John Locke Update / Research Brief

Why Biden’s “Public Option” Would Double Down on High Hospital Prices, Not Solve Them

posted on in Economics, Health Care, Health Care & Human Services
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The American public is intimately familiar with the dysfunction that can occur in our health care system. Exorbitant hospital prices, unworkable health insurance plans, and surprise bills can be common for Americans as they obtain regular care.

new study published by the RAND Corporation is shining light on hospital pricing problems in the United States. The study examined claims from inpatient and outpatient services and found that private insurers paid 247 percent of what Medicare would have paid for the same services at the same facilities. This study builds on two previous studies, which found hospitals paid 224 percent of Medicare in 2016 and 230 percent in 2017.

Following the report’s release, many speculated that the only solution to a dysfunctional health care market is through government rate-setting in a public-option plan that would compete with private health insurance companies. Building on the Affordable Care Act with a government-sponsored public option is a centerpiece of Joe Biden’s health agenda.

One question is often overlooked in all of this discussion, however: Why are hospitals able to charge above-market prices and patients still pay them? The simple answer is they can. They can because through our third-party system and intense health care regulations, hospitals and insurers operate with greater pricing leverage than they otherwise would have in a more competitive market.

Usually, the question asked in health care is “What can government do to fix it?” Far too many people fail to ask instead, “Is government the problem?” In this research brief, I will illustrate health care price dynamics, how a public option would function, and why that plan could not solve our health care pricing woes.

Health Care Price Dynamics

To understand how a public option would work, first you need to understand the dynamics of health care prices in our current health care system. Most Americans or their employers pay premiums to a health insurance company in exchange for a given set of benefits at a network of providers. Sometimes these rates are pre-negotiated, and sometimes they are determined after care is completed. The negotiations between a health insurer and health care providers depends upon their relative clout and market power in a given market. The more market power an insurer has, the lower the rates it can negotiate. The more market power providers have, the higher rates it can negotiate.

Health insurance is essentially the price of admission to use a given health care provider at the rate negotiated between the insurer and that provider. When there are few insurers in an area, they have an advantage in negotiating prices with providers. But if there are just a few or only a single provider such as a hospital in the area, the hospital has all the negotiating power. The hospital could threaten to go out of network for the health plan’s covered lives.

The reality is, progressively fewer hospitals aren’t a part of a large hospital system, and fewer insurers are offering products across the U.S. Among other things, these developments have resulted in much higher hospital prices in comparison with any other country.

When insurers have to pay more, those prices get passed on to everyone in the form of higher premiums. When insurers are subject to onerous benefit mandates, the cost of those regulations is priced into what we pay for insurance. When the government provides hundreds of billions in subsidies to insurance companies, insurers can spend more and charge more for their products.

After years of health care regulations, lax antitrust stances, and plenty of cronyism, the health care system has formed into a complex web of insurance contracts, massive hospital systems, and lots of bad incentives that result in higher prices. Many of the financial interests of hospitals and insurers are aligned, with both benefitting from higher costs to patients. Patients are the ones that lose in this system, while most providers and insurers make out fine.

A Public Option?

Outrageous hospitals bills, high insurance premiums, and unusable deductibles have led many people to demand government step in and do something. They would have government provide a public health insurance plan to negotiate much lower rates than private insurers can, thereby being able to provide cheaper plans. This idea is the central tenet of Joe Biden’s plan. According to his website, Biden would both increase premium subsidies to insurers and provide a public option plan like Medicare: 

As in Medicare, the Biden public option will reduce costs for patients by negotiating lower prices from hospitals and other health care providers. It also will better coordinate among all of a patient’s doctors to improve the efficacy and quality of their care and cover primary care without any co-payments. And it will bring relief to small businesses struggling to afford coverage for their employees.

This plan may sound like a sweet deal, but the reality is many of those same promises were made ten years ago as the Obama administration tried to pass the Affordable Care Act. According to the Committee for a Responsible Federal Budget, the new Biden plan would add $850 billion to deficits between 2021-2030. Not only would the federal deficit continue to explode under a public option (making no real difference in overall health care spending), rural and critical access hospitals could be impacted, too. A report from Guidehouse found that a public option could put 55 percent of rural hospitals at risk of closing.

Government Policies

As a good friend once analogized, “the old lady that swallowed the fly” is the perfect illustration of the U.S. health care system. Government initially got involved through hospital regulations, Medicare, and Medicaid, which distorted the health care market in numerous ways. The problems got worse. Yet just like the old lady trying to solve the problem of the fly by swallowing bigger things and creating bigger problems for herself, the government continues to overregulate the market, trying to fix the issues that wouldn’t have been created were it not for previous government interventions in the health care market.

A perfect example of government doubling down on bad policy with more bad policy is certificate of need (CON) laws. The government created Medicare and other public insurance programs that paid for health care in a way that incentivized overinvestment in capital, such a new buildings and equipment. After a land rush to build new hospitals to make a nice profit from the government through the new reimbursement system, the government decided that the solution was to swallow something bigger: further regulate the health care market by creating a central planning committee in each state to regulate the number of hospitals, providers, and equipment in a given area. The impact of CON laws has been catastrophic in terms of fostering a functional health care market and properly distributing health care resources.

Say No to a Public Option

 Looking at the high costs in the health care system, someone might think the only way to make any progress is more government intervention to “Fight back against those greedy capitalists and their price-gouging!” Without a doubt, prices are exorbitant, but the blame falls on a succession of bad public policies providing very bad incentives within the health care system. The special interests who benefit from those high costs on everyone else lobby Congress to keep the policies and their incentives in place, or worse, double down on them.

True health care reform would approach the problems from the supply side, with providers and the distribution of health care resources around the country, and the demand side, with reforming the way health insurance works. Most previous health care reforms resulted in nothing that actually brings down the cost of care. Instead, they just entrenched a poorly designed system with bad incentives through government coercion.

The public option proposed by Biden would be more of this kind of costly “reform” from Washington. It would build on the Affordable Care Act, rather than address the tough questions about how the health care system has evolved into the thing it has.

Jordan joined the Locke Foundation in the summer of 2018 as Health Care Policy Analyst. After two years in the research division, he moved over to the government affairs team. Jordan now works with state decision-makers in the public and… ...

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