Annual Privatization Report 2005 - Health Care

Health Care


Politics vs. Patient Care: Why Public Hospitals Are Turning Private

The impact of private ownership on performance is neatly illustrated in a retrospective study of 92 expeditions made to the Arctic over the period 1818 to 1909. Most major discoveries were made by privately funded expeditions. Most tragedies (lost ships and lives) occurred on publicly funded expeditions. Why? It turns out that incentives matter.

Private expeditions more clearly aligned the rewards for discoveries. This resulted in systematic differences in the way public and private expeditions were organized. The same is true of most government-funded enterprises.

Take hospitals. Public and private hospitals are organized very differently, and for good reason. One must satisfy a community of stakeholders, the other a community of shareholders. In the former case, a conflicting mix of social, political, and business objectives results in weak incentives to control costs.


Incentives Matter

Public hospitals are expensive, but unfortunately, high cost doesn't buy better care. Instead the cost burden comes from inefficient accounting, restrictive personnel and procurement regulations, a tangled web of bureaucracy and a general lack of accountability.

Consider the case of Natividad, a public hospital owned and operated by Monterey County in California. Most private hospitals don't actually employ physicians. They act as workstations where doctors perform services. After surgery, the surgeon and anesthesiologist each bill the patient, and the hospital bills for services it provides. So doctors who use private hospitals have an incentive to keep track of their patients. Natividad's doctors don't. They're staff. They get a salary regardless of whether or not procedures are recorded. Predictably this contributes to a dismal recording system filled with gaps (unreported procedures and uncollected co-payments), incorrect coding (one out of four bills contains an error), and lack of follow-through (missed billing deadlines).

The best run hospitals typically collect payments within 50 to 60 days. Natividad's average is around 70 days and has been as high as 133 days.

While incentive problems conspire to shrink revenues, Natividad is also afflicted with inflated costs. Personnel rules such as fixed salary schedules make it difficult to recruit and retain hard-to-fill positions. So the hospital turns to overtime and temps that cost up to three times as much. Revealing the dismal state of the hospital's cost accounting system, the last CEO complained, "We didn't know how many positions we had." Besides obvious potential for fraud and abuse, sluggishness in adopting new computerized accounting reflects a weakness that partly stems from a tangled bureaucracy. Bureaucracy and red tape slow decisions and inflate costs.


Politics vs. Patient Care

The many stakeholders in public hospitals have a conflicting mix of social, political, and business objectives. It is often unclear who is in charge: the CEO, board of supervisors, trustees, employee unions, doctors, patients, inspectors, or taxpayers. Ideally, the elected County Board of Supervisors outlines broad health-care policy, and approves major expenses and the yearly budget. Together with oversight from appointed trustees, the hospital CEO drafts a budget, and approves expenses and plans that follow the Supervisors' guidelines. In reality, unresolved issues of authority and accountability complicate the budget process, interfere with construction and procurement decisions, and slow innovation. A University of Arizona study notes that elected boards are likely to micromanage operations to satisfy political objectives that create inefficiencies and might not always coincide with taking care of the poor.

For instance, in 1993 construction began to replace Natividad's main building at a cost of an estimated $75 million. Five years later the project was finally completed, and costs had mushroomed over 50 percent to $116 million. Cost overruns translated into hiring freezes and slowed innovation, restricting investments in new medical equipment and, ironically, in computerized accounting systems.

Faced with shrinking revenues and inflated costs, public hospitals squeeze funding for other programs. This leads to calls for higher taxes, reinforced by threats of cuts in health services. In the case of Natividad a recent tax measure (Proposition Q) was voted down. Limited in their ability to raise taxes, county governments like Monterey face the decision whether they can continue owning and operating a hospital.


The Evolution of Health Care

Although the public hospital has been a fixture of American life for decades, urbanization and ongoing revolutions in health-care delivery challenge conventional wisdom that a public hospital is the best way for government to deliver health services. Yet bad news for public hospitals can be good news for patients.

