Health Care Crises Facing Our Nation Today:
Strategies for Reform

March 24, 2003

Transcript prepared from a tape recording

9:45 a.m.	Registration
10:00	Presenters:	Newt Gingrich, AEI
		John C. Goodman, National Center for Policy Analysis
		Thomas Saving, Texas A&M University and National Center for Policy Analysis
Noon	Adjournment

Proceedings:

MR. GINGRICH: [in progress] It works better now? Thank you.

The issue of how we provide for health and health care is literally a matter of life and death, and a matter of an enormous amount of money, and we have a very, very expensive system, over 13 percent of our Gross Domestic Product, that is, over 13 cents of every dollar in the economy, and yet it's a system which, in many ways, is avoiding modernization, avoiding change, avoiding improvement, avoiding quality, in ways that are really fascinating.

John Goodman and I were chatting a little while ago about the fact that this--you know, this is almost a perfect test case of how public policy can slow down and impede progress, because any kind of free market environment, people who invent better ideas, better solutions, better products, have a migration towards them as the customer looks up and says, gee, that's better.

We can show you case after case after case in health where somebody invents a better way of saving lives, a better way of treating cancer, a better way of stopping hospital-induced illness, and it just doesn't spread. Everybody else goes: Nice try, I'm not interested, and they go back to what they're already doing, because it is a system in which producers have remarkable power to avoid change, unlike in a free market. Producers who avoid change are called bankrupt. But in health, they just managed to do it.

Second, this is a system in which for 40 years we have pursued an experiment that is exactly the opposite of everything we told the Russians. That is, for the last 40 years, we have put more and more power in centralized bureaucracies, whether they are corporate, federal or state, and so you now have more health decisions made by bureaucrats and fewer health decisions made by medical personnel, to a degree that is really quite stunning, and so you have a whole layer of cost and of slowing the rate of adoption, because in fact the person who's health is involved is not directly tied into the decisions and the power structures that are being made.

Third, this has become a system in which people are actually encouraged to be passive. In effect it's not your health. It's your company's health, it's your HMO's health, it's your doctor's health.

But we don't have a system today which says you ought to know about yourself, you ought to know about taking care of yourself, you ought to have primary responsibility for yourself, and, by the way, you're financially invested in your own decision. We've gone in exactly the opposite direction. You should be passive, you should rely on professionals, a third party will decide what you can get, when you can get it and where you can get it, and you shouldn't ask too many questions because that just slows down the system which is efficiently working around you, despite your desire to learn things.

If you think about it, that's exactly the opposite of a healthy system. I mean, if we had a federal department of home ownership that said please don't worry about your roof because we will have a roof inspector, and the roof inspector will show up on an occasional basis and they will then hire a roof repairer, and it is not your job to pick your house, it's not your job to worry about your house, it's not your job to learn how to take care of your house. You in fact are what we will now call a passive client, and you are the housing client.

Now, to some extent, that is how public housing works. But everybody who lives in their own home would think this was nutty. If we offered you, you'd never have to worry about your house again because a federal bureaucrat will do it for you, or your corporation is now going to set up a human resources department of housing, and they will hire four housing experts who will save you from thinking about it. You would know it made no sense.

So we're starting today a dialogue, our goal in being here today is to have a dialogue in which we start laying out really different ideas, "outside the box" ideas that we think are much more likely to dramatically save lives, and save money, which is actually the title of a book we're producing, but the notion being that the right system is better for health and better for pocketbook.

It's not a choice between pay more to be healthy or pay less, you're going to die. It is a choice between encouraging the adoption of newer, better systems, in which case you'll actually be healthier but it will be less expensive, and this process of transformation we think is very, very important. We're going to take it on in three zones and then throw it wide open for questions.

First, and I'll introduce him in a second, Dr. John Goodman is going to discuss making health insurance personal and portable, and how we can migrate back from the 1943 decision that group insurance is the only way to go.

Then Thomas Saving is going to present his idea which is creating a market for sick people. How do we incentivize the right performance? How do we incentivize the right kind of way of taking care of people? And then I'm going to talk about the whole problem of health care in a tort system which minimizes reporting errors and minimizes getting to quality, because if you were to report errors you're simply an advertisement for another law suit.

And so I'm going to talk about creating a better system of health, justice, and moving to a system in which both the individual's better protected, the system is encouraged to move towards quality, and information can be made public without automatically creating a target for trial lawyers. Then we're going to toss it open to you to take us wherever you'd like to as we discuss how to create a better health system for the future.

Let me start with Dr. Goodman who founded the National Center for Policy Analysis in 1983. He's the co-author of more than 50 published studies and seven books. Dr. Goodman is one of the most positive, aggressive, and interesting conservative intellectuals in the country today. He has had a substantial impact in developing medical savings accounts, for example, which The Wall Street Journal called him the father of. He is also--National Journal declared him winner of the "devolution derby" because of his ideas on ways to transfer power from government to people.

I've known John for years. He is a "fountain of ideas." He is a very serious systematic student of how ideas can make this a better country and we're delighted you're with us, and you are now going to take us through how we dramatically improve the current health insurance system.

DR. GOODMAN: Thank you, Newt. It was worth a trip to Washington just to hear that introduction, by the way.

Originally, we had entitled this session "Thinking Outside The Box," and part of the motivation was a feeling, at least on my part, that we were having too many health care briefings where we were just rehashing the same old ideas over and over again, and so we asked, well, why not have a briefing where we discuss ideas that no one else is talking about, but are nonetheless important.

Then the question was: Would anybody come? and I see that quite a number of you did come. So let's turn to the first idea, which is personal and portable health insurance. And you might ask: Why would we want to do that? One reason is continuity of care.

Now it didn't matter so much back in the old fee-for-service system, but in today's managed care world, when you change jobs you change health plans. When you change health plans you typically change doctors, and what that means is if you or a member of your family is sick and undergoing treatment, you don't have continuity of care.

Another reason is continuity of coverage. Even if you don't switch jobs, in the commercial insurance market, contracts typically only last 12 months, and what that means is if you're being inured right now, at the end of, within 12 months, your employer may choose another health care plan or may cease providing health insurance altogether.

A third reason is consistency of costs. Now in the individual market, which is the only private sector market where we have true personal portable health insurance, costs go up the same for all the members. So once you join, individuals are not singled out for special premium increases because they get sick.

But in the small group market, essentially, as I said a moment ago, the contract is only for 12 months. So what that means is, at the end of the 12 months you're essentially kicked out of the pool, and if you want to buy back into that pool, or some other pool, you're going to be rerated, and what that means is if somebody in the group got sick and has expensive health care costs, your rates are going to go up.

Really, that isn't insurance, and it's one of the reasons why the small group market is so dysfunctional today.

Another reason, and for me, the most important reason is consistency of quality, and it's so important that I'm going to come back in a few moments and spend a little bit more time on that.

The final reason has to do with economic efficiency. If you want an efficient economic system, you want employers and employees to come together based on expected productivity, not based on expected health care costs. You don't want people choosing employers because of the health benefit plan.

You don't want employers choosing employees because of what they think their health care costs are going to be. Fringe benefits really should be on the fringe. It shouldn't be at the core of the decisions that people are making.

Now how do we get to personal portable health insurance? Well, one model that appeals to a lot of people is just the individual market, which as I said earlier, is already a system of personal and portable insurance.

Of course under the current tax law, this market's in disfavor. The tax subsidies go to employer-provided insurance and you basically get no tax relief if you file your own insurance, and some people would like to end the tax subsidy to employer-provided insurance and encourage everybody to be in an individual market [?].

But we don't have to be quite that radical in order to get a personal and portable health insurance system.

Another model on which to build this idea is the TIAA/CREF model for retirement plans. The TIAA/CREF system, as many of you know, is a system that is put in place for employees of colleges and universities, and essentially you have to enter through an employer, you have to be employed by a college or a university. The employee makes contributions to a retirement plan. These are typically matched by an employer. It's perfectly portable. It travels with the employee as he goes form college to college, and he remains a member even if he leaves the academic world to go to work for government or a think-tank or a business. You don't get kicked out of the system. You still can participate in TIAA/CREF. There is a continuous choice of plans. Every ten minutes, if you like, you can call up and change your portfolio.

Now how would this system work in health care? Basically pretty much the same. You'd enter through an employer. There would be employer and employee contributions. It would be completely portable, and the only difference is this last item, there would be long-term contracts.

Now why, you may ask, do we need long-term contracts? and the simple answer is that all the consistencies and continuities that we talked about just a moment ago require consistency and continuity in the membership of the pool.

Now the difference between health insurance and retirement plans is that in a retirement plan you can separate the investor from the assets; but in a health insurance pool, you can't separate the members from the pool because the members are the pool.

Put another way: You can have one member of a pool go and join another pool, but, collectively, the members can't go join another pool. The pool doesn't exist. Even if a substantial number of people leave one pool and join another, they change the nature of the original pool.

So if you want consistency and continuity of health insurance, you have to have some kind of consistency and continuity in the membership of the health insurance pools.

Now how do you change plans? Well, we're going to talk about that in a moment and we're going to suggest ways that you can move from one pool to the next but it's not going to be a free for all, the way that it is for the employees of the Federal Government, in the FEHB program, or a continuous free for all the way it is in the Medicaid program.

