05/18/2010 05:12 am ET | Updated May 25, 2011

Perverse Incentives in Healthcare

A study recently published in the Journal of Pediatric Surgery reveals once again our healthcare system's perverse incentives.

The authors, from the Yale University School of Medicine, investigated the treatment of newborns with congenital anomalies. Drs. Loren Berman, Marjorie S. Rosenthal, and R. Lawrence Moss wanted to know if such infants born at non-children's hospitals received different treatment depending upon whether or not they had health insurance. Their conclusion: newborns with congenital anomalies but no health insurance were 2.5 times as likely as those with health insurance to be transferred to children's hospitals!

Why would this be? The answer is both obvious and disturbing: the birth hospitals want to keep the paying patients but push off those who cannot pay. And this should not surprise us. Surgery and other care for such patients is usually quite costly. Who can blame cash-strapped hospitals from seeking to avoid covering the bills of the uninsured?

Now, one might think, at least this is good for the uninsured--they are more likely to get transferred to the children's hospitals, with more readily available expert care. And this is why the article is titled "The paradoxical effect of medical insurance on delivery of surgical care for infants with congenital anomalies." Yet, as the authors point out, by placing a greater economic burden on the children's hospitals, the specialty care available at such institutions will become endangered, making care worse for everyone in the long run.

In the end, we find that medical care is provided not solely by need or what will be best for the patient, but instead is shaped, is incentivized in subtle, but important ways by our methods of financing healthcare. This is far from the only study to demonstrate this.

And, furthermore, this is not the only perverse incentive we find in our healthcare system. What are some other examples?

1. Health problems often take years to develop, but because the relationships between insurers and the insured are frequently temporary, the insurance companies have little incentive to invest in the future health of the insured. Why should an insurer spend funds on preventing or delaying the onset of conditions such as Type 2 Diabetes, when many or most of the insured will be under a different insurer 5, 10, or 20 years down the road? It will cost the first company money now to save the second company money later on the patients who will stay healthier longer because of the earlier investment.

2. Because, in general, we pay physicians for doing things, physicians are being incentivized to provide services patients might not need. And they are incentivized to offer those services providing the greatest reimbursement for the least time required. We are talking increasingly about value in health care, and this is quite important, but we need to redirect our entire system so that our goal is to protect our health as appropriately and as efficiently as we can--and this is a very different goal from paying people to do things.

3. Although primary care is most critical for preventing health problems, we pay our specialist physicians much more, two or three times as much, as we pay our pediatricians, internists, and family doctors. This incentivizes medical students to go into the specialties even though investing more in training and compensating primary care practitioners will likely result in overall improvements in health.

4. Finally, insurance companies are incentivized to cover those individuals who are least likely to need medical care and to avoid individuals who are most likely to require it. This has resulted in "cherry-picking" the insured, as well as the horrendous practice of recission, where insurers seek often flimsy reasons to cancel retroactively the coverage of individuals who are facing expensive treatments.

So, how can we counter a healthcare system shot through with these and other perverse incentives?

The current effort to overhaul the healthcare system is certainly a good first start. Yet it remains unclear how we can truly abandon perverse incentives so long as we maintain such a fractured system. The way health insurance and healthcare work best is by placing all of us in a single risk pool. This means that, as with many other sorts of insurance, some years I pay more than I take out and other years I pay less. Those who are younger and healthier pay in now, in part so that they will have care available for when they become older and less healthy, and in part because some small percentage of the young will require expensive healthcare, and we cannot predict who will wind up in this group. The more we divide the risk pool, the more expensive it becomes to provide care for those who are most in need. And of course we do not deny care to those outside of the risk pool when they suddenly need to jump in. Healthcare for the uninsured is not free, as the Yale study on congenital anomalies makes clear.

By further combining risk pools and by increasingly paying for value instead of for doing things, we can reverse the perverse incentives. We should be able to insure everyone in our country, and actually slow the growth of and even lower our overall costs. We know this is the case because many nations pay much, much less per capita for healthcare while attaining considerably better results.