“Medicare-for-all” has become a common campaign promise on the political left but it suffers in the details, first from any widely-accepted definition, which can range from a (not-so-simple) “public option” to a complete nationalization of the healthcare insurance payments system. Second, all of its configurations that I have investigated suffer from an apparent naivete or lack of understanding of some basic healthcare math, and this post will take a stab at a couple of the most egregious misunderstandings. I strongly support major healthcare reform, but the math and the accounting throw up some major obstacles that need to be dealt openly and honestly.

In an earlier post I tossed out for comparison three working healthcare system models from other countries that show different ways of dealing with some of the complications inherent in the process, even with the best-run. Any proponent of continued change to the U.S. system would do well in examining these three, as well as the remaining ten or so most successful national models. We have pursued a “go-it-alone” mode since our earliest attempts at addressing this problem, and most of these changes, including many incorporated in the Affordable Care Act (which I supported) have failed because we have refused to talk about how some other countries have more successfully dealt with those complications. In order to move forward we need something closer to informed consensus on the details rather than slogans.

There are lots of “math problems” in healthcare and insurance, so my discussion here is limited to two of these that seem to me to be most abused in public discussion. The first is in understanding the economic and accounting difference between the marginal costs of healthcare services versus fully-absorbed costs. The second math problem I call the “tyranny of the mean.” Many common prescriptions for addressing healthcare costs assume that the easiest way to hold down costs is to simply reimburse below the average billing cost for services. That turns out to be like trying to hold back the ocean’s tide.

The fixed cost dilemma and the “common good”

Back in February, I wrote a post about why people were being billed for emergency ambulance rides costing $2000 or more, even for short distances. On the more trivial side, people commonly complain about high hospital charges for small items, like the recent example I saw of charging $4.50 for a single menthol lozenge.

The short answer here is that medical expenses can be broadly categorized into two categories – fixed costs and variable costs. The variable cost of that single lozenge might only be a penny. But in some manner that medical facility needs to get reimbursement for all of its fixed costs of operation that do not vary much with patient and service volume, amounting to perhaps millions of dollars per year that it spends building and maintaining its facility, plus paying administrators, IT/clerical staff and others not directly involved in patient care. The common accountant’s solution to that “fixed cost dilemma” is called fully-absorbed costing, in which all billable activities are allocated some percentage of those often-large fixed costs. Thus, when you get that lozenge, you are also paying a small piece of all of the background services and facilities that made that lozenge appear in your hospital room. It is not necessarily a fair system, but it works to balance the books at the end of the month.

The real relevance of the “fixed cost dilemma” to how we deliver healthcare is seen in my ambulance example. In the past, many communities saw a 24-hour, fully-staffed emergency transport system as a public good, like the fire department, and indeed it was often housed there. If any specific charges were billed to patients or hospitals, they might have been only the marginal costs of that one extra single run, perhaps just the incremental vehicle costs plus hourly salaries of the paramedics just for that amount of time. The much larger fixed costs and the costs of “idle time” were “absorbed” by all citizens of the city or county, not just the patients using the service that month. This is usually the way we still run that fire department, by the way. Sometimes homeowners might be charged for specific services by the fire department, but the much larger “24-7” fixed costs of the department are almost always borne by the community at large as a “common good.”

The same has traditionally been true for many medical facilities, such as traditional “county hospitals.” But most of that has changed, where in order to minimize the tax burden on “the commons,” fully-absorbed costing is now used almost everywhere to pass on as much of that large fixed cost as possible to each individual patient using the system. For instance, if it costs $1 million to fund an EMT system in a county with a population of 100,000, that computes to $10 per resident. If you need to instead keep those costs out of the property tax bill and you allocate them instead to 500 ambulance users in that period, that’s where the $2000 per-trip charge comes from.

You can blame much of the visible rise of healthcare costs in recent years to that seemingly-simple change of accounting. The critical question, with huge mathematical and political implications, is this: “Is healthcare a common good, substantially paid for by all citizens as a group, or is it an individual good, with all costs to be borne by the end-users of that healthcare system?” Choose your math wisely.