Now what would the system look like? A number of years ago, the NCPA got together with Blue Cross/Blue Shield of Texas to work out a way of doing this in the State of Texas. We found out, unfortunately, that everything that we wanted to do was blocked by HIPPA, which we can talk about later this morning, if you like. Basically, this is not a plan but more of an outline, sort of like the Bush administration plan for Medicare reform. But let me go quickly through the outline.

The idea is that employers--and no one has to do this, we'd make this completely voluntary--but we concluded in the short amount of time virtually everyone in the small group market would take up this option.

The employer makes a fixed contribution for each employee, so he's a defined contribution employer. The contribution goes to the plan which is chosen by the employee and the employee pays the difference between the actual cost of the plan and the fixed contribution that the employer offers.

So if I just pick an example ,suppose our employer is offering $300 per employee. The employees, in principle, could be members of many different plans, they will have many different premiums, and what the employer does is pretty much what an employer does in a 401(k) plan.

In this example, the insurer charges a monthly premium of $400. So the employer's contribution, remember, was only 300, so he deducted a $100 from the employee's salary and remits the $400 to the insurance plan.

Here's an insurer that's a cheaper plan, it only costs $200. The employer is offering three hundred. I would hope that in this case the $100 saving would go to the benefit of the employer, perhaps deposited to his IRA or to a 401(k) plan.

Again the role of the employer here is pretty much like the role of the employer in a 401(k) plan. It's basically financial.

In a sense, the employer who does this gets out of the health insurance business, and what this means is that some of the things the employers are now doing with respect to health care, they would cease doing. They would have to be done by someone else, perhaps a health insurance agent, perhaps the insurance plan itself.

For the employee, you have the advantage that you can get into a plan that you like and you can stay there. Now a lot of people, especially a lot of conservatives, think that what most people want is a choice of plans every year, but it turns out that even for federal employees, when they get a choice, the vast majority of them stay in the plan that they were in the previous year. I think it's about 95 percent stay where they are.

So what most people want is not to choose a new plan every year. What most people want is to get into a plan, form a relationship with doctors and insurers that they're comfortable with, and stay exactly where they are.

Now most people don't have a problem conceiving of the end result of personal and portable health insurance, but they have a problem in understanding how we would ever get from where we are now to this new system.

I'll tell you that if everyone is healthy, there's no problem at all; but of course everyone is not healthy, and so you have to think carefully about what you're going to do about people who are sick. You don't want to create a situation in which all the sick people don't have health insurance.

I discovered in this area, as within so many health care discussions, that people start out thinking about healthy people because most people are healthy, but before long, once you get into a plan you find out you're spending 95 percent of all your time thinking about what you're going to do about sick people, and if you don't think through that problem, you don't have a workable plan.

Our thinking on this topic started one night when I was sitting on an airplane next to the chairman of Blue Cross/Blue Shield of Texas, and I pointed out to him that once a year the Blue Cross agent comes to the NCPA wanting to re-enroll us, or enroll us in a Blue Cross group plan.

What I said is that you also sell individual insurance and you have this huge individual insurance pool, so why is it that every year we have to buy group insurance from you? Why can't I just enroll all the NCPA employees into your individual insurance pool?

His response to me was: Well, why would you want to do that? I said, well, for one thing, it's cheaper, contrary to what a lot of people think, and certainly, if we could buy into the individual pool, take advantage of the economies of scale of group buying, it would definitely be cheaper in Texas and in most other states.

Beyond that, we'd end up with a product owned by the employees, and it will be portable, and we went into all the advantages of portability.

So thinking along those lines, we began to talk to the Blue Cross actuaries about how we transition from where we are now to where we want to be, and basically we liked the idea of the employer starting off the process just the way employers function today.

Right now, annually, the employer has a contract for group health insurance and instead of buying a group policy, the employer would buy all the employees into an individual plan, a plan created specifically, perhaps, for this new type of system.

What that means is that, initially, employers would buy, the way they buy group health insurance and they would have to play by certain group rules, and what that means is that a certain percentage of eligible employees would have to join the plan, the employer would have to make a contribution that was a certain percentage of the cost of the plan, and these are rules that normally insurers require of employers.

Beyond that, the system would look something like this.

Our employer's share of the premiums would be paid with pretax dollars, so we don't really need to change the tax law, at all, to do this. I'd like to change the tax law, but even if we can't, at the state level we should be able to create a personal and portable insurance.

Initially, all the employees would enter the same pool. With the passage of time, they would be able to move to other plans and employees would move from one employer to another, and that's why you could end up, if you have 35 employees, with 35 different plans.

Incidentally, if we were talking about this 20 years ago, the NCPA would probably not want to do this if we had to individually write 35 different checks every month to 35 different plans, but in this day and age, you can handle it all electronically with the punch of a button, and it's very easy to have different plans for different employees, the ways you have different 401(k) choices for different employees.

The policies would be individually owned. There would be individual premiums based on age and perhaps other factors. In many small groups that's already done anyway, by the way.

Individuals would not be underwritten as individuals but the group would be experience rated, the same way you do it in group health insurance today, at least on the initial entry into the system, but not after you're in the system.

The pool's guaranteed renewable. Once in it, people can stay for as long as they like. No experience rating after entry. It doesn't matter who gets healthy, who gets sick. Everybody's rates go up the same. If they have to be increased at all, it's the same percentage for everyone in the pool, and, again, the contracts are long term. How long?

Well, I would say at least three years, and perhaps much longer than that. But we find that there's some evidence that beyond three years, it's hard to predict what people's health care is going to look like. So if you have at least a three year contract, it's hard for people to "game the system."

Now let's talk about how people are going to be able to move from one plan to the next, and as I said earlier, this is not the central feature here. What I think most people want is to be able to get into a plan they like and stay there.

But people will have occasions when they want to move from plan to plan, and we may even want to encourage that, and the question is how do you get that done?

Well, unlike other health care systems, and the system we're envisioning,there are very careful rules on how you enter and also very careful rules on how you leave, and before I get to that, I want to contrast that with a completely different model that many of you are familiar with and that's the managed competition model, the model that's currently in existence for federal employees, and I want to talk about that for just a moment because it contrasts with the way we think the system ought to work.

This is a cost curve for people in a health care plan and all we've done here is we've arrayed people from the sickest to the healthiest, along the horizontal axis, and what the curve shows is that these people down here who are the sickest cost the most, in fact they're spending most of the money, and these people down here are healthy and they're not spending much money at all.

Now if you are entering an insurance pool, any insurance pool, and you know you have to stay there for some time or you think there may be some difficulty getting from this plan to another plan, you have strong incentives to care about what the entire curve looks like.

In other words, you may be relatively healthy. You may be down here. But you know that while you're in this plan you may get heart disease, you may get cancer, and so you have a reason to care about how this plan takes care of people who are really sick and are high cost.

But if you're in a system where you can move at the drop of a hat and the minute your health condition changes, you can go join some other plan, then the only thing you need to care about is how the plan treats your health care condition.

So if you're down here in this range, all you need to care about when you enter this plan is how people, how the plan treats people like you ,and you have no reason to care about how it treats people who are not like you. That is a very, very bad incentive.

Now over on the supply side, here's how it looks to the manager of the pool which ma of course just the employer. In a managed competition system, everything's community rated, so everybody who enters the pool pays the same premium, and the plan's free to set the premium but it's the same premium for everyone, and of course what we're showing here is that if you're one of these stick patients, the plan's going to lose a lot of money on you because it's going to pay more for your health care than you're going to bring to the plan in premium income.

But if you're down here, the plan's going to view you as very profitable because you cost a lot less than you bring to the plan in premium income, and of course a lot of people have pointed out that in this system the plans have incentives to avoid the sick and attract the healthy.

What a lot of people don't realize is that the perverse incentives do not stop once everyone has rolled in the plan, they keep right on going, and this is where the issue of quality becomes so important.

I mean what's happening here is this plan, now, with all these enrollees at this end of the cost curve, these are the people the plan didn't want in the first place, it doesn't want to encourage them to stay and it doesn't want to encourage anyone else like them to join.

These people at this end of the curve are profitable. These are the people the plan wanted in the first place, it wants to keep them, it wants to encourage more people just like them to come to the plan.

So as far as quality of care is concerned, the managers of this plan have incentives to respond to these perversities in the following way.

Their incentive is really to overprovide to the healthy, because as they spend more on the healthy, they'll encourage them to stay in this plan, they'll encourage other people like them to join the plan.

Their incentive is to underprovide to the sick, again for the same reason. They're losing money, they didn't want the people in the first place, they don't want more people like them.

At this end of the diagram we have something that looks like the old airline deregulation. Some of you who are as old as me remember how the airlines used to compete. They couldn't lower their fares. So since they couldn't lower their fare, they couldn't compete priced down to the level of cost. They did the reverse. They competed cost up to the level of price by adding on amenities and quality improvements.

The other end of the graph is sort of like rent control. In rent control, the landlord can't raise his rent, he can't compete rent up to the level of cost, so you do the reverse. Through quality deterioration allow cost to come down to the level of price.

Now if nothing's standing in the way of these incentives, if you don't have professional ethics or malpractice or threat of criminal law, we'll follow these arrows right to the cost line, and the incentives here are to provide every enrollee with care exactly equal to the premium that he brings to the plan.

