Holman Jenkins of the Wall Street Journal ($) has some interesting observations about America’s health care finance mentality today in his weekly Business World column. The subject of the column is the rather inane political issue involved in the importation of government subsidized prescription drugs from Canada, but Mr. Jenkins uses the subject to clear up some common misconceptions regarding how American drug companies finance development of drugs and how America’s health care finance mentality affects such development.
Inasmuch as American drug company profit margins are relatively high, some politicians who are in favor of imports from Canada suggest that American drug prices are too high and that the companies are greedy, which Mr. Jenkins quickly debunks:

What can it possibly mean to call an industry “greedy”? Drug companies are said to be an unconscionable exception because their profits are comparatively high, 15.4%, when measured as a percentage of sales. But here’s a question: Grocery stores have a measly return on sales of 1.4%, and liquor stores an even measlier 1%. So why does anybody invest in these businesses rather than the drug business? Last time we looked, the grocery industry and liquor stores still existed.
Such indictments of the drug industry overlook the fact that profits are a cost — the cost of a company’s capital. Nobody pays back their investors more than they are obligated to. By the same token, if your capital costs are 15.4% of your total costs, profits had better be 15.4% of your revenues or you won’t be in business long. Measures of profitability, in short, tell you a lot more about an industry’s need for capital than about its “greed.”

And how about the demagogues’ allegation that the excessive amount of money that drug companies spend on advertising is proof that they make too much money? Mr. Jenkins explains:

Wrong. Companies spend money on advertising because it generates profits, not because it consumes them. You’ve spent 10 years and $500 million to develop a new product and haven’t rung up your first sale yet. What could be a smarter investment than spending a few dollars more to let the world know the product exists? Advertising actually makes companies more willing to invest in R&D. Capital can be earned back faster; fixed costs can be spread over a larger number of customers, allowing each to be charged a lower price.

But then Mr. Jenkins bears down on the real problem relating to financing of prescription drug development — America’s health care finance mentality:

America’s real problem is that drugs have been roped into the same perverse incentives that govern most health care spending. Consumers don’t weigh cost vs. benefit; drug companies focus their development efforts on drugs aimed at large populations of price-insensitive, insured patients. At the same time, consumers who don’t have drug insurance and pay out of their own pockets scream bloody murder because drugs seem like a violation of a natural order in which medical care is increasingly perceived as a costless entitlement.
Think we exaggerate? Everybody noticed when HCA, the big hospital chain, earlier this month put aside $700 million to cover the bad debts of uninsured patients, who are typically good for only seven cents on the dollar. Little noticed was the fact the company also has to cover the bad debts of insured patients, who routinely skip out on their co-payments and deductibles. Nowadays these people are good for only 45 cents on the dollar on average.
Medical bills seem to have become optional to Americans when deciding which envelopes to toss in the trash unopened at the end of the month. “Hospitals are ninth” on the payment list, HCA’s Chief Jack Bovender told Reuters in February, well behind mortgages, car payments and cable-TV bills. “The only thing people pay worse is the student loan program.”

Read the entire column. Good stuff again from Mr. Jenkins.

Pierre Lemieux, who is an economist with the University of Quebec in Outaouais and with the Independent Institute in California, has written a revealing op-ed in today?s Wall Street Journal ($) regarding the hidden costs of Canada?s nationalized health care finance system and the devastating effect those costs are having on the quality and timeliness of Canadian health care:

