A Healthcare Cost Analysis leading to effective and fiscally responsible solutions.

Bob Stern
22 min readSep 30, 2019

The US spent $3.4 Trillion on healthcare in 2018, twice as much as the OECD, a peer group of comparably advanced nations that enjoy universal healthcare.

The OECD is an intergovernmental economic organization with 36 advanced member countries committed to democracy and the market economy, identify good practices and coordinate domestic and international policies of its members. Most OECD members are high-income economies with a very high Human Development Index (HDI) and are regarded as developed countries.

Lets call our excess healthcare cost and potential savings of $1.7 Trillion a year the “spending gap”

This article will show the following:

  • The “spending gap” is mainly due to higher unit prices paid by Americans for drugs and healthcare providers rather than overuse of the healthcare system.
  • Higher drug and provider prices are largely due to the concentration of market power enjoyed by drug companies nationally and hospital healthcare systems in most local markets which allow them to impose anti-competitive pricing tactics against payors (you and the insurance industry) and patients. This results in weak negotiating power by payors since payor market power is very fragmented, leaving the pricing power with hospital healthcare systems and drug companies.
  • Inefficient claims/payment management processes leading to high administrative costs due to a comparatively large number of insurance companies, each with their own claims rules.
  • Pragmatic adoption of the best features of the OECD healthcare systems may save over 68,000 lives a year at a much lower cost.

We’ll make the case we can successfully attack the sources of the problem using common sense pragmatism to remove expensive artificial barriers to competition thereby energizing markets and leveling the playing field between buyers and sellers.

One can find many inefficiencies in our healthcare system and they should be addressed. But inefficiencies exist in all healthcare systems. This article will examine the factors driving the $1.7 Trillion U.S. Spending Gap and healthcare availability disadvantage. As we proceed to look at causes, we will measure the net costs the U.S. incurs or saves. External factors and inefficiencies can work both ways. For instance, U.S. obesity is higher vs. the OECD which costs us more but we smoke less and are younger on average which leads to our lower costs vs. the OECD. We’ll attempt to net it out where possible.

  • We consider to what extent the “spending gap” is influenced by social, demographic, and health behaviors.
  • We will consider if the U.S. consumes more healthcare.
  • We will examine if Healthcare industry R&D is the cause of the Spending Gap.
  • We will examine market forces and artificial market barriers that impact the Spending Gap.

The “Spending Gap” is $1.7 Trillion!

The US spent about $3.4 Trillion dollars on healthcare in 2018 funded by co-pays, deductibles, private insurance, the VA, and Medicare/Medicaid. With about 326 million people in the U.S., that works out to about $10,348 per person. We spend approximately double or $5,179 per person more than the OECD or $1.7 Trillion more than we should when compared to our OECD peers.

The $1.7 Trillion/yr “spending gap” exceeds our Federal Defense and Welfare budgets combined and even more than the government collected in personal income taxes in 2016.

In addition, 99.9% of the OECD population has public or private health insurance. The US covers 91.2% leaving over 28 Million people uninsured.

Since the “spending gap” exceeds personal income taxes and many comparably rich nations provide universal healthcare equal to ours in terms of health outcomes, it makes sense to examine how we can benefit from adopting existing practices that would work best in the U.S.

We have nothing to lose by being open-minded.

Is U.S. healthcare better and do we enjoy better access to services?

The U.S. does not have better health outcomes or an access advantage from its comparatively expensive healthcare system. U.S. life expectancy is 78.8 years vs. 81.2 years for the OECD overall.

The charts below show appointment wait times, the number of physicians, physician visits, and hospital utilization in the U.S. are not equal to the OECD average!

Life Expectancy

Wait times are not a U.S. advantage

Our wait times are not better than our OECD peers.
Wait Time

As we noted, the OECD has over 99% healthcare coverage for its citizens. A paper published in the academic healthcare publication “The Lancet” estimates if the U.S. had universal healthcare, over 68,000 lives a year would be saved. The article notes “These are predominantly the lives of young people, given that most individuals older than 64 years are already covered under Medicare. Adults aged 25–35 years are disproportionately represented, accounting for more than 9 million of the uninsured.”

