Is Private Health Insurance More Costly Than Public Health Insurance? Five Principles

Uwe Reinhardt had a post the other day at The New York Times economics blog comparing Medicare with Medicare Advantage (MA) plans. He basically sifts through the evidence on which is less costly: Medicare (a public plan) or the private MA plans. But while his column is definitely worth reading, it does not go far enough. In fact, given the persistent obsession with this question — especially by people on the left — I don’t understand why competent health care economists don’t clear the air of nonsense more decisively.

I consider the titular question of this post a silly question. People who think this is a legitimate issue invariably are making errors in economics or committing errors of logic or misunderstanding  institutional details or (as is the case with Paul Krugman) making all three mistakes in a single editorial. Notice I didn’t say anything about empirical evidence. Tom Saving and I did a bit of that for Health Affairs sometime back. But, we don’t need empirical evidence to resolve issues that arise only because someone hasn’t mastered the syllogism.

To help everyone think through this, I offer five principles.

Principle 1: There is almost nothing the government can do that the private sector cannot do as well or better.

Do you think a surgeon is likely to perform better surgery or more efficient surgery if he gets his fee from the government instead of Blue Cross? How about a nurse? Or a hospital administrator? If the answer is “no,” and it surely is, what is it about government that could possibly lower the cost of health care? The answer is: almost nothing.

It is sometimes said that government can produce things at a lower cost because the government doesn’t have to earn a profit. But people who say this never learned the concept of profit in Econ 101. Every hospital, every physician’s office, every other health care business requires capital. There is a cost of capital. If there are risks involved (the risk, for example, that aggregate fees will not be high enough to cover outlays) then the cost of capital is higher. These costs have nothing whatsoever to do with whether the entity is public or private.

Here is what is true: accountants do not typically record the cost of capital in the financial statements of public entities. But failure to record a cost doesn’t make it go away. To the contrary, ignoring the cost of capital in public accounting unquestionably makes public ventures prima facie less efficient — because investment decisions will tend to be made without regard to their real costs.

What about the idea that whole systems (with all their complexity) might work better if they are public rather than private? For example, for years the auto companies have complained that health care costs are so much higher in the United States. than for auto workers across the border in Canada. If so, there is a straightforward remedy.

There is nothing that the Canadian government is doing that the auto companies and the unions cannot do for themselves. As I have written before, the auto companies can form an HMO and tell it to ration medical care the same way the Canadians ration care.

That the auto companies don’t even seriously consider this option (all the while urging government to consider it) is understandable. The reason is cultural. When a Canadian doctor has to ration care, she is likely to tell the patient, “There is nothing more we can do.” The doctor almost never says, “We could save you, but the government cares more about money than it cares about you.”

An American doctor, however, might well say, “We could save you, but your employer cares more about profit that it cares about you” — thus generating a lot of employee ill will.

This is a cultural issue, though, not an economic one.

Principle 2: The few things government can uniquely do can be done without public insurance.

The advocates of socialized medicine frequently claim that government can use its position as a monopsony (single) buyer of care to negotiate lower provider fees. This is what they envision happens in Canada, for example. In fact, governments usually don’t bargain with medical providers. They simply announce a low price they intend to pay and the suppliers of care can take it or leave it. That’s what happens in the U.S. Medicaid program, for example, and almost a third of doctors decide to leave it — refusing to accept any new Medicaid patients.

However, and this is key, the government doesn’t need to pay provider fees in order to suppress them. It can simply impose price controls on all providers. In fact, if paying providers below-market fees is socially desirable, that is exactly what the government should do for all patients, not just the patients the government happens to insure. Such an act would not make health care more efficient, however, it would just shift costs from patients to the providers of care.

Remember: shifting costs is not the same thing as lowering costs.

Principle 3: Most public insurance in this country is actually administered by private insurance companies.

I can’t begin to count the number of people I have met who believe that BlueCross is evil because it is private and that Medicare is good because it is public. I usually ask, “Who do you think runs Medicare?” Following an awkward silence I usually supply the answer: “It’s BlueCross!” And other insurers.

