Some Inconvenient Truths About Medicare and the New 'Public Plan'

Some Inconvenient Truths About Medicare and the New 'Public Plan'

By Regina Herzlinger and Robert Book - July 25, 2009

The fundamental problem with health care reform is the absence of realistic plans to reduce unit costs. Without cost controls , tens of millions of newly-insured people will further cripple U.S. global competitiveness, which is already grievously injured because the U.S. spends roughly 70 percent more on health care, as a percentage of GDP, than other developed nations, yet cannot point to commensurate 70 percent increases in value.

So far, the Democrats rely on two allegedly cost-controlling remedies - a new national health-insurance marketplace, modeled on the Massachusetts Connector (which features only private health insurers), augmented with a public insurance program. Advocates aver that the cost problems of Massachusetts, whose marketplace recently required a $115 million budget slash, can be remedied with a cost-controlling, government-run program, such as Medicare.

But polls reveal that many Americans don't buy it. Does anyone believe that a government-run grocery store would provide more value for the money than successful private-sector stores, like Publix Super Markets?

Medicare's alleged cost-controlling ability is illusory, driven by faulty math, regulatory power to shift costs to the private sector, and pricing formulas that pass expenses to taxpayers and future generations.

The 800-pound gorilla is Medicare's unfunded liability for future benefits, estimated by Medicare Trustees at $38 trillion. Medicare created this massive liability by charging current enrollees too low a price: government used the payments by working non-beneficiaries to make up the shortfall. If Medicare were a private insurance company, it would have to increase its costs by an additional trillion dollars annually to account for the interest on this debt (assuming 3% interest). But the federal government's accounting ignores this expense.

Will government continue to rob Peter to pay Paul when it prices the new public plan? If so, an estimated 83 million people would eventually move out of private plans into a grossly underpriced Medicare, vastly increasing the liability. At $38 trillion, it already equals than two and a half times 2008 GDP.

Medicare's cost advantages are dubious in other ways. Advocates assert that Medicare's administrative costs are 3 percent (or 6 - 8 percent with support from other government agencies included), compared to 14 to 22 percent for private employer-sponsored health insurance (depending on the study cited), or even more for individually purchased insurance. On a per-person basis, however, Medicare's administrative costs are higher than those of private insurance, although private plans have additional administrative expenses, such as state premium taxes, marketing, and returns for stockholders. Medicare administrative expenses appear lower as a percentage of total costs only because enrollees need, on average, more health care services than those privately insured. Expressing them as a percentage makes Medicare's administrative costs appear lower because they are spread over a larger base of health care costs. To be sure, the average general and administrative expenses of US private insurers are far higher than those in Switzerland, where expenses average 5%; but the public plan is even worse.

Medicare and Medicaid's regulatory power also enables them to underpay providers by an estimated $90 billion dollars compared to private insurers. Currently, private insurers pay higher prices to take up the slack. But if the market were entirely composed of public insurers, who would pay providers adequately? Faced with reduced pay prospects, all too many doctors, nurses, and other professionals would retire early or, because they are enormously talented people, pursue other occupations. The looming doctor shortage could become a national crisis as prospective physicians, whose education requires many to incur massive debt, would reluctantly opt for occupations where the government does not control their livelihoods.

The Democrats' health care reform will likely eventually require drastic rationing of health care for the sick to control costs. Consider the patients in other public plans -Canadians who may wait a year or longer to get radiation therapy or the millions of Britonsof Britons who wait to get into a hospital or have an outpatient procedure.

Expanding the number of people with health insurance? Of course.

But not through a mispriced "public plan."

That sort of "reform" will maim either our economy or our health, and most likely, both.

Regina E. Herzlinger is the McPherson Professor at Harvard Business School, a Manhattan Institute senior fellow, and author of “Who Killed Health Care?’(McGraw Hill, 2007). She is a director of a private insurance company. Robert A. Book, Ph.D., is Senior Research Fellow in Health Economics in the Center for Data Analysis at the Heritage Foundation in Washington DC.

Copyright Regina E. Herzlinger, 2009.

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