Senate Homeland Security and Governmental Affairs Committee Hearing
Good morning Chairman Johnson, Ranking Member McCaskill, and Members of the Committee. I am
Why
The fundamental function of any kind of insurance is to reduce financial uncertainty by pooling risks. Consider homeowners insurance. On average, if a large number of people pay a premium in advance, a relatively small number will have their houses burn down. Because not everyone has their homes burn, there is sufficient money in the pool to replace the homes of those who suffer the loss. This system works because both higher-risk and lower-risk people pay money into the pool, not just the people who face a high risk of loss.
At the turn of the 20th century, medical care was largely ineffective and medical costs were low. People rarely entered the hospital, did not face unexpectedly high health care costs, and did not need health insurance. n2 For example, only five percent of infants were born in hospitals in 1900. As medical technology advanced in the early 20th century and more people sought treatment in hospitals, health care costs began to rise. The costs of hospitalization also introduced wide variation in health care expenses for American families, so that middle class families that could previously pay bills might not be able to pay a large hospital bill. n3
Even though the need for health insurance had grown, the market did not develop because insurance companies were concerned that "health" was uninsurable for two reasons. First, they feared a problem known as "moral hazard," which occurs when an insurance changes the behavior of the insured person. In health insurance, moral hazard occurs because health insurance increases the amount of medical care people consume by lowering the cost of care. Moral hazard affects all types of insurance, but is less of a problem in some areas; for example, few people begin driving recklessly simply because they have insurance to repair their car in the event of an accident. A second reason insurance companies were reluctant to enter the health business was because they recognized that people who knew they might be more likely need medical care would be more likely to seek out insurance. This problem - known as adverse selection - was as big as a problem for insurance markets in the 1920s and 1930s as it is today in the non-group market. For insurance to be effective and affordable, both healthy people and people more likely to become ill must buy insurance.
The problem of adverse selection was solved in 1929 when
The Blue Cross plans became enormously popular, both among members and hospitals. They enabled hospitals to receive a constant stream of revenue and offered financial protection for
In the 1940s, a series of events ensured the expansion of the health insurance market and its employment-based nature. The tremendous mobilization of troops and resources during World War II led to a huge decline in unemployment, which fell to a low of 1.2 percent in 1945. n7 Beginning in 1942, the National War Labor Board limited the ability of firms to raise wages to attract increasingly scarce labor. Health insurance (and other fringe benefits) were exempted from this ruling. As a result, firms began to offer health benefit packages to secure workers.
Unions worked to negotiate for health insurance on behalf of workers, a right that was assured in 1949 when the
Perhaps the most influential aspect of government intervention that shaped the employer-based system of health insurance is the tax treatment of employer-provided contributions to employee health insurance plans. Employers are permitted to deduct health insurance contributions (like wages) from their taxes as a cost of doing business. But unlike wages, employer contributions to employee health insurance premiums are exempt from employee taxable income. This "tax subsidy" of employer contributions to employee health insurance premiums first occurred in 1943 with an administrative tax court ruling and was later codified under the 1954 Internal Revenue Code. n9 The tax treatment of employer provided health insurance provided an additional incentive for its expansion; research shows that the 1954 statute increased the generosity of existing plans and the number of firms that offered coverage. n10 The tax treatment cemented the institution of employment-based health insurance in
How our health insurance system leads to rising health care costs
Policies that encourage the development of very generous health insurance plans, such as the favorable tax treatment of employer sponsored health insurance coverage, contribute to rising health care costs because they increase moral hazard. To the extent that the additional health care purchased by consumers is necessary and cost-effective, this increase in utilization is not problematic. But if the care consumers are purchasing is of low value, the extra utilization does not improve health and adds to rising expenditures. In the early days of health insurance, the risk of consumers receiving low-value care was small, since health insurance plans were much less generous.
This changed rapidly. Health insurance became more generous in the 1940s and 1950s. Consumers could purchase not only hospital insurance, but also coverage for medical expenses both inside and outside of the hospital, so benefits became less limited and defined. At the same time, the charge and cost-based reimbursement systems developed by
As time has passed, insurance coverage has become more generous and the share of health care expenses paid by consumers has decreased. In 1950, when approximately 50 percent of the population had hospital coverage, consumers paid 64.9 percent of health care expenditures out of pocket. Only 10 years later, this number had fallen to 55 percent, and to 40.8 percent in 1968, just a few years after the implementation of Medicare. n16 Today, consumers pay only about 12.4 percent of their health care bills. n17 Given that the function of insurance is to provide financial protection against large, unexpected losses, reducing consumer out of pocket payments so they can afford care is not necessarily a bad thing, but it is important that the care consumers receive is necessary and cost-effective so that health care expenditures do not rise unnecessarily.
