December 12, 2024
I’m not one to generally tout the wisdom of the economics discipline, but it actually does offer some useful insights into the likely motive for the murder of Brian Thompson, the CEO of United Healthcare (UHC). According to media accounts, the suspect, Luigi Mangione, was angered by his own and others’ experiences being turned down when submitting claims for healthcare service. United and other insurers make a profit by restricting the claims they pay, so their profit motive goes directly against people’s need to get healthcare.
That simple story is undeniably true, but the picture is more complicated. Many of the claims being submitted are outlandishly high, due to high prices for drugs and medical equipment, as well high fees for medical specialists and hospital administrators. In recent years, private equity firms have also seen the healthcare industry as a promising source of profits.
Our doctors on average get paid more than twice as much as their counterparts in other wealthy countries. Our pay structure for CEOs and other top corporate executives is out of whack and badly needs reforming. Private equity is largely a predatory industry that often profits by conducting itself in ways that would be too embarrassing for a publicly traded company.
These are all important sources of bloat in the healthcare sector, as is the insurance industry itself, but I want to focus on the relatively simple story of prices for drugs and medical equipment. This is where one of the most basic principles of economics, marginal cost pricing, has much to tell us.
When we see drugs that sell for tens of thousands of dollars — or even hundreds of thousands — for a course of treatment, it is almost never because the drug is expensive to manufacture and distribute. It is due to the fact that the government has granted the drug company a patent monopoly for its drug. It’s the same story with various types of medical equipment from scanning equipment to dialysis machines and other devices that can save lives. When a company has a monopoly on an item that can be essential to people’s health or life, it can charge an enormous price.
There is a logic to these patent monopolies: They give companies incentive to invest millions, or even billions, in developing these life-saving products. I’ll get back to this, but let’s first focus on the issue from the standpoint of society.
Suppose a drug company is charging $100,000 for a course of treatment for a serious disease. This number is not imaginary. When Sovaldi, the breakthrough drug for Hepatitis-C, was first introduced more than a decade ago, the company charged $84,000 for a three-month course of treatment, which was usually a complete cure for a debilitating and life-threatening illness. That would be well over $100,000 in today’s dollars.
If a patient told UHC, or any insurer, that it wanted it to pay $100,000 for a drug, it is understandable that it would want to scrutinize the proposed payment closely. It would want to be certain that the person actually had the condition for which they wanted treatment. Maybe it would demand verification from more than one doctor.
It would also want to be sure that the proposed treatment would actually be effective. Because of the huge markups allowed by patent monopolies, drug companies have enormous incentives to claim that their drugs are more effective than may really be the case. There may be risks for patients that drug companies conceal, as was the case with the addictiveness of the new generation of opioids. For these reasons, it is understandable that an insurer would want to make sure that the drug really was the best treatment for the patient.
The insurer would also reasonably ask if there are lower cost alternatives. If an extremely expensive drug provides only marginal benefits over a cheap generic (e.g. it need only be taken once a day rather than multiple times), it might be reasonable to insist that the patient take the cheap generic.
These issues arise because the drug can sell for a price that is far above its marginal cost. If we had Sovaldi selling for a few hundred dollars for a course of treatment, the price of generic Solvaldi, it’s unlikely the insurer would be asking many questions.
These sorts of issues arise with many of the situations where insurers decline approvals. This applies not only to drugs, but scans and the use of medical equipment. An insurer may not want to pay for a scan using the latest device but would instead insist on a simple X-ray or other cheaper scan. If there were no patents on the latest device, the cost of using it would be little different than the cost of a simple X-ray machine. In the no-patent world, there would be little reason for an insurer not to tell patients to use the best available technology.
Note that these issues would arise even if we had a single-payer system. A monopsonist buyer could force the drug companies and medical equipment manufacturers to accept lower prices, but we still would face the problem that they would be charging prices that are far above their marginal cost. In that case, there would still be good reason to carefully scrutinize the use of new drugs and medical equipment that cost far more than off-patent alternatives.
This stems from the mechanism for financing innovation. We want drug companies and medical equipment manufacturers to be able to make enough profit to give them incentive to innovate. If we forced their price down to generic levels, there would be no reason to make the investments needed to develop better drugs and medical equipment.
Another Way to Finance Innovation
We don’t have to rely on patent monopolies to finance research. There are alternative routes, most obviously direct public funding. We already spend more than $50 billion a year supporting biomedical research through the National Institutes of Health and other government agencies. The industry spends around $120 billion a year which it expects to be reimbursed through its patent monopolies. This spending would need to be replaced.
We would probably need an alternative structure to NIH for this funding. (I outline a system of long-term contracts in Rigged [it’s free], but we can debate how a system of public funding could be best structured.) However, the savings from having drugs and medical equipment available at generic prices would be enormous. We will spend over $650 billion this year on drugs and other pharmaceutical products, more than $5,000 per family. The cost would likely be in the neighborhood of $100 billion if they were sold without patent monopolies. We spend another $200 billion on medical equipment.
More important than the savings is the changed structure of incentives. Insurers, or whoever was deciding on whether to pay the tab, would be looking at the actual cost of the drug or medical device to society at the point where the patient needs it. As it is now, we are asking patients, who are almost by definition in bad health, to pay for research that might have been done (and paid for) ten or twenty years ago. That makes no sense.
We also would take away the incentive for drug companies and medical equipment manufacturers to misrepresent the safety and effectiveness of their products. This is especially the case if a requirement of getting public funding is that all research findings be fully open. In that case, the companies developing a drug or medical device would have no special access to information. The entire community of researchers would have all the same information.
Does This Fix the Healthcare System?
Having drugs and medical equipment sell at free market prices would eliminate many of the tough calls insurers make today. The insurance industry itself is still an enormous source of waste that would be eliminated with a single-payer type system, but many of the tough calls would still exist if we left our current patent monopoly system in place.
If we instead funded innovation upfront, and had cheap drugs and medical equipment, most of these tough calls would go away. There still would be cases where there are tough calls. For example, open-heart surgery can involve many hours from highly paid cardiologists and heart surgeons, as well as extensive preparation and follow-up from a number of other healthcare professionals. Should we be prepared to pay these costs for a person in their eighties or nineties?
Of course, this cost would be considerably less if we paid our doctors closer to what they get in other wealthy countries and didn’t have hospital administrators with ridiculously bloated salaries. But getting drugs and medical equipment at free market prices would be a great start in reducing the number of tough calls we have to make in deciding on medical care.
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