Health A La Carte

Medicine's Perverse Incentives Lead To Waste

By JOHN E. SKVARLA III with FRANK ELLIOTT

RALEIGH—As we debate health care reform in North Carolina and the U.S., consider the following fable: Suppose that you are given a fresh start in business. No longer do you have to worry about selling your product, generating new business, developing new products, pleasing your customer, collecting for sales, spending less than you collect, managing people, and doing all other things that shorten your life considerably.

Your fresh start comes with some minor strings attached. You can't actually begin to work for yourself until you are at least 30 years old. Between the ages of 25 and 30 you must serve an apprenticeship. However, during this apprenticeship you will be paid a salary considerably above the national average.

Your new profession is in the restaurant business. It's a good business to be in. People must eat, so there will always be a need for the service you provide.

Now, the goals of your restaurant are quite simple— to provide good food and make as much money as possible. These are realistic goals, and totally in keeping with the laws of human nature. How smart do you have to be to succeed?

 

Following The Rules

 

Before we answer this question, let's look at the rules of the game:

Rule Number One As a result of serving your apprenticeship, you received a specialty license for this restaurant. Those without such a license can't legally compete with you.

Rule Number Two: In this restaurant, there are no prices on the menus.

Rule Number Three Since you are trained as a professional restaurateur, after asking a few questions (such as "how hungry are you?" or "what did you have for breakfast?") you alone determine what the customers will have to eat.

But wait, you say. The customers will never stand for this. You might order something that the customers can't afford or doesn't like. Isn't the customer going to demand to know all this is costing?

No because there is . . .

Rule number Four The customer doesn't pay the other restaurants in town, you send the .Insurance company for payment. Moreover, the customer doesn’t even have to pay for the insurance , customer's employer does. So the customer couldn't care less about how much food is ordered by you or how much it costs. All the customer knows is that he has a great appetite to satisfy and only the best will do. Why not the $500 bottle of wine? If the wine isn't finished or food is left on the table, so what? It really doesn't matter. From the customer's perspective, he doesn't appear to be paying for it. And, if satisfying the customer's voracious appetite requires turning the process over to a food specialist, what does it matter? For all the customer knows, the restaurant could be submitting false invoices for food not actually served. Who cares? Not the customer—someone else is paying. Let someone else worry about it. That's a problem for the insurer.

Finally, Rule Number Five The insurance company doesn't act as the middleman for free. As its compensation, it gets to keep a percentage of the premiums paid by the customer's employer for the coverage. Every year the restaurant's price hikes are simply passed on to the good ol' guy who signs the paychecks—the employer—in the form of increased insurance premiums.

Under this system, you and every other restaurant owner will want all of your patrons to have three-, four-or five-course meals, because that increases the bill and hence your income. More is clearly better.

Under this system, the customers quickly learn to expect the very best. Give me the finest filet mignon. Give me two filets! And if after the main course everyone is full but they would like a little taste of that chocolate cheese-cake on the dessert cart, of course you'll insist that they take the whole piece. And even if they only want a bite, they'll agree. Who cares?

As for the insurance company, as long as they can pass the cost of this feeding frenzy to the employer, they don't mind the waste. After all, the insurance company is paid with a percentage of the bill, so the higher the bill, the higher their income. It's a wonderful system. Everybody gets something without paying anything.

 

Payment And Incentives

 

Of course, such a system is so laughable, and so implausible, as to be ridiculous. Anyone can see that it is tailor-made to give everyone the wrong incentives— incentives that foster wastefulness and ever-higher costs. But this is how we provide health care in the U.S.

Health care providers are paid when they perform procedures, operations, tests, and so forth. The more they do, the more they are paid. Patients, who are shielded from the costs, have no reason to quibble about the number of procedures or the price, and in fact usually demand the most and best regardless of a cost they don't even know. And insurance companies, until recently, also had no reason to worry about cost. Insurance industry profits may only average 1.74 percent of premiums, but what would you have: 1.74 percent of a million dollars or 1.74 percent of a billion dollars? In effect, the insurance industry has sold its corporate customers down the river by simply passing along the escalating costs run up by a system they were instrumental in creating.

Our health care system combines the best of capitalism with the worst of socialism in an explosive mixture that has sent health costs rising like a mushroom cloud. From a capitalistic perspective, providers are free to practice where they want, and in what specialty they want, and to charge what prices they want. Patients are free to go to whatever doctor they prefer to visit.

