High Performance Health Care
Health Policy

Health Care Market Distortion – by John McCall with contributions from Jack Militello and Jean-Marc Choukroun

Friedrich Hayek was convinced the markets provide the best means to order the world.  For him and his circle of economists, top-down planning is necessary but that no single group of planners are able to manage the complex of modern systems.  Therefore, the markets need to be free to organization the business flow of economic systems.  On the other hand, markets cannot be left to complete self-regulation.  Governments should exist to insure that markets function well.  Today we see the interaction of health care markets and government playing out on a dysfunctional path of failed legislation, escalating costs, and diminished coverage.

A recent New York Times article (Mankin, 7/30/17) notes that in Econ 101, students learn that market economies allocate resources based on the forces of supply and demand. Prices adjust to bring supply and demand into balance.  This usually works out well, but not in the case of health care.  Blame can be shared among all the actors within the health care system.  Yet, reigning in the culprits may do little good because of the way policy making as distorted the health care market itself.


Market distortion is defined as any aberration in market behavior due to influences, events, or policies that are not consistent with perfect market competition and rule of law.  We should pause and reflect on the numerous ways our system has been distorted, and ask if reverting to a “free” market actually serves our needs or further complicates what is already an elusive challenge.

Distortion Number One: Tax-free employer-provided health insurance

Employer-provided health insurance enjoys an exemption from taxation. This exemption includes income as well as payroll taxes such as social security and Medicare tax. While private individuals need to purchase health insurance with after-tax dollars, exposing their total income to income, social security, and Medicare taxes, employees of corporations providing health insurance enjoy a tax break. Just under 50% of the U.S. population (155 million) is insured by employer-provided benefits. A rough estimate of the value of that exemption is $250 billion annually.   Also, this group is now taken out of the exchange-based insurance pool, failing to mitigate broader risks.

Whether or not one believes this is a good or bad thing, it is certainly a profound distortion of the market. It allows employers to offer a reduced-cost benefit to employees that smaller businesses and private individuals cannot.  Often, people prolong their working lives in order to maintain health insurance benefits that would otherwise be unaffordable as retirees.

Distortion Number Two: Insurance Regulations

Health insurance is regulated at the state level. Individual states may have disparate regulations governing coverages, provider access, provider due-process, pre-existing conditions, and a host of other purviews. Legislation specifically empowers the states to regulate insurance, but there is no question that doing business across all fifty states and the District of Columbia, with varying fees, applications, and regulatory requirements increases the cost of health insurance countrywide. In many states, there are oligopolistic conditions where a handful of insurers dominate the state market and have effective barriers to the entry of competition.

Distortion Number Three: Taxpayer Funded Health Care

In the private insurance market, insurees pay insurers to manage the financial risk of health care events. Private insurance is true insurance, a risk swap. Medicare, Medicaid, and VA Health Care are not true analogs to private insurance. They are entitlement programs to provide health care cost coverage or services based on program eligibility. While Medicare assesses the insured fees to offset the cost of the program, the business model of each is significantly different from true insurance. These three programs constitute just over a third of the entire population, with the percentage rising each year as the population ages.

These programs are funded by the American taxpayer and effectively remove from the potential total insurance pool certain groups that would otherwise have difficulty finding or affording health insurance. As such, they distort both the economics of health care and the health demographics of the population, In effect, the federal and state governments become the providers of last resort. Conversely, the insured pool becomes more predictable, lower cost, and more profitable.

Distortion Number Four: Uninsured Health Care Provision Law

The percentage of uninsured in the U.S. is less than 10% as reported by the Kaiser Foundation for 2015. Does this mean that this segment of the population does without health care? In some cases yes, in some no. Health care providers are obligated by the Emergency Medical Care and Treatment Labor Act (1986) that prohibits all hospitals from denying emergency care to indigent or uninsured patients, and also prohibits public hospitals from denying even non-emergency care. As a result, uncompensated health care cost $84.9B in 2013, also reported by Kaiser Foundation. For public hospitals, these costs are often borne by local or state taxpayers. The costs become highly opaque, in that respect.