How far we go in that direction, I don't know but the incentives are terrible. This is the same graph with a risk-adjusted premium. A lot of people are very high on risk adjustment, but even with risk adjustment you have the same perverse incentives. The plan has an incentive to adjust cost to meet whatever risk-adjusted premium it receives.

Now in this diagram, I've assumed that the risk adjusters pretty well know who's sick and who's healthy, but the reality is in a lot of real world risk adjustment schemes, it's hard to predict who's going to be high cost and who's going to be low cost next year, and Mark Pauly and Phil Porter and I did a paper where we showed that if you can't, with some degree of accuracy, guess who's going to be your high-cost patient, who's going to be your low cost, risk adjustment can lead to worse results than if you didn't have risk adjustment at all.

I would point out that not only are the incentives in this system very perverse but there is a sense in which you can look at the entire employer-provided health care system as sort of a managed competition system writ large.

The reason I say that is imagine a world in which you're a potential employee, you have employers competing for you, the wage is the same at every job, the working conditions are the same at every job, but the health care plans differ.

When you approach an employer, you essentially face a community-rated premium to the degree that you have to pay part of the premium at all. That's kind of like the diagram we're looking at.

But over on the employer's side, employers know that if you come to the plan and you or a member of your family is sick and has high health care costs, well, you're like the people up here in this unprofitable region of this diagram.

On the other hand, if you're a healthy employee, members of your family are healthy, then you're like the people at the other end of the diagram. So there's a sense in which the entire employer-based system suffers from some of these same perverse incentives as the more stylized systems that we've been talking about.

Interestingly enough, if I can just have one more minute on this, this is what happens in Britain, it's what happens in Canada, it's what happens in New Zealand. Wherever politicians are rationing health care resources, they tend to underprovide to the sick and overprovide to the healthy. The reason they do is is because all the votes are over with the healthy people and the 4 percent of the population who, potentially, are going to spend half the health care resource, they're either too sick to vote or they may even be dead by the time of the next election.

So in those systems politicians underprovide to the people who most need the care and overprovide to people who don't need it, and that's why you can do polls and find that most people like the system, and at the same time discover that cancer patients can't get their drugs and the brain tumor patients can't get their MRI scan, and so forth.

The alternative is what we call a compensation model and that is a system under which movement among plans requires some kind of compensation at a minimum. One plan is not going to be able to dump its sick people on another plan, and we may want something even more elaborate than that and that's going to be what Tom Saving is going to talk to you about in just a moment.

By way of summary, let me say that personal and portable health insurance promises advantages, continuity of care, continuity of coverage, some rational way of imposing future costs on people, good incentives with respect to quality and is not inconsistent with an efficient economy.

It's something we can reach by building on where we are now but it is going to require care in how we permit people to move from plan to plan. Thank you.

MR. GINGRICH: Thank you very much, John.

As you'll see, these two fit together in answering one of the most important questions, which is that the way we have tried to design financing over the last 40 or 50 years, we have a consistent advantage to, in effect, what's called cherrypicking. As one example was explained to me 10, 12 years ago, if you are a clever insurance company and you are in a particular market, simply having your office on the second floor of a building with no elevator guarantees that you will select out, mathematically, for healthier people.

That may seem odd, but it actually, over time, has a significant statistical impact, and so in many ways, if you're an insurance company, you have today I think two really perverse incentives. The first is to try only to insure people who don't need it, because that way it's an optimum profit system. The second is to try not to pay out the money you've collected, because that way you get to keep it.

So if you were to look at the time value of money and all the different devices insurance companies use to minimize payment and to drag out the payment process, you see one of the major inefficiencies of the health system and one of the things which most drives doctors and hospitals crazy. On the other hand, if you look at the way in which risk adjustment is designed today by very clever people who sit around--and what they're doing is a perfect free enterprise model, in that they, inside their particular subset are saying, How do I maximize return for my investors? and it turns out that if you can only cover healthy people you get dramatically higher returns than if you cover sick people.

So I don't think that's a question of morality. These are not bad companies. These are people responding to the incentives that have been built over the last 50 or 60 years ,and doing precisely what I think economists would suggest to you rational behavior is in terms of the system as it has grown.

John Goodman has begun to outline a way of thinking about a much more stable system with much greater personal control, with much greater continuity, but it requires, as he ended his presentation, it requires rethinking what the incentives are in the system and how we can, to use the title that Dr. Saving gave us, you know, How do we create a market for sick people?

That is, how do we actually create the right incentives to create the right kind of insurance system?

Let me just say that Dr. Saving, who is both the director of the Private Enterprise Research Center at Texas A&M, and a senior fellow at the National Center for Policy Analysis, has a very distinguished background in economics.

He's been president of the Western Economics Association, president of the Southern Economics Association, president of the Association of Private Enterprise Education. But in addition to his academic ability, he clearly has an ability to be acceptable on a broad basis. President Clinton appointed him a public trustee of the Medicare and Social Security trust fund, a position he still holds, and President Bush appointed him to the President's commission to strengthen Social Security. So along with our former colleague here, Mark McClellan [ph], he's in a relatively small group who have been acceptable to both Presidents Clinton and Bush, and that in itself would be an achievement worthy of having you up here.

But would you walk us, Dr. Saving, through this model of how to create a market for sick people.

DR. SAVING: Thank you, Newt.

It's a pleasure to be here. I think the first thing I'd like to do, by way of introduction to this problem, is to--I wrote down here as John was speaking some little things versus something else, and one of them I wrote down was insurance versus insurance.

Now that sounds like those are the same thing, but in the health market, what we refer to as insurance is not that at all, and I think we want to refer to maintenance costs versus insurance.

In fact I was at the American Medical Association giving a little speech, a couple of years ago, and Jim Rogers and I were discussing this issue, How do you risk adjust? and I said it's interesting that in economic and in finance, we use the word "risk" to describe the uncertainty around an expected value.

In health care, we use the word "risk" to describe the expected value, and we consider a risky patient one with a high expected value. That's not risk, and I think that we can deal with that, and when we refer to, as John did, risk adjusting, or as the balanced budget amendment referred to, and as CMS is now doing, risk adjusting, they're really discussing expected value adjusting.

So that's really the key to creating these markets, however, and that's the reason I'm saying it here, is the key to doing this is to price the premium for maintenance, health care maintenance, on the basis of expected value, and to then sell insurance.

Now what's insurance? Well, insurance is the insuring yourself against a bad outcome. Well, what's a bad outcome? A bad outcome is if your health status changes, so that your expected value in the next go-round is different than it was in this go-round, and that's what makes you, if you've had a bad health shock, you've developed diabetes or you developed cancer, you become a bad outcome, and how do you deal with that and how do you buy that insurance, and it's an interesting concept.

I'm going to go through some things fairly quickly, which appear, may perhaps be unrelated to this, and we'll get to how you might actually accomplish this two-part pricing, as I'll call it, the pricing of maintenance and actual insurance, and we'd say, What's the problem that we're dealing with? John outlined it very well, so I won't spend much time on it, and some of the solutions I'm going to really suggest later on, are going to apply much more to the Medicare market and I'll tell you why--because there it's much easier to deal with this insurance aspect, and I'll discuss that, briefly, when we get to it.

but as John pointed out, in the non-Medicare market, which is the market where people are in at the moment, the extent we tax the young and healthy to pay for the high-cost users, we encourage them to be uninsured, and so we look at the uninsurance problem, we say those are young healthy people, we're pricing them out of the market, in effect, and if it weren't for the insurance aspect of this, if it was just the health maintenance part, they wouldn't be in the market at all, and there may be no other way for them to buy this insurance, so we're monopoly kind of pricing it to them and they're way overpaying.

In the Medicare market, the reimbursement policy encourages the high-cost user and this was John's point, to be in fee-for-service Medicare, and Medicare plus choice providers, to try to avoid enrolling the high-cost users.

Now the third thing is, as Newt knows from being in--as any of the political aspects know, because consumers and payers are different. Consumers make no effort to control expenditures. As I like to say, if we had travel care like we have Medicare, there wouldn't be any coach seats on the airplanes. So I think it's important.

Now what's the benefits of health status-based premiums? and by health status-based premiums i really mean maintenance costs.

One, preexisting conditions are not a deterrent to obtaining coverage. Preexisting conditions don't matter. They don't matter for a very simple reason, that the premiums are, expected, cost-based. Now the insurance--and if you're a very sick person, in a sense, you have a disease that has high costs, high expected costs, you may have actually very small variance. You may have very little risk.

In fact you might argue that the healthiest people have the biggest risk cause they have the biggest change, potential change in their status. So they're the ones who are going to pay the big insurance premium, and the very small health maintenance premium.

If you have health status-based premiums, customers will be able to move freely between providers, if--and that's a big if--if there's a insurance component in what they're paying, because then their last provider has actually sold them a health status insurance policy and they'll pay off on that policy should their health status change, and that will allow them, in their new health status, to have the funding to pay the new health status-based premium.

The young and healthy aren't priced out of the market because their maintenance premium will be low. So I've indicated to you of course their insurance premium will be perhaps much higher. They may be much riskier. But we've done very little research on that.

Our research is really basically on predicting expected values and not actually about risk and I think it's important that we get at this notion of trying to price the risk here and not the expected value, and in this case we'll have competition for both the sick and the healthy because the sick will, sick meaning the high expected value people, will be equally desirable to suppliers, and in fact since they may have lower risk, they may be more desirable.

