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Why does health care cost so much in the U.S.?

Surprise, it is not utilization; drug costs and administrative costs appear to be the major factors

Photo by Richard Asinof

Lou Giancola, the former president and CEO of South County Health.

By Lou Giancola
Posted 5/13/19
In looking at the reasons behind why U.S. health costs are so high, the results of a recent study suggest that the solutions may need to focus on concrete steps to reduce drug costs and administrative costs.

What are the concrete steps that the R.I. General Assembly could take immediately to rein in drug costs? Are there ways that the R.I. Office of the Health Insurance Commissioner can identify growth in administrative costs as a function of cost? Are the efforts to reduce costs focused on reducing utilization and transferring costs to lower-cost settings misguided? How can investments in Health Equity Zones and in healthy, affordable housing reduce medical costs? What are the medical costs of treating substance use disorders, including alcohol, and the diseases of despair, including suicide, in Rhode Island?
In a recent story by Providence Business News reporter Mary MacDonald, there was a nugget that reflected the dawning realization by economic development officials about what may be the Achilles heel of the planned development of the newly named Providence Innovation and Design District on the former I-195 land: there is no affordable housing in Rhode Island, and no place for workers coming into the state to live.
The best use of real estate, according to I-195 Redevelopment District Commissioner Mike McNally, as reported by MacDonald, now includes development of more housing for workers, because the city has among the tightest rental markets in the U.S. “Young people come into town and they can’t find a place to live,” McNally said, adding, “What you see, with the pressure of housing, the economics work. That’s why we had four proposals for housing.”
Of course, you could draw the exact opposite conclusion – the economics around housing have not worked because of the failure to invest in new affordable housing as a fundamental principle of economic development, and it has precipitated a housing crisis in Providence and in Rhode Island. As Barbara Fields, the former head of RI Housing, said: “Housing is where jobs go to sleep at night.”
That same kind of “faulty” thinking may also be prevalent in health care: that increased utilization is driving up medical costs, which can be reduced by transferring care to lower-priced settings. The problem is: demographics may not support such thinking; if you don’t invest in prevention of chronic diseases, when they flower and peak in an older population, they will swamp the system, much like those 100-year-floods that are now occurring every year, because of man-made climate change.

PROVIDENCE – An article in the January 2018 issue of the Journal of the American Medical Association tried to answer the question of why health care is so much more expensive in the U.S. than in other high income nations like the United Kingdom, Germany, France, Denmark, Australia and Japan.

To start with, the authors found that the U.S. spent $9,403 per capita on health care in 2016 compared to $5,221, on average for the other high-income countries.

The country closest to the U.S. was Sweden, which spent a mere $6,808 per capita, 27.5 percent less than the U.S. If the U.S. had the same average cost as Sweden, we would be spending nearly $908 billion less on health care.

If you’re like me, you are probably thinking that the U.S. is somehow different, accounting for our higher cost. We must have more old people who use more health care. As it turns out, the U.S. has the lowest percentage of people over 65 years of age of all the countries included in the comparison.

Japan, with 25 percent of its population over 65, had per capita spending of $3,727. Clearly the age of our population is not the answer.

The U.S. stood out as having the highest poverty rate, 27 percent, compared to a mean of 18 percent for all countries. This is remarkable difference but doesn’t explain the significant difference in cost.

Population characteristics don’t explain the cost differences
The authors reviewed multiple population characteristics such as the rate of smoking, alcohol consumption, obesity and the rate of poverty. Surprisingly to me, the U.S. had next to the lowest rate of smoking and was in the middle of the pack on alcohol consumption. On obesity and overweight of people over 15, the U.S. led the pack. However, none of these measures could explain the cost differences.

They also reviewed outcome measures such as life expectancy, maternal mortality and low birth weight. As has been known for some time, the U.S. fared very poorly on outcome measures. The U.S. had the lowest life expectancy, but it was onIy 3.6 percent lower than the mean. On the other outcome measures, the U.S. ranked at or near the bottom of the pack. So, the conclusion that the U.S. spends a lot on health care, but doesn’t get as much value as other high income countries, seems to be borne out by this data.

The article then compared utilization of services in the U.S. and these other countries and finds no substantial differences, with just a few exceptions that are not sufficient to explain the cost differences. This was a surprising finding to me, but health policy experts I spoke with seemed to know that this was the case.

Productive function?
The authors conclude that the major differences in cost are accounted for by the price/cost of what economists call the components of the productive function. That is, the cost of the labor and supplies which are required to produce the service.

The price of drugs leads the list of higher cost inputs. Per capita spending for drugs in the U.S. was $1,443 compared to a mean of $749 for the comparison countries.

As drugs account for 10 percent of all health care expenditures, this alone explains 5 percent of the difference in cost or approximately $247 billion in excess cost for the U.S.

Administrative costs in the U.S. were 8 percent of overall cost, or approximately $264 billion, compared to 3 percent of health care expenditures in other countries.

Lowering our administrative costs to 5 percent would result in approximately $100 billion in savings.

The earnings of health care professionals were also found to be much greater in the U.S., contributing to higher cost. In particular, specialty physicians are compensated at a much higher level than that in the other countries.

To reduce cost, change the strategies
It has been surprising to me that there has been so little discussion of this article and its conclusions. Our current health care policy has been almost exclusively directed at reducing utilization or transferring care to lower-cost settings.

This continues, even though data show that the gains made through utilization control, net of the required investment, are marginal at best.

That is not to say that we don’t have over-utilization of services, as many studies have suggested. However, it begs the question of why, as a country, we don’t attack areas that could yield significant near-term savings with policy changes directed at areas in which our costs are so out of line with other developed countries.

There has been much talk about drug prices, but little action to date. While there may be merit in considering radical reforms, such as Medicare for All or a Public Option, these will take years to implement. In the short term, we should be focused on concrete steps to reduce drug and administrative costs.

Lou Giancola recently retired as the president and CEO of South County Health.


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