An article posted Sunday on the Los Angeles Times’s Web site reports that two new, potential blockbuster drugs to treat hepatitis C, Sovaldi and Olysio, will be priced as high as $1,000 per pill, or $84,000 for a 12-week treatment cycle.  Given the incidence of the illness, these prices could cost patients, insurers and taxpayers billions of dollars a year for California patients alone. This story illustrates one problem – although certainly not the only one – with the U.S. health-care system that makes it by far the most expensive in the world.  (We spend about 18 percent of economic output on medical care.)

In the United States, private health insurance sometimes excludes from coverage certain categories of care but essentially covers all treatments with any medical efficacy for illnesses that are covered, without any consideration of cost effectiveness.  Specifically, almost all insurance policies cover “medically necessary” care, a term usually left undefined.  If the insurance company refuses to cover a treatment recommended by a patient’s physician, the law of at least 44 states provides the patient with the right to appeal the decision to an external review panel independent of the insurer.  In almost all cases, the standard that the reviewer applies is entirely a medical one – i.e., whether the treatment is expected to provide any medical benefit – with no hint of concern for whether the likely medical benefits are justified in light of the treatment’s cost, at least in the absence of a lower-cost treatment option that is equally effective to the recommended one.

It is easy to see what kind of incentives this system provides: Patients who have low-deductible, low co-payment insurance will demand any and all pharmaceuticals and other treatments that promise any benefit at all, net of the risks and side effects of the treatment, without regard to cost.  This is a standard “moral hazard” problem.  And pharmaceutical companies, device manufacturers and health-care providers will price their products and services accordingly. Especially when the product is under patent, this system provides precious little in the way of a check on the seller’s pricing power.

Under the Affordable Care Act, more people will have private health insurance coverage, and new breadth-of-coverage requirements (when finally enforced!) will mean patients will find that their policies exclude fewer categories of treatment.  These reforms are net improvements, in my opinion at least, but they will exacerbate the moral hazard problem that plagues our health-care system and drives up costs.

Perhaps the new hepatitis C drugs are so valuable that it is efficient to prescribe them, and for the pool of insurance customers to eventually pay for them in the form of premium increases, even at their eye-popping price tag.  But it is also possible that the marginal health benefits of these drugs, compared to existing treatments, do not justify adding that much cost to the system.  The point is that, given the way the health insurance system is structured, we won’t be able to tell.

In a pair of articles — one published last month in the Michigan Law Review entitled “Comparative Effectiveness Research as Choice Architecture: The Behavioral Law and Economics Solution to the Health Care Cost Crisis,” and another to be published next month (but already available online) in the Journal of Health Politics, Policy, and Law entitled “Relative Value Health Insurance” —  I explore this problem in greater depth and propose a solution: Government provision of information to facilitate a private market for a (currently non-existent) product that I call “relative value health insurance.” 

Over the next week, I’ll publish a series of blog posts on different aspects of this pair of articles, starting with an explanation of my specific proposal and then turning to discussions of why other prominent proposals to deal with the moral hazard problem in health insurance are unlikely to be effective and the conceptual and practical problems that would need to be overcome to implement the proposal.