New technologies and drugs have radically reduced the number and length of hospital stays. The result, according to a study by the Urban Institute, was a 14 percent drop in total hospitals in the United States from 1979 to 1998. Over that same period almost one-third of public hospitals were either converted or closed. In California, no new public hospital districts were formed between 1978 and 1998. While hospital districts were first conceived in the aftermath of WWII when Congress saw a need for rural public hospitals, rapid urbanization, telemedicine, remote monitoring, and the Internet are revolutionizing rural health markets, and attracting competition from private clinics and hospitals.

A recent study reminds us of the benefits of competition. It turns out that for-profit hospitals have important spillover benefits for medical productivity. They exert a "peer effect" when their not-for-profit counterparts mimic their behavior. Where there are for-profit hospitals, those areas have lower levels of hospital expenditures, but virtually the same patient health-care outcomes. [This effect has been noted in other areas, as well. See, for example, "Indirect Competition Reduces Prison Costs," PW Nov. 2003]

The economic argument for government ownership and control usually rests on some perceived market failure. In the case of public hospitals, it is mostly the fear that the poor and under-insured will fall through the cracks. In California counties have a statutory obligation to address the needs of the indigent under Welfare and Institutions Code section 17000: "First and foremost, public hospitals were meant as a safety net for "all incompetent, poor, indigent persons, and those incapacitated by age, disease, or accident…[and] not supported…by their relatives or friends [or] by their own means, or by…private institutions." We do need a safety net, but we need to modernize the safety net.


Modernizing the Safety Net

Benevolent citizens have learned the hard way that running a hospital is a tough business and more public hospitals are turning private. Municipalities are refocusing on meeting the needs of the disadvantaged, rather than the business of running a hospital. In California the rush to the exits is reflected in the fact that less than 15 percent of the state's hospitals are public while 85 percent are private. In seven counties, MediCal obligations are now being carried out by a sort of county-operated HMO. For example, in Orange County, Cal Optima contracts with a panel of health-care providers—hospitals, pharamacies, physicians and clinics, who agree to offer discounted services to MediCal enrollees.

Around the country municipalities have demonstrated they can serve indigents more efficiently and effectively by selling their hospital assets. Communities get a cash payment that can be used to retire debt and establish a trust fund for community health care. Since 1994, over 100 charities have emerged from hospital sales that control nearly five billion dollars.

Privatization can bring the best of both worlds: lower taxes and better services. The time has come for local governments to become selective purchasers of health care for the poorest and sickest among us, and to get out of the business of running hospitals.

By Dr. Francois Melese


Mandatory Health Insurance Now!

It will save private medicine—and spur medical innovation.

Why not tell Americans they are responsible for buying their own health insurance from now on? If people couldn't pay for medical care, either through insurance or out of pocket, they wouldn't get it. "After people begin to notice the growing pile of bodies by emergency room entrances," Tom Miller, former director of health policy studies at the Cato Institute, wryly suggests, "they will quickly get the message and go get medical coverage."

But that's not going to happen, says Mark Pauly, a health-care economist at the University of Pennsylvania's Wharton Business School. "Americans don't want to see their neighbor dying bleeding in the street," he says. "Therefore we already make sure that everyone gets some medical care when they need it. The alternative would be a world in which voluntarily uninsured people wore a bracelet that read: 'In case of an accident, do not take me to the nearest hospital. I've made my choice.'"

Since it's unlikely that Americans will allow their improvident neighbors to expire without medical care in the streets, is there a politically palatable alternative that can preserve and expand private medicine in the United States? Yes: mandatory private health insurance.

The New America Foundation, a liberal policy shop in Washington, D.C., has outlined some elements of how such a system would work. The slogan for its proposal is, "Universal coverage in exchange for universal responsibility." The devil is in the details, of course, but the plan offers some interesting possibilities. For example, mandatory health insurance coverage might be combined with medical savings accounts that would encourage people to save and invest for future medical emergencies.

The New America Foundation proposal preserves private insurance and allows consumers to choose among competing insurance plans and coverage options. Most intriguingly, the plan offers a way out of the dysfunctional employer-financed, third-party-payer model that is so grievously distorting our health-care system. Employers eventually would devolve responsibility for health insurance to their employees by giving them the money the companies currently pay to insurance companies. Employees would then have a strong incentive to shop around for the best health-care deals, putting pressure on insurers to keep costs low.