The problem is that as insurance has become more generous, our system has tended to reward providers on a fee-for-service basis. Under the fee-for-service system, providers are reimbursed for every service they provide. This system incentivizes volume-based care. Providers do not have a financial interest in limiting services; in fact many have a financial incentive to perform more services. n18 Patients rely on physicians to determine the services they need, since medical decisions are complex. n19 When patients pay little for their care, they consume more; the
The implementation of Medicare in 1966 provides an excellent example of how cost-based reimbursement coupled with insurance coverage can lead to high utilization and rising expenses. From 1966 until 1983, hospitals were reimbursed on a cost-plus basis. Research shows that within four years of its implementation, Medicare resulted in a 37 percent increase in real health expenditures, with about half of that increase coming from the entry of new hospitals into the market and the other half coming from expansion of services. n21 Even after 1983, when Medicare switched to a system of fixed prospective payment based on Diagnosis Related Groups (DRGs), a hospital's revenue is still a function of patient admissions, thus incentives for volume based care still exist. The response of health care expenditures to the introduction of Medicare suggests that up to 50 percent of the rise in real health care costs between 1960 and 1990 may be due to the overall spread of health insurance. n22 Moreover, evidence suggests that as insurance expands the market for health care, it generates incentives for increased development of technology. While some of this new technology represents a significant improvement over current treatments, other innovations do not improve outcomes compared to existing procedures, yet cost more. n23
It is worth emphasizing that at least some of the increase in expenditures was probably "worth it" in the sense that the benefit to patients outweighed the costs. Moreover, there is evidence that Medicare significantly reduces financial risk for elderly people with the highest health care expenditures, which is one of its goals as a social insurance program. n24 The development of cost-effective technologies that help patients is also worthwhile. What is not worthwhile is inefficient, low-value care that emerges when providers are incentivized to deliver high-volume care regardless of cost that patients with generous health insurance coverage are willing to pay for.
How can the past inform present health care policy?
History can guide policymakers seeking to improve health care delivery and constrain health care cost growth, but it does not offer a simple solution. Rather, it suggests that the problem of adverse selection presents a long-standing challenge to the effective provision of insurance in the non-group market. History also suggests that constraining cost growth will be difficult as long as health care providers profit from providing volume-based care. Movements to shift payment to reward value-based care that emphasizes quality and cost-effectiveness will be key to any policy seeking to limit the growth of health care expenditures. Finally, research shows that consumers respond to cost sharing such as high-deductible health plans (HDHPs) by significantly reducing spending both in the short run and over time. n25 Studies show that consumers with high-deductible health plans engage in cost-conscious medical decision making, such as increasing use of generic drugs, but it also suggests that they reduce spending on both low-value care as well as necessary care. n26 In addition, at least one study finds no evidence of consumers learning to price shop, even after two years in a high deductible plan, although this may be related to the fact that employer contributions to employee health savings accounts may engender moral hazard. n27 Combined, these studies suggest high-deductible health plans are effective at reducing costs, but need to be carefully structured to motivate consumers to obtain necessary and high-value care while minimizing the use of low-value services. n28
n1.
n2. Thomasson, Melissa A. (2002). "From Sickness to Health:
n3. In 1927, the government formed the Committee on the Costs of Medical Care (CCMC) to investigate the medical expenses of American families. Comprised of physicians, economists, and public health specialists, the CCMC published 27 research reports, offering reliable estimates of national health care expenditures. According to one CCMC study, the average American family had medical expenses totaling
n4. Four percent had surgical coverage, and 2 percent had coverage for in hospital medical benefits.
n5. Thomasson, Melissa A. (2002). "From Sickness to Health:
n6. See Thomasson, Melissa A. (2004). "Early evidence of an adverse selection death spiral? The case of
n7.
n8. Scofea, Laura A. (1994). "The Development and Growth of
n9. The first such exclusion occurred under an administrative ruling handed down in 1943 which stated that payments made by the employer directly to commercial insurance companies for group medical and hospitalization premiums of employees were not taxable as employee income (
n10. Thomasson, Melissa A. (2003). "The Importance of Group Coverage:
n11. Madrian, Brigitte (1994). "
n12.
n13. A nationwide study of employer plans in the late 1940s found that of 215 employer plans, the most generous plans paid
n14. Chung,
n15.
n16. Rice, Dorothy P. and
n17. Calculated from
n18. Several studies suggest that physicians respond to financial incentives by changing treatment when the incentives change. For example, a 2011 study found that after Medicare implemented an average sales price payment system for physician-administered drugs (such as chemotherapy drugs) that reduced the reimbursement for a common lung cancer drugs, oncologists responded by increasing the rate of chemotherapy for patients with lung cancer; rates of treatment for lung cancer increased by more than 10 percent within the first 30 days after diagnosis. See Jacobson, M., Earle, C.C. and Newhouse, J.P. (2011). "Geographic variation in physicians' responses to a reimbursement change."
n19. Consumers can shop for some types of care (such as outpatient MRIs, non-emergent surgeries and certain drugs), but are often at the mercy of providers who recommend imaging, drugs, or surgery in the first place. These providers may have financial incentives that influence their behavior. For example, a 2012 study by the
n20. Newhouse, Joseph P. and the
n21. Finkelstein, Amy (2007). "The Aggregate Effects of
n22. Finkelstein, Amy (2007). "The Aggregate Effects of
n23. For example, a 2013 study found that proton beam therapy offers no long-term benefit over traditional radiation for prostate cancer, yet Medicare pays
n24. Finkelstein, Amy and
n25. Haviland, Amelia M.,
n26. For an example of how HDHPs affect generic drug choice, see Waters, Teresa M.,
n27. Brot-Goldberg, Zarek C.,
n28. Chernew Michael,
Read this original document at: http://www.hsgac.senate.gov/download/09/05/2017/testimony-thomasson-2017-09-06
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