Code Red: Two Economists Examine the U.S. Healthcare System

June 16, 2013

Are Employers to Blame for our High Medical Prices?

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:02 am

In a recent New York Times blog, Uwe Reinhardt places much of the blame for high and rising medical prices on passive employers. He argues that employers should work just as hard to reduce healthcare benefit costs as they work to reduce other input costs. But he then observes:

“One reason for the employers’ passivity in paying health care bills may be that they know, or should know, that the fringe benefits they purchase for their employees ultimately come out of the employees’ total pay package. In a sense, employers behave like pickpockets who take from their employees’ wallets and with the money lifted purchase goodies for their employees.”

I think that Reinhardt gets the economics wrong here and, in the process, he puts too much of the blame on employers. Reinhardt is right in one respect – employees care about their entire wage/benefit packages. If benefits deteriorate, employers will have to increase wages to retain workers. Thus, it seems that if an employer reduces benefit costs, it must increase wages by an equal amount. If that is true, we can understand why employers are passive.

The correct economic argument is a bit more nuanced. Employees do not care about the cost of their benefits; they care about the benefits. If an employer can procure the same benefits at a lower cost, the employer need not increase wages one iota. In this regard, there is nothing special about health benefits. Suppose an employer offers employees the use of company cars. Workers don’t care what the employer paid for the cars, and if the employer can purchase cars at a deep discount, it will pocket the savings.

Reinhardt may be wrong about the underlying economics, but he is correct in the big picture. Employers may have an incentive to reduce benefits costs yet they are passive purchasers. With a few exceptions, nearly every American corporation outsources its healthcare benefits to insurers and ASO providers and then looks the other was as the medical bills pile up. Sure, they complain about the high cost of medical care, but they don’t take direct action by aggressively shopping for lower provider prices. Doesn’t this passivity demonstrate a lack of interest? No more so than the fact that auto makers do not aggressively shop the lowest rubber or silica prices implies that they are disinterested in the costs of tires and windows. Auto makers outsource the production of tires and windows (and most other inputs) and let the Michelins and PPGs of the world worry about rubber and silica prices. By the same token, American companies outsource the production of insurance and let the Blues and Uniteds of the world worry about provider prices. This is entirely appropriate.

Could employers do more to reduce healthcare spending? Employers have dramatically increased deductibles in recent years, and this has had some effect (though no one is certain just how much.) Employers tried forcing employees into narrow network plans in the 1990s, mostly in the form of HMOs, but employees rebelled against the lack of choice. (Some of you may remember the “Patients’ Bill of Rights” that Congress nearly enacted.) I don’t expect too many employers to repeat that mistake. Employers might offer cheaper plans alongside expensive ones, but they probably won’t pass most of the savings on to employees. For one thing, employers want to keep most of the savings for themselves. Perhaps more problematically, there is a growing body of evidence that this could lead to an adverse selection death spiral that would disrupt employee choices.

It is hard to imagine that American businesses have been willfully negligent about healthcare spending. If only by accident, some employers would be worried about health spending. And if worrying about costs was enough to actually lower costs, then those that worried would outperform their competitors and gain market share. By now, every American would be working for a company that worried about health spending. The logic is pretty compelling: America’s firms are worried about health spending and are appropriately outsourcing these worries to insurers.

So why are medical costs and medical prices so high? I could give a list but this has been discussed ad nauseum so I will not repeat it here. Employer-sponsored insurance is on the list, but largely due to tax deductibility. If employers are otherwise on the list, they are towards the bottom.

6 Comments

  1. Your broad argument makes good sense but you to some extent want to have it both ways. Presumably, it is competition that ensures employers have incentives to focus on the cost of the plans; yet you suggest they pocket any savings. That implies competition in product and labor markets is relatively weak (so it is only competition in the market for corporate control that keeps managers focused on costs) — which seems unlikely to be true for the vast majority of employers.

    Comment by Henry Ergas — June 16, 2013 @ 3:27 pm

    • I think I am arguing just the opposite of your point. Any business that can get a cost advantage over rivals will profit, regardless of the degree of competition. That includes procuring labor benefits at a lower cost. Thus, employers do have an incentive to reduce health benefit costs without reducing benefit quality. But they appropriately outsource the effort to reduce costs to insurers. At the same time, employers recognize that some cost reducing efforts, like shifting workers to HMOs, may be perceived by workers as a reduction in benefit quality, which would require them to raise wages to offset. This hamstrings some cost reducing efforts.

      Comment by dranove — June 16, 2013 @ 4:09 pm

      • Yes, agreed — all businesses can profit by eliminating unnecessary costs. But most businesses face intense competition in product and labor markets and so will pass those savings on. Agree too that it makes perfect sense for them to outsource those savings (presumably, they would check from time to time they are getting the best deal); and also agree that if workers perceive cost reduction as quality reduction, that will lead to less than perfectly efficient investment in cost reduction.

        Comment by Henry Ergas — June 16, 2013 @ 4:14 pm

  2. I try to stay away from any generalizations about ” employers.”

    The retail and fast food industries live in a very different universe than investment banks or high tech firms or universities. Alain Enthoven pointed this out over 20 years ago.

    Low wage employers have plenty of workers to choose from, and the jobs are simple enough (some would say “dumbed-down” ) so that turnover is no big deal.

    In fact the most ruthless low wage employers like turnover — it keeps wages low and weeds out troublemakers and destroys seniority.

    An employer does not need to offer health insurance to get workers in the door in the morning. Firms with no health insurance do not have appreciably more sick days than firms which do offer insurance. When someone gets real sick in a low wage firm, they are fired, or they lose so many hours that in effect they fire themselves.

    Employer health insurance is a luxury, which does not make it a bad thing.

    But as was pointed out in a Dranove article about 1 year ago, employer health insurance could go the way of pensions in not too many years.

    Comment by Bob Hertz — June 17, 2013 @ 4:49 pm

  3. By what level of scholarship does Uwe leap to his conclusion. I just read the post and clicked through the links. He doesn’t site any research interviews or large scale behavioral observations that show executives being passive patsies when it comes to the costs of health care coverage.

    I distinctly recall observing just the opposite. I watched CEOs direct executives working hard to find ways to economize and watched many consultants and agents research and present solutions for better health care coverage for less.

    Where’s the foundation for his leap? I need something more from the experts to decide not to believe my lying eyes.

    Comment by lhaughton — June 28, 2013 @ 9:44 am

  4. Actually, large employers have been a significant driver of healthcare cost containment initiatives for a good decade. This does not mean they have done a good job, just that this has been the objective. When shopping for ASO services, the importance of lower-cost networks and health management offerings has gained over considerations of lower unit administrative costs. Hence, large insurance company acquisition strategies have shifted away from merely adding membership to “high performance” networks and wellness programs. Separately, regarding employer’s objectives about pocketing savings vs. passing them on to employees, employers hardly have the objective of reducing costs. This is not doable. The objective is to bend the cost curve down and minimize future benefit reductions. So far we have seen benefit reductions and have little idea if they have been mitigated by the flurry of cost containment strategies. Recent developments in wellness programs, ACOs and such do hold out some promise.

    Comment by Dhun Mehta — July 11, 2013 @ 9:02 am


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