As a market distortion, this law provides a less than ideal safety net for all potential patients, especially during medical emergencies. The system maybe prone to abuse and the uncompensated costs are often uncollectable, requiring health care providers to fund through a different means.

Distortion Number Five: Agency Problems

Agency problems typically involve two parties where one is acting on behalf of, and in the best interest of, the other party. In normal economic transactions, there is usually a buyer and a seller, and the two parties agree to a product/service at a price, consummating a transaction. In health care, there can be three or more agents involved, which complicates the buyer-seller relationship.  For the typical insured party, the cost of insurance may not be all that transparent, particularly employer-provided insurance. The employer manages the insurance purchase function, administers a good deal of the claims process, and acts as an advocate for the employee during dispute resolution. The cost of care is patently opaque, as the employee and even the employer are not privy to the details of the contract negotiation between the insurance payer and the provider.

As a result, consumer behavior is altered. Patients want the best care available and want it quickly. Where conditions are life-threatening, patients want the freedom to choose life-saving and life-extending treatments and expect them to be paid for through their insurance or alternative coverage. Patients behave less like rational consumers in health care than in most other markets. The layer of insurance and agency insulates the consumer from the normal repercussions of economic transactions.

The consumer/patient is often in a position of not knowing what is needed and relying on health care professionals to make care-related decisions.  Services and tests may be ordered out of caution, not necessity.  Insures apply guidelines to cover access and its related cost.  This may lead to the consumer/patient to accept these terms with being affected by the cost.



There are other distortions in the health care marketplace, but these five appear to have a predominating impact.

When the health care conversation leans toward free market solutions, one needs to be very careful to remember the following:

  • There are very few, true free markets. Almost all markets are encumbered with regulations, laws, policies, and other externals that influence their behavior.
  • Very few markets behave like true, free markets. Almost all markets have some level of monopolistic, oligopolistic, or regulated monopoly behavior. Where barriers to entry are high, regulatory influence is great, and public interest/health are affected, there is likely to be less entrepreneurial behavior, at least in the short run.
  • True free market approaches (laissez-faire, caveat emptor) can result in failed transactions where one or both parties suffer. That suffering is how the market develops and refines. Is suffering tolerable in the health care market?

Imagine what the health care market would look like if we removed the distortions listed above. Take away the tax advantage of employer-provided health insurance and how many companies would get out of providing insurance altogether? What would happen if gradually all employer-covered insured became a part of the private individual insurance market? What would happen to insurance pools?

What if Congress decided to exercise the Commerce Clause and allow health insurers to market across state lines? Would the criteria selected for national implementation be the low cost bar, or the high cost bar? Would opening the gates provide a more competitive insurance market? Would the insured benefit? Or would we wind up with 3-4 major insurance companies dominating the market?

The federal government isn’t getting out of the health care business, but it can profoundly influence the rest of the market by how it decides to reimburse providers. Today, providers flourish with privately-insured patients, break even with Medicare patients, and lose money on Medicaid patients, generally. What if the government reduced Medicare benefits to the level of Medicaid? What would be the impact on providers?

What would happen to providers who carry a significant amount of uncollectable, uninsured receivables if other payers such as local and state taxpayers decide to not fund these debts? Would there be a sector shakeout putting public hospitals at risk?

As deductibles move higher and higher, and as patients slowly become health care consumers, how will the market be impacted? Will patients make more health care decisions based on economics?

Our evolving health care system will indeed shake out over time. That’s the predictable outcome of disruption and change. But when we consider how to change, alter, repeal, and replace ACA, when we think about how to move in the right direction toward a marketplace where people can get the care they need without breaking the bank, it’s likely that this market will always be encumbered with social policy and safety nets that limit free market approaches. Ideally, those distortions can be safeguards against excess, but not preclude innovation and entrepreneurship

Previous Post

You Might Also Like