A couple of months ago my younger son, Nolan, broke his arm at Super Hero Camp at the YMCA, because he apparently couldn't actually fly.  The YMCA called my wife, who called our pediatrician, who referred her to the emergency room at a local hospital.  When they arrived, Nolan was given a Tylenol and sat on a hospital bed for four hours or so, until a doctor arrived.  The doctor spent five minutes or so setting the bone, and then it took another half hour or so to get a cast on it.

And what was our out-of-pocket bill for a simple broken arm, with no surgery or other complications, involving only an hour or so of a doctor's time in total?  Over $3,000.  This was reduced somewhat from the off-the-street rate because my health plan had a negotiated rate with the hospital, but is still pretty outrageous in my opinion.

In our case, there were some things that could have been done differently.  Our pediatrician could have referred us directly to the orthopaedist who set the bone and put the cast on it, rather than sending us to the emergency room (the most expensive place to go).  Nolan could have sat in the lobby rather than on a hospital bed until he was treated; hospitals charge big bucks for ER beds by the hour.

But to me, the whole episode shows that our current health care system is horribly broken.  I don't consider myself a free-market evangelist, and I think this example shows how the free market can fail if left alone, but I also think that our system is not actually working as a market should.  Here are the problems I see:

First, the stakes for patients are sometimes very high - life and death.  In economic terms, you could say that the demand is very inelastic; when people need treatment, they often can't choose not to get it.  This has the effect of raising prices; in a nutshell, providers have patients over a barrel, and they don't stop to think how much things cost.

Second, stakes are high for providers as well.  They deal with large numbers of patients, some of whom may act irrationally due to their own high stakes.  Some patients will sue a doctor whether the doctor's care was good or not.  Providers must purchase malpractice insurance, and because the patients' stakes are high, judgments are high, and therefore the insurance can be expensive.  Doctors do whatever they can to avoid a chance of misdiagnosis or other mistakes, and err on the safe side by ordering lots of tests, some of which may not really be needed.

Third, medical technology, fueled by inelastic demand, is improving at a fast pace.  New technology is always expensive.  While in some cases this technology can make things more efficient, I think in most cases it takes significant time (years) to reach a break-even point.  I think providers buy these tools partly for bragging rights, and partly in order to treat conditions that would otherwise be untreatable.  Patients with those conditions stay alive longer, which is a good thing, but this results in higher costs overall because these patients need more care.

Fourth, providers are often required to treat uninsured patients for free.  These costs must be passed on to other patients.

All the factors above conspire to raise the prices that providers charge for their services.

Fifth, providers and insurers have a huge information advantage over patients.  Only providers know what treatment is actually needed and what is optional (although as mentioned above, they try to err on the safe side).  Only providers know how much they charge for procedures, because they don't publish a price list.  Only insurers really know what's covered and what's not; coverage is big and complicated, so knowing what's in and what's out is hard, and even if something is covered, insurers don't publish a price (reimbursement) list either, so you don't know what they're actually going to pay.  This information gap translates into higher costs for patients.

With all the above in mind, I propose a few rules that might help:

1. Require providers to publish a price list, in hard copy on the premises (on the wall, for example), as well as online, for the procedures they perform.
2. Require insurers to publish reimbursements for common procedures, in the same way.
3. Require providers to get patient approval before ordering any procedure (except in life-or-death situations where the patient is incapacitated of course).  The doctor must review the procedure with the patient, and the review must include the price charged, the amount to be reimbursed by the insurer, and the resulting out-of-pocket cost.
4. Require insurers to work with all providers, and vice versa, for the same price.  The whole "in-network/out-of-network" thing is an unnecessary complication that does not add value to the system as a whole.  This rule would greatly simplify coverage and help reduce the information gap between insurers and patients.
5. Require everyone living in the U.S. to be covered by an insurance plan.  This idea is part of current proposals.  Although I'm a Democrat, I'm ambivalent about the idea of a 'public option', and I feel that President Obama is right when he says that the public option is not the only way to achieve the goal.  But it's in everyone's interest that everyone be covered.
6. Because prices and reimbursements are fixed, the patient must pay any shortfall between the price and reimbursement if the reimbursement does not cover it.  Conversely, the patient pockets any reimbursement over what the provider charges (I wouldn't expect the latter situation to occur very often, if at all, though).  This gives the patient a direct incentive to shop around, which in turn gives providers an incentive to keep prices down and insurers an incentive to keep reimbursements up.

I envision a web site where the price and reimbursement lists for all providers and insurers are centralized.  Patients would be able to go to the site, cross-index a provider and insurance plan, and see exactly what they would pay for any given procedure or set of procedures.  Online tools could allow easy comparison of providers and insurers, similar to existing e-commerce sites.

While there are other proposals that may also have merit, the ones above are designed specifically to address the functioning of the health care system as a market.