Saturday, March 20, 2010

Understanding the Actuaries: Financial Projections in Health Reform


Health Reform will likely become law this weekend.  Many have stated that the recent financial projections from the Congressional Budget Office (CBO) that show the reform package saving money in the first ten years, and reducing the debt in the following ten years gave the wavering moderate Democrats enough political protection to vote for the bill and put it over the top.  The CBO is a very credible agency that is charged by Congress with making actuarial financial projections based on the assumptions that Congress gives it, as well as the specific wording of a bill using accepted standards of actuarial analysis.  The best way to understand actuarial science is through two old jokes.  (My take on this is influenced by my own background as a physician who was a Principle of an Actuarial Firm.)

Jokes About Actuaries

Joke #1 – Three people are trapped in a deep ditch.  They are an engineer, a builder, and an actuary.  The engineer is very upset and says “We will never get out.  There is nothing I can design to allow us to escape!”  The builder then says, “I have no lumber or tools so we will never be able to get out.”  The actuary is sitting at the bottom of the pit smiling.  He say, “Don’t worry.  I will get us out of here.  All we have to do is first assume a ladder.”

Joke #2 – A businessman has to make some financial projections for his company and does not know whether to hire a mathematician, an accountant or an actuary so he decides to interview all three in order to decide.  He first calls in the mathematician and he asks, ‘How much is 2 plus 2?”.  The mathematician answers “4”.  He next calls in the accountant and he asks “How much is 2 plus 2?”.  The accountant answers “That depends on whether we are talking about a cash basis or an accrued basis and whether it is pre tax or post tax.”  The businessman then calls in the actuary and asks “How much is 2 plus 2?”.  The actuary answers  “How much do you want it to be?”  The actuary is promptly hired.

It Is All About the Assumptions

In my professional life, I have spent a great deal of time helping actuaries by defining assumptions based on medical and epidemiological facts.  Those assumptions often dramatically change projections.  In the case of the current health reform package, the leadership of the Congress has developed assumptions that are designed to create a more favorable financial projection.  Thus, at the eleventh hour, the health care bill was modified to also include reform of education loans which has nothing to do with health care.  What that did do, since the CBO assesses the financial impact of the bill, is it included any savings in the education loan reform as being credited towards health reform.  Perhaps the most troubling assumption of the many that were used is the assumption that cuts in Medicare will occur even though there are no concrete proposals to cut costs in that program.  I have written previously about the fact that there is a companion bill which prevents a lowering of Medicare fees to physicians.  The bill assumes that costs will be cut by the following mechanisms:

Proposed Strategies for Reducing Health Care Spending.*

Establish insurance exchanges.

Reduce excessive Medicare payments.

Shift from a volume-based to a value-based payment system in Medicare.

Tax generous insurance plans.

Empower an independent Medicare advisory board.

Address and reduce fraud and abuse within the Medicare program.

Enact malpractice reform.

Invest in information technology and comparative-effectiveness research.

Invest in prevention.

*Adapted from Cutler.4

While Professor Cutler in his Wall Street Journal Op Ed piece outlines optimistically that these components will save money, experience states that each of these efforts will have consequences and political battles that will likely subvert the goals of creating savings.  Many of these strategies can also be put into place without the added expense of increasing coverage dramatically as this bill does and even without new legislation.  The unasked question is why, if they are able to be done, have they not been done already!  The assumptions that create the savings are based on all of these strategies being done in a non-political way that is only designed to save money.  That is rarely the reality.  We are also already investing in information technology and we are already supposed to be reducing fraud and abuse in Medicare yet costs are still rising. 

The History of Congressional Estimates in Health

This habit of creating assumptions that are overly optimistic did not start with this bill.  In 1965, the House Ways and Means Committee estimated that the hospital insurance portion of the Medicare program, Part A, would cost about $9 billion annually by 1990.  Actual Part A spending in 1990 was $67 billion.  In 1967, the House Ways and Means Committee predicted that the new Medicare program, launched the previous year, would cost about $12 billion in 1990.  Actual Medicare spending in 1990 was $110 billion—off by nearly a factor of 10.  Each time these estimates were prepared by actuaries working from assumptions from Congress.  One could go on and on.  It is safe to say that the estimate of the current health reform costing just under a trillion dollars is likely to be very low.

Who Cares?

Perhaps we should not care.  Perhaps the good coming out of the bill is so important that the high costs which every thinking person should recognize should not even be a factor in our assessment of the new law to be.  That may be the case but at the very least, we all deserved a bit more openness and honesty about the costs during the course of the debate.  A recent article in the New England Journal of Medicine put the health reform debate in the context of our national debt.  In the article, Michael E. Chernew, Ph.D., Katherine Baicker, Ph.D., and John Hsu, M.D., M.B.A., looked at our national debt and saw some danger lurking in creating a new national entitlement to increase that debt.  We are currently in debt to a point of danger to our national welfare and security.  Compared to other countries, our debt as a percentage of our Gross Domestic Product (GDP) is seen in this chart.


While the United States was once the example of fiscal strength and prudence, we are now rapidly becoming a profligate spender of other people’s money to a degree greater than Turkey and Spain.

The Answer

I don’t have one.  I only know that I am happy to see certain parts of the health reform bill become law.  I also know that the likely cost of the health reform bill is probably at least double the current CBO estimates (and I am being very conservative).  I am just fearful of the financial future of our country.  Just remember that actuaries are always slaves to the assumptions that they are given.  Unfortunately, if we are stuck in a financial hole, we can’t assume a ladder.