Plenty of Costs, Plenty of Benefits

Kellogg Insight: The electronic health-insurance exchanges are experiencing a few technological glitches, to say the least. What do you think will happen?

Craig Garthwaite: The first question to consider is “Are they going to fix the website?” It’s a pure technology problem, and while it’s certainly an embarrassment, it’s not a disaster yet. I think it will be fixed in time to get people into the exchanges.

The better question is whether we can get young, healthy people into the exchanges. There’s a lot riding on that. For example, insurers can’t charge older subscribers more than three times what they charge younger ones. That means 26-year-olds are actually subsidizing 64-year-olds, because the younger group is much less likely to use healthcare benefits. The argument, just like for Social Security, is that the 26-year-old is actually subsidizing his future 64-year-old self, which is valid. But for the cross-subsidization to work, you have to get a lot of 26-year-olds into the system.

I worry about that because the young-and-healthy segment has hardly flooded the individual insurance market in the past, even though it was priced very well for them. So we’re trying to get them to buy insurance by using a gradually increasing penalty, or a little “push.” (As a side note, it seems like a larger initial penalty would have been more effective for motivating participation.) That brings us back to the glitches you mentioned: the website delays and other hassles are creating a push in the opposite direction, to the point where younger people may just choose to sit this year out. Then we’d have a disproportion of older, less healthy people in the exchanges, and that would probably mean higher future premiums. Then, when younger people consider getting insurance in the second year, they’d face a slightly larger penalty, but they’d also be looking at higher premiums—so it becomes a horse race between penalty and premium.

Overall, I think the goal should be to get the exchanges fixed by the year’s end at the latest, because people have until March to pick a plan. I also don’t think it makes sense to delay enforcement of the penalties, because that will give younger people yet another excuse to wait.

KI: Some experts expect hospital consolidation to continue unchecked under the ACA, and for prices to increase as a result. How do you think the exchanges will affect competition, especially among insurers?

Garthwaite: This relates to several interesting issues. One has to do with the size of provider networks in insurance plans. The lower-priced plans in the exchange tend to be what we call “narrow network” plans, like the HMOs we saw in the 1990s. Insurers offering these plans target a specific network of providers and promise them higher patient volume if they cut their prices; these in-network services are covered with generous benefits, but no coverage is offered for out-of-network providers.

From an economic point of view that’s an efficient system. But it’s hard for large employers to choose a narrow network for all of their employees. Think of the diversity of Northwestern employees’ home locations and healthcare needs. Then imagine the university trying to pick the best small network to address all of these. If you have narrow-network plans as options in an exchange, and you let individuals pick the right network for them, that is a better system.

That said, we have to give something up to get healthcare costs down. That means either fewer services covered or fewer providers offered. If someone wants Northwestern Memorial Hospital in their plan, for example, they’ll have to decide if they’re willing to pay more for a network that includes it. The more of those decisions we have to make as consumers, the more some of the anticompetitive effects of hospital consolidation may be counteracted. Bear in mind, though, that if you have excessive consolidation, you can’t have narrow networks. That’s why the FTC is so focused on consolidation in rural areas, where there just aren’t many hospitals to begin with.

KI: The media has covered how some people have lost their existing insurance plans due to the ACA. What’s your take on this, and what does it mean for consumers going forward?

Garthwaite: It’s clear that many people in the individual market didn’t have plans that met the ACA’s minimal standards as related to cost-sharing, lifetime limits, or essential benefits. While it’s of value to have some minimal standards, it also means the ACA is taking away many of the dimensions on which insurers could compete with regard to innovative benefit design. So we’ll see far less competition on the “generosity” of insurance plans going forward. For example, some people might want very high deductible plans with very low premiums, but we’re mostly taking that off the table (with the exception of a handful of plans like the exchange’s Bronze Plan). I’d like to see more competition on those dimensions, as it makes consumers more sensitive to the marginal cost of their treatment.

That’s one of the big problems we have in healthcare right now: People don’t pay the marginal cost of their treatment. In fact, we typically have no clue what it is. Even though I’m an “expert” on health insurance, I was shocked by the hospital bills we received after we had a baby. A lot of money was being paid, but not by us, so we didn’t have to think much about, say, whether to stay an extra night at the hospital (we did). The problem is that Obamacare is codifying our ability to stay in the dark about our marginal healthcare costs.

Think about how differently we’d approach our healthcare if more of us had reference-pricing insurance plans, where the insurer pays a fixed amount for certain services—like $1000 for an MRI—and we have to pay the difference. We’d be much more likely to shop around, and ultimately seek out a lower price. There’s huge variation in the pricing of medical procedures, and part of the reason is that we have no incentive to price-compare.

KI: You said in a recent interview that you expect the cost of the ACA to be much more than the government has predicted. Can you talk about that?

