Healthy Competition: What’s Holding Back Health Care and How to Free It

by Michael F. Cannon and Michael D. Tanner

Healthy Competition was published in 2005, but I pulled it off my shelf and reread it in early 2017, in the midst of the discourse about how to “repeal and replace” the Affordable Care Act (ACA, also known as Obamacare). Both the ACA and the proposed replacement focus on insurance, ignoring the exorbitant cost of health care in the United States. In this book, Cato Institute scholars Michael Cannon and Michael Tanner examine how the basic economic principles of price transparency, competition, and consumer choice could lower costs, reduce waste, and increase quality of care.

“Economic competition… keeps revealing the new ‘best’ answer in an ever-changing world… When innovations come along that provide greater value—that is, higher quality and/or lower prices—consumers will gravitate toward those new options.”

“First and foremost, market competition requires a wide pool of competitors and potential competitors, including entrepreneurs with new ideas… In markets where consumers are free to choose from numerous producers, competition reduces prices and makes products of ever-increasing quality available to an ever-increasing number of consumers.” Within the medical field, examples include cosmetic surgery and laser eye surgery, where patients pay directly.

In the health care sector, “many of the necessary conditions of healthy competition have been disabled. On the consumer side, government promotes excessive levels of health coverage. On the producer side, it imposes excessive regulation, which dampens competition.”

The authors note that the majority of Americans (60.4% in 2003) get health insurance through their employer and “roughly 86 cents of every dollar spent on medical care in the United States today is financed through a third party.” Only 13.7% is paid directly by the patient.

“When patients enter the medical marketplace with excess coverage, they have less need to weigh the benefits of health care against the costs. They end up utilizing care that provides little value. Since patients are not very particular about costs and benefits, neither are providers. They have less incentive to focus on innovative ways of meeting patients’ needs or to furnish information about prices and quality. Costs cannot help but rise in such a market.”

“In most markets, the interests of consumers, producers, and payers are well-aligned because the consumer and the payer are the same person… Since patients directly pay on average only 14 cents on the dollar for medical care, they tend to demand medical care that costs $1,000 even if it provides only $140 of value.”

“America’s health care sector produces enormous waste alongside productivity gains because our overreliance on health coverage gives patients every incentive to consume technological advances, even if the added expense does them no good…  A study of Medicare patients… who had little risk of adverse gastrointestinal reactions used the expensive COX-2 drugs as often as those at high risk, despite the availability of cheaper alternatives.”

The solution is to have consumers decide how to spend their health benefits. “Former Medicare trustee Tom Saving and Andrew Rettenmaier of Texas A&M University write, ‘When consumers care what health care costs, suppliers will have to compete for consumer dollars and this competition will reduce the cost of care.’ Reducing incentives for excessive coverage would also reduce wasteful expenditures.”

“When consumers are spending their own money, each purchase transmits information about their preferences, enabling producers to respond by providing more of what consumers value… Instead, payments to providers are based on what is important to insurers, employers, and government.”

Of course, in order to make informed decisions, consumers need to know prices up front. “The Federal Trade Commission (FTC) and Department of Justice (DOJ) observe, ‘The public has access to better information about the price and quality of automobiles than it does about most health services.’ … University of California, Santa Barbara, health economist H.E. Freh notes: ‘The problem is there are millions of prices… A typical hospital will have at least tens and maybe hundreds of payers with different prices.’”

The authors quote Michael Porter and Elizabeth Teisberg, authors of Redefining Health Care:

The most fundamental and unrecognized problem in U.S. health care today is that competition operates at the wrong level. It takes place at the level of health plans… It should occur in the prevention, diagnosis, and treatment of individual health conditions or co-occurring conditions. It is at this level that true value is created—or destroyed—disease by disease and patient by patient. It is here where huge differences in cost and quality persist. And it is here where competition would drive improvements in efficiency and effectiveness, reduce errors, and spark innovation.

Cannon and Tanner are proponents of Health Savings Accounts (HSAs) as a vehicle for giving consumers more control over their health care expenditures.  An HSA is much like a 401(k) dedicated for medical expenses… However, in contrast to 401(k)s, withdrawals for medical expenses are never taxed… To be eligible for an HSA, individuals must be covered by a qualified high-deductible health plan.”

