Free Lunch (30 page)

To WellPoint shareholders Schaeffer may well have been worth
his money, but what about the subscribers? Their health status did not improve and claims weren't paid any faster, nor did
premiums grow at a slower rate. In fact subscribers were paying more and getting less of what they paid for, a price hike as subtle
as it was brutal. Physicians and laboratories, their fees reduced, saw the smaller “medical loss ratio” as nothing more than a pay
cut.

That pay cut came with added costs, not just tightening up on fees. To reduce the reasons
the health insurers could delay or refuse payments, the physicians and other providers had to hire teams of office workers to
polish the paperwork they sent in to WellPoint, a deadweight loss.

Schaeffer said the fact that
WellPoint was paying out less for medical care was due to forces beyond his control. He called it a sign of the market at work. “It's
not our intent to upset or exploit physicians,” Schaeffer told
Medical Economics
, a
magazine on financial matters for physicians. “We've got to maintain a professional and business relationship that's mutually
reinforcing. At the same time, lowering costs is the way of the world today and in the future.”

Schaeffer's “way of the world” did not apply to his pay and that of the other health care executives. Schaeffer
was neither unusual nor even the top dog in this game. Norwood Davis was paid less than $900,000 in 1995 as head of the
nonprofit Blue Shield/Blue Cross of Virginia. When it converted to for-profit status, his successor, Thomas G. Snead, received $6.5
million just six years later, along with stock options valued at $16 million.

The top dog so far is
William McGuire of UnitedHealth Group, which grew out of a small nonprofit Minnesota health insurer into the second-biggest
publicly traded health insurance company in America. It became that despite the fact that Minnesota law prohibits for-profit health
care, an annoyance the company got around by having a nonprofit front for its business. UnitedHealth Group covers about one in
six Americans, most of them older and on Medicare. In 1999 McGuire demanded that his board give him stock options equal to 2
percent of the company's value. He also demanded a clause in his employment contract that guaranteed him his job unless he was
convicted of a felony, a clause that would turn out to be very valuable to him.

McGuire's deal
was much sweeter than Wasserman's. If the way McGuire ran the company made its stock price soar, he would become a
billionaire perhaps twice over. And if his leadership resulted in a middling performance, the long-term rise in the stock market
virtually guaranteed him tens of millions of gains because his options, like those of most executives, were good for 10
years.

The board of directors proved their devotion to McGuire by giving him the options, the
job guarantee, and everything else he wanted, insulating him from the risks of a competitive market. They even agreed that when
he made personal use of the company jet they would pay the taxes he would owe on that benefit, making his personal travels free.
On the other hand, if McGuire failed, he was guaranteed his basic pay package and the options value due to the overall rise in the
stock market. Flip a coin. Heads McGuire wins big or bigger. Tails, McGuire can't lose.

Theoretically the competitive market is supposed to restrain all expenses, including the chief executive's pay,
so that, as Adam Smith wrote, labor and capital are rewarded with no more than the value of their contributions. Since for-profit
insurers compete in a market that also has nonprofit firms, how can for-profit insurers afford the lavish pay of chief executives like
McGuire and Schaeffer?

The answer is in what Schaeffer boasted about just a year after
becoming a for-profit business—shortchanging subscribers.

The markets that Adam Smith
wrote about were simple and straightforward, not complex pricing mechanisms, such as health insurance, that few people except
actuaries and lawyers grasp. These contracts simply defy normal human understanding.

In
Adam Smith's day corporations were few, allowed to exist for limited purposes and limited times, unlike the immortal but soulless
entities of today that have the legal status of persons. Spending less on the very service promised is not a simple task. If a health
insurer just cut payments, it could expect subscribers to go to other insurers. Insurers have devised elaborate mechanisms to
deny health care and limit benefit payments, systems with their own intricate internal policies shielded by a mask of confidentiality
that protects the privacy of patients and their doctors. Complexity is a friend of the insurance company scheming to fatten its
bottom line by paying for less health care service.

The first strategy of corporate-run health
insurance companies is to avoid marketing to employers and other groups where the need for health care is likely to be highest.
Careful selection of customers to reduce risks can cut the amount that will be spent on health care by 30 percent. The second
strategy is to find ways to pay providers less. Tough bargaining is legitimate. But the for-profit health care companies make the
paperwork so complex that sometimes it's just not worth it for a doctor or hospital to get the full amount their contract
requires.

The third strategy, as almost everyone in America has learned by sad experience, is
to deny care. Subtle rules govern how the insured are paid for their medical expenses. Many of these rules are not posted
anywhere. Physicians whom patients never meet, like Dr. Linda Peeno, make the decisions. Even if the rules were posted, most of
them would make no sense to the average American because they are written to be opaque. The benefit statements health insurers
mail to subscribers are about as decipherable as income tax forms.

Individuals, bipartisan
Washington has been telling us since at least the Nixon administration, should shop for the best medical care, comparing prices.
Competition remains the most widely recommended elixir for our ailing heath care system.

This idea ignores the fact that most people are not capable of assessing the skill of any physician, much less
comparing the relative value of the price of one thoracic surgeon to another. Those with blind faith in markets are untroubled by
this. Adam Smith did not share their faith that a complex market like health care would be fairly regulated by market forces. Smith's
markets required full knowledge by both buyer and seller and no coercion to buy or sell.

