There are No Free Rides

Alexandra F. Baldwin

As House Republicans begin defending their (largely indefensible) Obamacare replacement, Americans will be inundated with incomplete, misleading and counter-productive discussion about the cost of health care. As the designated cold water thrower around here, let me walk through some reality to explain why everyone is bound to be unhappy.

First, we need to clear up the distinction between health care and health insurance. Health care is the actual provision of products and services related to your health. When you go to the doctor, take a pill, get an X-ray or put on a band-aid, you are consuming health care. Health care costs money.

Health insurance is a means of paying for health care. It is an agreement whereby a whole bunch of people agree to share certain health care costs and pay a portion of the overall costs rather than the exact costs that they incur. As a really simple example, imagine that there is a 1% chance that you will get cancer, and it will cost $200,000 to treat. Rather than just roll the dice, insurance allows 100 people to pay $2,000 each and then the one person who gets cancer will have his or her treatments paid for. I’m sure you all understand this, but I need you to fixate on one key fact: the average costs (your premiums) cannot, in total, be less than the expenditures of the plan.

Our public policy discussions too often focus on the cost of health insurance premiums, and not the underlying costs of delivering care. Whether it is candidate Obama’s promise that “your premiums will fall by $2,500,” or any of the myriad discussions of rising premiums under and outside of Obamacare, we tend to focus our discussions on health insurance premiums and not health care costs. But, obviously, health insurance premiums cannot fall unless health care costs fall.

And health care, quite frankly, costs a lot of money, at least in the way that we consume it. Let’s just walk through a typical visit to the doctor to get an idea of how much. To begin with, there is the actual doctor, and she’s not going to treat you if she doesn’t get paid. By objective standards, she gets paid a lot: per payscale.com, the average US Doctor of Internal Medicine earns $182,000 annually (specialists earn a lot more).  

As much as that seems like a lot, it is hard to see what the alternative to that is…clearly, we want smart, hardworking people to become doctors and we want medical schools to be rigorous and thorough. If we are going to attract the kind of people that we all want to attract to the profession, and we want to ensure that they are properly trained, then those people are going to have to earn a lot of money. If I am smart enough and willing to work as hard as required and take on the debt required to become a doctor, I’m simply not going to do that if the income tops out at $100,000. Why would I, when I could become an investment banker or a chemical engineer or any of a whole bunch of other professions that require a lot less school and offer much higher earnings potential?

Now let’s step out of medicine and look at how some other professions might charge for a person of that capability level. In professions like accounting and management consulting and law, where an employee’s time is allocated to specific clients and billed accordingly, it is pretty normal for billing rates to be as much as four times the hourly rate of the employee, based on their annual base salary. In other words, a staff accountant that earns $75,000 annually (which comes out to $37.50/hr based on a 2,000 work year – 50 weeks of 40 hrs/week) is likely to be billed out to clients at something like $125-$150/hr. An associate at a law firm that earns $250,000 ($125/hr) is likely to be billed out at $500/hr and similarly valued people at Management Consultants would be priced in a similar fashion.

This multiple allows for the employee’s salary, the employee’s benefits and bonuses, and all associated overhead. No employees (other than really socially-challenged lawyers;-)) can bill for their entire 2,000 hour year, as they end up spending time in training, or on firm-development initiatives or they just aren’t utilized because there is no paying work to do that day. Their billing rate accounts for that downtime. It also accounts for support staff that is not billed directly to clients, for firm management functions like HR, Finance and Marketing and for general overhead like buildings and equipment and insurance, etc. If the firm is well run, there is profit left over for the partners. And thus ends “Professional Services Industry Economics 101.”

Let’s now go back to the doctor earning $182,000 annually and her nurses who earn, say, $80,000. Since a doctor’s office has a lot more overhead than an accounting firm (more equipment, more support staff, more insurance), it seems like a 4x multiplier is probably insufficient. I’m going to use 5x to make the math easier, but it may in fact be even higher than that. At that rate, the doctor’s rate is something like $450/hr, and the nurse’s something like $200/hr. And that applies not just to the time you are sitting with them, but any time that they spend preparing for and reviewing your visit. So, a totally routine visit to the doctor with no additional tests, no special treatments and nothing out of the ordinary that consumes, in total, just one hour of a doctor’s time and one hour of a nurse’s time is likely no less than a $650 endeavor.

Keep in mind, this is before we have even begun to discuss any specialists. Do you need a cardiologist? Did you break a bone and need an orthopedist? At $500,000 annually, you’re looking at hourly rates that look something like $1,250. God forbid you need surgery, where the surgeon costs that much, the anesthesiologist costs about $1,000 and three or four nurses cost $200/hr each. The point being: going to the doctor is expensive because doctors are expensive and hospitals are expensive. Unless you are willing to downgrade the quality of people who can be doctors, downgrade their training or downgrade the equipment and facilities that they use, there is no way around this.