The Canadian system is built around a compulsory public-insurance regime that provides most medical and hospital services free. Of course, it is not free for the taxpayer, who finances the system at a rate of 22% of all taxes raised in Canada. The Canadian government pays about 71% of total Canadian health care expenditures, compared to 44% paid by the government in the U.S. This translates into public health expenditures of 6% of GDP in Canada and 7% in the U.S. ? a rather small difference. More than three-quarters of the difference in total expenditures is due to higher private expenditures in the U.S. Why are private health expenditures so low in Canada? The main reason is that they are illegal, which gets us to the heart of the system’s hidden costs.
Canadian public health insurance is not only compulsory, it is also monopolistic. The system is administered by provincial governments under strict guidelines imposed by federal law and federal subsidies. Private insurance covering publicly insured services is illegal. Physicians are forbidden to accept private payments above the fees billed to the government. Hospitals are public or non-profit, and tightly regulated. Physicians’ fees are determined — or “negotiated” — by provincial agencies. Prices of drugs are controlled. In short, the public supply of medical services is rationed, and there is little private alternative. Hence the apparent low cost of the system.
The hidden costs include the poor quality of services, and the costs imposed on customers (aptly called “patients” in this case) who have to wait in queues.
Quality is subjective and can only be evaluated through consumer choices, but the government won’t let consumers make choices and vote with their feet if they are not satisfied. Anecdotal evidence of questionable quality is everywhere. In a recent piece in Montreal’s Gazette, a Canadian related her own experience, and contrasted the “kindness, discretion and professionalism” of staff in U.S. hospitals, with the frequent rudeness of unionized personnel in the Canadian system.
Long waiting lines are a fixture of the system. The Fraser Institute, a Vancouver think tank, has calculated that in 2003, the average waiting time from referral by a general practitioner to actual treatment was more than four months. Waiting times vary among specialties (and, less wildly, among provinces), but remain high even for critical diseases: The shortest median wait is 6.1 weeks for oncology treatment; excluding radiation, which is longer. Extreme cases include more than a year’s median wait for neurosurgery in New Brunswick. The median wait for an MRI is three months. Since 1993, waiting times have increased by 90%.
Waiting lines impose a real cost, which is approximated by what individuals would be willing to pay to avoid them. Waiting costs include health risk, lost time (especially for individuals whose time is most valuable), pain and anguish. Socialist systems are notoriously oblivious to anguish, discomfort, humiliation and other subjective factors which bureaucrats cannot measure or don’t value the same way as the patient does.
* * *
Liberalization proposals are met by the “two-tier system” bogey man — that if choice is allowed an unequal system will develop. But if directly paying a doctor is illegal, there are legal ways to jump the queues. As pointed out by Professor Livio Di Matteo of Lakehead University in Ontario, what now exists is a three-tier system. The very rich (like Robert Bourassa, the late Premier of QuÈbec) go to the U.S. for rapid, personalized, high-tech treatments. The second tier is made of “the well informed and aggressive, who can push their way to the front of the treatment line.” The poor and those with no connections get stuck in the queue.
At least two Indian groups are now considering building private clinics or hospitals on their land ? just as other sorts of illegal-elsewhere trade thrive on Indian reserves. Yet, Canadians who patronized such clinics would still be prohibited from purchasing private insurance to cover the service, leaving the opportunity only to the wealthiest.
As noted by Harvard professor Patricia Dantzon, another hidden cost of the Canadian system comes “from forcing everyone to have the same level and type of insurance,” whatever their individual preferences are.
One last cost should not be ignored: the loss of personal responsibility and the habit of dependence on the state. Opinion polls show that Canadians are generally proud of their public health insurance. Indeed, for most people, any basis for comparison has been made illegal. Auberon Herbert, a libertarian Member of Parliament in late 19th century England wrote, “If government half a century ago had provided us all with dinners and breakfasts, it would be the practice of our orators today to assume the impossibility of our providing for ourselves.”

This insightful piece dovetails with a discussion that I have been having with fellow Houston blogger Milton over at Trivial Pursuits regarding the flaws in America?s health care finance system and how self-insurance could be deployed to improve competition between health insurance products currently in the marketplace. One example of self-insurance that is an attractive alternative to many current health insurance products is the woefully underpublicized Health Savings Account (?HSA?) concept that was enacted into law last year. To introduce the concept, it is helpful to review how American health care costs are currently financed.
Every dollar that an employer pays in employee health insurance premiums avoids income and payroll taxes. For the employee with average income, this generous tax subsidy means that government is effectively paying for almost half the cost of the employee?s health insurance.
On the other hand, if the same employer tries to deposit that same dollar into a savings account for the benefit of the employee from which the employee could control the payment of medical expenses, then the government taxes the dollar and grabs almost half of it before it reaches the savings account.
Accordingly, America?s tax laws provide a generous subsidy for third-party insurance and none for individual self-insurance. In so doing, our tax laws promote use of third-party bureaucracies to pay for even minor discretionary health care expenses despite the fact that such expenses would be managed much more efficiently if patients paid them on their own.
The new health savings accounts address this defect in the health care finance system, at least to an extent. The legislation gives deposits into HSAs the same tax advantages as those granted to an employer?s health-insurance premiums. In so doing, individual self-insurance can now compete with third-party insurance on the same financial basis and individuals can now control some of their financial investment in health-care without a tax penalty.
However, even more importantly, the HSA legislation addresses in a rational manner the knotty social issue — that is, how do we allocate dollars between health care and other goods and services? Or stated another way, how do we decide which medical procedures are worthwhile and which ones are not? There are basically three ways:

● In countries such as Canada with nationalized health insurance, government makes the decisions (either directly or indirectly) in an arbitrary, inefficient, and often unfair manner;
● The second method is to restrain spending using the techniques of managed care. Over the past 15 years of increasing managed care in the American health care finance system, most of us have experienced, at best, the irritation, and, at worst, the capriciousness of having employers and large insurers ration health care for us; and
● Finally, the third option is to allow individuals to make their own choices between health care and other uses of their money through vehicles such as HSAs.