If you are in the “Medicare-for-all” camp, you had best be taking a stand on that choice, on how you are going to allocate those fixed costs, and on how you are going to reach that necessary consensus. That has become a very tough hill to climb in the United States in recent years. [1]

The tyranny of the mean

The method by which Medicare reimbursements are determined is a complex one involving standardized treatment codes, “relative value units,” and geographic location, among other factors. [2] Comparing these reimbursement rates to actual provider costs is an even more complex analysis, but recent studies have put the percentage of Medicare reimbursement at between 80% to 89% of the average billed fees, with more recent studies tending toward the low end of that range. [3] Medicaid reimbursements, on the other hand, have been documented as low as 60% of mean billings, which is why many providers opt out of providing these services. At the other end, private insurance carriers have been reimbursed in the range of 14% above the mean. And in reality, if the patient does not fall into one of these three categories of insurance, the bill often winds up in the “uncollectable” account, which you can think of as more “fixed costs” to be borne by the rest of the patients, as described above.

No matter what level of billings you start with, there mathematically will be an arithmetic mean (average), with somebody getting reimbursed more than the mean and somebody getting reimbursed less. That is where the “dancing” begins, or in academic terms, the economic game theory. [4]

I have had some experience on the financial side of a Federally Qualified Health Center (FQHC), one of the lowest-cost healthcare provider options in the American system. Not-for-profit FQHCs are usually formed in inner cities and rural areas to provide medical and behavioral health services to under-served populations. But even they need to deal with all three of these reimbursement types, and by the federal rules they are required to take almost all who show up at the door, and so they get stuck with the unpaid debts of the uninsured as well.

If the FQHC sets their billed rates for each procedure too high, then they are not equitably serving the population for which they have been formed to serve. On the other hand, if they set their rates too low, then Medicaid, Medicare and private insurers will still demand their “pound of flesh” in the form of mandated discounts from the “official rate” for the service (kind of like the mythical “rack rate” posted on every hotel room door). In that event the FQHC would be unable to pay the large fixed costs of its operation. The ever-climbing average costs of health care services need to be addressed (and that’s a complicated topic in itself), but you don’t bring costs down simply by refusing to pay. Reimbursement discounts are like squeezing a long balloon from one end. The “tyranny of the mean” causes a big bulge somewhere else that just might burst on you.

Medicaid reimbursement rates are almost always well below the fully-absorbed cost of most services, and sometimes even below the marginal cost of those services, even at the most efficient and low-cost medical providers. For an FQHC, this difference is partially made up in the form of various federal and state grants paid in exchange for serving that hard-to-service population. In essence, this is part of that common good I mentioned above. All taxpayers are contributing a small amount each to funding the fixed costs of having that FQHC at the ready for the most vulnerable citizens, and so the per-service reimbursements can then be lower.

Medicare reimbursements for FQHCs, on the other hand, are typically close to the break-even marginal cashflow point. If run well, they can probably keep the doors open on Medicare reimbursement rates. But even not-for-profit organizations like FQHCs need an excess of revenues over expenses in order to modernize facilities and expand their reach further into their under-served communities. This is where those “above-the-mean” private insurance reimbursements come into play. They give these low-cost healthcare providers current and future financial viability. Especially in the inner cities, however, “private pay” can be hard to come by.

Most for-profit medical providers, on the other hand, charge higher “rack rates” and usually get higher reimbursements, but they also are required to generate a return on capital to their investors. And so, they need to engage in the same “rate-setting dance,” often refusing Medicaid patients in their need to “bump up the average” to remain financially viable.

Even if you don’t believe in “for-profit” medicine, it will remain deeply embedded in the American system unless a better alternative is found, and simply forcing the for-profit insurance providers out of the system, as some versions of Medicare-for-all propose, won’t alone “change the mean” of provider billings. Either Medicare reimbursement rates would be forced to rise, increasing the cost of the program, or many major healthcare facilities, and even many not-for-profit FQHCs, would be forced out of business.

So, let’s “do the math” here and spend more time looking at how other countries handle these issues.

The first in this series of “politics informed by math” was this post on the subject of voter fraud. The next part of the series, on the math behind “money is speech,” has now been posted. 

Notes:

1. I wrote about the concept of the commonweal in March in a post about governmental budgeting.
2. A good, simplified explanation of rate-setting can be found here: Stryker, Carol. “How Medicare, Other Payers Determine Physician Reimbursement Rates.” Physicians Practice, 12 December 2013.
3. Krause, Trudy Millard. “Private Carriers’ Physician Payment Rates Compared With Medicare and Medicaid.” Texmed, 19 May 2016.
4. I wrote an earlier post about the concept of economic game theory as it applies the nuclear showdown with North Korea. The concept still holds in the less dramatic arena of healthcare reimbursement negotiation.