However, they recommend significant changes to the laws regulating HSAs:

  1. Increase HSA contribution limits to allow employers to deposit the full value of workers’ health benefits directly into their HSAs.
  2. Eliminate the health insurance requirement for HSAs.
  3. Allow tax-free HSA withdrawals for all health insurance premiums.

“Congress should [allow] individuals to purchase health insurance with HSA funds. This would allow all individuals, even those without employer-sponsored coverage, to purchase health insurance with pretax dollars. Allowing full deductibility of individually purchased insurance in this way would make coverage more affordable for millions and further level the playing field between employer-sponsored coverage and other types of insurance.” I follow this logic, although most large employers are self-insured, so I wonder what the “full value” of a healthy worker’s benefit would be.

It is important to make a distinction between routine health maintenance and major procedures. “Like auto, fire, and homeowner’s insurance, health insurance is supposed to protect against unlikely but high-cost events. Ordinarily, it would not cover regular checkups for the same reason that auto insurance does not cover oil changes: such expenses are neither unlikely nor high-cost… Of course, there is no reason why someone should not be able to purchase coverage for regular checkups—as long as she is willing to pay the added cost.”

“As workers with low-deductible coverage accumulate savings, they would be able to cover more out-of-pocket costs. As a result, they likely would move toward higher deductibles to save money on their premiums… Lifting the insurance requirement would also give workers the option not to purchase health insurance at all, but accumulate savings in their HSA instead.”

The authors do not explain what happens when an uninsured consumer incurs a catastrophic medical problem without having accumulated sufficient funds in the HSA. I suspect that very few Americans could afford to pay for a major medical condition (such as cancer) without insurance, so I don’t agree with the authors’ recommendation to eliminate the catastrophic insurance requirement.

“Health care consumers would be more parsimonious when spending their own money, thus forcing producers to provide higher-quality, lower-cost services, and to provide better information to help patients make good decisions… Large HSAs would also reduce administration costs for employers. Employers would be able to maintain their current level of health benefits while eliminating the layers of bureaucracy required to administer them.”

The book includes a chapter on regulation. The authors are in favor allowing consumers to buy health insurance across state lines. “Competition among states would lead them to tailor their regulation regimes to consumers’ preferences and to abandon regulations that make health coverage unappealing or too costly.”

Cannon and Tanner note that costs could be lowered revising medical licensing laws to allow more health care to be provided by allied health professions, such as nurse practitioners and physician assistants. “Studies have shown that within the scope of their training, nurse practitioners perform comparably to physicians in terms of cost, health outcomes, and patient satisfaction. Nonetheless, many states’ licensing laws forbid allied health professionals from having direct access to patients and prohibit these professionals from opening independent practices.”

State certificate-of-need (CON) laws are another barrier to competition. “Currently, 35 states have such laws that require hospitals, nursing homes, and other facilities to obtain state approval before they may build a new facility, expand an existing facility, or offer new services. In such proceedings, it is common for competitors to have much to say about whether a new facility is needed. The FTC notes that numerous studies show ‘market incumbents can too easily use CON procedures to forestall competitors from entering an incumbent’s market’ … CON laws serve special interests at the expense of other providers and the public at large.”

Cannon and Tanner write about the lengthy FDA approval process. “The FDA’s power to withhold new treatments is a threat to the freedom and the health of patients. Each year, the agency denies terminally ill patients access to experimental treatments that might improve or save their lives.”

The authors also advocate medical malpractice reform. “However, the U.S. Constitution does not grant Congress the authority to impose substantive rules of tort law in the states… State legislatures are the proper venue for correcting excesses in state civil justice systems… A ‘loser pays’ rule often would reallocate the costs of frivolous lawsuits to the correct party.”

The U.S. health care system is by far the most expensive in the world: 18% of GDP compared with 4% in Singapore. Congress cannot solve this problem by rearranging the deck chairs on the health insurance Titanic. Health insurance premiums are driven by the cost of claims. Addressing the underlying costs must be part of any real solution. This book offers a path to lower costs through price transparency, removal of anti-competitive barriers, and reduced waste.

Cannon, Michael F., and Michael D. Tanner. Healthy Competition: What’s Holding Back Health Care and How to Free It. Washington, DC: Cato Institute, 2005. Buy from