From the beginning, Medicare and Medicaid have been mainly run by private contractors. Who else was going to do it? The government certainly had no experience doing so.

Now do you think that when BlueCross is called “Medicare” it suddenly becomes more efficient than when it is called “private insurer”? If not, then can we put this nonsense aside once and for all?

Principle 4: Most people with public insurance are in private sector health plans.

More than one out of every four Medicare beneficiaries is in a private Medicare Advantage plan and two-thirds [see here, page 13] of all Medicaid enrollees are in private plans under contract with state governments. In the future those numbers will likely rise. In fact, almost all of Medicaid will eventually be contracted out to the private sector as state governments desperately try to cope with the impact of Medicaid on state budgets. Why turn to the private sector? Because of the next principle.

Principle 5: It is only in the private sector that one finds anyone who has an incentive to lower costs without rationing care.

Most providers have an incentive to increase costs rather than lower them. Their incentive is to maximize against the payment formulas of third-party insurers — whether public or private. And surprisingly, most private insurers also have no incentive to lower costs other than by negotiating lower provider fees. BlueCross, for example, has no incentive to lower Medicare’s costs when it is administering Medicare. When its clients are private employers, BlueCross (for reasons that are historical and institutional, but ultimately because of bad government policies) rarely interferes with the practice of medicine. In Dallas, for example, virtually every hospital in the Metroplex (no matter how efficient or inefficient) is in the BlueCross network.  Similarly just about every doctor (no matter how good or how bad) can be in the BlueCross network if he or she chooses.

However, there are providers who do have an incentive to lower costs and they appear to be responding to those incentives. Surprisingly, they are using some of the techniques the Obama administration says it likes (medical homes, coordinated care, evidence-based medicine, etc.) and that appear not to work well when the government funds pilot programs to try them out. Even more surprising, where these efforts to make medical care more cost effective are most visible is in the Medicare Advantage plans — the very plans that president Obama and many Democrats in Congress seem to be hostile to.

I have previously reported on the efforts of IntegraNet, which appears to achieve good medical outcomes while holding costs down to about 70% of premium income. (Technically, that’s a 70% MLR.)

Two things are important to keep in mind when comparing what I have just said to the table in Uwe Reinhardt’s post. First, the people who are holding down costs and daily searching for new ways of doing so are not the insurance companies (the Medicare Advantage HMOs) — at least as far as I can tell. They are separate companies (e.g., independent doctors associations) operating under contract with the HMOs. Second, if what I am saying is true, the real cost of delivering care under the Medicare Advantage program is much lower than anyone realizes and it’s mainly going to the profits of the HMOs and the entities they are contracting with.

That implies that more competition (ah, more privatization!) has the potential to considerably reduce the taxpayer’s future burden.

Comments (24)

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  1. Paul H. says:

    Very good. Well done.

  2. Ken says:

    Glad to see this. There is so much nonsense written about this, including an editorial in the New York Times today.

  3. Charles Johnsen says:

    Wow! Reason, wisdom, and clarity!

  4. Buster says:

    If I recall the details correctly, Joseph Newhouse and his colleagues initially began the RAND Health Insurance Experiment (HI) to prove [Kenneth Arrow was correct] that health care indeed different — medicine care distributed collectively was more effective and efficient. However, they were startled at the results, which found individuals could control decisions and cut spending without adversely affecting their health. Proponents of Medicare For All can attest to huge efficiencies for centralized control of our health care dollars. However, the potential waste that approaches 30% of each dollar spent (according to various studies – including RAND HI) puts a huge dent in that argument. Add to that the fraud in public programs then the idea that bureaucrats can do a more efficient job running health insurance tends to diminish. Medicare cannot even agree to a scheme to efficiently require durable medical equipment vendors to bid on services. Medicare cannot formulate a program that forces hospitals to bid on which gets to perform certain procedures within a region. The political influence peddling in public programs is pervasive.

