A Case Study of Government Failure

Bernie Sanders and other socialists believe health care should be provided by the state. Their latest version of this idea is “Medicare for all”.

How does Medicare oppose the private provision of similar services in the open market? Since Congress just acted on Medicare prescription drugs, let’s look at drug coverage by answering this question.

Medicare was the last major insurer to cover drugs. When Medicare was created in 1965, the benefit structure was simply a copy of the standard Blue Cross plan sold at the time. Since Blue Cross did not cover drugs, neither did Medicare. The reason Blue Cross didn’t cover drugs is because drugs played a very small role in the healthcare system at that time and weren’t that expensive anyway.

Over time, things changed. Today, we get our best performance in health care through spending on drugs. Compared to just about everything we do in medicine, the benefits per dollar of cost of drug therapy are far greater than the benefits of medical or hospital therapies.

Because drug coverage reduces overall health care costs and improves patient outcomes, in 2003 virtually every major health plan in the country covered prescription drugs and had done so for some time. Yet Medicare was well into its fourth decade without drug coverage — and it took a major congressional push to get coverage even then.

Why the difference? Private companies will always tend to make changes when there are opportunities to cut costs and better serve their customers. In the political arena, however, nothing changes unless the pressures of vested interests change.

Medicare drug coverage reflects policy, not rational insurance principles. Whether it is car insurance, home insurance or any other type of insurance, certain principles usually govern insurance contracts. In general, people insure themselves for small expenses that they can easily afford on their own and rely on third-party insurance for large expenses that could be financially devastating.

From day one of its existence, however, Medicare turned that principle on its head. Whether it’s a doctor, hospital, or medication, Medicare has traditionally paid for many small expenses that older people could easily afford on their own, while leaving them exposed to tens of thousands of dollars in catastrophic costs.

Why the difference? In any insurance scheme, a small percentage of the insured accounts for a very large percentage of the claims in any given year. In health insurance, for example, about half the money is spent on 5% of the insured. When the insurer is the government, that means half the money will be spent on 5% of voters – people who might be too sick to vote.

But politics is the art of taking from Peter and giving to Paul. It will always be tempting to do if there are many more Pauls than Peters.

This is why in countries where a Minister of Health allocates funds for health care, such as Great Britain or Canada, there is intense political pressure to take the sick few and spend the money on the many who are relatively healthy.

These same political realities affected the design of Medicare.

Medicare has a “donut hole” in its drug coverage. That is, after a certain point, Medicare pays less for drugs than it was paying until a patient’s costs reach another threshold and catastrophic coverage kicks in. The only reason for a “doughnut hole” is to create a benefit for the many elderly people. with small drug costs. This benefit is “paid for” by forcing the few seniors with high drug costs to pay more out of pocket. It’s also why very few seniors pay $10,000 or more each year for specialty drugs, while the typical senior only pays 25% of the cost of low-cost drugs.

Medicare requires three premiums for three different insurance plans. Seniors under traditional Medicare typically pay separate premiums to three different insurers: one for Part B coverage for medical care, a second for Part D coverage for drugs, and a third for Medigap insurance for fill in the gaps in Part A (hospital care) and Part B.

Yet because the providers of these three plans have different financial interests, it results in waste, inefficiency, and substandard patient care.

Consider the effect of having one insurer that covers drugs, while the other two cover medical care. If a diabetic skips insulin and other medications, it’s actually profitable for the drug insurer, since these are expenses they don’t have to cover. However, if such failure to adhere to a drug regimen results in emergency room visits and hospitalization, these are costs that the other two insurers will have to bear.

The fact that insurers have competing and opposing financial interests means that there is no possibility of alignment with the goal of cost-effective and well-managed care.

Medicare creates perverse incentives to tax the sick for the benefit of the healthy. When insurers are forced to charge the community rate (charging the same premium regardless of health condition) and there is no adequate risk adjustment, they will have an incentive to overcharge the sick ( to discourage their membership) and to under-price healthy people (to encourage their registration).

In Medicare Part D, this perverse incentive leads to distorting effects in the “rebate” system. Suppose a diabetic goes to a pharmacy where the list price for insulin is $100. His 25% share is $25. However, unbeknownst to him, the insurer obtains, say, a $90 rebate from the pharmaceutical company that produces the insulin. This means that the actual cost of the insulin to the insurer was only $10, so a fair payout to the patient would only be $2.50, not $25.

What happens to this “profit”, which the insurer realizes but does not share with the patient? It competes by charging lower premiums to purchasers of Part D drug coverage.

In this way, the system overcharges sick people who need drugs, while relatively healthy contributors are underpaid.

How the private sector differs. About half of all Medicare enrollees participate in the Medicare Advantage program – where they enroll in private plans that look a lot like plans offered by employers. Although these plans are regulated by Medicare bureaucracy, they have enough freedom and flexibility to avoid some of the worst features of traditional Medicare.

In Medicare Advantage (MA), for example, people pay a premium to a single insurer, which is responsible for all costs. This means that the insurer has a non-conflicting and integrated interest in keeping patients healthy and minimizing costs.

Due to a very sophisticated risk adjustment system, these plans have just as much economic incentive to attract the sick as they have to attract the healthy. So instead of a rebate system, these plans pass on rebates from drug producers to patients — and more.

In the Houston area, for example, Aetna
Elevance (Anthem) and Oscar offer MA plans that make maintenance medications for the chronically ill completely free or available at a very nominal cost.

A diabetic, for example, would tend to pay nothing for insulin and other medications and would have access to an endocrinologist at no cost or for a $5 copayment. Indeed, plans believe that by reducing these costs to the patient, they avoid the higher costs of a critical illness.

IntegraNet Health offers an added benefit to some members of these plans – eliminating the donut hole entirely, on the theory that costs are lower in the long run if patients don’t skimp on their medications.

Given the freedom to do so, private health care and private health insurance can meet patient needs much more effectively than government-run and directed health plans.

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