Now the current reforms that try to address provider screening, which is the item that John was talking about, where you try to get the healthy people into your plan because of community rating, we have the 1997 mandate that CMS developed, then HCFA, now CMS, developed risk-adjusted premiums.

They used the primary inpatient diagnostic cost group, which is the model they began with. That model does not carry you very far, as we know, because it's based on the last diagnosis that you had, which provides very little information.

Now that's the only information that you had from the continuous Medicare history file or the other files that are really kept by CMS, until they developed the newest file which had a lot of onerous recordkeeping on the part of suppliers but, in any case, they're resolving this, and the hierarchical condition category model is based on--is disease based versus last diagnosis cost group based. So it puts people into a disease category, does a much more effective job of forecasting the expected costs in the next year, and by "expected," I mean for that particular disease, and you may have more than one of these and get rereformed [?].

Now, once again, of course, these reforms, that is, are retrospective and, rather, no one is taking bids from providers to find out what they would be willing to accept, a diabetic patient who has ophthalmic complications, for example, which will be one of the disease categories in the 61 disease categories that CMS is going to use.

But we're not taking bids from anyone. CMS is providing to people what they're willing to reimburse at, in the hopes that, of course, someone who's more efficient at treating that kind of patient would like to attract that patient, and then, in the subsequent year, costs would fall.

Now John mentioned long-term contracting. One way to deal with this issue about insurance is to give people lifetime contracting, and you can do this for Medicare because of course CMA, when someone turns 65, you could argue that they have at least a pseudo account, and you could give that account to, the total amount to providers, they've got the up-front money now, they love sick people cause they're going to die in the next six months and they're going to keep the lifetime money.

So in this case, they'll favor sick people and try to get rid of the heathy guys who are going to live a long time.

I'll show you some data on exactly what those costs are like, because that's important to understand what's going on. The second thing that's important to understand what's going on is that expected costs rise with age. It's just as if you signed a maintenance contract on your car. You know, when it's new it requires very little maintenance. The older it gets, the more maintenance it requires.

But you could also have insurance on the car if bad things would happen to it, and that's the two aspects of the things I'm discussing . The age makes that cost go up and the only insurance part of this is when you go of the expected line just with age, and we'll talk about some of that.

In this case you'd give providers a guaranteed, a prespecified number of annual payments, regardless of customer survival, and I think that's an important criterion. So they benefit when the customer dies. They might lose money. But that's a question that's an empirical question.

While I say that, and it might sound obvious to you, we know there's a high cost of dying, so there's a real empirical question as to whether a long-lived customer is more costly in a long-term contract like this than a short-lived customer, and that depends on what those costs look like and we'll talk about those in a moment.

Then when a customer changes provider, the current provider has to pay the new provider a severance payment, and the severance payment is this insurance payment.

If you've had a change in health status, remember, the customer is paying for insurance. You're the carrier. It's just like you had a fire in your house. That's the downside, and it's very interesting--this is very much like in the financial markets, when you get an equity and it has a high variance in its return, there are two things you can do to get rid of the variance.

You can sell calls on the upside, so what you do is sell the upside to someone, and then you buy puts on the downside.

This insurance we're talking about here is basically a put. You're buying a put from the insurance company, from the provider, and if you have a bad outcome, something new happens to you, then they're provided to pay you an amount because that bad thing has happened to you.

We have that all the time in accidental death and dismemberment insurance, and this is exactly that kind of insurance.

Now if we're going to try to redo Medicare in this way and we have to get--something that the President's program is really trying to do--get catastrophic coverage, get prescription drug coverage, and get no first dollar coverage.

The latter part is not what they're suggesting, but the first two are. The last one is important in trying to make markets work. But I want to talk about why reform is necessary and then I want to very quickly go on past this, because this is something I'm going to do this afternoon.

But just to give us an idea in the Social Security aspect, these programs are very quickly going to be consuming half of all federal income tax revenues, and they're going from a point where they're providing money to the Treasury to taking more than half of all the federal income tax revenues.

We're going to have to dramatically change these programs if we're going to do anything, and given the time, I want to go back, I may come back to some of this.

Now these are some of the things I wanted to show you, some empirical evidence of what goes on here and how things work.

Here's the average annual Medicare reimbursements by age and age [inaudible] and it's kind of important because what this shows you and I--

DR. SAVING [continuing]: [in progress] the red line. Here are the individuals who, in the 1912 birth cohort, that's the one you have the most data for, who died at age seventy, and this is what they consumed in every year, and if you look at the seventy diers versus the red line for the seventy-five diers, the seventy-five diers consumed less health care every year of their life, and the eighty diers consumed even less health care every year of their life, and the eighty-five diers consumed less health care.

Healthy people live longer, and they consume less health care every year. Then the next, the blue line, is a ten year later cohort. So if you compare--and what's interesting about this is if you compare the seventy age of death, the cost of dying, in the blue line, this is ten years later, you can see that we're spending more money, in that ten years the cost of dying for a seventy-year dier is much more than it was ten years ago. It's much more for a seventy-five year dier than it was a decade ago, but on the other hand, the thing that this also shows is that the older you are when you die, the less we spend on dying. So as you'd expect. That's kind of an expected analysis we'd do for you.

Now the question is, What does that have to say about insurance and the notion? These are the present values, so that if you paid someone a long-term contract and gave them the decade of promised payments that I indicated to you, you can see who's the most profitable person for providers and it's sick people, people who aren't going to live very long.

You make the most money on people who aren't going to live very long. The longer they live, the more they cost you in a present value sense, and what's happening here is you're spreading things between two things. There's the risk of dying and there's longevity risk, and those are two risks that a provider has to take, and the providers are looking at both those risks and they're offsetting risks.

That is, dying is expensive but it also cuts off what you have to pay in the future. So these are offsetting risks and you can get a feel for this by looking at the one year, and these little curves tell you how much the very few people are spending, and we already know that 5 percent of the people spend 80 percent of all the dollars in health care.

But that's a one year sample and that's not really quite fair, because those individuals who spend a lot that year may spend very little the next year, and if you look at what's happening is, the curves just flatten out as you go to cumulative spending.

People get more and more alike as you lengthen the horizon, and we call that, in statistics, that's something referred to as regression to the mean. That is, people have high expenditures in a year, one, because they belong there, they're the high expenditure group, the other one is they've had a bad outcome that year and they're in the high expenditure group.

So the next year, a lot of those people revert back to normal, as you'd expect, because they didn't belong in the high expenditure group to start with.

Now this gives us an idea of what it would really take to price these things, because it asks us, if you're in the bottom of quartile in spending, between 65 and 69, what are you like in the remaining of your life? Remember, I showed you the graph that says, that implied, on the average, people tend to stay there. But what this shows you is how many people actually stay there, and as you can see, a lot of them stay there but a lot of them move to the top.

But the remaining lifetime spending for somebody who's at the bottom is 38,245, for someone at the top it's 57,000. Not surprisingly these are the numbers that you would have to compensate people for, to be able to move them, and it's a way--this can be done, and with Medicare it's much easier to do than it is in the younger population, and the reason for that is you can argue that CMS has a pseudo account for you, and in fact this would actually save them money, allow the sick to move, allow people to try to compete for the sick, and it's competition for the sick that's going to allow us, as Newt has talked about, to take advantage of low-cost techniques, because if you can find a low-cost technique to take care of the sick and these are the compensations you're getting for doing it, you will try to enroll the sick and you'll try to innovate in cost reduction innovation, and at the moment there's no incentive for anyone to try to invent techniques that reduce costs.

Every other industry that we're aware of, if you invent a cheaper way to do something, all the customers come to you, and as I say often, when I drive to Dallas I see these signs, and one of the members of my board of directors is the chief of radiological oncology at MD Anderson in Houston ,and I was talking to the board about this and saying, you know, I dream about, as I'm driving up and I see these signs that say Lasik surgery 595 an eye, everything taken care of, and I say I dream of the day when MD Anderson will have this ad.

Of course she just goes crazy at this point. But will say: Come to MD Anderson for cancer treatment, 295 a day, everything included. But I say you might say, "Come to MD Anderson but the price will never be mentioned because nobody cares."

But if people cared what it cost, that's the ad we'd see. Now she's a little perplexed about that but I think that's where we have to go if this can work. I think we can in fact create a market for sick people. But we first have to get our terms right. We have to argue about the same things, and this is about expected costs, maintenance costs and insurance. We can create that insurance market but we have to allow the pricing to go that way and nothing that we're doing at the moment does that. I know the risk-adjusted premiums don't do that, they only relate to the expected value part of this, so I can't say I yet have the answer, although within six months or so, I'm hoping to be much closer to that answer of how we provide the insurance aspect of this market. But in any case, conclusions.

Again, to get control of Medicare costs, something I'll talk about this afternoon, actually, customers must care about price. Community rating is not only not necessary in health care markets, but as John has pointed out, it's counterproductive.

In the long run, sick people are not more costly. They're only more costly in the short run. In fact healthy people are more costly in the long run, and ideally we'd like to see providers post prices that are what we now refer to as risk-adjusted but actually are expected value adjusted. Thank you.

MR. GINGRICH: Let me start by noting that if you listen to both Dr. Goodman and Dr. Saving, the number one characteristic of what we're talking about today is that the current system is not designed to produce the right outcome, either in medical behavior of financial behavior. I think this is a very important first break point that I think both of you would emphatically agree with, but I want the audience to really think about this.