  5. Ramesh Chandra says:

    John, Great article as always.
    The best way to handle costs is let Insurance companies handle major medical thru HDHP plans($10k ded and up).
    Let individuals (at their choice), put deductible portin tax free in an h s a. Esentially they are self-insuring the first $ payments. They can spend or accumulate this amount for later use. They can invest this tax-free in investment of their choice and control it.
    This is the best way to really free up this country.

    More and more doctors r setting up mini-clinics, urgent care, and wellness programs.

    Unfortunately the Govt is throwing away money by interfering with the market place.

    Only one thing we can be thankful to the Democrats for. They awakened many entrepreneurs.

    We can c opportunities while competing against Govt. bureaucracy.

    Do u know most exchange hdhp plans in Wash state has deductibles of $20k and still the plans are expensive?

  6. Uwe Reinhardt says:


    I think what you have here is a set of credos to which you subscribe. You are welcome to them, but I do not feel compelled by logic to embrace these credos myself. But as a catechism for a particular doctrine your post reads well.

    One could have a lively debate about your first credo alone. It reads:

    “Principle 1: There is almost nothing the government can do that the private sector cannot do as well or better.”

    As an economist, you should know that here one must be clear about the meaning of “better.”

    A profit maximizing business firm has every incentive to minimize the production cost (to it) of producing a given batch of output.

    But it also has every incentive to extract the maximum revenue from society for that batch — cost to the consumer.

    So here’s a homework assignment: Suppose the Iraq war had been fought solely by private sector companies — by the Haliburtons of this world.

    Tell us how that would have gone better. Should have been an interesting read.

  7. Jane Orient says:

    “Private” plans (funded by tax money) DO have an incentive for covert rationing, and the “savings” go to the plan.

    I want OUT of Medicare. How about a way to buy seniors out, say for the $451/month it costs to buy in? This might allow a private market for catastrophic insurance (say deductible > $25,000). Or one might self insure, especially if “capital gains” tax were eliminated when assets were sold to pay bills.

    Hypothesis: B + D + “Supplemental” is a rip-off. Has anybody crunched numbers for premiums compared with maximal expected benefit in a year?

  8. Don McCanne says:

    The take on this general topic by Eduardo Porter in the New York Times I find much more compelling. Well worth a read:

  9. Al says:

    Uwe writes: “So here’s a homework assignment: Suppose the Iraq war had been fought solely by private sector companies — by the Haliburtons of this world.”

    If the contract was to get rid of Saddam the US troops would have been out of Iraq along time ago. That is one of the problems with government. Once a program is started it seems to almost never reach its end.

  10. Al says:

    John, if what you say is true “Second, if what I am saying is true, the real cost of delivering care under the Medicare Advantage program is much lower than anyone realizes and it’s mainly going to the profits of the HMOs and the entities they are contracting with.”

    something I don’t disagree with, then why does the Medicare Advantage program require a higher per capita payment?

  11. Kyle says:

    Dr. Reinhardt has a serious vendetta against pmcs. Because most contractors have different constraints than Uncle Sam, they have adapted to contemporary operating environments better than traditional forces. The U.S. military was not prepared for asymmetric entanglements, and has the burden of dealing with that whole pesky international approval thing. For some reason I doubt that neo-crusaders like Erik Prince care what Al-Jazeera has to say about him, but U.S. Presidents should. The point is, you’re comparing apples to oranges.

    Responsiveness and efficiency in state administered programs is a joke. Everyone knows it and no one is laughing.

  12. Deborah Thornton says:

    Just heard from a senior cititizen friend, who recently had his forearm and hand removed because of cancer – that instead of having 3 choices for a replacement – he now has only one, the worst quality, as a result of new medicare approval standards. Can’t pay himself for a better one, AND the arm/hand cost is about $150,000. Reimbursement only $85,000 to Dr. Cost to Dr. $100,000. Dr. loses $15,000 on providing it at all. And the medical device tax is about $15,000. Dr. basically said to him, “Are you sure you want this? It won’t work properly.” Can you say “rationing”? And a return to the dark ages?

