NATIONAL CENTER FOR POLICY ANALYSIS
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Controlling Health Care Costs With Medical Savings Accounts

Third-Party Health Insurance

Many people believe that health care spending should be determined by medical "needs." Yet if we followed the practice of spending health care dollars whenever a need was being met (or a medical benefit created), we could easily spend our entire gross national product (GNP) on health care. In fact, we could probably spend half of the entire GNP on diagnostic tests alone.

The Potential Demand for Health Care. What prevents medical costs from being even higher is that patients are constrained by obstacles such as time, money and inconvenience. For example, medical science has identified 900 tests that can be done on blood. 2 Except for the cost and inconvenience, why not make all 900 part of our annual checkup? Similarly, an annual checkup could include a brain scan, a full body scan and numerous other tests - all of which are valuable even to people who appear healthy.

As an example of how the demand for the services of primary care physicians could soar, consider: 3

  • In any given year, Americans make about 472 million office visits to primary-care physicians.

  • If only 2 percent of nonprescription drug consumers sought professional care rather than self-medicating, the number of patient visits would climb to 721 million.

  • The number of primary-care physicians would need to increase by 50 percent to meet the increased demand.

  • If every person who now uses nonprescription drugs chose professional care over self-medication, we would need 25 times the current number of primary-care physicians.

How Third-Party Insurance Increases the Demand for Health Care. The vehicle by which we spend other people's money in the medical marketplace is third-party health insurance (provided by an employer, an insurance company or government). Prior to 1965, increases in health care costs were relatively modest because a large part of the payment was made out-of-pocket by patients. Since then, Medicare and Medicaid have expanded government third-party insurance to more and more services for the elderly and the poor, and private health insurance has expanded for the working population. As Figure I shows:

  • About 95 percent of the money Americans now spend in hospitals is someone else's money at the time they spend it.

  • Four-fifths of all physicians' payments are now made with other people's money, as are three-quarters of all medical payments for all purposes.

When patients pay only a fraction of the real cost of the health care they receive, they have an incentive to over-consume. Since we pay only 23 cents out-of-pocket for every dollar of medical care we receive, we have an incentive to continue consuming until medical care is worth only 23 cents on the dollar to us.

The expansion of third-party insurance coverage since 1965 has had a predictable consequence: health care spending has soared from 6 percent to 12 percent of GNP, and the rate of increase shows no sign of abating.

Numerous studies have shown that the amount of medical care people consume varies with the out-of-pocket price they have to pay - often with no effect on health. For example: 4

  • A Rand Corporation study found that people who had access to free care spent about 50 percent more than those who had to pay 95 percent of the bills out-of-pocket (up to a maximum of $1,000).

  • People who had free care were about 25 percent more likely to see a physician and 33 percent more likely to enter a hospital.

  • Despite these differences in consumption, there were no apparent differences between the two groups in health outcomes. 5

The Rand study was conducted from 1974 to 1982. A $1,000 deductible over that period would be equivalent to a deductible between $1,380 and $2,482 today.

Third-Party Payment of Small Medical Bills. Using insurers to pay small medical bills is especially wasteful. It is comparable to using an insurance company to pay monthly utility bills. That might be convenient, but the convenience would be costly.

  • Studies show that physicians spend an average of $8 for each insurance claim they submit.

  • Most employers and insurance companies spend another $8 for every check they write.

  • If the third-party payer investigates the legitimacy of a claim, a $25 physician's fee can easily generate another $25 in administrative costs - thus doubling the cost of medical care.

Considering that a substantial portion of insurance claims are for small-dollar expenses, using third parties to pay small medical bills adds substantially to the nation's annual health care costs.

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