We're making an argument that the entire current debate about health care is, in the end, misleading, and takes you down to a dead end because it doesn't get at deep enough changes.

The trying to reform the current system just becomes more expensive, more convoluted, more complex, because it is the underlying principles of the current system that aren't going to work.

I wold argue that we want a transformation in health rather than reform of health because a transformation implies moving to a different set of principles and a different set of structures whereas reform implies the current system's really okay, we have to just do a few small things.

When I talk about first principles, let me just give you four examples, one of which has come up here, but I think health, in my experience, and I spend a lot of time on national security and a lot of time on health and health care.

Health is about thirty times more complicated than national security. That is three thousand percent, not thirty percent more complicated, and it is an enormously dense process that literally involves both life and death and financial well-being for the society at large.

I think the only way you deal with systems this complex--I think this is what then Mrs. Clinton, now Senator Clinton, did not understand in '93. You can't invent single national legislative changes in systems this complicated.

What you can do is set a general direction in terms of a vision and you can go back to first principles from which you can generate lots of smaller initiatives, but you can't possibly take a system this large, this complex, with this many different variables, and design a single national change.

I want to give you four examples of principles, one of which we've just spent a good bit of time on. The first one--and this is very important, to have a principled argument about the future of health as opposed to arguing about the details of the latest proposal.

The first principle is simple. I think all three of us would argue markets work. That the historical evidence is that markets are the most effective way to have human organize their behavior, and that, as a general rule, markets tend to lead producers to provide more choices at higher quality, at lower cost.

Now that's a very important first question because the entire history of health, which has been embedded in a public service, bureaucratic, third party mentality, that is, regulatory behavior's important, markets are not. It is the duty of regulators to reshape markets and to protect you from the market.

That model, which in a sense grew out of the progressive movement at the turn of the last century, that model, we would argue, in fact, leads to bureaucratism, so that in the end, you have so much red tape and so much third party direction, that you lose all the underlying market power.

This is a very important test question because if congressional hearings and if administration, meetings started with the question, Since markets work, how do we migrate health back to markets? you have totally different discussions, than if the question is, How do we marginally reform the current third party bureaucracy to get a slightly better outcome? which actually turns out to produce more red tape, more expensive, more convolution, and not only more expensive, not as good outcome.

The second point I would make, which is on a slightly different topic, but I think it's central to thinking about lives as opposed to money, is that quality matters. But the fact is we have had, since the rise of Henry Ford's use of standardized parts in 1905, the rise of Alfred Sloan's invention of consumer pooled engineering at General Motors in the '20s, and the rise of Western Electric's quality program in the last '20s, we have had almost a century of experience in manufacturing, and in other activities, at producing dramatically more productivity at substantially lower cost.

You then arrive at health care where you learn, for example, that there are 2 million hospital-induced illnesses a year. That is, if you're in a hospital for more than four days, the odds are even money, the hospital will give you a disease which it will then charge you to cure.

Now there's no other place in American life where you would accept 2 million illnesses a year, a million 500,000 in long-term care facilities, illnesses a year. There's no other place in American life where you would accept that without some kind of systematic effort to find out what's going wrong.

There are an estimated 44,000 to 98,000 deaths from medical errors in hospitals annually. That's an Institute of Medicine number. That's the equivalent of losing one shuttle between New York and Washington daily. You'd never accept that. You would insist on some kind of dramatic change, if we were losing one shuttle a day.

So I just want to suggest to you that quality really matters except in health, and that you have to rethink the health system to figure out, how do you get the data, which is at the heart of quality, how do you get the systems thinking, which is at the heart of quality, and how do you create a culture of improvement?

Third. In the last 35 years, information technology matters . I mean, this particular presentation is live on television nationwide by satellite, through cable. Virtually all of you have cell phones, most of you have personal computers, people go on the Internet universally, or almost universally, 70 percent penetration, have use, if not ownership of computers. Then we come to doctors writing prescriptions.

Now we know doctors writing prescriptions is inherently dangerous. We know that it leads to medication errors. We know that 40 percent of all prescriptions require a call-back from a pharmacist to find out, What did you write? I can't read it. Did you know the patient's already taking something, and this will kill them? Or did you know there's a less-expensive version of the same thing available? 40 percent of all prescriptions.

Now a society, which tolerates doctors writing paper prescriptions this deep into the Information Age, is telling you, systemically, that something's wrong with the whole health field, that it hasn't migrated to the higher quality, more rapid, more accurate, less-expensive process.

Fourth example. Individuals have to be at the center of health, not patients, because you ought to be at the center of health before you're sick enough to become a patient. So if you look at actual lifetime costs, which is longer than the Medicare data, there is no question that a diabetic who learns early that they're diabetic, or even better, learns that genetically they are pre-diabetic, and learns to change their nutrition and their exercise, is stunningly less expressive and dramatically healthier than a person who goes through a cycle of losing their feet to amputation, going blind--diabetes is the largest cause of adult blindness--losing their kidneys and then having dialysis which is a $5.3 billion a year program, because while we won't give you insulin to avoid dialysis, once you're sick enough we will pay for your dialysis as a federal program, which has got to be maniacly [?], the most backwards way of thinking about human health that we have in this country, and finally, you get heart disease.

So if you take care of yourself with diabetes, you're still walking, you're still seeing, you're not going to a kidney dialysis center and you're not getting open heart surgery. But that requires a totally different structure than the current structure, and it starts by going from episodic care based on acute problems by random doctors you happen to be with this year, to a lifetime system of an electronic medical record and a sense that you own your care, both in terms of your personal health, and as John was saying, in terms of your paying for it. Because it's the connectivity of my money and my health that makes people believe it's real.

Now having said that, we have a series of handouts that we've given out today. My particular contribution is an introduction to our book, "Saving Lives and Saving Money," that'll come out in April. We have here, at the American Enterprise Institute, a health room. Dana Pavey, who's our director of research, will be glad to take any of you through it. We got to a health room because we decided if it's thirty times as complicated as national security, none of us were smart enough to even imagine it.

So we have been putting up on the four walls of the health room the entire system of which today's discussion of financing is only a piece. because you have to look at the system. You have to be aware of the scale of complexity we're trying to deal with when we discuss health care.

We are launching a Center for Health Transformation because I think this is a long-term iterative process, and anybody who is here today, or who's watching, who would like to know more, either about the book, "Saving Lives and Saving Money," or about our Center for Health Transformation, can go to Newt.org. my first name, dot org, and there's a link there that gets you there.

My focus for the next few minutes, though, is on the litigation aspect of this because it's a perfect case study of the fact that what you need is a transformation, not just a reform.

Trial lawyers basically make three arguments for why they should be able to get rich off of the health system, and make no bones about it, 58 percent of the money in litigation today does not go to the family of the patient who's the victim. 58 percent goes to administrative cost and trial lawyers.

Now here there are three basic arguments. first, law suits create better medicine. If we weren't punishing doctors, they wouldn't be good. I would argue the exact opposite is true. If law suits created better medicine, you wouldn't have 44,000 to 98,000 medical error deaths a year. You wouldn't have 2 million hospital-induced illnesses. In fact the threat of law suits suppresses the information necessary to get to a quality system, because no rational hospital and no rational doctor is going to voluntarily post what would become an advertisement for a law suit.

So without serious reform of the system, I would argue transformation, as I'll describe as a second--I don't think you can get to real quality because the trial lawyers are the major impediment to quality, both financially and psychologically.

Second, lawyers argue that law suits punish bad doctors. That's simply statistically not true, and ironically, it's not true on two opposite fronts.

First of all, whether or not a bad doctor ever gets punished is a matter of a random lottery. Did the right patient find the right trial lawyer to get to the right jury, and were they persistent enough?

Second, it turns out that a vast number of the cases don't involve bad doctors. They involve very good doctors. In fact a substantial number of the cases involve very good doctors in which everybody agrees they did nothing wrong but the jury feels sympathetic for the victim, and so the jury, in effect, punishes a great doctor doing a great job, takes up a year and a half or two years of their life, diverts their attention, weakens the number of patients they can deal with, even though every expert looking at the case says nothing went wrong here. This was good care. It had, unfortunately, a bad outcome because sometimes even great care, health is so complicated, even with great care you can still have a bad outcome.

So you have a system which neither punishes the bad nor protects the good but in fact is a random lottery of litigation.

Finally, trial lawyers argue they have to have that big a share of the money because otherwise they couldn't afford to take care of the poor. That the only way the poor can get legal care is to be able to have a lawyer who's willing to gamble because the upside is so big.

Interestingly, about 20 years ago, New Zealand looked at precisely this model, and after a long commission, New Zealand concluded it was taking too much time, it diverted too much money away from the patient who needs the money, it was too random, and it was in fact highly destructive, and New Zealand went to a very different system of health justice, and I just want to suggest to you a couple of principles.

First, as a first principle, every American under our Constitution has the right to a jury trial involving an equity situation. It's actually in the Bill of Rights as a constitutional amendment. That occurred because the FOUnding Fathers believed that the second greatest value, after the right to representation before taxation was the right to have your neighbors and your peers judge you in a case because they so deeply distrusted the judges appointed by the British king.

