Diagnosing Misconceptions about Health Care

As businesses starts grappling with health reform, it's becoming clearer that the Obama plan is predicated on some false assumptions about the health care industry.

Three assumptions underlying the legislation are simply wrong, making it hard to see how the plan ever reduces costs. It assumes that health insurers are highly profitable, that doctors and hospitals operate on lean margins, and that the source of change and innovation in health care delivery is going to come from hospitals and medical practices that consolidate into more closed provider networks.

The Obama plan taxes the industry nonetheless, first with fees, then by directly regulating their profitability.

All three of these suppositions have been erroneous in the past, and will remain wrong in the future. It's almost as though nobody in the White House or the Senate drafting and shaping the plan's contents had ever worked in the health care industry in any meaningful capacity. But that couldn't be possible.

On the first point, insurers are indeed profitable, especially relative to other sectors such as consumer staples (which operate on 3 percent margins). But the average profit margins of managed care companies have been relatively stable at about 5 percent.

Compare this to the real estate industry (operates at a 10 percent profit margin), oil and gas (15 percent), and network communications (25 percent). In the health care space, the most profitable segment is drugs, which on average operates at a 16 percent profit margin.

In practice, the managed care industry is highly competitive and pays out a predictable and substantial part of its revenue on medical care. This is especially true relative to other types of property and casualty insurance, which hold on to a more substantial portion of their revenue (and operate at a 10 percent profit margin).

The Obama plan taxes the industry nonetheless, first with fees, then by directly regulating their profitability. This is self defeating--leaving plans with less capital to re-invest in new products or make the transition to the state exchanges in 2014.

Next, the Obama plan assumes that hospitals operate on the brink of insolvency. But these institutions are rife with waste and poor management.

Many not-for-profit hospitals operate at breakeven only by plowing money into wasteful spending. They pay outsized salaries to attract locally prominent doctors and buy unnecessary equipment to gain marketing edge in local communities. How many hospitals need a "robotic" surgeon or "hyperbaric oxygen"?

Finally, the Obama plan assumes that hospitals and doctors will consolidate to form "accountable care organizations" that will then become the source of innovation and change in the way health care is delivered. But meaningful change in the way health care services are delivered almost never emanates from hospitals.

On the contrary, most of the significant innovations in the way health care is delivered have been expressly designed to keep patients away from the hospital: long-term care facilities, rehabilitation, hospice care, and outpatient surgery companies, to name just a few examples. All these innovations are credited with improving outcomes and lowering costs. And all of these concepts originated inside for-profit, venture-backed companies. Many of these concepts were destroyed once changes in reimbursement rules forced these services back into the hospital setting.

Maybe hospitals are where the union jobs reside, so the bill was biased in their favor. Maybe someone saw a health insurance executive getting off a gulfstream and wrongly assumed that's where all the money was stuffed. Or maybe the architects of the Obama health plan just didn't understand the business of health care.

Scott Gottlieb, M.D., is a resident fellow at AEI.

Photo credit: iStockphoto/A_Carina

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