In that connection, the HSA is the most flexible health care finance product currently on the market. HSAs allow individuals and their employers to make deposits each year equal to their health insurance deductible (there is currently a limit on the size of the deductible and a supplemental insurance policy is required to cover catastrophic illness or injury expense in excess of the amounts deposited in the HSA). The funds in the HSA grow tax free and the funds may be used to pay such things as health care expenses that would not otherwise be covered by third party insurance, insurance premiums while the owner of the account is changing jobs, and health expenses during retirement.
However, the new law is not perfect. For example, as noted above, the maximum amount that can be deposited into an HSA in any year is currently somewhat limited. Consequently, the combined cost of depositing funds in the HSA and paying for the supplemental insurance that is required can turn out to be more expensive than simply buying a third party policy with a relatively high deductible.
Moreover, products such as HSAs are only part of the solution to the problems in America?s health care finance system. From my vantage point, some sort of nationalized insurance or federally-backed private insurance is still going to be necessary for people who simply cannot afford to fund HSAs or buy private insurance, and for people with severe medical problems who cannot afford the costs attendant to those problems. In regard to these groups, the tough issue is how do you ration the health care? Or, stated another way, there must eventually be a political consensus on the limitations of such federally-insured health care. Otherwise, we simply have created another federal program that balloons into yet another governmental financial debacle.
However, for those of us fortunate to be reasonably healthy and productive, the concept of HSAs is a viable alternative to higher cost private health insurance. I encourage you to examine the product as an alternative to your current health insurance policy.

This short BusinessWeek Online story does a good job of summarizing the reasons why America’s health care finance system hinders the decline in prices in health care that Americans have enjoyed in many other sectors of the economy, most notably retail sales (ala the Wal-Mart reference). One big reason noted:

Sometimes, however, Americans use more care because they think it’s free, or almost free. And that’s one big reason why health care hasn’t become Wal-Mart-ized. When you buy that DVD player, you whip out your credit card and pay with your own money. That makes you want to comparison shop for the best deal. But when it comes to buying drugs, consumers have little incentive to shop around. If you have good insurance, you’re going to pay the same $10 or $15 whether you need the most expensive drugs or not.
A recent study that looked at drugs used to treat arthritis pain provides some insight. Arthritis sufferers can buy relatively inexpensive over-the-counter treatments, such as Motrin or similar generics, or much more costly prescription medications called cox-2 inhibitors, such as Celebrex or Vioxx. Both kinds provide equal pain relief, but the cox-2 drugs may reduce the chances of stomach bleeding or ulcers.
The study concluded that people with good drug insurance were twice as likely to get the more expensive drugs than those without insurance, whether they were at risk for bleeding or not. If someone else — the insurance company — is paying, price doesn’t matter.

Hat tip to the Mises Economics Blog for the line to this article.

Tyler Cowan over at Marginal Revolution and Jane Galt at Asymmetrical Information have interesting posts on the productivity of American health care, health care cost, and related statistics. Mr. Cowan concludes that Americans pay more for health care than other countries, but get better health care in return. We die sooner than people in other countries because we eat too much and exercise too little, among other facts. Similarly, Ms. Galt points out that many of the outcomes measured in the health care debate are both difficult to measure between countries, primarily because many have non-health-care contributing factors. Both posts are insightful and well worth reading.
As each of these posts reflect, generalized nationalized health care is no panacea for the problems that we face in America’s health care finance system.

This NY Times article reports on the Medicare trustees’ report today that Medicare will need to dip into its trust fund this year to pay increasing expenditures and that the program will become insolvent by 2019 unless changes are made in the program. The 2019 go-broke date for the Medicare trust fund is seven years sooner than what the trustees projected last year.
Here is a copy of the entire report.
The trustees report that Medicare’s deteriorating financial condition is largely the result of the new Medicare prescription drug law that will increase costs by more than $500 billion over the next 10 years. The trustees also noted that projected lower tax receipts devoted to the program and higher expenditures for inpatient hospital care also are contributing to the growing financial problem.
Thomas Saving, a distinguished economics professor at Texas A&M University is one of the Medicare trustees who figures prominently in the report.