So it's very deep in the American culture, that you have the right to protect yourself, that the legal system is the place you go to to protect yourself, and I would argue that any argument for reform that allows the trial lawyer to masquerade as the defender of that right, is going to have a constant uphill problem.

Instead I would argue we should consider inventing a system of health justice in which you could have immediate access, even without a lawyer, if you didn't want one. You could have your case heard with very real speed by a panel who could give you an award, if you deserved one, with none of the money going to lawyers, or a very modest amount, with no loss of time, because remember--one of the side effects, both in workmen's compensation and in malpractice suits is that people who should be rehabilitated are often told by their lawyer: Don't get rehabilitated before the trial, because if you're totally rehabilitated before the trial, the jury won't believe you ought to get the money.

Yet the fact is every medical study I know of says the earlier you start rehabilitation, the less damage there is, the more complete your life is.

So we currently have a system which actually encourages bad medical behavior in order to get more money. Now the system I'm describing, a system of health justice, would have an immediate access to a health court, the health court could immediately judge whether or not you have a legitimate case, they could immediately make a decision in a matter of weeks, not years.

If you decided you had not been treated fairly, you would still have a safety valve of going to a civil court, getting a judge, but you would take the judgment with you. Now why does that matter? It matters because that random trial lawyer looking for the blackmail case, where it's easier to settle out of court than to actually try the case, would suddenly be faced with having to climb the mountain of the prior judgment of the expert panel that concluded you didn't have a good case, and my guess is 80 or 90 percent of the current blackmail cases would disappear because they simply wouldn't make any sense.

Furthermore, most of the legitimate cases would disappear because the health care would say you're right, you need the money, and the goal ought to be to get something like 85 or 90 percent of the money actually to the family that needs the money rather than to either the administrative process or the lawyers.

Now notice what I've just described, because it's parallel to what both Dr. Goodman and Dr. Saving described. I'm suggesting to you that the current system is not, in the long run, reformable in a healthy way, in terms of litigation.

What we need to do is reconceptualize based on first principles. How do we ensure that you have access to protect yourself? How do we ensure that you have access to resources if you need them? How do we do so in a way which is both fair to you as an individual, fair to the medical professional, which actually encourages bringing up information, encourages working on quality, encourages surfacing mistakes, and does so in a way that both saves lives and saves money.

Let me say, finally, I believe so deeply in the quality side of this, that I think we should pass a reform which doctors and hospitals could only participate in if they were prepared to post their mistakes and post their problems with things like hospital-induced illness, and if you posted it, you'd be in the new system and you would go to a health court. But if you didn't post it, you would be immediately available for the old system because you would have been betraying your trust both to your patient and to the larger society.

I think we have to say to doctors and hospitals, we are not going to tolerate 45- to 98,000 people a year dying from errors. We're not going to tolerate 2 million hospital-induced illnesses, and a million, 500,000 nursing home-induced illnesses.

But in return for your participation in creating quality, we are prepared to provide you a fairer, a more stable and a more rational system of justice than the current litigation lottery that I think has every doctor and every hospital worried that it could literally bankrupt them.

So you've had three big ideas, I know a number of folks in this audience, this is not a group that is passive or meek, and we're going to turn it over now to the audience to jump in, and I think we have several microphones. So who would like to start. Way in the back. Yes, ma'am?

QUESTION: Thank you very much. I'm having difficulty tracking how the premium would be established under the proposal for the individual, and I have a second question, if you need more questions.

MR. GINGRICH: John, do you want to start by, either one of you comment on how the premium will be established.

DR. SAVING: Well, in the system I described the premium would be established by the marketplace, and I described a system in which employers initially buy all their employees into an individual pool, and so there's competition among the pools, and employers choose one, just like they choose group health insurance today. So you initially buy this insurance the way you buy group insurance.

Then once in the pool, premiums would rise the way they rise with individual insurance. So you buy in the way you buy group insurance, but in subsequent years the premiums rise the way they do in individual plans, which means you can't single out people for changes in health status. Everybody's premium goes up the same.

Is that what you meant?

QUESTION: So you're just saying the only adjustments that can be made once you're in the pool is for age rating, is really what you're saying?

DR. GOODMAN: No. What I'm saying is once you're in the pool premiums go up as costs go up and they go up the same percent for everyone in the pool.

QUESTION: Right. But the individual adjustments on top of that would relate to age rating?

DR. GOODMAN: Well, in what I described there are not individual adjustments on top of that.

QUESTION: So it will be group rating all the way. There wouldn't be any--I was just having a hard time because if you listen to both of what--

MR. GINGRICH: Well, if you'd yield for a second, I think Dr. Saving may want to comment, because I think his model is slightly different--

[Simultaneous conversation.]

DR. GOODMAN: There is a difference in what we're talking about.

QUESTION: Okay. Oh, good.

DR. SAVING Yeah.

DR. GOODMAN: So that's probably what's confusing you.

DR. SAVING: In response to your question, I think the premiums themselves are expected value-based, so that means that if you have a health shock during the year and you're now a much higher expected value, that premium rises. Now in the sense--now be careful now, because the premium I'm discussing already has two components. This is like a two-part tariff.

Part one is someone is going to pay the maintenance on your house for the year, and you know what that's going to cost, electric bill, all that kind of stuff, and you pay that amount, and that's going to be individually based on your house.

Now you're also going to buy insurance as you do. If you have a house, you have it insured, and you have it insured against various kinds of casualty risk, and in this case ,for health care, the casualty risk is a change in your health status, and you're going to buy health status insurance.

If you have a negative shock to your health status, the next year, what will happen is of course your premium's going to rise significantly, but the insurance is going to cover that because that's why you bought the insurance, and I think that's important, to separate those two things, because if we're going to have a market for sick people, the sick people, one, have--the price at which the provider is going to get has to be the expected value of that patient. Otherwise no one wants them, and, secondly, they have to have the wherewithal to actually pay the price, if we're going to have a system that's really done in a private kind of a world, and the insurance takes care of that.

So I think in both of those aspects, this can be done, but unless we get the words right, and unless we know it, that we're discussing exactly the same thing, we can't revise the system. It's not going to work. We're always talking about different things. We're talking about insurance, except it's really expected value, it's not insurance at all, and so let's get the analysis right, let's talk about the right thing, and then we can do it, this can be done, and it's going to be easier perhaps to do it for Medicare because, as I've indicated, CMS might have a shadow account for everyone, and the money is really there, and we don't know what this insurance premium really is because we've never really addressed risk, and we need to do that, and we haven't done it very well yet. Risk, we've al--is expected value.

MR. GINGRICH: Can I--if I can pick up on what she asked, since I'm not an economist, and as a historian I sometimes get lost. If I understand what you're saying, in effect there is a maintenance fee, which is sort of the ongoing expenses, and what we have done today is we simply have sort of a prepaid maintenance fee that is part of this larger point, and then there's actually an insurance fee which is where you are buying coverage against the possibility that you will in fact get much sicker or have some negative event. I mean, is that the two boxes?

DR. SAVING: That's right, and the advantage of this over what John was discussing is that only you, and only your expected costs are affected by a negative shock. The people who happen to be bunched in with you in their group, their expected costs haven't changed, why should they pay because you had a bad shock? and I think that's important.

What is it about--why should we make this a common property deal? It's not common property, and in fact the whole idea of having these policies be expected costs-based is that they're not common property, and you've paid the insurance premium. When your house has a fire, everyone else's insurance premium doesn't go up, and I think this is important, to make, to separate these two things, and we separate them, we solve an awful lot of problems.

MR. GINGRICH: Who else had a question? [inaudible].

QUESTION: Thanks. I think it's worse than that. I think the combination--I mean, it isn't insurance. It's like a third party payment for your annual grocery bill. You know, your employer contributes and you go and buy groceries, and eventually the grocery store gets reimbursed, maybe, depending on the rules.

I think the combination, and the last time I tripped across numbers, more than 80 percent of our health care spending is third party payment.

I think, effectively, there's no difference among third party payers, whether they're private sector, government, or employer funded, or directly consumer funded.

In terms of the type of economic behavior they induce in the consumer, they make health care look substantially like a free good. You know what a free good generates in terms of demand, essentially infinite demand. So that's the cost driver, I suspect, if you looked a little further.

Combine that with an increasingly regulated delivery system and you've got intermediaries who don't know how to price their product, and take every measure, scrupulous and unscrupulous, as Mr. Gingrich alluded to, to keep costs down. I think first principles really do matter, and the first principle that matters most is your first principle, and I would take it to the logical corollary, that the most important specific policy conclusion there is to roll back, where possible, third party payment in this whole process, and that one-pager on MSA is probably the most high leverage policy item in the package.

MR. GINGRICH: John, do you want to comment.

DR. GOODMAN: Sure. I agree with you, totally. So we need a regular medical savings account which covers everything that's discretionary, everything that's routine, but you need the third party insurance for the catastrophic events.

Now a lot of people think that the medical savings account ought to end with the small dollar items, but I in fact think we ought to--I didn't talk about this today--think in terms of the casualty model of insurance. You know, if you have hail damage to your roof, what happens if an adjuster comes out, you agree on a price, and that price is sufficient to cover repair to the roof.

But if you want to have a nicer roof, you can add money to it, and so the adjuster's not really telling you what you have to do. He's just giving you the financial ability to repair your roof. I don't see a reason why we couldn't apply the same model to health care.