Many high income Americans understand the problems with U.S. healthcare overall but think they have an advantage due to their better insurance plans. However, in a study published in JAMA in 2020, researchers asked “Are the health outcomes of US citizens living in the 1% and 5% richest U.S. counties better than the health outcomes of average residents in other developed countries?” They concluded “that privileged U.S. citizens have better health outcomes than average U.S. citizens for 6 health outcomes but often fare worse than the mean measure of health outcomes of 12 other developed countries. These findings imply that even if all U.S. citizens experienced the same health outcomes enjoyed by privileged U.S. citizens, U.S. health indicators would still lag behind those in many other countries.”

Sources of excess costs

The “spending gap” either results from higher unit cost or more healthcare consumed (higher utilization), or a combination of the two.

Social factors cost $205 Billion

This section will examine some societal/lifestyle factors which are commonly cited as reasons our healthcare outcomes are worse than other 1st world counties by leading to more healthcare being consumed.

Violence, Accidents, & Suicide are not the problem.

You may hear America is a more violent country and has a higher incidence of auto accidents and suicide which results in lower life expectancy, making our healthcare outcomes look bad by comparison.

Some will cite an an analysis by Ohsfeldt and Schneider in their book, The Business of Health: The Role of Competition, Markets, and Regulation: which stated “ death rates among adolescents and youth can have a dramatic impact on estimated life expectancy. In that light, it is important to note that some specific cultural aspects of American society largely outside the purview of the health care system contribute to rates of death from injury, both unintentional (accidents) and intentional (homicide and suicide). Rates of death from injury are usually high in the United States compared to other developed countries, which affects the apparent underperformance of the U.S. health system”

However, Ohsfeldt later acknowledged a simplistic statistical method was used for his “little book project.” which yielded incorrect results. They should have recalculated life expectancy after removing those who died from these causes from overall the mortality stats

While there are higher death rates for younger people from these sources, they have no meaningful impact overall on US death rates due to their relatively small numbers. Violence, accidents, & suicide are not the reason we have lower life expectancy than the OECD.

Obesity fattens the bill

The U.S. has a higher incidence of obesity than the OECD, (U.S. 38.2% vs OECD 18.5%). The total U.S. healthcare cost of obesity has been estimated at $316 Billion. Higher U.S. obesity rates result in extra U.S. healthcare costs of about $154.69 Billion.

Defensive Medicine

Based on studies conducted by The National Center for Biotechnology Information, the total cost of the legal system to the healthcare system including defensive medicine is about $80 Billion/yr. Yet, it is likely some defensive medicine actually has health benefits. There are legal costs associated with healthcare systems in OECD countries too so our excess costs should be less than $80 Billion/yr as we net out the difference. Since no reliable data was found on the legal costs imposed on OECD healthcare systems, we assumed the entire $80 Billion is a source of extra US costs.

Where is the Higher Utilization?

However, if obesity, defensive medicine, and other social factors such as the opioid epidemic are driving US healthcare costs higher, then Americans should be consuming relatively more healthcare. But the evidence suggests we do not utilize more healthcare per capita than the OECD average which suggests these factors are not significant enough to be the source of our “spending gap” vs our OECD peers.

Let’s look at some other items driving the “Spending Gap”

Potential Cost of Social/Lifestyle Factors

We have not addressed the offsetting impact of social factors that favor the US such as lower tobacco and alcohol use, a lower percentage of people over 65 and a higher percentage of people under 21. Nor have we included any potential health benefits of defensive medicine or the cost the legal system may impose on the OECD, all of which, if included in this analysis would lower the cost impact caused by U.S. social factors vs. the OECD.

Admin costs and complexity ($204 Billion)

U.S. healthcare suffers from the highest admin costs in the world. A New York Times article reports “One obvious source of complexity of the American health system is its multiplicity of payers. A typical hospital has to contend not just with several public health programs, like Medicare and Medicaid, but also with many private insurers, each with its own set of procedures and forms (whether electronic or paper) for billing and collecting payment. By one estimate, 80 percent of the billing-related costs in the United States is because of contending with this added complexity.”

A JAMA study reports “Administrative costs of care (activities relating to planning, regulating, and managing health systems and services) accounted for 8% in the US vs. a range of 1% to 3% in the other countries.” The net administrative burden is costing the U.S. about $204 billion annually, but as the JAMA study notes, absent the Byzantine insurance payer system the U.S. has, the administration cost gap would be inconsequential.