There is another part to this, as well. Proponents of free-market health care often cite long wait times to see specialists in Canada or the UK or other nationalized health system countries. Americans are generally unwilling to deal with these sorts of wait times and demand much more ready access to doctors and facilities. Maintaining that access usually means that those doctors and facilities are utilized at a lesser rate than they would be under different circumstances.

Of course, there is more to health care than doctors and nurses. There are also medicines, medical devices and testing equipment, and they are all expensive, too. The dynamic is similar, though…medicines cost a lot because research and development of new pharmaceuticals and new medical devices is an extraordinarily high-risk business. It takes years and hundreds of millions of dollars to bring a new drug to market, so it should follow logically that no one is going to pursue the development of a new drug without the prospect of enormous sales of that drug.

There are ways that we could reduce this, of course, but like most economic problems, there is a reaction to any of those policies. We could streamline the FDA approval process so that more drugs get approved and the time to approve them is shorter. Or we could allow for more competing therapies to get to market to increase the available options to treat any one condition and bring down prices through competition. Shortening and weakening patent protections would accomplish a similar goal. All of those, however, decrease the expected revenue that a drug maker can expect to generate from any particular project. It’s possible that the increased likelihood of success will offset the lowered expectation of revenue, but it is more likely that it will result in currently viable drug research projects becoming unviable.

Further, I am not sure that I really need to give you a whole host of details about the risks of cutting back on the FDA approval process. There are some pretty obvious downsides to that.

I’ve certainly heard all of the arguments about pharmaceutical company profitability. How can they justify their “obscene profits”? Drug companies are some of the most consistently profitable enterprises in the world and have produced outsized growth for nearly 40 years now. The after-tax earnings of pharma giants are staggering: Merck $4 billion, Pfizer $7b, Gilead $13.5b, Novartis $7b, Lilly $3b, Amgen $8b, Roche $9.5b. Their margins are matched only by certain segments of the software and tech services industry.

They are wildly profitable because they are wildly successful. The demand for their products is extremely strong and highly inelastic precisely because those products work so well. Just step back and think about this for a second…they have invented pills that can literally cure cancer. Is it surprising that therapies like this are highly sought after by people who need them? And the question that Bernie Sanders and his ilk refuse to acknowledge: do we really want to slow down the pursuit of new groundbreaking therapies because we’d rather drugs be cheaper?

​No, that is not a false choice. That is basic economics: if drugs were less profitable, there would be less drug discovery. It is entirely possible that we think, as a society, that we would rather give back some future advancement in exchange for less expensive drugs but we can’t pretend that trade-off doesn’t exist. Expensive drugs lead to more new drugs because there is more incentive to pursue those new drugs. The same goes for medical devices and testing or diagnostic machines: the invention of the MRI was only possible because there is a market for $300,000 MRI machines, and there is only a market for $300,000 MRI machines because there is a market for $2,000 MRI’s. And, of course, there is only a market for $2,000 MRI’s because MRI’s are a legitimately breathtaking miracle of modern science.

All of which is my long-winded way of getting to the truth about medicine: it’s really expensive to provide, and we almost universally think that the value provided by modern medicine is still above and beyond its cost. Insurance is a way to defray the unexpected costs incurred by one person because of some misfortune, but it can do very little about the overall cost of care (it can refuse to pay for things, or it can negotiate lower prices, but the power to do that is limited by both regulation and consumer pressure).

Insurance, in fact, may actually be driving up the overall cost of care. Since consumers have paid a flat fee for all of their health care (save copays) there is incentive to use as much health care as they may possibly need, regardless of cost. Imagine that, if you wanted a car, you had to pay the average cost of a car but you got to drive whatever you wanted. The obvious result is that there would be a run on Maseratis, and it would cost $185,000 to own a car. This is how we consume health care: once you’ve paid your insurance premium, the natural tendency is to look for the Maserati whenever you need a ride somewhere.

The House Republicans, therefore, tackled an impossible task this week. They attempted to provide a health care plan that delivers on the fantasy that American politicians peddle voters on Health Care. Our public discourse talks about covering more and more stuff for more and more people in more and more places while somehow not requiring anyone to actually pay for it. As they are wont to do, politicians don’t have the stomach to try and deliver a cogent and truthful message to their voters: you can’t get everything you want.

​Just as there are no free lunches, there are no free rides. We, as a nation, have convinced ourselves that we are entitled to unfettered access to world class care, but we refuse to acknowledge that such an attitude is diametrically opposed to any sort of cost control. Until we own up to our own unrealistic expectations, we’re never going to do better than last year’s ACA, this year’s AHCA or next year’s longer, less effective acronym.