The Most Powerful Force for Reducing Health Care Costs: The Marketplace

13 Aug 2016 | HEALTH, John Goodman

By John C. Goodman 

Originally posted at Forbes, August 2016 

A massive experiment in California is proving embarrassing to the health policy community. It’s showing that one of the most common and doggedly held beliefs of the experts is completely wrong.

Readers who don’t mix and mingle with the health policy types may wonder why anyone should care what policy wonks think. The short answer is that how the “experts” think affects you and me. When they get things wrong (which is about 90 percent of the time), the rest of us must cope with a health care system in which costs are higher, quality lower and access more difficult than if the wonks had chosen a different profession altogether.

So, what’s happening in California that’s so unusual? The giant insurer WellPoint (Anthem) handles health care for California state employees, retirees and their families (Calpers) and historically it did what other insurers do – use its bargaining muscle to get big discounts from hospitals throughout the state. This reflected the conventional view that it takes a large entity to obtain prices that individual patients could never achieve on their own.

Yet with all its financial power representing a huge number of patients, WellPoint was still paying bills for hip and knee replacements that ranged all over the map – from a low of $15,000 to a high $110,000.

So WellPoint entered an agreement with CalPERS to pay for these procedures in a different way for about 450,000 enrollees. WellPoint encouraged them to go to only 41 hospitals for their joint replacements. These were hospitals that provided good quality care and routinely charged $30,000 or less. Patients were free to go to elsewhere and initially about 30 percent did so. But they were told in advance that WellPoint would pay no more than $30,000 for a joint replacement outside the “network” (At all the hospitals, patients pay a 20% copayment up to $3,000.) So if a hospital charged, say, $40,000, the patient would have to pay the extra $10,000 out of pocket.

Note: under the new arrangement, WellPoint didn’t negotiate with any hospital. It didn’t send a letter. It didn’t make a phone call. It didn’t plead. It didn’t beg. It didn’t threaten or cajole. If any of that went on, it would be the patients doing it, not the insurer or their employer.

What happened next was remarkable. As confirmed by Berkeley health economist James Robinson and his colleague Timothy Brown, within one year, the out-of-network cost fell by one-third and by the end of the second year the average out-of-network cost was below $30,000.

Because that experiment went so well, WellPoint and Calpers decide to quite bargaining with providers over a great many other services and see what the enrollees could accomplish on their own. Writing in The New York Times yesterday, Austin Frakt summarized the results of these experiments:

Prices for [hip and knee replacements] fell by an average of more than 20 percent, saving Calpers and its patients $6 million over two years….[F]or cataract removal surgery, the average price paid also dropped by nearly 20 percent, saving $1.3 million over two years. For colonoscopies, $7 million was saved — a 28 percent drop. And for knee or shoulder arthroscopy, prices fell by about 17 percent.

Over the same two-year period, employer costs for health care rose by 5.5 percent.

What Frakt doesn’t mention (and what very few health economists other than yours truly are ever going to mention) is that the California experiments completely upset the paradigm that dominates conventional health policy thinking. Truth be known, most health policy wonks think the way Bernie Sanders thinks. They have believed for their entire professional careers that bureaucracies are far superior to individual patients in bargaining with providers. Clearly they are wrong.

None of this is surprising to my colleagues and me, however. We have been observing for years that wherever patients control the marginal dollars, health care markets work and they work very well.

If third parties were paying all the bills, would not exist. Nor would MinuteClinic or Teladoc. Nor would Uber-type doctor house calls or uber-type home care visits. There would be no transparency and no price or quality competition in the market for cosmetic or laser surgery.

The list goes on.

This article was originally posted at Forbes on August 10, 2016. 

John C. Goodman is President of the Goodman Institute and Senior Fellow at The Independent Institute. His books include the soon-to-be-published updated edition of Priceless: Curing the Healthcare Crisis, the widely acclaimed A Better Choice: Healthcare Solutions for America, and New Way to Care: Social Protections that Put Families First. The Wall Street Journal and National Journal, among other media, have called him the “Father of Health Savings Accounts.”