Primary Sources of Excess Spending

We’ve accounted for as much as $439 Billion of the $1.7 Trillion “Spending Gap”. That leaves $1,261 to go.

It’s the prices Stupid!

In a January 2019 article in Health Affairs, the authors updated a study they conducted in 2003 and concluded “ A 2003 article titled “It’s the Prices, Stupid,” stated: “we found that the sizable differences in health spending between the US and other countries were explained mainly by health care prices. We used (OECD) Health Statistics to update these analyses and review critiques of the original article. The conclusion that prices are the primary reason why the US spends more on health care than any other country remains valid, despite health policy reforms and health systems restructuring that have occurred in the US and other industrialized countries since the 2003 article’s publication. On key measures of health care resources per capita (hospital beds, physicians, and nurses), the US still provides significantly fewer resources compared to the OECD median country. Since the US is not consuming greater resources than other countries, the most logical factor is the higher prices paid in the US.”

Drug Pricing

Drugs commonly cost 3X more in the U.S. than in our OECD peers.

According to a Wall Street Journal article, “ Drug prices in the U.S. are shrouded in mystery, obscured by confidential rebates, multiple middlemen and the strict guarding of trade secrets.” The article continues “The state-run health systems in Norway and many other developed countries drive hard bargains with drug companies: setting price caps, demanding proof of new drugs’ value in comparison to existing ones and sometimes refusing to cover medicines they doubt are worth the cost.” and “ The government systems also are the only large drug buyers in most of these countries, giving them substantial negotiating power. The U.S. market, by contrast, is highly fragmented, with bill payers ranging from employers to insurance companies to federal and state governments.”

Inexplicably, with 29% of spending for U.S. retail prescription drugs, Medicare has huge negotiating power it can’t use by law. The Medicare Modernization Act of 2003 states the secretary of Health and Human Services “may not interfere” in negotiations between pharmaceutical companies and prescription drug insurance plan providers.

That Medicare can’t negotiate drug prices is unique among federal health programs. As a contrast, Medicaid has mandatory drug rebates & the VA requires drug providers to charge the lowest price paid by any private-sector buyer. The VA pays 40 percent less than Medicare Part D, according to a study published in Health Economics.

Aside from the large buyers like the VA and Medicaid, no single insurance company has the market power to achieve prices competitive with our OECD peers.

Note the drug price differences in the U.S. vs other countries as a result of these policies.

Drug Innovation

The US spends about $350 Billion a year on prescription drugs. Assuming we only pay twice the world average (for the exact same drug), that would mean we are spending $175 Billion more as a nation than our OECD peers. A common fear of the US paying lower prices is that the drug companies will not have any funds for R&D. However, in 2017, Pharmaceutical company R&D amounted to about $90 Billion or only about 50% of excess U.S. drug costs. Drug spending paid to manufactures could drop by $87 Billion/Yr and not impact R&D at all!

Medical Procedure Pricing

The cost of medical procedures is much higher in the U.S. than our OECD peers as well. Again, here are some examples.

Why are Drug and Procedure prices so high?

Our OECD peers organize their healthcare markets in a variety of ways from the government-run National Health Service in Britain to having different levels of private/public healthcare providers funded by different schemes blending varying levels of private insurance and public financing of the healthcare costs. What the OECD systems have in common is they are very involved in setting national standards and negotiating systemwide healthcare prices which lets them benefit from their concentrated market power.

The U.S. is an outlier in its high reliance on private insurance and fragmentation of negotiating power. This is the main driver of the cost gap!

Barriers to a Free Market

In a free market, prices settle where supply and demand are in balance. If prices are too high, supply will exceed demand and prices will be forced down. If prices are too low, demand will exceed supply and there will be shortages forcing prices up. Normally you’ll not observe much price deviation for most products from competing suppliers. For instance, gasoline will not cost $2/gal at one station but $7/gal at a station across the street.

While most markets have some minor imperfection, most are not significant and are of small consequence. An example is switching costs. If you rent an apartment for $1,000/month it will not be worthwhile to move to an equal apartment to save $10/month. The cost and hassle of moving (switching costs) can result in minor price variations for the same apartment.

But healthcare markets have imperfections that have a big impact on prices.

