states that it is fine to lie as to
    promote the cause of Marxism.

    Charles Hurst. Author of THE SECOND FALL. An offbeat story of Armageddon. And creator of THE RUNNINGWOLF EZINE.A true conservative’s weekly..

  24. Somehow in other countries, they manage to pay half of what we do and cover everyone. Yes, they have waiting lines. But they pay much less.

    1. so the government created fiasco we already have should be replaced by another government produced fiasco. yeah rationing is totally awesome

  25. health insurance (or Medicaid) only pays like 1/5 to 1/3 the list price. So to compensate, hospitals & doctors charge 5x as much. feeling sad

  26. Your categorization is well here and I hope you will write more on it. I liked the way you shared here about health issues.
    Obgyn mountain view, ca

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