Sticker shock won't go away.

Photographer: Spencer Platt

There's No Miracle Cure for Health-Care Costs

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
Read More.
a | A

You’ve probably read about huge disparities in regional Medicare spending, without equivalently huge disparities in health outcomes. You’ve probably read that quite a few times. It is one of the most favorite data points for people writing about health-care costs, because it suggests there’s a magic pot of money that can be neatly drained out of the system without making anyone worse off.

Unfortunately, like the other magic pots of money that people thought they’d found in the health-care system, this one turns out to be underwhelming.  A new study looks at hospital spending not just by Medicare, but by private insurers. And it turns out that areas where Medicare spending is low often have high private spending, and vice versa.

This is not really that surprising. Health care is an industry with substantial cross-subsidies between different classes of customers. Hospitals can make most of their money on private patients, then get a little extra revenue by filling beds with Medicare or Medicaid patients paying lower rates. Countries that pay higher prices for prescription drugs subsidize the research that benefits countries paying less. Doctors manage their caseloads to make sure that they can take some patients whose insurers (government or private) reimburse less generously, while still paying the rent and the staff.

Just looking at prices is often very confusing. One of the easiest ways to write a compulsively clickable article on health care is to find the list price of some procedure, and compare it across providers, states, or countries. Yet this metric is not very useful, because prices are set with reference to lots of other things -- expected discount rates for various insurers, fixed costs, the price of other procedures. What we want to look at is cash flows, not an isolated price.

You may still be confused. Well, let me see if I can’t make it clearer with an old accounting joke. Yes, there are such things as accounting jokes, but don’t worry: You don’t need to know any actual accounting to understand this one.

A long time ago, back when people still filled out expense reports by hand instead of spending three hours trying to get the online expense system to work, a man took a client out for a week on the town. He had a very good week, and at the end of it, he escorted the man out of the restaurant where they’d had lunch to put him in a cab to the airport. Noticing that it was raining, he whipped out an umbrella to protect his customer from the rain. Unfortunately, just as the happy man climbed into the cab, a gust of wind shredded the salesman's umbrella.

Fret not, the delighted customer gave his firm a huge order. And the salesman duly submitted his expense report for $122.46. At the bottom, he listed “1 Umbrella: $3.99”. (Yes, as I said, it was a very long time ago.)

The next day, his expense report came back via interoffice mail with the umbrella x’d out in red and a note from accounting. “You cannot expense an umbrella” it read. “Please fill out a new report and resubmit.”

Our perplexed salesman sat down and wrote out a helpful note explaining that the umbrella had been lost while sheltering a client during a sales call. Then he laboriously filled out a new expense report for $122.46, with “1 Umbrella: $3.99” again listed at the bottom.

You can probably guess what came back in the interoffice mail the next day. The notes flew back and forth, with increasing degrees of venom. Eventually he got a note written entirely in red pencil that said “I will not approve any expense report with an umbrella on it. Fill out a new expense report without it, or good luck finding a new job.”

The next day accounting got a new expense report for $122.46 and a note appended, also in red pencil, that said "As requested. Good luck finding the umbrella.”

Looking at health care prices in isolation is a great deal like playing find the umbrella. For example, if Medicare or an insurer refuses to reimburse a hospital for sending a well-paid nurse to someone’s bedside to administer a pill, they may price the pill at $10. That doesn’t mean they’re necessarily gouging on the pill; it just means that the price includes more than the pro-rated cost of a bottle of Tylenol.

Doctors, hospitals, other providers don’t care about the prices for individual services. They care about whether they can cover their costs. If you drive down the price of one thing very low, other prices may rise to compensate. If you look at just some of the prices, you may seem to have won a great victory on health-care costs. But if you look at aggregated spending, you may still find that you are losing the war. Or at least, the umbrella.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor responsible for this story:
James Gibney at jgibney5@bloomberg.net