I think the medical savings account can have an important role to play, even for heart care and cancer care and expensive care, provided we have that underlying casualty model of insurance to cover the bulk of the expense.

MR. GINGRICH: Dr. Saving.

DR. SAVING: I think that's a really good point because in the system that I'm discussing, you can separate of course the expected costs from the insurance, and in fact what we're really looking at is something in the original--and some of you are old enough, some of us are old enough to remember when Disneyland used to have a two-part tariff. That is, you had an entrance fee into the park and you paid for the rides, and the more popular rides had higher prices, and the Six Flags motif, which was you paid once, which is the health care idea, and you rode all you wanted to, all day.

Now it's clear in that market, the one-part tariff, the buy and spend the day at the park is what's one in the competitive marketplace, but here it's important to recognize that if you don't have to worry about catastrophic care, and the insurance is what's buying you a change in health status, so you already have that coverage, you don't have to enroll in--if the common property deal makes consumption more expensive, people won't be in that part of the health care system.

They'll pay themselves. Cause that's an option. Each year when you come up, you don't have to be in the system. You can just go in fee for service, and pay for your own, and as long as you've got the insurance part of it, you're covered for things that matter, and that's why people care about this, and I think we can solve that problem in that way, and that would drive the prices of this other thing down to exactly the same as if you didn't have the third party, cause then you would solve the common property issue. But that's an important point and I'm glad you made it.

MR. GINGRICH: First of all, the Bush administration, last year, took a step in your direction when they changed the rules so that flexible spending accounts can now carry over, and that means that for, I think about 85 million people who have a flexible spending account, you don't have to rush out and spend it in December or lose it, and it's a first step in the right direction. In our book, "Saving Lives and Saving Money," we have a specific proposal as an idea to think about. I don't want to defend it, in detail. But building on things that John has worked on before, we suggest a health spending account where, when you first went to work you'd get a $1500 deductible insurance and the $1500 would be in an account.

The account would carry over, have tax-free interest build-up, so by the time you were in your thirties or forties, you would probably have somewhere between 30- and $50,000 in a health spending account, which means you're only buying insurance for events which would be above that number. We also suggest that at some number--and the values are probably in the 20- to 30,000 range--wherever it no longer dramatically lowers the premium for insurance, that we would give you the option of either withdrawing the money as taxable income, or allowing it to stay in and continue to build up for as long as you want it to.

Now our goal was to find a way to migrate from the current system back to you having a first dollar interest in your own health, and I just want to say one thing that I--because health, like education, is one of those zones that we took out of the marketplace, decided people were too stupid to take care of themselves, and said you have to have gatekeepers and bureaucrats, what have you.

I get the pushback, "Oh, if that was your money, maybe you wouldn't take care of yourself."

Now my point to everybody is when you have your own house and you have to repair it, you have to make a real decision about your money. If you drive a car and it needs to have the oil changed, you have to make a real decision about your money.

We routinely assume that if people are in the marketplace about theirselves, that they have a longer time horizon than this afternoon, it's not always--all of us violate that principle on occasion, but the whole core of a free society is a belief that all of us in fact will have longer time horizons than this afternoon, and so we believe if you had the money, if it was in your account, that you would in fact--and you'd rapidly build information systems so people would have access to a lot more knowledge about which drug they're buying, what other alternative drugs they could buy, what are the hospital's records on safety, et cetera, cause you'd have changed the locus of responsibility and power back to the individual.

So I think this is actually a step towards your two-tier model, where the maintenance would all come out of your health spending account and only the catastrophic problems would in fact require insurance.

DR. SAVING: I agree, it is a good step. I'm not convinced that I would be in favor of a system that makes you keep all the money in your health account, because we don't do that, to build up money in your house account so that you don't have to have fire insurance, and you ought to be free to choose either one, and I think it's important, that choice, and in fact no one probably builds up an account at their bank, the fire insurance account, that when it gets equal to the value of their house they no longer buy fire insurance.

So I suspect that the market would be the one in which people would not want to do that.

MR. GINGRICH: Who else has a question? Yes.

QUESTION: Would you speak about HIPPA, in general, and the privacy rule, in particular, and their effects on health care.

MR. GINGRICH: Do you want to talk about HIPPA or do you want me to?

DR. GOODMAN: I don't want--privacy--but I want to talk about HIPPA and why it prevents personal and portable health insurance. I'll just do this quickly. This isn't obvious. In fact we had the insurance commissioner's office in Texas look at this or had some Washington employee benefits lawyers look at this, and after many, many hours of research, they concluded that here are the rules.

That an employer cannot buy an individual insurance plan for an employee, and have that plan be paid for with pretax dollars. Okay. That violates HIPPA.

If he does it with after-tax dollars, he can get around HIPPA, but then he doesn't get the tax advantage. So you either can have the tax advantage or you can have portable insurance; but not both. Now when I've explained this to people on the Hill, they look shocked. They have no idea that HIPPA did this. But somebody must have known; otherwise, how do we get this result?

MR. GINGRICH: Dr. Saving.

DR. SAVING: One of the issues that I didn't mention but I meant to mention here, when I was doing it, is the privacy issue, and why would an individual in making a contract with somebody else not want to divulge information, and basically it's patients wanting to scam the providers.

So basically it's a law which encourages scamming on the part of patients in not revealing the asymmetric information, the information that they know about themselves, that the provider doesn't know, and if the provider tried to do the same kind of deal, and not say what it was, how they treated patients, you know, then they would have a problem, a legal problem with the contract, and in this case we're allowing individuals to make contracts in which they hide information that they actually have on themselves, and I think it's important for this private system, in which the insurance component of this would already have compensated you for your health status, that your health status is at that point known to everyone. You have no reason to try to scam anyone cause you already have the funds available to pay the expected value premium, and there's no scamming going on. I think that's important, though, and I think the issue about privacy and contracting is important.

MR. GINGRICH: Yes, ma'am?

QUESTION: For Mr. Goodman, I was wondering about why you think the individual market is less expensive and what is appealing to you about that as an employer?

DR. GOODMAN: In many places, Texas, for example, the individual market is less expensive because the small group market has become so dysfunctional primarily because of HIPPA.

What HIPPA has done is allow groups as small as two, and in some states, by the way, it's groups as small as one, get to buy insurance under the guaranteed issue rules. What that means is that if you have a small organization, everyone's healthy, you can go bare and avoid all those expensive insurance premiums, and wait until some member of the group gets sick, and then you buy in, guaranteed issue, inside a band that controls how high the rates can be, and there you have your insurance.

This is gaming the system, and this kind of gaming is creating so much havoc, quite frankly, in the small group market, that a firm like Mutual of Omaha, which used to sell insurance in every single state, is getting out completely out of the individual market and the small group market.

MR. GINGRICH: Let me just comment for a second. I think there's a powerful reason that you ultimately want individuals to own their own health maintenance and insurance, and I like the distinction that Dr. Saving makes, but if you design it right in the age of the Internet and you take out most of the intermediation costs of all the various people who currently live off selling you the insurance premium, and if, in addition, you have the right kind of risk adjusting on the part of--I may be using risk adjusting wrong here, so you can correct me--but so that you don't have cherrypicking.

So you've designed a system where the incentives are to have an honest relationship and to actually take care of everybody. I think then you actually could have what is, in effect, group insurance purchased individually.

I mean when you go to Wal-Mart, you're actually making an individual purchase but you've had an intermediary which has aggregated those purchase opportunities at the lowest possible cost.

Now we don't insist you actually have to set up your own retail store. Historically, individual insurance has been absurdly expensive, both because it optimizes the risk, since it's a group of one, and because the administrative cost of finding you, selling to you, and administering to you in a pre-Internet system is very, very expensive.

But if you designed what would in effect be pooled individual insurance, it would in fact maximize your responsibility and your choice, I think.

Yes? Right here.

QUESTION: It's become a pretty universal practice among larger employers now to take advantage of the IRS provisions that allow for flexible spending accounts up to $5,000 with "use it or lose it" provisions. I was wondering if Mr. Goodman could address whether he thinks this is part of the problem or part of the solution.

DR. GOODMAN: Sure. Let me just correct something Newt said a moment ago. It's that the Treasury ruled that the health reimbursement account should roll over. It could rule that the flexible spending account could roll over too. They haven't done that yet, and a lot of people in the administration think, well, Congress probably should make this decision.

As many people here know, the flexible spending account is an account where employees put pretax dollars in a monthly basis, it has a "use it or lose it" rule, and therefore, at the end of the year, if you still have money left in the account you're encouraged to spend it.

If these accounts could roll over, it would change the American health care system, dramatically, overnight, and why is that?

Because--and most people don't know this--employers can contribute to these accounts but most do not. If these accounts could roll over, then employers would have an incentive to create all kinds of new health care plans in which you have new kinds of divisions between what third party pays for and individuals pay for, and you don't have any of these arbitrary restrictions that we have on medical savings accounts.

See, even with medical savings account reform that's being proposed on the Hill, you're still going to have a thousand dollar deductible that's across the board and applies to everything.

But with a flexible spending account, the idea there is it fills any gap that happens to be in the third party plan, and so you have complete flexibility, and by the way, the most interesting medical saving accounts, the ones that have developed in South Africa where medical saving account plans have half the market there for private insurance, they're not across-the-board deductible plans.