For example, the information asymmetry between health providers and health consumers is very high. Examples include:

Normally, as the price of a good rises, demand for that good drops. In healthcare, the consumer often is not in a position to bargain on price due to lack of price information, provider choice constraints imposed on them by their insurance carrier and/or lack of choices in a geography, and by the often urgent need for care as demonstrated in this cartoon.

As discussed below, the continued concentration of healthcare providers in many communities limits provider choices for consumers and restricts price negotiating power by insurance payers and consumers alike. The barriers to entry are very high for new hospital systems. In addition, healthcare systems force their physicians to direct referrals to more expensive in-house services, reducing choice for patients and physicians alike.

Let’s examine some evidence of free market dysfunction resulting from information asymmetry, price opacity, and weak buyer negotiating power by observing examples of common healthcare price behavior.

Price Variations locally and by payer type.

For evidence of market dysfunction and the lack of free market prices, note the extreme price variations for these procedures in the same city.

In Philadelphia, a hospital-based MRI can vary by 600%!

In Tampa, a knee replacement can cost from $10,000 to over $30,000.

https://www.nytimes.com/interactive/2015/12/15/upshot/the-best-places-for-better-cheaper-health-care-arent-what-experts-thought.html

In a study of 937 hospitals nationwide for Knee Replacement surgeries, the prices paid for by private insurance varied by 600% compared the much more stable and lower pricing enjoyed by Medicare exercising its considerable pricing power.

https://www.nytimes.com/interactive/2015/12/15/upshot/the-best-places-for-better-cheaper-health-care-arent-what-experts-thought.html

The next graph shows hospital list prices (what you get charged without insurance), compared to private insurance payment rates, and Medicare Reimbursement rates. The graphs above and below show how much less Medicare pays for procedures given its stronger bargaining position.

https://healthcarepricingproject.org/

“The marketplace is just not working,” said Gerard Anderson, a health-care economist at Johns Hopkins University. Insurers that must negotiate reimbursement with health-care providers for plans offered by employers pay roughly 50% more than Medicare on average, he said, and those rising costs are “the main culprit for why the U.S. spends so much on health care.”

Provider Concentration & Price Transparency

About 77% of Americans living in metropolitan areas are in hospital markets considered highly concentrated, ranging from Modesto, Calif., to Trenton, N.J., according to a Wall Street Journal analysis of 2016 data from researchers at the University of California, Berkeley.”

“If you’re the single hospital system in an area, you essentially can set your price, because you’re a monopoly,” said Patrick Conway, the chief executive of Blue Cross and Blue Shield of North Carolina. “We literally have to have them in network.”

According to a Wall Street Journal article, “Dominant hospital systems use an array of secret contract terms to protect their turf and block efforts to curb health-care costs. As part of these deals, hospitals can demand insurers include them in every plan and discourage use of less-expensive rivals. Other terms allow hospitals to mask prices from consumers, limit audits of claims, add extra fees and block efforts to exclude health-care providers based on quality or cost.”

As Cigna’s chief medical officer, Alan Muney stated: “No hospital system should be able to exercise market power to demand contract agreements that prevent more competitively priced networks.”

The article continues, “ Restrictive hospital-insurer contracts have helped prevent even big employers, including Walmart Inc. and Home Depot Inc., from moving forward with plans they were exploring to try to lower costs and improve quality for their workers.”

“Hospital care is the largest single component of health-care spending in the U.S. It accounts for more than $1 trillion a year — roughly three times what is spent annually on prescription drugs, the third-largest category. The second largest is physician and clinical services, many of which are now provided by hospital systems as well.”

Same Hospital, Different Price

According to a working paper for the National Bureau of Economic Research by Questrom’s Keith Ericson, along with Northwestern University’s Amanda Starc and the University of Pennsylvania’s Stuart V. Craig, insurer pricing negotiations for “allowed amounts” at individual hospitals can lead to variations of up to 13 percent across insurers for identical procedures at a single facility. They found statistically significant variations in price for the procedures across insurers. In some cases, these insurer negotiated rates meant that the price of identical procedures at the same hospital might vary by hundreds or even thousands of dollars.

Because individuals frequently pay out-of-pocket costs for a procedure, these variations can have a real impact on what consumers pay.

