Rule: a prescribed guide for conduct or action; a regulation or bylaw governing procedure or controlling conduct (1).
Recently I read a sick leave policy that was six pages long. It was very thorough, describing what constituted illness, how the illness would be verified, how long the person had to notify the company of an absence, and many, many more rules. Although the following words were not written on the document, it was clear: “We are worried employees will misuse this policy, so we are trying to imagine and close every loop hole we possibly can.”
Coincidentally, this was the same day the news began reporting on a new regulatory framework for financial institutions: trying to avoid a repeat of factors that contributed to the current recession. It got me thinking about how the need for more rules is a clear and early sign that ANY system that is missing a natural balance of incentives will require excessive guidelines to KEEP PEOPLE from doing exactly what the system encourages them to do.
Why do we have rules anyway?
Of course some rules are necessary, and intuitively designed to keep us from harm, such as: ‘No running with scissors!’ Or ‘Don’t ever touch the hot stove!’ In other words, some rules protect the young from consequences they cannot fully understand, or protect us from dangers we may not be aware of.
Other rules are intended to protect others, such as setting speed limits on roads, or setting building requirements for how strong a structure must be.
While these rules make sense, too often we find ourselves spending extraordinary time and money devising and enforcing rules that are only necessary because we created a poorly-designed system in the first place.
If we require lots of detailed rules, was the system misaligned to begin with?
Whenever you see a long set of rules, or a call for significant new regulation, it probably means the system has created incentives that remove real-life consequences and accountability from the decision maker. Remember, we all make decisions based on incentives; if we believe a certain action will harm us or those we love, or is not worth the cost, we simply won’t do it unless coerced. If a behavior has significant benefit to us, and little or no risk or cost involved, it is more likely we will do it.
Take the case of the financial industry. Over the past decade, some workers were rewarded handsomely for achieving quick, though risky, returns without being held accountable for the long-term solvency of the firm. Where a generation ago, lenders retained mortgages for their full terms, in recent years high-risk mortgages were sold off so that others carried the risk of failure. Without the threat of future losses (decision makers removed from accountability) closing any loan—no matter how ridiculous—became the goal. However, if the individual granting the loan retained (even a small amount) of accountability for its successful repayment, risk-taking dropped substantially.
In the case of the very complex sick-leave policy, the intention (as we discussed in the previous blog) is to protect individuals from a loss of income when they become ill. However, when employees bear no financial accountability for their absence and have no other way to gain value from paid days-off, the misaligned incentive actually encourages people to be absent when they are not ill. Naturally, it takes a lot of rules to keep people from misusing time off when the incentives promote just that.
Incentive alignment reduces the need for rules.
A perfectly aligned business arrangement reduces the need for rules. In the simplest example, pay-for-performance eliminates the need for a large portion of work rules. If my compensation is only a commission every time I sell your product, or a fee for every task I complete, there is less need for rules about what hours I work, where I work, or how I do my work. In many cases, rules about work hours and work location result because the employer pays workers for time instead of output.
So, it isn’t surprising that there are rules to make sure people complete the necessary hours, when almost no rules would be needed to pay them on output instead. Strict regulations about how work resources (phones, vehicles, equipment) are used become less necessary if employees bear some accountability for operational costs, or profit. When wasteful spending affects one’s own bonus, abuse drops off quickly.
In our company, there are only two rules about time off: let someone know as far in advance as you can and check with others to see that responsibilities get covered. That is because we have no paid-time-off. Instead, we are paid the value of paid-time-off in each month’s salary. Within the limits of getting one’s work done, we can then take as much or as little as we want, and it is subtracted from pay. This way, each of us takes the time we need, according to our own value for that time. One can hardly “misuse” a benefit you pay for yourself.
How does this apply to health?
Health insurance is designed to lessen the financial risk of unexpected illness. However, it also protects us from the consequences of our own unhealthy behaviors. Rules about wearing seatbelts and helmets and carrying vehicle insurance have evolved in part because the public doesn’t want pay for severe brain injuries that result from risk-taking. We do this instead of telling individuals that they or their families will bear some responsibility for the cost.
Let’s imagine we (government and employer) started today, putting $2,000 per year in a health savings account for each person from the time they are born. The money is tax free, earns interest, and can only be used for medical care until the person is 70 years old, after which it can be spent or given to one’s heirs. If a serious treatment is needed, the person must pay a real portion of the expense out of their savings first, before insurance or public funds would be available.
By having a direct connection to a funded health account, individuals would have an incentive to find the most cost-effective treatments, rather than assuming that the most expensive option is best. The system would require fewer “rules” governing what will and won’t be covered, because individuals will use more discretion when spending their own funds.
What would be the reduction in health spending made possible just by connecting people to their own health dollars? Right now the country spends $2.4 trillion per year on medical care (2). The Kaiser Family Foundation reports that H.S.A.-qualified plans are priced between 15% and 25% lower (3). If we take the midpoint, this means saving $480 billion per year or $9.6 trillion over 20 years.
The amount saved in rules and regulations now enforced by Medicaid and Medicare fraud divisions? Fraud is estimated at $600 billion per year (4). If incentives were better aligned so that consumers paid more attention, we could conservatively estimate that they would detect and prevent 20% of that amount. In twenty years this would be another $2.4 trillion—a total savings of $12.0 trillion dollars.
The cost? A break even; twelve trillion dollars over the next 20 years that could go into savings account deposits for every citizen. However, half will supplement retirement (after age 70) at a time when social security is in jeopardy—instead of being spent on insurance premiums. And a good portion will cover costs now assigned to Medicare. And finally, the creation of a massive consumer market in healthcare would force incredible efficiencies and innovation that would change the ever-skyrocketing trend we have today.
OK. We know that health savings accounts are not being considered in the current drafts of national reform. And that putting consumers in charge of spending has not been mentioned as a strategy. But in light of the number of rules that ARE in the legislation, maybe connecting people to the real consequences (both good and bad) of their health decisions isn’t a bad idea.
Why this matters: It is common for organizations to apply rules to try and govern behavior. However, many of the behaviors they hope to change are encouraged by the very systems the organization created in the first place. Sharing a portion of accountability and real consequences—even if you give them the money first—helps align incentives and reduce the need for more rules.
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References
1. Merriam-Webster Online. "rule." Accessed July 17, 2009.
2. National Coalition on Health Care. Health Insurance Costs. 2009. Accessed July 17, 2009.
3. Kaiser Family Foundation, Health Research and Educational Trust. Employer Health Benefits: 2008 Summary of Findings. Accessed July 17, 2009.
4. Bennett R. Medicare and Medicaid Fraud Cost Taxpayers Billions. MD Buyline.com; 2009. Accessed July 17, 2009.
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