Even some Republicans are suggesting that mandatory health insurance be required for at least some Americans. Senate Majority Leader Bill Frist (R-Tenn.) recently argued that it is unfair to expect taxpayers to pick up the health-care tab for the third of Americans without health insurance who make incomes over $50,000. "I believe higher-income Americans today do have a societal and personal responsibility to cover in some way themselves and their children," the senator said in a speech at the National Press Club in July.


Privatizing Medicaid and Medicare

Uninsured Americans currently receive health care for which they don't have to pay. Their bills are paid by tax dollars spent on Medicaid or the state Children's Health Insurance Programs, or through higher insurance premiums and medical charges to make up for the losses doctors and hospitals incur when they treat the uninsured. Why shouldn't we require people who now get health care at the expense of the rest of us to pay for their coverage themselves?

There's a big bonus. "Mandated coverage would replace Medicaid and state Children's Health Insurance Programs because lower-income and unemployed people would receive a voucher to purchase private health insurance," says Wharton's Mark Pauly. "This would mean full privatization for people under age 65." He holds out an even brighter prospect: "Actually, in principle, mandated coverage could replace Medicare too." The entire medical system could be privatized. The slowly expanding Medicare, Medicaid, and S-CHIP behemoths that are inexorably absorbing more and more of the U.S. health-care system could be eliminated.

Mandatory health insurance would be not unlike the laws that require drivers to purchase auto insurance or pay into state-run risk pools. They also resemble the libertarian Cato Institute's proposals for reforming Social Security, which do not eliminate mandatory payments; they privatize them. Similarly, school voucher plans generally mandate that children receive an education. As the Rose and Milton Friedman Foundation notes, universal school vouchers would allow "all parents to direct funds set aside for education by the government to send their children to a school of choice, whether that school is public, private or religious." This system separates "the government financing of education from the government operation of schools."

Once government and health insurers have defined a standard basic package of health-care benefits, the current dynamic of constant government meddling in health insurance and health-care markets that leads to higher and higher costs should change. Consumers, transformed from passive recipients into direct purchasers, can be expected to be vigilant about government interference that would increase their rates or reduce their services.

As Rep. Bill Thomas (R-Calif.) noted at a recent National Center for Policy Analysis conference, if everyone had to buy his or her own coverage the way people buy car or homeowner's insurance, and if the size of the tax breaks didn't hinge on employment status, you would have the beginnings of a real market. Thomas said he wanted to make basic, low-cost catastrophic health-care coverage widely accessible through tax subsidies and credits. More extensive coverage would be available to individuals who wanted it, but they would have to pay for it with after-tax dollars.

Under a mandatory insurance scheme, all Americans would be required to purchase a basic high-deductible catastrophic health insurance policy from a private insurance company. "Let's say you cap the deductible at $4,000 and set a limit that out-of-pocket health-care costs can't exceed 10 percent of an individual's or family's income," suggests Pauly. "That would mean that a family earning $30,000 per year would receive $1,000 in a health voucher." In other words, the family would pay the first $3,000 of medical expenses out of pocket and receive a $1,000 voucher to cover expenses up to the $4,000 deductible.

A high deductible would encourage people to be more careful about the services they purchase. They would shop around for good deals on drugs and scrutinize the costs of various treatment options more closely. Of course, some people inevitably would try to save a penny or two by delaying a visit to the doctor for their stomachache, only to find out later that it's cancer, but no system can make people perfectly prudent.

Health insurance policies covering catastrophic expenses today typically cost under $300 per month for a family of four. So that's $3,600 per year for insurance. Assuming employers pay between $6,000 and $9,000 to cover an employee and his family, that means workers would be getting an extra $2,400 to $5,400 in their paychecks. Even a $3,600 policy would be expensive for a family living on $18,000 a year, so perhaps they would be required to pay 10 percent of their income, $1,800, for insurance and receive a voucher for $1,800 to cover the rest of their premiums.


Money in the Bank

This plan differs from the mandatory health-care schemes in Germany and France, which are financed by payroll deductions set at a percentage of wages up to a certain income level. In the United States today, an employer generally pays the same health insurance premium for each employee. So if the premium at a company is $5,000 a year per employee, under this plan each employee would get $5,000, tax-free, to purchase insurance. That money would make a lot more of a difference to an employee earning $20,000 than to one earning $80,000.

