The GOP’s American Health Care Act, like Obamacare, does nothing to address the core drivers of health-care hyperinflation. Unless those issues are addressed, costs will continue to escalate.

The GOP’s American Health Care Act, like Obamacare, does nothing to address the core drivers of health-care hyperinflation. Unless those issues are addressed, costs will continue to escalate, and all efforts to make health care affordable will be futile.

What has relentlessly driven health care from 4.5 percent of gross domestic product (GDP) in 1950 to 18 percent today? To understand that dynamic, we must step back 50 years and observe the context in which Medicare developed, and the policies it spawned.

Some claim Medicare is more efficient than private insurance companies. That is both true and false. Since the Medicare law was passed in 1965, the government has become the largest payer of health-care services. During that time Centers for Medicare and Medicaid Services (CMS) policies have gradually but radically transformed our health care economy to fit Medicare, while the cost of health care has tripled.

Making Things Easy for Medicare Makes It Worse for Us

From Medicare’s viewpoint, our current system is very efficient:

The doctor or hospital submits a coded bill. Medicare runs the bill through its computer, which analyzes the codes according to their payment rules. The doctor or hospital gets a check or a denial of payment, based on the computer’s analysis of the billing codes.

For Medicare, that’s simple, fast, and efficient. But how was this efficiency achieved, and at what cost?

Medicare was created 52 years ago to address seniors’ rising health-care costs. American health-care costs had increased from 4.5 percent of GDP in 1950 to 6 percent of GDP in 1965, a relative cost increase of 33 percent in only 15 years. Trends in health insurance were a major factor. During World War II, manpower was in short supply, but the government-imposed wage freeze prevented employers from raising wages to attract workers. They were, however, allowed to increase benefits.

The normal purpose of insurance is to protect against catastrophic losses. But to make employer-provided insurance desirable as compensation, it needed to be “spendable” for regular expenses. This created a growing demand for “low deductible” and “first-dollar coverage” insurance. Unions increasingly demanded this benefit. Medicare joined this trend by providing first-dollar coverage, and another feature patients found attractive: direct insurer billing.

Insurance is critical to a secure and prosperous economy, when used for its only economically valid purpose: the payment of a small, fixed amount, to indemnify against an unlikely, but much greater possible loss. Thus “first dollar coverage” and “low-deductible” insurance is not insurance at all. It is “pre-paid health care.” This makes no more economic sense than pre-paid rent or groceries. Beyond creating the consumer-payer disconnect, it introduces an additional resource-consuming third party and an additional layer of complexity into every transaction.

In the “old days” if you had health insurance, you paid your doctor or hospital bill yourself, then submitted the bill to your insurer for reimbursement. That was a nuisance for patients. As more people became insured by employers and Medicare, doctors and insurance companies found “direct billing” attractive. These insurance trends created health care’s “consumer-payer disconnect,” a critical cost driver not seen in any other sector of our economy.

The Consumer-Payer Disconnect Is a Major Cost Driver

The consumer-payer disconnect meant that if you had good insurance, you didn’t have to worry about how much anything cost, because somebody else was paying. Doctors soon discovered that, although an uninsured patient might complain about a big bill, insurance companies and Medicare usually paid it without question.

What could they question? All they had to judge was a piece of paper with some medical jargon and a dollar sign, followed by a big number. Doctors and hospitals had discovered the “insurance cookie jar,” and they dug in often and deeply. Uninsured patients were increasingly unable to afford the ballooning fees, but doctors and hospitals did very well—for a while.

These effects of this consumer-payer disconnect turned Medicare into a budget buster, while similarly straining private insurers. Costs were skyrocketing. In retrospect, Congress should have addressed the policies driving the insurance abuses causing the health care hyperinflation. Instead, they resorted to the usual knee-jerk reaction of governments confronted with rampant inflation: price-fixing.

Medicare was empowered to tell doctors and hospitals what prices it would pay, instead of the other way around. But how was Medicare to define its own prices unless they knew what they were paying for? There was no standardized nomenclature for medical bills. One hospital might bill for an “exploratory laparotomy with removal of appendix” and another, having done the same thing, just bill for an “appendectomy.” Medicare’s solution was medical coding.

Medical Coding Became the Next Big Cost Driver

Next Medicare required that all bills be coded: every charge must be justified by an ICD (International Classification of Diseases) diagnosis code, and identified with a specific CPT (Current Procedural Terminology) code.

Sounds simple, but the notion was quixotic from its inception. Language in general, and especially the process or medical diagnosis and treatment, is simply too complex to effectively capture in a set of codes. Even if it were possible to devise a complete set of codes, they would soon be out of date due to changes in practice and advances in technology. Consequently, the number of codes and the rules regarding them have steadily increased. There are now more than 150,000 codes and growing.

How did doctors and hospitals respond? Predictably enough, by gaming the codes. They soon learned which paid best, and favored those. That not only improved reimbursement, but introduced financial bias into care decisions. In response, Medicare created ever-more-complicated codes, “code modifiers,” and payment rules, upping the ante. A cat-and-mouse game has existed ever since.

Before long, the whole business of medical billing became so complicated that no doctor or any traditional medical employee could cope. Consequently, schools and colleges all over America offer programs to become a “certified medical coder,” which, along with “medical billing and preauthorization specialists” and “regulatory compliance specialists and consultants” have become three of the fastest-growing professions in America. Medicare has become “the most efficient insurer” by spawning three entirely new professions and hundreds of thousand employees whose only function is to cope with Medicare’s rules.

The cost of these functions is now so high that it’s driving small and solo medical practices into extinction. More and more, physicians are being forced into larger groups, in bigger towns and cities, to achieve the economies of scale required to simply get their bills paid. How efficient is that?

