Medicine, Mortgages and the Middle Class

by Tom Robertson

Executive Director, Vizient Research Institute

In a 1968 essay published in the journal Science, Garrett Hardin, an ecologist worried about population density, coined the term “The Tragedy of the Commons”. Hardin was concerned that a population growing exponentially would outstrip the limited natural resources needed for its survival. The commons referred to shared resources. Tragedy in this context takes on its dramatic definition – an unhappy ending involving a heroic character – as opposed to an outright catastrophe. The tragedy was predicated on the rational tendency of individuals to make decisions in their own best interest even when doing so works against the interests of society as a whole.

Following Hardin’s example, consider a grassy pasture open to multiple cattle ranchers. At the outset, the density of the cattle is well within the carrying capacity of the pasture. Over time, however, each rancher realizes that they can increase their own revenue and profit by adding cattle to the pasture. Eventually, the ecosystem approaches the point where adding any more cattle undermines the well-being of the herd. Over-grazing will deplete the grasses, cause erosion, and lead to an unhappy outcome for the group as a whole.

At this point, each rancher asks themselves “what is the marginal utility of adding one more animal to my herd?” The incremental revenue associated with adding one more cow accrues directly to the individual rancher while the detrimental risk is divided equally across all ranchers. In an unfortunate twist of logic, it is actually rational for the individual to make a decision that will ultimately harm the entire group, including themselves.

Now instead of a pasture, imagine that the scarce resource is the typical middle-class working household’s income. Instead of cattle ranchers, the decision-makers are health systems. And instead of adding one more animal to the herd, the consumption decision is to extract one more percent of a price increase from commercial insurance companies.

A family’s disposable income, like the pasture, has a limited carrying capacity. As health care prices and associated spending rise faster than wages, other essential purchases – like gasoline or groceries – get crowded out. As long as health systems consider increasing market share, revenue, and operating margin as measures of their overall success, it is perfectly rational for them to negotiate the highest private sector prices that they can.

When confronted by criticism of their prices, health care providers typically explain that higher private rates are needed to subsidize shortfalls in government payments, which fail to cover the costs of services rendered. While that explanation is absolutely true, upon closer inspection, it appears that providers have acted rationally, but in the process have added cattle to the pasture.

If subsidizing government shortfalls was the only reason for extracting higher private sector prices, providers with the largest proportions of government-sponsored patients would have the highest commercial payment rates. Annual reviews of commercial insurance claims data by the Vizient Research Institute has shown that providers with the highest proportion of Medicare and Medicaid patients (and the biggest need for subsidy) tend to have the lowest private sector prices while the providers with the lowest proportions of government patients (and hence the lowest need for subsidies) tend to have the highest commercial insurance prices.

The explanation centers around bargaining clout. Providers with the highest proportions of private sector patients often have a breadth of services and amenities that make them the most difficult for insurers to live without; the resulting strength at the bargaining table leads to higher private sector prices. By exercising that pricing leverage, providers inadvertently deplete the economic carrying capacity of middle-class households that are already struggling to make ends meet.

Toward the end of his essay, Professor Hardin observed “We can never do nothing…once we are aware that the status quo is action, we can compare its advantages and disadvantages with the predicted advantages and disadvantages of the proposed reform.”

We are fast approaching the point where health care spending will exceed the carrying capacity of the middle-class working family’s income. We cannot slow the rate of increase in health care spending sufficiently by curbing utilization. If they haven’t already done so, prices are on the verge of eclipsing the middle-class household’s ability to pay; the market has failed to rein in health care prices despite forty years of trying. The irony in Hardin’s tragedy of the commons is that perfectly rational individual pricing choices by health care providers make sustainable spending difficult if not impossible to attain. The indisputable failure of the market to deliver sustainable pricing suggests that rate regulation may not be as far off as we once thought.

We’re still far enough from the precipice to change course. But the cattle are grazing.