Medical costs continue to spiral higher. Our firm works with clients on both sides of the employer/employee perspective and both are frustrated by the high cost of medical benefits.  Medical insurance costs have been increasing by as much as 15% a year. Those added costs are consuming the money that would normally have been used for employee raises. As a consequence, raises this year may be little more than the cost of living.

Employers don’t like spending more for healthcare and employees don’t like their raises being wasted on the same old medical coverage. The cause of this vicious circle is identifiable, and a solution where both employees and businesses can do better is possible.

My undergraduate major at Stanford University was Electrical Engineering and Philosophy. Those are seemingly unrelated majors, and as a consequence they provided opportunities to take wisdom from one discipline and apply it to another. For example, something that I learned in engineering provides wisdom to understand the high cost of medical benefits.

When designing circuit diagrams and computing electrical flow I learned that each system needed “negative feedback”. Negative feedback is a component in the equation that dampens the reaction as the reaction increases. Without negative feedback a process spirals ever greater and out of control. The effect cannot be maintained for long.  With electrical circuits, energy flows will exceed component tolerances until one component fails. I remember circuits that were wired without negative feedback. When the component blew, a small mushroom cloud of smoke rose from the circuit boards. In college we called this “failing the smoke test.”

Our current system of providing health care benefits fails the smoke test.

All systems must have negative feedback in order to be stable. Economic systems are no exception. Their demise may require decades to fail the smoke test, but the resulting destruction is no less complete. There are rules for building stable electrical circuits and there are rules for building stable economic systems.

Here is a rule for building stable economic systems: Who pays for a service and who is empowered to decide if a service should be given and who actually benefits from the service should all be the same person.

Applying this principle to medical care demonstrates why medical costs are spirally out of control. Generally HMOs and employers pay for medical services. Doctors dictate which services are given, and patients are the ones who actually benefit from these services.

Consider a hypothetical example. A patient’s routine blood test has an abnormal reading. There is a very small chance it is something treatable. If it is treatable there is a very small chance it is something serious. If it is something serious there is a very small chance that speed is important in avoiding a life-threatening situation. The procedure to determine if it is something serious for certain is very expensive. There are other courses of action, including waiting and doing nothing, which could legitimately be taken. How do you think the HMO, the doctor, and the patient will side?

The HMO won’t want to pay. The doctor will want to do the expensive procedure, both to get paid and also to reduce the possibility of a medical lawsuit, and the patient will want the benefit for no out of pocket costs. In all but a few cases, the evil HMO loses and medical costs spiral upwards. This is the direct result of the semi-socialization of employer-sponsored HMOs.

My grandfather-in-law, Dr Edwin Jacob Froelich, was a medical doctor in St. Louis, Missouri for 52 years starting in 1912. He used to tell the story of patients who would come to him with an injured wrist. The office visit would cost fifty cents. Sometimes at the end of physical exam it would still not be conclusive if the arm was fractured or merely sprained.

“It might be broken.” he would advise, “Or it might not be. We can’t be sure without an X-ray. An X-ray costs $10. You can pay the $10 and find out today, or we can splint it and wait five days and see if it is still hurting.  If it is still painful in five days we can assume it is broken and put it in a plaster cast. What would you like to do?”

Ten dollars was a lot of money.  Some patients decided to save the money and wait five days. They had the negative feedback of paying for the service as well as the empowerment to determine if they valued the benefit enough to pay for it. All three (payment, empowerment and benefit) in the same person kept medical costs relatively low.

In future articles we will look at some of the proposed solutions to spiraling health care costs.  There are many ways to address the problem, but all of the solutions that will work involve negative feedback, and the best solutions unify payment, empowerment and benefit in the same individual.

Photo by Amanda Perez on Unsplash