Garthwaite: The government assumed that only 3 million people who qualified for employer coverage would get insurance through the exchange. In my opinion that’s a gross underestimate. Far more than 3 million will join the exchange, and each will represent dollars the government wasn’t expecting to spend.

Other assumptions also contribute. Part of how the government made the ACA budget-neutral was by assuming there would be $700B in reduced payments to Medicare. We’ve said we’d do that many times, but we’ve never done it, partly because seniors in the US tend to get what they want—and they want to keep their health benefits the way they are.

But there are benefits to go with these higher costs. The exchanges mean that people can move more easily across employers—or choose to go freelance—because they’re no longer locked into a specific job. My research, for example, shows that many people are working primarily for the health benefits, and now they’ll have more freedom. That means that 60-somethings who don’t yet qualify for Medicare won’t be forced to keep working until they do. It also means young people who want to start a business—like many Kellogg MBA students—can do that without worrying about affordable benefits. These are good things for individuals and the economy.

KI: Once people are no longer locked into employers by health insurance, what does it mean for businesses? Will they have to work harder to attract and retain people?

Garthwaite: It would be reasonable to assume that wages will go up if employers pay less for health insurance because their employees access it through the exchange. But it’s not clear how much they might rise. Part of the issue is that most employees don’t know how much employers pay for their insurance. Many think the cost of insurance is what they themselves pay, which is usually only a small percentage.

The exchanges should also mean a more level playing field for employers. Under the pre-exchange system, big players benefited because they could use their larger employee pools to get better rates. That shielded them from competition for talent with smaller competitors, who had to pay more to offer health benefits. With the exchanges in the picture, benefits will be a much smaller factor in the attractiveness of a given employer.

KI: If personal incomes do increase due to the ACA, will that help offset the higher costs you’re predicting?

Garthwaite: To a degree, yes. But that’s been built into the system already. One problem is that the people who are most likely to get shifted from employer-provided insurance to the exchanges are lower-income, so they don’t pay much tax to start with—they’re usually in the 15% bracket or lower.

KI: Speaking of lower-income citizens, the ACA was crafted with the idea that every state was going to expand Medicaid benefits. But if they don’t, there will be many people who are out of luck—their states won’t offer them Medicaid, and they don’t have high enough income to qualify for subsidies on the exchange. How do you see this playing out?

Garthwaite: Well, take Texas, where a lot of residents earn between 100% and 138% of the poverty line. This segment was expected to be on Medicaid, but if the state doesn’t expand the program, they will qualify for the exchanges, and that’s going to cost the federal government more money. People below the poverty line (which is about $20,000 in household income for a family of four)—the ones who need help the most—are going to be out of luck in terms of accessing insurance. But they’re still going to be showing up at hospitals to get care, and that will drive up costs, too.

Luckily I think this is only a temporary issue. There’s just too much money at stake. Consider an analogy: We used to have a drinking age of 18 in the US, but the government wanted to expand it to 21. They couldn’t tell the states what to do, but they could restrict highway dollars from those who refused to comply. Many states, like Louisiana, opted not to take the highway money in the short term, but eventually caved. That will happen with the Medicaid expansions too. There will be horror stories about people not having insurance and hundreds of millions of dollars in federal money being turned down, mostly by the states that need the most help. So I don’t think this will be a long-term issue.

KI: So we have to ask: Are we headed toward a single-payer model?

Garthwaite: A single-payer model solves what’s called a “static-efficiency” problem in economics: people want something (healthcare) that costs too much for them, and we can help by having the government provide it. But it doesn’t solve the dynamic-efficiency problem. Namely, in a free-market system, financial incentives (profits) drive important innovations like better medical treatments.

A single-payer system would set prices too low to motivate much medical innovation. The technical term for it is a “monopsony,” or the opposite of a monopoly—there’s only one buyer (government) for many sellers (medical providers), so that buyer can artificially decrease prices. If you look around the world, the single-payer systems pay artificially low prices for services and don’t reward innovation. But we’re less likely to end up in a single-payer system because there’s no public option in the current exchanges. I was very much against that option because it would have created an artificial competitor in the exchanges with the benefits of government backing.

KI: So does that mean the US is subsidizing innovation for single-payer systems?

Garthwaite: It’s hard to imagine we’re not. The European Union has many successful drug manufacturers, for example, but they’re making products that are big sellers in the US, like Merck’s former blockbuster Vioxx for arthritis. That may not be ideal for the US, but the alternative might be that no one incentivizes innovation, and that’s not good for anyone.

KI: What will the exchanges look like 10 years from now?

Garthwaite: A decade from now I think the exchange systems will be working—at least on the technology side. I believe we’ll be paying shockingly more than we thought for them. So we’re either going to have to adopt a new set of income taxes or reduce spending in other areas to support the system. I have no faith that the ACA, as currently developed and implemented, will lead to any cost-containment, certainly not with the people in charge of it now, who have no private-sector insurance experience.