But socialism creeps in when it is time to pay the bill, Providers dip into the ever-so-deep well of money called prepaid health insurance. Experts discussing this system call it the "third-party payer" system, but what they mean is prepaid insurance, whether obtained through a private company or through Medicare, Medicaid, or Workers' Compensation. And there is no limit to the number of times providers can go to the well.

This is where the process begins to unravel. Like the restaurant owner who orders food for the customer, physicians control about 80 percent of all demand for health care in this country; thus physicians control 80 percent of our health care expenditures. Physicians tell us, the patients, what we need, when we need it, and how much we need. and we, as customers, do not question our doctors' recommendations -- we are immune from the the direct cost of most of the care we consume as a result of the third-party payer system.

Finally, aside from financing the necessary education ( the average physician is about $80,000 in debt upon graduation) doctors don't have to invest as much in capital equipment and inventory as other businesses do. They do have to pay for a nurse, an insurance administrator, and an office (if they're in private practice) but they don't have to pay for major diagnostic equipment. This equipment is paid for by the local hospital. Why? Because hospitals depend on doctors to fill up their beds. If buying the latest medical technology will accomplish this, it's a good investment for the hospital. Ask any hospital administrator who the hospital's customers really are. If he or she answers anything other than the doctors, it's a good bet that this particular administrator is either unemployed or working for the government. As a physician once told us when discussing a particular business investment, "Please understand, we doctors aren't used to paying for anything needed for us to make money."

Roll it all together -- the private and government money, near-monopoly specialization's, captive audiences, and subsidized equipment -- and it's plain to see that for providers of health care, our system is truly one of the most lucrative economic engines ever created.

How the System Changes Over Time

But this is not the end of the story. Let's take a look at what happens to our restaurant if we consider how human nature will affect its operation over time. One thing is pretty obvious: As more and more restaurateurs learn the rules of the game, they will realize that they should be in the high-end of the market. Why run a coffee shop when you can serve haute cuisine and make four times as much money per order? It's human nature

Another thing that will necessarily occur is that customers will find themselves being taken more and more for granted. Suppose they want seafood but there's only one seafood restaurant in town? They'll have to patronize that one restaurant, no matter how long it takes to be seated. The owner, having a monopoly, will only pay middling attention to their customers' happiness.

And what about the insurance company which ostensibly pays the bill? Does it ever call the restaurant patrons to ask them about quality? How was the food? Did you really get all 12 courses that appeared on the bill? How was the service> Did someone pull your chair out when you were seated?

Also, human nature tells us that some smart restaurant owners will eventually realize that they can make more money by organizing the menu la carte -- that is, billing separately for the meat, the vegetables, each bread stick, each grain of salt -- rather than by the traditional practice of charging one price for an entire meal.

Human nature would foretell one further event in our restaurant saga. After all the trends toward four-star French restaurants, la carte bill, and so forth, and with costs going through the roof, eventually the employers (remember: the ones who are paying the insurance premiums) would balk at having to pay so much to keep their employees fed. Some employers would start their own restaurants, run by licensed professionals on their own payroll, because they could feed their employees for less than the restaurants on the "open" market charge. Some would demand that the insurance companies to which they have paid premiums for all these years start looking out for the employer's interest, too.

Eventually, so many employers would start to demand a legitimate business relationship that insurance companies would become quite concerned. After years of coziness with the restaurant owners, the insurers would scramble to shift their allegiance to the employers and try to rein in skyrocketing costs. To do that, they should begin to question the restaurant owners' decisions. does this customer really need that second slice of apple pie? Why didn't you serve them the domestic Cabernet instead of the vintage Bordeaux? The restaurant business would be swamped with enormous red tape created by all these controls. And some restaurant owners would start playing cat-and-mouse games with the insurance companies, in an effort to elude the controls.

This sad, muddled, budget-breaking state of affairs, with an industry all but paralyzed by red tape, is unfortunately the conditions is which we find our health care system in 1994.

(Where do we stand in 1997) The Insurance company now says this person with Multiple Chemical Sensitivity is not really hungry. Let him sat at the best table, in 12 minutes ask him how he enjoyed meal, Collect 20% of the average priced meal or sue him and ask him to leave and not come back. After all: that's the restaurant business.

Skvarla is president of Comp Containment Inc., the parent company of a firm that develops and distributes medical diagnostic equipment. Elliot is a reporter for the Winston-Salem Journal. They are the Authors of We're Not That Stupid: The People's Prescription to What Really ails America's Health Care System (Signal Books).
1994 by the John Locke Foundation Inc. Published in the Carolina Journal, a bimonthly magazine of analysis and commentary on state and local public policy issues in North Carolina

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