Possible Good News on Price Transparency

There are efforts underway now in Washington to compel insurers to publicize the negotiated rates they pay for medical services. The requirement could affect insurers providing coverage in the private-employer market, where about 158 million people get their health insurance.

Additionally, doctors and hospitals would give patients their total price of care before they get services or treatment whether or not the health-care provider is in the patient’s insurance network.

Predictably, providers are not happy. One executive stated a broad proposal requiring price disclosure wouldn’t give consumers an accurate picture of out-of-pocket costs under their insurance plans while another said a disclosure requirement could violate contracts between providers and insurers.

Provider Concentration Restricts Physicians choices as well.

According to a Wall Street Journal article, “Hospitals have gained more power over doctors with a wave of acquisitions of practices and hirings in recent years, and hospitals are getting more aggressive in directing how physicians refer for things such as surgeries, specialty care, and magnetic resonance imaging scans, or MRIs.”

“Patients are often in the dark about why their doctors referred them to a particular physician or facility. Increasingly, those calls are being driven by pressures to keep patients within a hospital system, even if an outside referral might benefit the patient, according to documents and interviews with doctors, current and former hospital executives and lawyers.”

“Insurers have been working to steer patients toward doctors’ offices and other non-hospital locations for many types of care because they are generally less expensive. The same service often costs twice as much or more when delivered in a hospital setting, compared with a doctor’s office, according to an analysis of dozens of medical services performed for The Wall Street Journal by the nonprofit Health Care Cost Institute.”

“Patients often pay more out-of-pocket as a result. A study released earlier this year by researchers at Yale University and elsewhere found that patients whose doctors worked for hospital systems were 27% more likely to get their lower-limb MRIs at a hospital, and their scans cost $277 more on average, with about $90 of that extra amount being added to the patient’s out-of-pocket cost.”

Primary care doctor employment by hospital systems has grown 57% by 2016 in just 6 years.

The price increases simply as a result of where the health service was performed. The forced shift of referrals to in-house hospital facilities is driving prices higher.

Let’s make it simple

The primary source of higher US healthcare costs is higher pricing per unit driven by weak payer negotiating power, anti-competitive market behavior, high provider market concentration, and an inelastic demand curve. In addition, the proliferation of payers leads to much higher admin costs systemwide.

Social issues, defensive medicine, and high patient utilization are not primary cost drivers.

Suggestions on how to proceed

Let’s be clear, there is no easy answer.

To start, I suggest we carefully study the pros and cons of the different OECD healthcare systems. We should adopt the best practices of these different systems to cover everyone, make a big dent in our costs, and use the benefits to gain better healthcare and economic outcomes.

My initial thoughts are:

  • What sets the US apart from its peers is the weak negotiating stance of the payors. Let’s create a national program to negotiate prices, allowed drugs, procedures, and justify the value proposition of newer medical technology which would put our healthcare pricing on par with our OECD peers. This is the norm in the developed world.
  • Eliminate limited provider networks. All patients would be able to use any provider. Surprise out of network billing would disappear.
  • NDA’s restricting pricing information provided to consumers would be eliminated, creating more transparency.
  • The gag-order restrictions placed on health care employees referring patients to competing facilities would be outlawed.
  • The claims process and forms should be standardized across insurers in order to reign in administrative costs.
  • Coverage would expand to include all citizens.
  • A small amount of the large savings would be directed to improve social factors which would lead to a healthier population and even lower healthcare costs.
  • Create a mandatory citizen-owned savings plan funded by citizen and employer contributions that would be used by citizens to pay for their normal medical consumption and larger expenses as they arose. This plan would be backstopped by a government-funded program. The idea is to create a national mindset where citizens expect both an efficient and effective healthcare system. This concept has been proven in Singapore where their healthcare costs are about 75% less costly than ours with similar healthcare outcomes.

The above steps would results in more competition among providers, greater price transparency, and insurance companies competing to offer claims services at the lowest cost to consumers and/or employers.

Won’t taxes rise?

Universal coverage could be funded without raising income taxes due to large potential savings.

As the chart below shows, the government already spends about the same share of GDP as comparable wealthy nations. What sets us apart is our high rates of private spending driven by high U.S. prices.

While the spending gap is $1.7 Trillion, let’s assume we only achieve $1.2 Trillion in savings which leaves total spending at $2.2 Trillion/Yr or $500Billion/Yr higher than the OECD average.