There is typically no deductible in the hospital because they assume patients are not exercising a lot of discretion in the hospital. There is a high deductible for physicians visits because they figure there's a lot of discretion there. But if it's a drug that chronic patients need to take and failure to take the drug could lead to higher health care costs, they drop the deductible back to zero. There are a lot of other interesting innovations that I could talk about.

But you need flexibility. What Kennedy and Archer agreed to was great for 100,000 people, but if you want millions of people to have a health spending account, it needs to be completely flexible, it needs to be an account that can change from year to year, and that can't happen if Congress is telling you what exactly it has to look like.

DR. SAVING: I think another issue with that is, What do you do with the saving that's left over? I think it's very important--the fact that the current flexible savings accounts are not valuable because it actually encourages people to treat the same common property problem, is treating it as if it's all first dollar coverage. But my argument is that you would want those to actually revert back to the individuals as cash in their pocket. They have to treat this as if it's their own money, and I think that's important, and when I was dealing with the HHS people in Texas who are concerned about Medicare patients going, using the emergency room as their family doctor whenever they have the sniffles, and they were asking me, you know, how you might deal with this, and I said, well, you have to charge them when they go in.

They said, well, we're thinking about doing that, it's a $2 charge, and I thought, well, you're wasting your time. It costs two or three hundred dollars to go to the emergency room and you're going to charge them two dollars. You need to charge them two or three hundred.

They said, well, where would they get the money? they're on Medicare. I said well, we would give them an account at the beginning of the year, and it may have $5,000 in it, and they've get to keep all of the money that's left at the end of the year. Every penny goes into their pocket. Now that, to the state, that's a strange way of thinking about the world, and I said then charge them full cost of the emergency room and none of them will go to the emergency room. They'll be going to the A.M./P.M. clinic. It's their money, and it'll actually be cheaper for the state.

Now that was an innovative way they were--and I don't know to what extent they'd have to get a special variance from the Bush administration, but they've indicated that they're going to be free with those things, perhaps, and they might be able to do it. But it's an innovative way to treat the Medicare market, where you have this inefficiency in the way they're consuming care.

VOICE: [inaudible].

DR. SAVING: Medicaid. I'm sorry. I meant to say--didn't I say Medicaid? I meant Medicaid. I'm sorry.

QUESTION: Dr. Saving, you present a very interesting model, particularly for Medicare. It kind of reminds me of a model presented, a competition model for other industries and markets by Dr. John Porter at the Harvard Business School.

What I'd like to know if you mentioned providers as being the competitors. Within the Medicare model, are you talking about clinics, doctor--

QUESTION: [in progress] it wasn't just the insurance company?

DR. SAVING: Well, no, it's not, it's not insurance companies, although they might be in the--in effect, of course, insurance companies, you know, for group insurance aren't in the insurance business anyway. They are in the paper shuffling business.

So at Texas A&M University, we have group health--I keep quotes around that insurance word in this case--but Blue Cross/Blue Shield handles it, but Blue Cross/Blue Shield is not at risk. I mean, we are at risk. We're the total risk-taker here, and all they do are shuffle the paper for us.

So, in a sense, when we get bids from providers--insurance companies, not providers themselves ,they deal with the providers. So it's this, see, you deal with the people who are going to do the paperwork for you. They deal with providers. They offer you an arrangement that your group might find more attractive than another group who came in who has a different set of providers, but you're right--they're not the providers--and this could work either way.

But I'm not sure why you need the intermediary, and in this case these people are intermediaries by accident, in effect, in the way this industry's been organized. But I would envision it'd be organized in a very different way than this and you wouldn't--but fee for service might require you to have someone who's going to handle the expected accounts. But at the beginning of each year, of course you'd have to decide whether you were going to be in one of these deals or not, and you don't have to be, because the only reason you're in one now is because of the bad outcome. But you're already insured for that in a separate kind of a market.

So I think it would open up completely and completely change the way the medical markets work.

MR. GINGRICH: Yes, ma'am?

QUESTION: Your new system assumes the employer as the access point. What do you do for people who are unemployed and don't have that access point, in your new system?

DR. SAVING: You're speaking to me. I don't say anything about who's--now it's true that the way John was discussing the method he was talking about, the employer is the access system. In the ideal world, we would completely do away with the favorable tax treatment for employers, perhaps completely take away and just refer to those fringes as ordinary income for employees, and then give them the same break as they move to their own, and that would get all employers out of the insurance business and we'd have totally portable insurance, and with this pricing system, the reason where employers are entered [?], there's no reason for that. It's just very strange. Employers aren't in any other business like that, and I think that it's inefficient and we need to get rid of the tax benefits of it and restore them to individuals instead of giving them as a property right to employers, and it'll change the employment market, too, as John has pointed out, and I think in very beneficial ways.

DR. GOODMAN: If I can comment on this. I like the Bush tax credit proposal. I helped design it. It provides a one thousand dollar refundable tax credit to people who buy their own insurance. I like the proposal and I like the amount, and the reason why I like the amount is because one thousand dollars is about what we're spending every year on free care for the uninsured in this country, and what I would like to do is go beyond what has been proposed and link up what we're doing on the spending side with what we're doing on the tax side.

Now I think what we ought to say to every American is the government's going to offer a thousand dollars for your health insurance, and if you choose to be uninsured, we're going to dump it into the safety net in the area where you live, and if you choose to have private insurance, we're going to give it to you in the form of refundable tax credit.

But we need to link the spending programs and the tax programs, and I think we'll find that the vast majority of people who are now uninsured would rather be insured than rely on a safety net.

MR. GINGRICH: In the very back.

QUESTION: Thank you.

Dr. Saving, Dr. Goodman, you're both trying to climb a very steep mountain on which some prior researchers have established a few base camps, primarily Cochran with his time consistent insurance in the mid '90s, and more recently, Mark Pauly with his incentive compatible guaranteed renewable insurance.

Now both of them had some problems. Cochran, because he really had a jump-off point at age 65 where he couldn't deal with the transition to Medicare. There's also some problems with being able to borrow at a relatively risk-free rate in the early going.

Pauly's proposal basically gives you individual insurance if you want to stay with that plan forever, but you don't really get to move around.

What type of institutional reform structure would provide some type of neutral honest agent which would enable that type of choice of plans to evolve, moving from, in effect, where you start to where you're going? In the case of Medicare, you've got to ask a public agency to be extremely nimble in being able to engage, allow market transactions and paying different amounts to different people.

In the case of the private side that John mentions, once that individual insurer as it, they're not going to want to let you go unless there's, in effect, some type of side payments, well-structured, by a neutral agent.

So how do you deal with the fact that health insurance is a service contract that's going to change over time, there are going to be different networks, there are going to be different types of care? You're projecting a long-term contract where the actual underlying nature of what's provided is going to vary quite a bit and you might want to have some competition from one insurer to another.

DR. SAVING: Well, let me comment, because I think that it's important--of course with Cochran, what he was doing, and given his background in finance, he was, in effect, selling calls to buy the puts, and that's where he had problems, because there wasn't really an up side, in a sense, where someone had the money to be able to pay, and that's where he got into trouble.

I'm envisioning a system in which what we now view as the providers are providing the expected cost, and a change in your health status is what you're paying for insurance. So, really, I have a one-sided market in the sense of the puts, in the same way that you deal with most other assets that you own.

In fact I think all assets that you own, except financial assets, are dealt with that way. No one is selling a call on the up side on their house but they are buying the put on the down side.

Now in financial markets we know--and that may be because simply the call market doesn't exist, and we know it does exist in the financial markets.

So in my view, these are totally separate events, and because they're separate events, the health part of this thing, it can be just a competitive market, and you can either be in it or out of it because you're insured on the down side.

So if you can insure on the down side, you don't have to be in what we now refer to as health insurance, because you are, individually, each year, going to make the decision of whether you're going to pay on a use basis or you're going to pay a lump sum fee for what your maintenance costs are going to be. I think that part's important and that's the way it'll work, but you're right--a lot of people have already worked on this and Cochran's piece was, I think, a very seminal piece in this area.

DR. GOODMAN: I think for the younger population, I'm not sure that we need something quite so elaborate as what Tom is talking about for Medicare or what Pauly or Cochran talked about. But at a minimum, I do think that we need this. That if you're a sick, high-cost patient, you don't move plans unless both plans agree, which means that the plan that you leave is probably going to have to--I'm sorry--the plan that takes you is going to have to be compensated. So you can have a simple market for sick people.

Now if a plan becomes, develops a comparative advantage, let's say in treating cancer patients, so it has lower costs, then the two plans can come together, and it's like international trade. Let's specialize and trade our patients. Now the patient doesn't have to move unless he agrees.

But if both plans agree that the move won't be good, it's hard for me to imagine the patient's going to disagree.

QUESTION: Dr. Saving, could you be more specific about the transition for the high expected value patients in your Medicare proposal.

DR. SAVING: Okay. Well, the issue would be--and that would be true in any, where you're going to make a transition, is that under the existing system you have high expected cost patients, and given the new way CMS is going to be dealing with this, I think that we're going to have a much better idea of what those are, and Medicare will simply have to give those--you call them "vouchers," if you like--that's a bad word in Washington. But it gets to the notion that you're going to empower the high-cost patients with a high amount of money in which to enter this market, and that's how you have to do the transition, and I think that's what we have in mind, in effect, right now, with these things