A source of frustration for policy makers is that effective policy and feasible policy do not always neatly intersect. Of course the political climate determines the reforms that receive serious attention, but some proposals fail even without ideological opposition. One roadblock for evidence-backed proposals that policy makers must navigate is the “wrong pocket problem”.
The wrong pocket problem is a situation that arises when an actor, typically a government agency but sometimes another financial interest like an insurer or hospital network, opts not to invest in a cost saving program because they will not directly benefit from their effort. For instance, a program may be neglected when it requires an upfront investment that will not pay dividends for many years. This is a particular issue when regimes change quicker than the benefits of good policy manifest, incentivizing agencies to look for short term solutions. Equally problematic is when the cost savings generated by one actor’s investment are realized by a different actor. In this case the savings literally go into the “wrong pocket”. In both cases, otherwise efficient policies may not receive sufficient investment.
Healthcare policy experts, tasked with solving the looming fiscal crisis due to mandatory entitlement spending, must be particularly mindful of the wrong pocket problem. Many existing proposals for reform fail to do so, and this only makes them more difficult to implement.
Consider the proposal put forward by a number of Republican presidential candidates[i] to raise the retirement age. Given that Americans are living longer than they were when Social Security was implemented in 1935, raising the retirement age is a pragmatic approach to curtailing entitlement spending. That said, political fallout is a real cost for politicians. In this case, the future monetary savings of raising the retirement age come at the immediate expense of dissatisfaction among voters who will have to wait longer to receive benefits. Political realities like this one shape the sorts of policy options that are viable. Perhaps then it is no surprise that none of the candidates who favored this idea ended up with the nomination.
Think next of an issue championed by politicians on the opposite side of the aisle: the mandated inclusion of prescription drug coverage in individual and small group health insurance plans under the Affordable Care Act. The health and economic benefits[ii] of prescription drugs are well understood, so again this seems like a common sense approach to rein in healthcare spending. However, cases like the Hepatitis C drug Sovaldi[iii] demonstrate how the wrong pocket problem can spoil some of the potential gains from this expansion in coverage. Treatment with Sovaldi, which lasts only twelve weeks, can cost more than $84,000. This cost is significant, but is still dwarfed by the lifetime costs associated with Hepatitis C. For this reason, it might be cost effective for insurers to treat all Hepatitis C patients with Sovaldi. However, insurers are discouraged from covering the drug due to its high short term costs. If a cured patient switches insurance companies after treatment, it is the new insurer that benefits.
Wrong pocket problems also arise where health and other policy areas intersect. Proposals calling for greater spending on housing for the elderly[iv] offer compelling evidence that keeping seniors in their own homes longer would lead to better patient outcomes and lower overall costs. However, producing a set of incentives that encourages the Department of Housing and Urban Development to implement programs designed to keep seniors in their homes when the benefits will be realized primarily by HHS agencies remains a challenge.
All of these proposals are well intentioned and rooted in evidence, yet each has been hamstrung by wrong pocket problems. Potential solutions exist, but they will not be easily implemented. For instance, Congress could do more to encourage and facilitate cross-agency cost savings. The CBO could take the lead on this by recommending that savings realized by one agency due to programs implemented by another be redistributed in subsequent years. Of course this works only if these sorts of savings are easily measured, and they often are not.
The best solution is for policy makers to preempt the need for congress to get involved by avoiding policy proposals that introduce wrong pocket problems where possible. If effective and feasible policy is the goal, this is a crucial exercise.