In 2017, federal and state governments spent $1.775 Trillion dollars on healthcare between Medicaid, Medicare, the VA, and other programs. If we hit our $2.2 Trillion spending target, we need to find $425 Billion from other sources to close the spending gap.

According to the Centers for Medicare & Medicaid Services (CME), here is how healthcare was funded in 2017:

The U.S. private sector spent $1.549 Trillion on private health insurance plus out of pocket payments in 2017. If we assume government spending stays constant, then private sector spending would have dropped from $1.549 Trillion to $425 Billion in 2017. Private sector spending would be $1.124 Trillion/YR lower while everyone would have health insurance.

Another Thought — Let’s Look Ahead

One could argue the assumption above that providers will quickly and meaningfully lower healthcare costs without a great deal of disruption may be a tad optimistic. Perhaps a more realistic goal would be to arrest large projected costs increases in the future.

Disclaimer: The following is a funding discussion meant to demonstrate we have the flexibility to finance universal healthcare and not raise taxes. It is not meant to be the actual solution we should follow! That will take some study.

You may be aware there is a movement on the left to implement ‘Medicare for All’ (M4A) which in essence provides Universal Insurance for all Americans. M4A was 1st proposed by Senator Sanders during his Presidential bid for the 2016 election. The proposal is not well defined and like the funding proposal above, is aspirational.

M4A stirred a lot of controversies. The Mercatus Center, affiliated with George Mason University, published a widely reported study stating M4A would increase government expenditures by $32.6 Trillion over the 10 year period from 2022 to 2032. The study used healthcare cost projections from the CME as a baseline and assumed certain cost savings in drugs, provider reimbursements, and admin costs but higher utilization to re-forecast healthcare costs under M4A.

There are two important things to note about the Mercatus study.

  1. The study actually showed National Healthcare Expenditures (NHE) dropping by $2 Trillion over the 10 year period. Since Mercatus assumed the government would pay all the bills, the headlines reported government costs would go up which would be true. But private insurance and out of pocket costs would go to zero, offsetting higher government spending by $2 Trillion while today’s uninsured would be insured.
  2. Interestingly, the Mercatus Center is highly intertwined with the Koch Brothers and other libertarian groups. The close relationship with these groups does not mean the study is incorrect but one could comfortably conclude the study was not biased in favor of M4A.

Taking the Mercatus Study at face value, you get everyone insured for $2 Trillion less.

Should we accept the study as it stands?

The truth is, nobody really can know. But we are still left with the fact right now, many advanced countries are delivering healthcare now for 1/2 of what we do. So we know it can be done.

Let’s look at the projected increases in NHE from the CME the study uses as a baseline which is the top line on the table below.

The study projects NHE costs will rise at a 5.95% annual rate. But the Federal Reserve Board projects 10-year inflation to be 1.73%. If we re-project the Mercatus NHE forecast to equal expected inflation, we would achieve additional savings of $8.81 Trillion over the 10 year forecast period plus the $2 Trillion in savings already projected by the study.

By containing price growth to inflation coupled with the Mercatus Study savings, the U.S. would enjoy about $1.1 Trillion in annual savings each year, not far off from our targets.

The big difference is the Healthcare industry would have to adapt to an environment where their revenues would grow with inflation. They would have to get creative with efficiencies and cost-cutting. This would put them on par with the rest of American industry.

How funds would be collected would need to be worked out, but private insurance premiums and out of pocket payments would drop much more than any payments required to fund the system.

The outcome of intelligent healthcare reform could have far-reaching consequences. For instance, much of our healthcare insurance is employment-based. Imagine how worker productivity, competitiveness, and worker mobility would be improved if our companies could shed most of their health benefit costs. Exports, wages, and profits would surely rise too.

Additionally, if the price barriers were reduced, consumers would be more likely to seek preventative care. This could have a negative cost impact as we might experience higher utilization of these services but it may also have a positive cost and health impact as we head off bad health outcomes based on lack of preventative medical care.

The biggest unknown would be the transition. Any meaningful change to the U.S. healthcare system would be highly disruptive to the status quo. A great deal of care would have to be placed on making the transition as smooth and smart as possible. But if we consider the US to be special, we should be up to the task of getting to the OECD average cost per capita.

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