  13. Devon Herrick says:

    I too read the Eduardo Porter article in the New York Times criticizing the profit motive as inappropriate for the health care industry. I’m a former accountant (and later an accounting manager) for a large, non-profit hospital system. As such, I find the argument that non-profit hospitals are somehow less greedy (and more benevolent) than for-profit hospitals to be naive. Non-profit status is a tax election – it does not remove the desire to earn a profit. Organizations that fail to earn a profit too many years in a row cease to be ongoing concerns.

    Back when I was an accountant, I remember how at the beginning of each month the hospital executives would begin calling for preliminary results about the financial performance of the previous month. The first questions were always about revenue for the month. Then they would ask questions about contractual allowance, bad debt and charity care write-offs. Then they’d ask how the expenses compared to budget. We couldn’t even close the books for the month before we were badgered for information. On the other hand, I recall very few calls when I was asked about statistics on the number of people helped (actually, there was another accountant in our office who tracked patient statistics). The calls I did receive about patient loads and nursing hours were always so a manager could fill out their report on productivity.

    There are good non-profit hospitals and bad non-profit hospitals. But the opposite is also true. Awhile back I read an analysis that discussed how opponents of for-profit hospitals often don’t account for the public good from taxes paid by for-profit hospitals.

  14. Alieta Eck, MD says:

    Excellent article, John.

    Only the actual providers of care, when working in a true free market, will be motivated to provide the best care at the lowest cost. Check out and see the free market at its best. Excellent prices are posted online for all to see. No subsidies– just third party free.

    Ramesh Chandra is correct when he says that the government throws away money by interefering with the marketplace. Federally Qualified Health Centers are a great example. These centers are able to give care at reduced fees because they are heavily subsidized by government grants PLUS no employed physician in a FQHC has to buy medical malpractice insurance.

    These FQHCs look like a great deal to the end-user, but the actual cost of care is $150 per patient visit. Contrast that with a private office that can provide care at $100 per patient visit with no government subsidies. Why are the taxpayers being forced to subsidize FQHCs?

  15. Don Levit says:

    Could you provide some specifics on the $20,000 deductible plans in Washington? Or at least provide us a link to the exchange’s web site?
    Are these plans available only to those 30 or younger, or those who cannot “afford” any other plan?
    That is how the PPACA reads for high deductible plans.
    My understanding of HDHPs is that they must correspond with deductibles of HSAs.
    To have deductibles of $20,000 or more, one would have to qualify his plan under “excepted benefits.”
    In that case, there would actually be 2 plans, with one plan covering the large deductible, and the second plan serving as a catastrophic plan.
    Don Levit

  16. Ron Bachman says:

    The delivery of medical care will never be private or free market until CMS stops setting the prices for services using privately controlled AMA CPT codes.

    Private businesses become competitive and efficient only when the can or have lost customers. Hospital CONs protect them from losing customers to competition from more efficent clinics and outpatient facilities. Doctor shortages and barriers to alternative providers protect that guild.

    Everyone has a profitable niche in a dysfunctional market.

    I have an additional principle for John: Anything the government gets involved with goes up in price. (e.g. healthcare, education, housing). I guarantee that we will pay more for health insurance next year than this year…ad nausea.

  17. Ramesh Chandra says:

    U and other ignorant economists(if u r one).
    U r so focused on looking at the big empty horizons and simplifying things with economic aggregates and useless measures.
    John writes with a lot of thought, not with ignorance.
    I deal with people and Doctors all day.

    I save people enough money with HDHP and health savings accounts that they have total freedom and best health care for today and tomorrow.

    Bt providing comprehensive health insurance, insurance companies with the help of Govt squandered public money.

    All u Macro-economists should go back to Micro-economics and pay attention to detail.

