The News Is The Declining Incentives For Medical Innovation

The federal health exchange, one of the centerpieces of the Affordable Care Act (ACA or “ObamaCare”), is gasping for life.  This is not the important story, however.

The U.S. health care system has flaws.  And, these flaws should have been the focus of the health care reforms back in 2009.   They weren’t.  The U.S. health care system also has many strengths.  Instead of leveraging the strengths of the U.S. health care system and addressing its flaws, the ACA which was signed into law by President Obama on March 23, 2010, undermined the system’s strengths and amplified its flaws.

A careful accounting of the health care industry’s successes as well as its failings illustrates a very simple theme: incentives are driving the outcomes.  Bad health care outcomes are resulting when the incentives are misaligned; good health care outcomes are resulting when the incentives are properly aligned.

Starting with the good, back in 2009 when the ACA was being debated, 84 percent of the U.S. population had health insurance.  Furthermore, surveys at the time also showed that most Americans were satisfied with the quality of the health care services they received.  For instance, a 2009 CNN survey that found 80 percent of Americans were satisfied with the health care services they received.

And, much of this satisfaction derives from what is arguably the health care system’s greatest strength – the incentives for innovation.  The major advances made in cancer medicines over the past few decades exemplify this innovative spirit.

According to the American Cancer Society , there will be 1.7 million new cancer cases in 2013. Compared to 40 years ago, better treatment and more effective therapies are helping improve both the quality of life for cancer patients while simultaneously improving the cancer survival rate.

An important contributing factor to these advances in cancer care is pharmaceutical research.  A 2012 study commissioned by PhRMA estimates that the development of new medicines is responsible for 50 to 60 percent of the increase in the cancer survival rates since 1975.  According to the National Cancer Institute, since its peak in 1991, the cancer death rate has fallen by 20 percent.

This success story exists because the current health care system incentivizes companies to discover new and better therapies.  These positive incentives lead to greater pharmaceutical research and, ultimately, to the creation of new and better cost-effective options for doctors.

Contrast these positive incentives with the adverse incentives that pervade the third-party payer system.  This system creates a complex web of payers, doctors, regulators, licensing boards, lawyers, and patients.  The isolation of patients from their doctors creates many adverse incentives.

As an example, patients bear a small fraction of the costs from any additional health care service.  Therefore, they have little incentive to monitor health care expenditures.

Doctors and other medical providers, on the other hand, also have no incentive to monitor costs.  The reason: lawsuits.  The risk of litigation incentivizes doctors to run extra tests (e.g. practice defensive medicine) to help minimize their risks of being sued.  According to the American Medical Association, defensive medicine in response to rising tort liability costs adds hundreds of billions of dollars in additional costs.

The lack of cost sensitivity also provides no incentive to effectively address waste, fraud, and abuse in the health care system, which has been estimated at over $700 billion a year!

Therefore, the problem of rapidly rising medical prices is caused by adverse incentives.  Neither patients nor doctors are incented to control the cost of medical care; and in fact, both patients and doctors are incented to let prices rise.

Instead of empowering patients along with their doctors and other medical professionals to manage their own health care, the ACA expands the power of third party payers worsening the adverse incentives of the U.S. health care system.

Some of the manifestations of these adverse incentives are already evident: such as the broken promise that the President made to the 84 percent of Americans with health insurance that they could keep their insurance if they liked it.  Others are yet to be felt, such as the drive for price controls that will diminish the incentives to innovate and other strengths of the current health care market.

In light of these fundamental problems, discussions about websites and experts from Silicon Valley are beside the point.  The rollout of the ACA is already harming the U.S. health care system and that harm grows by the day.  This harm is the important story.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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