Reforming Health Care

Health care in the United States is generally excellent, but, in many cases, it is also needlessly expensive. Reform should focus on introducing greater cost discipline to this important sector of the economy so that it imposes less avoidable financial stress on households and governments.  

In most markets, consumers enforce cost discipline through their choices. Waste is punished when competitors offering better deals gain market share. 

Health care needs much more of this kind of discipline. To move in this direction, reform should focus on helping consumers identify and select providers and insurance plans that offer the best value for the money spent. Put another way, the U.S. needs a structured health care and insurance market that rewards efficiency and productivity improvements. Of course, getting from here to there is easier said than done, but it is not impossible, and the payoff would be substantial.  

The starting point should be building the case for a market-driven reform plan by directly addressing the main criticisms advanced by opponents.  

The critics argue that medical care and insurance coverage are too complex for consumers to make informed decisions on their own, and that the dominant advantage held by those providing the services and selling the policies leads consumers to become passive rather than active shoppers in the market. Further, in emergency situations and when the clinical pathways for patients are uncertain, as is often the case with many cancer diagnoses, critics contend it is not realistic to expect consumer “shopping” to ever occur. 

These are valid points, but they can be misleading if the implication is that nothing can be done to help consumers navigate this complex market environment. That is not the case. 

Policymakers should see health care spending as falling into two categories, both of which can be placed within a market context. 

First, about 40 percent of total health spending is for services that are amenable to consumer discretion in the sense that they are relatively routine, involve high volumes of patients, allow for a degree of choice of provider, and involve some choice of timing. The types of interventions that fall into this first grouping are primary care visits, pediatric “well child” care check-ups, lab tests, diagnostic imaging, pregnancy and childbirth, common surgeries, and the routine management of chronic conditions. The share of services amenable to patient discretion could exceed 40 percent with new price transparency and consumer-assistance tools enabled by technological improvements, as suggested in a recent McKinsey report. 
The second category includes services better handled by “managed care.” That is, those providing services to patients, along with the insurance plans paying for the care, should have strong incentives to control total costs by carefully examining complex care-delivery processes for opportunities to improve efficiency. 

For both groupings, two changes would allow the market to work as it should. 

First, there needs to be standardization. When a patient is deciding on a surgeon for a common procedure, it should be possible to compare the all-in prices charged by providers in a designated market on an apples-to-apples basis. That is not possible today in most cases because there is no requirement that surgeons post their all-in prices for high-volume procedures based on standard definitions of what will be provided. For instance, if one surgeon includes anesthesia in the price and another does not, it will be difficult for the average consumer to readily make meaningful price comparisons.  

This same logic applies to insurance markets. The policies and patient cost-sharing requirements offered by competing insurers should be standardized so that consumers can easily identify high and low-premium plans. In today’s market, insurers hide behind the complexity of coverage rules and cost-sharing differences, making it all but impossible to see whether they are charging more than their competitors. With standardization, the policies would be identical, so the observed differences in premiums would be due to the relative strength of the competing plans to control costs, including through managed care practices. 

The companion reform to standardization is incentivizing the consumer to economize. When shopping for services that are amenable to consumer choice, market rules should allow the patients to keep the savings (or at least sizable portions of it) when they select lower-priced providers. To put this principle into effect, insurance policies must be required to incorporate it into their contractual terms. 

In the insurance market, government policy plays a crucial role, including in Medicare. Under the premium support model, beneficiaries would get a fixed level of support tied to the average premium charged in their geographic areas. If they use that support to enroll in plans costing less than the average, they would keep the savings. On the other hand, if they choose plans with above-average premiums, they would pay the added costs themselves. 

The Congressional Budget Office (CBO) estimated several years ago that premium support would reduce the combined Medicare costs for the beneficiaries and the government by 7.0 percent. The same concept can and should be applied to employer-sponsored insurance (ESI). 

These are the most important levers to pull to allow the market to function, but many other changes would help too. In particular, state policymakers should promote vigorous provider and insurer competition by removing obstacles that block new entrants from competing in their markets. These steps are especially important in metropolitan areas that suffer from excessive consolidation. 

Market-driven reform should be compared with the alternative its critics prefer: price regulation. If the government were to set ceilings on what hospitals and doctors can charge for services across the entire health sector (not just within Medicare and Medicaid), overall costs would indeed fall.  

But it would be a fateful step. Once in place, price regulation is hard to undo or modify. Those who are regulated often become adept at manipulating the invariably complex rules to their advantage. The regulated markets then become less competitive and more stagnant. 

Moreover, as decades of Medicare experience demonstrate, price regulation comes with a hefty dose of political meddling, which limits its cost-cutting potential. The regulator can only go so far before politicians intervene. The best that can be hoped for is modest restraint.  

That might be acceptable if not for the other risks, including a rigidity that prevents supply from adjusting to shifting demand and that delays the introduction of innovative technologies. With the government fully regulating the industry, capital and new investments dry up because the returns are unattractive. With reduced supply and capital, access to services can become more restricted, leading to waiting lists and a gradual decline in the quality of services delivered to patients. 

Policymakers should view consumers as an untapped source of persistent, rather than episodic, cost-control energy in health care. In a sense, the government needs consumers to play their usual role because mandates and price caps tend to backfire or get watered down. If consumers were to replace the government in the driver’s seat, cost discipline would become a permanent consideration rather than pursued only when political conditions allow it.  

James C. Capretta is a senior fellow at the American Enterprise Institute and the author of US Health Policy and Market Reforms: An Introduction, published by AEI Press in 2022.