    Concentration of money and power are the root of evil.
    The biggest dictators in the world came from socialist and communist background.

    There is savings from consolidation upto certain extent and if consolidation is boxed in properly.

    We r working with a Govt. where decisions r made ideologists and people pass resolutions w/o even reading them.

    First principle should keep Govt out until u can prove it is an essential function or task.

    If O is so caring about the downtrodden, he should donate half his salary to them.

    If Buffett is so fair, he should pay taxes on his entire income before he takes deductions on his so-called charitable donations.

    If unions care about the membership, they should follow Robert Townsend’s 20% rule and reduce the membership fee to the minimum expenses of the union work, not for indulging in their political frenzy.

    So don’t be blind, open ur eyes.
    Talk details , if u can.

  18. Dorothy Calabrese, M.D. says:

    Jane Orient, M.D., Executive Director of AAPS writes:
    “I want OUT of Medicare.”

    SCOTUS ruled “NO” to this on 01-07-13, denying Petition for a Writ of Certiorari No. 12-262. The questions presented were as follows:

    Will Medicare patients be allowed to opt-out of Medicare without forfeiting (a) all their future Social Security benefits and (b) being forced to repay all Social Security benefits they’ve already received?

    (1) Under the Social Security and Medicare Acts, does the Social Security Administration have the power to condition the ability of a person to waive Medicare Part A (dealing with hospital insurance) on his or her surrender of all past and future Social Security benefits?

    (2) Does the recent decision of this Court in National Federation of Independent Business v. Sebelius, 567 U.S. ____, 132 S. Ct. 2566 (2012) impose constitutional limitations on the power of the Social Security Administration to condition the waiver of Medicare Part A on the surrender of all past and future Social Security benefits?

    (3) Should the Social Security Administration receive limited deference under Skidmore v. Swift & Co., 323 U.S. 134 (1944), when it offers no reasoned explanation for linking Social Security with Medicare Part A in short rules that on their face are motivated in part by SSA’s disagreement with the philosophical and religious beliefs of those individuals seeking to separate the two entitlement programs?

    The Docket is as follows:

    Brian Hall, et al., Petitioners
    Kathleen Sebelius, Secretary of Health and Human Services, et al.
    Docketed: August 29, 2012
    Lower Ct: United States Court of Appeals for the District of Columbia Circuit
    Case Nos.: (11-5076)
    Decision Date: February 7, 2012
    Rehearing Denied: May 30, 2012

    ~~~Date~~~ ~~~~~~~Proceedings and Orders~~~~~~~~~~~~~~~~~~~~~
    Aug 24 2012 Petition for a writ of certiorari filed. (Response due September 28, 2012)
    Sep 19 2012 Order extending time to file response to petition to and including October 29, 2012.
    Sep 28 2012 Brief amicus curiae of American Civil Rights Union filed.
    Sep 28 2012 Brief amicus curiae of Cato Institute filed.
    Oct 25 2012 Order further extending time to file response to petition to and including November 28, 2012.
    Nov 28 2012 Brief of respondents Kathleen Sebelius, Secretary of Health and Human Services, et al. in opposition filed.
    Dec 5 2012 Reply of petitioners Brian Hall, et al. filed.
    Dec 12 2012 DISTRIBUTED for Conference of January 4, 2013.
    Jan 7 2013 Petition DENIED.

    Former Texas Congressman Dick Armey was a co-plaintiff in this case.

    This issue can be favorably resolved for Medicare patients by Congress. . . and none too soon!!

    Dorothy Calabrese, M.D.
    Allergy & Immunology San Clemente, CA

  19. Ramesh Chandra says:

    I was trying to find a HDHP plan for a client in Washington State.
    There were only 8 insurance companies offerin health insurance there.
    Golden Rule which available in most states is not available in WA.
    IN = In-network OUT = Out-of-network Cost-share amounts represent members’ costs
    Individual/Family1 Deductible PCY
    $5,000 / $15,000
    $14,000 / $42,000
    Coinsurance (Member’s percentage of costs, after deductible, based on allowable charges)
    Individual/Family1 Out-of-Pocket Maximum (Includes medical deductible only) PCY
    $2 Million

    Last time I saw I thought i saw $20k deductible plans.
    Yes, these are not H S A qualified.