Additional Effects of the Consumer-Payer Disconnect

A healthy and prosperous economy evolves because of two simple mechanisms at work in the marketplace: a) The incessant signaling of consumer needs and preferences by their choice of sellers and products or services. b) The incessant competition among sellers to attract buyers with preferred products at affordable prices.

This simple mechanism has resulted in a cornucopia of affordable products and services for Americans, but it requires that the consumers of goods and services also be the payers. When consumers are absolved of payment, or the providers are deprived of the ability to compete on price and quality, the result is the “consumer-payer disconnect” that now plagues our health care economy and prevents the normal market evolution toward better goods and services at affordable prices.

If you have Medicare or health insurance, you already know that your ability to choose your health-care provider has been diminished, and that you have virtually no ability to compare the quality and price of whatever options your doctor offers. But perhaps you still think you discuss treatment options to determine what’s best for your specific problem. That isn’t really what happens. Here’s why:

You doctor cannot select whatever is best in your case, only whatever options Medicare, Medicaid, or your insurer has agreed to reimburse. Otherwise, she’s effectively left holding the bag when payment is denied. Because it takes years for CMS and insurers to approve payment for new innovations in care, innovation in health care is limited. You may be missing out on new tests or treatments that would be better and cheaper. Because their options are highly constrained by labyrinthine rules regarding what goods and services can be paid, under what circumstances, and at what prices, your doctor and hospital are pushed to (a) “churn patients,” and (b) bill lots of those patient visits, tests, and treatments that can reliably meet the rules and regulations, to provide the greatest revenue per time or resources invested.

Your doctor and hospital are incentivized not to please you, but to please Medicare or your insurer, if they want to be paid. If health-care providers can’t control what they do or charge for it, their only option to increase revenue is to do more of whatever reliably pays most—i.e., to “game the system.” Theoretically, the rules are intended to prevent doctors and hospitals from doing (and charging for) things that might not be appropriate. To some extent, they may accomplish that. But the net effect of price-fixing by a central authority is:

to increase costs because compliance with complex rules affecting your every action is very costly, to create an incentive structure that rewards gaming the system, rather than providing the best care at the best price, to limit patient and physician choices, to suppress innovation and investment in health care, and to purge the system of the market dynamics that normally cause quality and affordability to increase over time.

Yes, Medicare’s “cost saving measures” have been effective for Medicare, in the short term. Consequently, virtually every major health insurer has adopted them. But the long-term effect has been to triple Americans’ cost of health care, from 6 percent of GDP when Medicare was founded in 1965 to 18 percent and growing today.

Grasping the Absurdity

Because it developed gradually over many decades, the enormity of the waste and inefficiency in our health care system is difficult to appreciate. Perhaps a simple analogy will help grasp it. The U.S. Department of Agriculture manages SNAP (the Supplemental Nutrition Assistance Program, or “food stamps”). Suppose rising food costs were busting USDA’s budget, and it responded like Medicare has to rising healt- care costs. What would our food industry be like?

Every grocery store in America would have to employ “certified food coders,” “billing and preauthorization specialists,” and “regulatory compliance personnel” to code every SNAP bill and ensure no one was audited or prosecuted for fraud. There wouldn’t be any prices on the food items in stores, and purchasers wouldn’t know or care what anything costs, because someone else would be paying. The introduction of new products and removal of old, unsavory ones would be glacial because every new food product would have to be reviewed and approved by USDA before it could appear on the shelves. Small and independently owned neighborhood grocery stores would disappear because they couldn’t afford the tremendous overhead of coding and compliance. Food costs would steadily escalate relative to other economic sectors.

That sounds absurd, I know. But that’s what happened in health care. That’s how it is today.

We Need to Get Off This Bus to Bankruptcy

Today, Americans pay twice as much as people in other developed countries for health care of similar quality. We are literally wasting nearly 10 percent of our nation’s net income to pay for unnecessary inefficiencies. Until we fix that problem, it will be impossible to ensure that all Americans have access to care—at least not without bankrupting our nation. And those of us who can afford health care will continue to grossly overpay for limited options.

Neither Obamacare, nor current Republican proposals, address these fundamental causes of rising costs, declining efficiency, and obstructed innovation. Health care policy should be based on an economic model that creates the incentives to drive doctors, hospitals, and patients back to their normal roles where:

Consumers choose providers based on cost, quality, and convenience.

Providers compete for patients and differentiate themselves based on price, quality, and reputation.

Insurance shrinks back to its normal role of protecting against catastrophic events.

Government involvement shrinks back to stimulating competition, ensuring a level playing field, and providing a safety net via subsidies to purchase care in a (much more affordable) health-care marketplace.

Only the above measures can restore vitality, efficiency, and affordability to our health care system. Additional important supportive measures (some of which are in the GOP plan) include:

Promoting high-deductible plans with health saving accounts, to encourage and empower consumers to responsibly manage their health care expenses.

Requiring providers to publish their prices, and not charge the uninsured more than insured patients pay.

Reducing the time and cost associated with developing new drugs and devices by streamlining Food and Drug Administration regulations, and requiring only proof of safety and not efficacy. (The best uses of new drugs are often only discovered after they become available.)

Allowing Americans to purchase and import drugs from any country with reasonable drug safety regulations. There is no reason U.S. consumers should subsidize the world.

Eliminating state boundary restrictions on insurance and services.

Tort reform to decrease the costs of “defensive medicine.”

The road to a vibrant, efficient and affordable health care system is clear. The only question is, are we going to drive it? Or are we going to continue down the path of price-fixing, central bureaucratic management, code-gaming, and abuse of insurance that got us where we are today?