Today, the vast majority of Americans with health insurance receive it through their employer. The employer typically pays a large portion and the employee pays the rest in premium. The reason why the employer offers health insurance is that premium payments are not taxed, meaning the company can offer a slightly more generous compensation package than with just salary alone. Most companies offer either HMO or PPO coverage.
An HMO requires you to be part of a network of medical providers, and typically requires a referral before seeing a specialist. Doctor visits cost the employee a co-pay (normally $5 to $20). Hospital visits also charge a co-pay ($100 is common). Beyond the co-pay, there is a very high dollar maximum for charges in a year. However, the company controls costs by limiting services available and often limits doctors on the care they can give you.
A PPO encourages you to be part of a network by offering discounts. A PPO does not typically require a referral before seeing a specialist. An employee must incur enough medical cost to meet the deductible (usually a few hundred dollars) before the insurance company begins to cover costs. After meeting the deductible, the insurance company will typically pay between 70 and 90% of the medical expenses, up to an annual maximum, after which they pay 100%.
Imagine if you will, that your local grocery store offered families a flat $100/week fee for groceries and then $5 per visit, and the family could pick whatever they wanted. What do you think would happen? People would take home more groceries than normal and they would choose the highest quality food in the store. I personally would die of a coronary after 50 straight days of eating my body weight in meat and Blue Bell ice cream. Few would exercise self-control about the kind of foods and the amount. Why get one Hershey’s bar when you could get three Godiva ones? Why not buy the free-range-slept-on-a-satin-pillow-with-daily-massage-and-yoga-classes eggs that cost $25 a dozen? The extra cost to the family to pick up a few more items would be zero, but it would still cost the grocer. The store would quickly go out of business.
This scenario is called “Income Smoothing” and it creates terrible incentives. Income smoothing is exchanging a random stream of expenses for a smooth and level one, which is exactly what an HMO does. An HMO does not actually meet the technical definition of insurance. Insurance is a financial arrangement to mitigate the risk of an unforeseen event, whereas an HMO covers all medical events expected and unexpected. There are a few special arrangements such as futures and swaptions in the financial world where income smoothing works, but it would not work well for our grocery store and it does not work well for health care.
Under an HMO, you pay a flat monthly fee and then just a few dollars for every doctor visit. There is an incentive to go to the doctor too much because your costs do not equal the actual costs. There are times when I could see myself spending $5 on a doctor visit and $5 on a prescription, because I can barely buy a bottle of Tylenol for that amount. There aren’t as many times when I would spend the real costs of $100 on a doctor visit and $150 on a prescription. A PPO is not as bad, but once the deductible is met and the policyholder only pays 10 or 20% of the actual costs, the incentives can be as bad as under an HMO. The added demand these health plans create increases the price of health care services nationwide.
Some may wonder just how big a problem these bad incentives really are. If the design of HMOs and PPOs caused every American to go to the doctor and get a prescription just one more time than needed each year (assuming an average doctor’s visit is $50 and a prescription is $50) this adds up to $30 Billion in wasted resources.
The general problem with the system of HMOs and PPOs is that they separate the costs from the consumer. The solution, as I have mentioned before, is Health Savings Accounts (HSAs). If you do not spend all the money in your account, you get to keep it. Every dollar of health care you use you have to pay for. Charges are not pooled with everyone else in the plan like an HMO or PPO. This incentive helps people control their use of medical services.
When the government started giving tax deductions for employer sponsored health plans, we lost control of our own medical care. We fear quitting a job we dislike because we are afraid of losing health care coverage. Some spend health care dollars irresponsibly because someone else is picking up the tab. To keep costs down, employers and insurance companies make many decisions for us and try all kinds of techniques to manipulate not just our decisions but also those of your doctor as well.
An HSA allows you to take your health care savings with you no matter what your employment situation. It corrects the bad incentives that have led to skyrocketing health care costs. It gives control of health care choices to doctors and patients, not employers and insurance companies.
Because of this, I support ending the tax deduction for companies offering health care plans like HMO and PPO plans and instead create a tax deduction for money placed in an HSA with a high deductible insurance plan. This would help fix the problems with the bad incentives caused by income smoothing. It frees us, and our doctors, from manipulation and interference by a cost-cutting bean counter sitting in a cubicle. It would also allow portability of insurance, and it gives you ownership of your health care funds.