A second component of the new private insurance scheme might encourage (or even mandate) that families and individuals make annual contributions to health savings accounts (HSAs) similar to those included in the otherwise very flawed Medicare prescription drug law. As currently formulated, HSAs allow employees to set aside pre-tax money to cover routine checkups, co-payments, prescription drugs, vaccinations, and so forth, while costly medical procedures are covered by high-deductible insurance policies. HSAs permit employees to keep their own money, rolling over any unspent funds in their HSAs at the end of the year and investing the money for future medical expenses or saving it for retirement; the money can be passed on to heirs. Since it's a real asset, people have an incentive to manage it frugally.

HSAs have several attractive features. Employers as well as employees make contributions, so instead of paying insurers for low-deductible policies, companies can give the money directly to their workers. Best of all, for those worried about the instability of linking health insurance with steady employment, people who lose their jobs can withdraw funds from their HSAs to continue their families' health insurance coverage. Employers will be attracted to HSAs because they will be able to lower their health-care expenses by offering their employees higher-deductible insurance plans. Such plans generally cost 20 percent to 60 percent less than conventional low-deductible health insurance policies.

There's no reason to put off the campaign for a mandatory private system until we've worked out all the details. To keep the great American health innovation machine running, it is vital to keep medicine private and consumer-driven, and that means going on the offensive now.

Maintaining our private medical system is vital because American health care and medical science are the most advanced and innovative in the world. If a national single-payer health-care system is adopted, most medical progress will be stopped in its tracks. The proposal for mandatory health insurance offers a way to maintain our private system, expand consumer choice, lower costs, and allow medical progress to continue.

By Ronald Bailey is Reason's Science Correspondent


A Glimpse: Health-Care Privatization in Western Democracies

Sweden has long been known for its extensive social welfare programs, but now it's developing a reputation of a different sort—health-care privatization. Sweden, or more specifically, Stockholm began experimenting with private-sector participation in health services during the early 1990s when waiting lists for care were growing longer and longer.

In 1991 the County Council pushed for market-based reforms that transformed Stockholm's health services into a laboratory of privatization experimentation. The County Council introduced competition and private-sector participation in hospitals, home care, ambulance services, and other areas of health care.

Lab and X-ray services costs dropped by nearly 50 percent, waiting times for examination and treatment fell 30 percent in one year, and competitive procurement lightened costs by about 10 percent for ambulance service and 40 percent for medical laboratories. After St. Goran's public hospital was leased to a private provider in 1999, costs dropped by 30 percent and the hospital was able to serve 100,000 more patients per year. Local leaders even turned to the privatized hospital for performance benchmarks, which were used to exert competitive pressure on other public hospitals.

The reforms that began in Stockholm eventually spread to other major cities.

Johan Hjertqvist of the Swedish think tank Timbro notes that today private entrepreneurs deliver roughly 10 percent of all health-care services nationwide. Private provision is less common in remote areas and more common in larger cities. In metropolitan Stockholm private contractors provide nearly 50 percent of primary care services and 20-25 percent of all services.

Australia has also moved toward private heath-care provision. In particular, hospital privatization has experienced much growth. State and federal governments have introduced private participation in more than 50 public hospitals, and Mildura hospital has emerged as an impressive success story. The government selected a private operator to design, build, own and operate a new hospital under a 15-year contract. The contract specifies that the private operator must provide service to all. The contract also includes provisions for third-party performance monitoring and penalties for noncompliance.

The results were encouraging. The new hospital cost 20 percent less to build compared to the public sector. Patient volumes increased, all performance targets have been met and the provider even made a profit.

The trend toward health-care privatization has spread to other unlikely corners, such as Germany and Great Britain, where the National Health Service has turned to the private sector to build and operate new surgery centers. Writing for the World Bank Rob Taylor and Simon Blair point out that in recent years Great Britain has used public-private partnerships in financing, construction, and facilities management for many public hospitals.

For more information on Swedish health-care reform:

Johan Hjertqvist, The End of the Beginning: The Health Care Revolution in Sweden, Part II, Timbro Health Policy Unit.

Impatient for Change: European attitudes to health care reformImpatient for Change: European attitudes to health care reform, The Stockholm Network.





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