Adding Up the Reasons For Expensive Health Care

By Steven Pearlstein
Wednesday, February 14, 2007

It's hardly an original point, but now that health-care reform is back on the political agenda, it's worth emphasizing: The reason the system has been so resistant to change is that lots of powerful interests do very nicely with things just the way they are.

Or, put another way: Although doctors, hospitals, insurers and drug companies say they, too, want things to change, any comprehensive reform would reduce their incomes and their profits.

All this becomes quite clear from a new study on the U.S. health-care system released without fanfare last month by McKinsey Global Institute, the independent research arm of the giant consulting firm, which counts many health-industry giants among it clients.

The study aimed to determine why the United States spends nearly double the average of other industrialized countries on health care -- with no better, and in some cases inferior, medical outcomes. Even after adjusting for wealth, population mix and higher levels of some diseases, McKinsey calculated that we spend $477 billion a year more on health care than would be expected if the United States fit the spending pattern of 13 other advanced countries. That staggering waste of money works out to 3.6 percent of the nation's entire economic output, or $1,645 per person, every year.

In laying out with remarkable clarity how and where we overpay, the McKinsey report punctures myths, exposes common misconceptions and highlights realities long ignored in the health-care debate.

Let's start with one the American Medical Association hopes no one will notice, which is that American doctors make a lot more money than doctors elsewhere -- roughly twice as much. The average incomes of $274,000 for specialists and $173,000 for general practitioners are, respectively, 6.6 and 4.2 times those of the average patient. The rate in the other countries is 4 and 3.2.

According to McKinsey, the difference works out to $58 billion a year. What drives it is not how much doctors charge per procedure, but how many procedures they perform and how many patients they see -- a volume of business 60 percent higher here than elsewhere.

Included in the income figures is $8 billion physicians earn as investors in diagnostic labs and outpatient surgical clinics. The good news is that those private facilities charge 20 to 30 percent less than hospitals for what they do. But McKinsey found that they don't save the system any money because the doctors who invest in them wind up ordering more tests and surgeries than doctors who don't -- in the case of tests, two to eight times more.

What we have here is pretty good circumstantial evidence of Pearlstein's First Law of Health Economics, which holds that if you pay doctors on the basis of how many procedures they do, and you leave it to doctors and their insured patients to decide how much health care they get, consumption of health services will rise to whatever level is necessary for doctors to earn as much as the lawyers who sue them.

Don't be distracted by arguments that American doctors need to make more because they have to pay $20 billion a year in malpractice insurance premiums forced on them by a hostile legal system, or an equal amount for all the paperwork required by our private insurance system. The $58 billion in what the study defines as excess physician income is calculated after those expenses are paid.

And McKinsey gives the back of its hand to the argument that American doctors deserve to earn more because of all the loans they take out while going through medical school and residency. Comparing median lifetime annual salary to median educational debt at graduation, McKinsey found that doctors do better than those in other professions requiring advanced degrees.

While higher volume is the story behind higher physician costs in the United States, the culprit for spending on hospitals and drugs is higher prices.

While Americans spend fewer days in the hospital than people elsewhere, that efficiency is more than offset by a higher average cost per day -- $1,666, four times the industrial-country average. There are multiple causes for this $224 billion in annual overspending on hospital services -- everything from more serious illnesses to more nurses per bed to extraordinary overhead and capital costs. The hospitals will whine about all their free care for the uninsured. McKinsey concludes that is a relatively minor factor in an industry that has managed to rack up hefty operating profits in recent years, even at supposedly nonprofit hospitals.

Despite all that annoying drug advertising on TV, Americans pop fewer pills than people elsewhere. But, according to McKinsey, we still manage to spend $57 billion a year more for drugs than other developed countries. Some of that is because the newest and most expensive drugs are typically available here 18 months before most other places. But the much bigger reason, McKinsey found, is that drug companies are able to charge, on average, 60 to 70 percent more for branded prescription drugs.

We can debate whether drug companies really need the extraordinary returns they get to sustain the level of innovation they produce; one can certainly point to other innovative high-tech industries that manage to thrive on more reasonable returns. But the industry's vast lobbying apparatus has yet to come up with a credible reason for why such a disproportionate share of that return has to come from Americans.

Proponents of a government-run "single-payer" system will certainly home in on the $84 billion a year that McKinsey found that Americans spend to administer the private sector portion of its health system -- a cost that national health plans largely avoid. But as long as Americans continue to reject a government-run health system, a private system will require something close to the $30 billion a year in after-tax profits earned by health insurance companies. What may not be necessary, McKinsey suggests, is the $32 billion that the industry spends each year on marketing and figuring out the premium for each individual or group customer in each state. Insurance-market reform could eliminate much of that expense.

Of course, any effort to reduce these excess costs faces determined opposition from well-financed lobbies, which is why many reformers prefer to focus on the goal of extending coverage to the 47 million Americans who don't have health insurance. But doing the one without the other, the McKinsey researchers warn, would be economic folly. Offering universal coverage without reining in costs would add another $77 billion each year in unnecessary and unproductive health spending.

Steven Pearlstein can be reached

© 2007 The Washington Post Company