The Healthcare Bubble

We just got through a couple of financial bubbles.  There’s another one, harder to see, in healthcare.

There are two basic criteria for a bubble.  First is a disconnect between value and price, with price exceeding value.  Second is for that disconnect to increase rather than correct.

The real estate bubble was built on two consumers and an intermediary.  One consumer was homeowners.  Homeowners are usually fairly unsophisticated, and make decisions irrationally: I love this house, someone else is bidding for this house, my realtor tells me it is good.  The other consumers were purchasers of debt securities: they wanted to invest their cash in securities that paid better than government debt.  The intermediaries were the realtors and the banks, who took a percentage of every deal.  We knew that real estate was a bubble because one could buy substantially the same asset for very different prices, and yet many assets were sold at the higher price.  (If buyer A and buyer B both wanted the same house and A was paying with cash while buyer B was paying with a no-money down subprime 2-year NINJNA ARM, buyer B was paying a much, much higher price for the house.)  Finally, real estate did not self-correct because it was a positive feedback system: every participant gained from inflating prices.

Healthcare is the same.

Several studies have shown that good health outcomes are not a function of the cost of care.  McGlynn at RAND showed that many patients receive unnecessary care and don’t receive recommended care.  Jack Wennberg and his Dartmouth Atlas Project showed that many people pay as much as 60% more for the same or worse results than others — and it’s not just pricing differences, they receive 60% more care.  Patients, physicians, hospitals, and insurers collude to keep the bubble inflated.  Many patients feel that more care is better care.  Care is complex, but patients usually like to get it.  There has been a lot of work on the placebo effect, and it’s clear that most people believe that care is helping them, and that more care helps them more.  Physicians, who are usually paid for the care they deliver more than the results they achieve, have a financial incentive to recommend that care.  Hospitals are in the same position.  (It should be noted that many, many physicians do not deliver unnecessary care even though it might be profitable to do so.  This is demonstrated very simply by noting that Wennberg’s atlas uses real care to identify the low-cost regions–those physicians who do not over-treat their patients.)  Many people think that private insurance companies profit by limiting care, but the reverse is true: insurers make their profits from a percentage of the care delivered.  If healthcare costs rise predictably, insurers price insurance accordingly and draw their profits from that amount.  Just looking at the math (and not at insurers), it is the unpredictable denials that drive profitability, where the insurance was priced assuming something was covered but then it wasn’t.

Just like with housing, we have a disconnect between the cost of care and the value of care: the best way to assign a value on health care is by looking at the minimum cost to achieve the best health outcomes.  The Dartmouth atlas shows this disconnect.  Just like housing, we have pressure to increase the this disconnect: the best health outcome is rarely perfect health.  Given this, people will often pursue better outcomes through seeking more care.  Further, providers are compensated for giving it, even if that care does not actually improve health.  This drives inflation.

Just like real estate in 2007, healthcare is in a bubble.  If everyone received the care delivered in the most efficient regions identified by Wennberg, 20% or more of health costs could disappear.  Note that Wennberg’s most storied finding was related to Medicare, the largest single health program in America and run by the government.  These savings could be more than all the interest paid on all the government debt put together.  If this happens fast, companies will collapse and hospitals will go bankrupt: they couldn’t afford the loss.  Even if it happens slowly, the end result will look very different from what we are used to seeing.

How will we recognize when this is about to happen?  I’m guessing that this will be a long, slow road.  If America adopts sensible health policy, this bubble will deflate all at once.  If policy remains the same, it is likely that soon, so many people will lose coverage that there will be a market opportunity for providers who promise only sensible care.  (This would also require policy change, especially with regard to shield laws for malpractice, but less radical.)

The key to understanding the bubble is recognizing what won’t pop it.  Health IT will not pop the bubble.  Universal coverage will not pop the bubble.  Medicare is part of the bubble, so expanding Medicare won’t pop the bubble.  The policy change that will pop the bubble would target services directly, either by using capitation or salary based models for physician payment.  Remember, pay for performance initiatives hold out only a tiny portion of the total payment for performance.  If I can get reimbursed for 60% more care but get a 5% penalty for doing so, by accepting the penalty I still get paid 52% more.

Like housing in 2005, much of healthcare is sustainable–in fact, it only survives–in an era of rising costs.  Flat or decreasing costs will hurt the system as much as they did housing and the banks.  For bearish investors, keep an eye out for another bailout–probably insurer and provider equity shorts would be better than shorting the debt, however think about GE, Siemens, and similar vendor-financing equipment vendors if hospitals are allowed to pass through bankruptcy.