Failing to Address Health Care Costs Just Puts Off the Big Accounting

Bill Robinson, a health insurance agent in the Palm Springs area, sent me an interesting article last week. The article reiterates a key, but too often overlooked, truth about health care reform. Until lawmakers tackle the rising cost of health care, all the debate over health care coverage will eventually amount to little.

Take even the most extreme reform: a single payer system. Supporters claim that eliminating health insurance companies, agents and the rest of the private health care sector will provide enough money to support a government-run system providing everyone with virtually unlimited health care. They’re wrong, but for now, let’s give them the benefit of the doubt. What is likely to happen in, say, 10 years? Consider that cost of $1,000 worth of medical care in January 1997 cost over $1,470 in December 2006 according to Tom’s Inflation Calculator and it’s clear even single-payer advocates are going to have to come up with a boffo second act. A one time saving just doesn’t cut it.

Which brings us to the article Bill sent from Financial Week, “Cost of health-care system bugs employers”. The article points out the motivation for business executives to be fully engaged with health care reform. Of the $1.9 trillion in total health care spending in 2005, $694 million was spent on private health insurance premiums. Employers paid for $462 million of this, fully two-thirds. It’s a bottom-line issue for employers of substantial proportions.

Which is why folks like Andrew Mekelburg, Verizon Communications’ vice president of federal government relations complains that the presidential candidates are focusing on health care coverage, not health care costs. “Until you fix the system we’re all going to pay more,” complains Mr. Mekelburg. He notes that the health care system lags other areas of the economy in leveraging technology to increase efficiency and improve results.

Many of those interviewed in the article agree that achieving universal coverage is important. But as Helen Daring, president of the National Business Group on Health, puts it, “It’s ironic: the main reason people do not have coverage is because they can’t afford it….Politicians say, ‘we’ll get the coverage in first, and we’ll worry about the costs later,’ but you’ll never be able to do the cost part later.”

And that’s the crux of the matter. The reforms being debated in Sacramento and elsewhere are important. Some are necessary. Yet most miss the point that it’s constraining the cost of the underlying care that drives everything. Worse, some of the solutions being put forward could make things worse. Consider the pay-or-play approach of Assembly Bill 8, the approach favored by the Legislative Leadership. Ted Nussbaum, a consultant on health care coverage to large companies, offers this warning. “They have to prescribe the amount we spend. ‘You spend X% of your payroll on health care.’ … And when you set the amount it takes out the incentives for employers to come up with more cost-effective care. … [A mandate] leaves no room for innovation and flexibility and creativity.”

This is common sense. If the government creates the floor for spending on a specific item, why would anyone fight to make the cost of the item less expensive?

The debate today turns on who gets coverage and who pays for it. This debate needs to expand to include a discussion on how much we all pay. Until that happens no reforms, not even the most radical, are going to do more than put off the big accounting that is coming. And the longer we wait, the tougher corralling cost will be.

AB 8 and Unintended Consequences: Funding the Pool

AB 8 requires employers to pay 7.5 percent of their Social Security payroll ($97,500 this year) on health care coverage. Two calculations are actually required: one for full-time employees; one for-part timers (working less than 30 hours a week).  The employees of companies which choose to pay this fee are required to enroll in a state run purchasing pool. If the funds are not enough, the manager of the pool, the Managed Risk Medical Insurance Board (MRMIB) can raise the fee. MRMIB also determines the benefits provided in the pool. So they sit in a very interesting position: they determine the demand,  the supply and subsidy of the purchasing pool.

Supporters of AB 8 call the 7.5 precent charge a “fee;” opponents call it a “tax.” The debate is more than academic. If it’s a fee the bill can be passed into law by a majority vote of each house of the Legislature. If it’s a tax, a two-thirds vote is required. Some of you may have noticed that the Legislature has a bit of a problem coming up with two-third majorities, which is why there’s no state budget yet. This will no doubt be the topic of law suits if the bill is “passed” by a simple majority, but it’s not the topic of this post.

Neither is the fact that “pay-or-play” systems like that envisioned by AB 8 appear to run afoul of ERISA pre-emption.  What this post is about is whether the 7.5 percent charge is sufficient to pay the bills of the new purchasing pool. Because if it’s not, then AB 8 will lead to continuous increases in the fee/tax. And if the fee/tax becomes an unacceptable burden on businesses, the result will be depressed wages as company revenue is diverted to the fee, lost jobs as companies move out of state or put off new hiring, and a resulting reduction in state revenues, undermining the state’s ability to pay for other services. Such a result would truly qualify as an unintended consequence.

The California Chamber of Commerce is among those who claim 7.5 percent charge won’t be sufficient on Day One. On the other hand, researchers at places like the UC Berkeley Labor Center produce studies showing the fee/tax is sufficient.

But Day One is not the only day Californians will have to live with the fee and the purchasing pool. Let’s consider what might happen down the road. And if past is prologue, an interesting issue would be see what would have happened if this scheme had been introduced in 1997. For that, let’s revisit our favorite inflation calculation site, the amazing “Tom’s Inflation Calculator.

For purpose of this thought experiment, assume that in 2002, there’s a company in California whose average Social Secruity wages are $40,000 per employee. A 7.5 precent charge against that payroll would generate $3,000 per year. Let’s further assume that this revenue is sufficient to pay for a health insurance policy through a state-run pool. In other words, let’s assume in 2002 the payroll fee/tax was sufficient to pay for the coverage provided.

Now let’s turn to Tom’s calculator.  The $40,000 assumed salary in 2002, adjusted for U.S. Wage Inflation, would be $45,427.22 in 2007. Applying the 7.5 percent fee/tax on this salary generates $3,407.04 (the cents are provided to give this high-level calculation a false sense of precision).  Now take the $3,000 cost of coverage in 2002 and adjust it for U.S. Medical Cost Inflation. Assuming insurance premiums just kept up with the cost of underlying care, the cost of coverage in 2007 would be $3,695.75 — 8.5 percent more than the revenue received. To make up this difference, the 7.5 percent fee/tax would need to be raised to 8.1 percent of wages.

That doesn’t sound like much of a miss, but it assumes the rate of medical cost inflation remains flat compared to what it was in the 2002-2006 period (for various reasons, Tom’s calculator does not include the target year’s inflation rate in the calculation). Yet the population is getting older. Technology is getting more expensive. Consumer demand is increasing. Does anyone really believe that will be the case? And with the state of the economy, does anyone contend wage inflation will increase at a faster clip in the future?

To put it simply, by pegging the cost of health care coverage to payroll, AB 8 makes a fatal flaw. The changes of them increasing in lock-step is virtually nil. Instead, health care costs are likely to increase at a far greater rate than wages. Which means the payroll fee/tax will need to increase — often and substantially — over time.

The result, those unintended consequences mentioned earlier.