Healthcare – Over-consumption

The great debate of the last ~3 years is the question of healthcare reform.  This debate, more than most, is about the values of individual voters rather than the merits of the various options on the table.  However, a dispassionate analysis of healthcare provides several key points.

In this first section, we explore the role of over-consumption in healthcare costs and identify the true root cause of the issue.  Once we identify the root cause, we compare the effectiveness of several models (including the two most frequently cited in the debate) in solving this problem.

Payer versus Provider

One of the biggest issues lost in this debate is the distinction between the entity that pays for care and the entity that provides care.  This distinction is central to the common ground that ought to exist in these debates.  No matter how you pay for healthcare (privately or publically), voters should demand that the funds be invested in the most efficient provider.

Choice and Control

Another popular debate in the context of healthcare is a question of who makes choices relating to your care.  Does the patient, the doctor, the health insurance company, or the government decide when you do and don’t get care?  When we talk about insurance companies, we talk about denying claims.  When we talk about the government, it’s called “rationing”.

The simple fact is that someone rations care in every model:

  1. If consumers pay out-of-pocket, they ration care based on their willingness to pay.  When a treatment is no longer worth the money, they “deny themselves” the care.  Except in cases where the ability to pay comes into play, no one thinks twice about an individual denying themselves additional care.  They may not even realize that it’s happening.
  2. If insurance companies bear the cost of care, consumers have no incentive to stop asking for more medicine and more procedures.  This effect is known as the Tragedy of the Commons.  Since the individual no longer denies themselves treatment but continues to bears the cost through higher premium prices, someone has to provide a financial control.  Insurance companies, therefore, step in and deny coverage.
  3. Public health insurance is no different than the private sector.  Consumers have no incentive to stop asking for more medicine or procedures and consumers bear the cost of this care through higher taxes so someone has to provide those financial controls.

The Real Problem

The problem with #2 and #3 is that your individual preferences have little influence on what you do and don’t get.  Consider a stylized example using Bob and John:

  • Bob has minor allergies that cause him $50 of discomfort per year
  • John has severe allergies that cause him $2000 of discomfort per year
  • The total pain and suffering without medicine is $2050
  • Only one allergy treatment exists and it costs $1000 per year to produce
  • Bob and John are both on an insurance plan (private or government) that charges them a $20 copay for medicine.

What decision does John make?  How does it affect society?

  • $2000 in allergy pain > $20 in copay costs, John consumes the medicine
  • John is $2000 happier – $20 out of pocket from John – $980 out of pocket from medical provider = $1000 in net gain for society

What decision does Bob make?  How does it affect society?

  • $50 in allergy pain > $20 in copay, Bob consumes the medicine
  • Bob is $50 happier – $20 out of pocket from John – $980 out of pocket from medical provider = -$950 in gain (so really $950 in loss) to society

The medical provider would have been willing to pay Bob $31 not to consume the medicine.  Bob would have been happier ($20 saved + $31 from provider = $51 > $50 in allergy pain).  The insurer would have been happier ($31 to Bob < $980 to buy the medicine).

Because the insurance company cannot read Bob or John’s mind, they have to decide either (1) to let both people consume the medicine or (2) deny both people the coverage.  Switching from a private insurance company to a public insurance provider does not change anything about this model. This is the root cause of much of the inefficiency in our medical system and a public system does not solve the problem.

The Real Solution

Let’s revisit the example of Bob and John, but design the healthcare system differently.  To avoid issues of equity entirely, we’ll even assume that the government is subsidizing care by paying for a Health Savings Account (HSA) and a High Deductible Health Plan (HDHP) for every American.  First we need to explain how these two components work:


A Health Savings Account is a savings account with special tax treatment.  Each year, a tax payer is allowed to deposit a certain amount of money and deduct that same amount from their taxes.  In 2011 the amount was $3,050 for an individual or $6,150 for a family.  If you pay medical expenses using this money (for example using a debit card), you can do so without a penalty.  This means that you can pay a certain amount of healthcare expenses with pretax dollars.  However, this money should be used to pay healthcare expenses; otherwise, you must pay both income tax and a penalty.

Because this is a savings account, any unspent money stays in the account from year to year and can collect interest.  When a taxpayer reaches 65 (or other exceptions like the disabled), money left in an HSA can be withdrawn without penalty.  In effect, any money you don’t spend during your lifetime becomes part of your retirement fund. 

In our example and assuming both Bob and John are single, we’ll assume that the government deposits $3,050 (the maximum) into their HSA account each year. If Bob or John face medical expenses that are “worth it”, they pay for those expenses using money from the HSA.  However, both Bob and John get to keep any money they don’t spend.  This means that they are discouraged from spending money on treatments that are not worth it.

Within certain limits, the HSA creates the “deny yourself” condition noted in #1 above.  So let’s return to the discussion above:

What decision does John make?  How does it affect society?

  • $2000 in allergy pain > $1000 in HSA costs, John consumes the medicine
  • John is $2000 happier – $1000 out of the HSA = $1000 in net gain for society

What decision does Bob make?  How does it affect society?

  • $50 in allergy pain < $1000 in HSA costs, Bob does not consumes the medicine
  • Bob is $0 happier but pays $0 more so society has no net gain or loss

Unlike the situation above, Bob does not consume the medicine and does not create waste or over-consumption when using an HSA.  Unlike traditional insurance models, an HSA allows us to help John and not encourage Bob to over-consume.

This works out great for simple costs, but it’s unclear what happens under two conditions:

  1. What if Bob or John end up in the emergency room or require expensive surgery
  2. What if Bob or John have a chronic condition that costs them tens of thousands of dollars per year.

The second is the harder problem so I address it in a different article, Healthcare – Categories of Care.  The first problem, however, is addressed by the second part of this article, the HDHP.


A High Deductible Health Plan is similar to a traditional insurance plan.  You pay a monthly premium and get coverage for the same medical conditions.  Unlike traditional plans, however, you pay your first expenses out of pocket.  For an individual, plans can include $1,200 to $5,950 out of pocket expenses.  For families, plans can include $2,400 to $11,900 in out of pocket expenses.

Once you reach your threshold, the insurance takes over. This means that a major medical cost including an emergency room visit or surgery is covered.  Like traditional insurance, there may be a modest copay to discourage abuse.  However, this system provides protection for major medical expenses.

Because the threshold for coverage is high enough to discourage waste, these insurance policies cost considerably less than traditional policies.  In fact, there was a point in my life where I could have paid 100% of the deductible plus the premiums and still spent less money than I would have on a traditional insurance plan.  This isn’t really all that strange.  It only validates the statement I made above, that someone in a traditional insurance plan “continues to bears the cost [of over-consumption] through higher premium prices”.

Once again, even if we want the government to pay for care, it can do so by paying the premiums.  Even if you want the government to subsidize care, it’s still more efficient to provide the care through this kind of model.


There are many factors that play into healthcare.  Over-consumption, however, is a major driver of the growth of costs.  This article discussed the root cause of over-consumption, explained why public and private systems are equally poor at addressing the problem, and identifying a model of delivery that does, in fact, solve the problem.

The only major issue that was not addressed in this model is the treatment of chronic conditions.  To find out more about chronic conditions, see Healthcare – Categories of Care.

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