    I should have saved it when I pulled.
    I did go back to Wash state exchange approved plans. They have only 5 plans approved.
    The highest deductible there is $10k.

    Until I find the actual plans that I can reference, I will not mention these $20k deductible plans.

    I do know Golden Rule is now offering a $12,500 deductible plan.

    My apologies , if i caused some confusion.
    But all my other points stand.

  20. David C. Rose says:


    I like your principles. Here’s another.

    Principle 6: Moreover, It is only in the private sector, with genuine competition between insurers, that the rationing that does occur has reason to be efficient.

    No health insurance policy has zero rationing. The question isn’t whether there is rationing, but who has the power to impose it and to which ends is it imposed. The closer the market for health insurance comes to being truly private and competitive, the truer it is that such rationing that does exist is not an exercise in power but is, rather, an exercise in mutually beneficial transactions that constitute baby steps to greater social welfare at the margin. Patients agree to limits to coverage in return for lower premiums. Insurers agree to lower premiums in return for limits to coverage. It’s a win-win situation like all repeated voluntary transactions. If the trade-offs involved end-up being something patients don’t like, competitors will offer polices with trade-offs that they do like unless such policies are impossible. If they are impossible no one should be offering them, even if magical accounting can make them seem desirable in the short-run.

    In countries like Canada rationing also exists, of course, but the key is that it is not an exercise in mutually beneficial transactions, it is an exercise in government power because there is nowhere else for consumers to turn. The relative absence of political upheaval over this fact has more to do with the absence of a ready counterfactual than it does with genuine satisfaction. In short, Canadian citizens don’t get to compare what they get with what they could have gotten in a private health insurance system in Canada. As such, there is no “competition as discovery “ mechanism to drive the realized level of rationing to a level that best promotes social welfare generally. Discovery is foreclosed by the absence of choice.

  21. Ramesh Chandra says:

    Assurant does this as Time Insurance in WA
    They call it catastrophic Plan,
    but essentially high deductible , but doesn’t qualify for H S A.
    I thought this was offered in the pool.
    But looks like it is offered outside the pool.
    Assurant Catastrophic Assurant Catastrophic
    Plan $10000 (Plan ID Plan $5000 ($10000 total
    059) out-of-pocket) (Plan 053)
    Estimated Cost Estimated Cost
    $247.09 monthly $412.71 monthly
    Plan Type Plan Type
    Annual Deductible Annual Deductible
    Family:$20,000 Family:$10,000
    Annual Out-of-Pocket Annual Out-of-Pocket
    Limit Limit
    Family:$40,000 Family:$20,000
    Includes deductible Includes deductible

  22. Harry Cain says:

    John, in general I agree with your thesis, but your comments on Medicare administration are a bit off the mark. It is true that the Blues and other insurers have long handled Medicare’s claims payments, (and other private organizations handle medical review issues) but they do so under contract with CMS which is not shy about determining how that business will be done. It would be more accurate to say that CMS administers Medicare (and actually does it quite well, under very difficult conditions imposed by Congress). The source of nearly all Medicare’s policy, administrative and financial problems is the Congress itself and its political/special interest decision-making for a huge insurance program.

  23. Caroline says:

    Spot on with this write-up, I absolutely feel this website needs much more attention.
    I’ll probably be returning to read through more, thanks for the advice!

    Here is my blog post; Caroline

  24. Ramesh Chandra says:

    We don’t get news from TV. We get propaganda and amateurs trying to influence us their way of thinking.
    That is why blogs like John’s are very important. I am hoping i can bring out my portals to engaging audience soon.
    check out after 30 days, if u like and only if u r going to be serious contributor.