Would you know how to shop for the pilot of the next jetliner you fly? Do we pay the pilot who lands his plane
without a bump more than those who sometimes hit the tarmac hard? No. We trust that the government will set minimum standards
of competency through licensing requirements, education, and testing. And then we entrust our lives to the airlines to make the
expert judgment on which qualified and competent pilots should be in command of their aircraft and our lives.

When the random car crash or fall on the playground makes one writhe in pain, negotiating price is usually
not on the agenda. If it were, the one in pain would be at a distinct disadvantage. While the conscious and observant can determine
the relative prices and quality of tomatoes at a farmers' market, the prices for medical procedures are not posted anywhere. Indeed,
insurers hold these prices, and the fees they actually pay, confidential. And in a hospital emergency room the only procedure
certain to be performed is the wallet biopsy, an invasive financial procedure to determine whether the patient has insurance to pay
the bill.

Health insurance does not cover the price of a service, but only a portion of the
“reasonable and customary charge.” This charge is different for each provider. Thus two people paying the same in premiums to
the same health care insurance company can collect different amounts for the same treatment just because one chooses a doctor
who charges lower fees and another picks a high-price doctor.

Examine a stack of for-profit
health insurance financial statements and a trend emerges. Premiums increase faster than benefits. One study found that health
insurers that converted to for-profit status reduced their medical loss payments by 10 percentage points. That is an extra dime out
of each premium dollar for such necessities as increasing executive pay. Another study estimated that two-thirds of the
administrative costs of for-profit insurers are spent on care denial.

Health care administration
cost Americans $123.6 billion in 2003. That is an average of $412 per person just for overhead—paperwork, marketing, executive
compensation and, especially, justifying denials of care. The total excess cost for administering the health care system works out
to more than a dollar a day for each American. It is as if everyone from Bangor to Hilo got up in the morning, lit a match and burned
a George Washington before breakfast—two on Sundays.

Americans spend nearly 6 times the
average of what 13 other modern countries do on health care, according to a study conducted by the McKinsey Global Institute in
2007. The McKinsey study shows that 86 percent of this excess cost is in the part of American health care run as a business
instead of a public service.

All systems have flaws, of course, and they attract people who try
to beat the system. Government can also encourage, or discourage, such misconduct by its rules. In a health care system whose
master is the bottom line, there are temptations that some simply cannot resist. The temptations are not just those passing open
vault doors with no guards, though cutting back on guards makes it easier. One of the most damaging byproducts of moving away
from nonprofits and toward for-profit companies has been to encourage thievery.

Stealing
from the taxpayers by billing for services not needed, not provided, or by mislabeling is rampant in the for-profit hospital industry.
Despite this, the federal government's capacity to uncover such frauds dwindles each year. If allowed to do their jobs, government
health care auditors pay for themselves many times over, something that is ignored by the ideology of “government is the
problem.” Also ignored when the ranks of auditors are decimated is the premise that taxpayers deserve to have their money
dispensed honestly and prudently or not at all.

Health care thieves tend to be entrepreneurial
and nimble, as Malcolm Sparrow of Harvard University has tried to teach a host of agencies. When government finds an area of
white-collar thievery it throws a spotlight on the problem, Sparrow says, causing the smart thieves to scatter like cockroaches into
the dark recesses where no one is looking. But typically the government does not move on to these dark recesses, but instead
focuses its beam of light ever more sharply on the area of fraud it knows about, catching only those cockroaches too dumb to
scram.

One of the biggest frauds, though by no means the worst in its audaciousness, took
place at Columbia/HCA Healthcare. In the 1990s the company owned about 350 hospitals, more than 500 health care businesses,
and numerous ancillary health care service companies.

Among those who grew rich as its
stock ballooned in value was the Frist family, which founded the HCA (for Hospital Corporation of America) part of the business.
The most prominent of the family is a heart surgeon, Dr. William Frist, the former Tennessee senator and onetime presidential
hopeful. Richard L. Scott, who in less than a decade had built up the Columbia hospital chain from two Texas hospitals, headed the
other half of the company. When the firms merged, Scott ran what became the world's largest health care company.

The company held itself out as a model for the increasingly cost-conscious world of health care, applying the
competitive practices of corporate America to an industry still dominated by nonprofit institutions. But what really fueled its growth
was fraud.

Under Scott, the hospitals schemed to collect billions of dollars from the taxpayers,
insurance companies, and individuals by keeping two sets of books. There were self-dealing arrangements, kickbacks to doctors,
and billing for services either not needed or not performed. The company even bought a rubber stamp, used at a Columbia/HCA
hospital in Arkansas:

CONFIDENTIAL

Do
not

discuss or
release

to Medicare
auditors

Kurt Eichenwald, an
investigative reporter, discovered that stamp. With colleagues at
The New York Times
,
he analyzed a huge pile of medical records to discern how taxpayers were being systematically cheated. The newspaper also
reported that the big accounting firm KPMG abetted the fraud. At the same time that KPMG was helping Columbia/HCA cheat the
government, it had a contract with Medicare to detect such frauds. Medicare even renewed KPMG's contract
after
its role in this fraud was reported in the newspaper. The federal manager overseeing the
contract later told congressional investigators that she read the article but “had not taken it seriously.”

The thefts came to light because of one honest man: an accountant in Montana, James F. Alderson, who was
the financial officer for one of the chain's hospitals. One day a visitor came to show him how to set up two sets of books, one of
them weighed down with phony expenses so that the hospital could extract more money from Medicare.