Explaining the Dentist Puzzle

Greg Mankiw today wonders about "the dentist puzzle," quoting Robert Frank:

Others have argued that inequality has increased in the United States because globalization has put unskilled American workers in competition with low-wage workers from other lands. Yet the basic pattern of inequality growth has been the same even among dentists, who are largely immune from foreign competition. Most dentists today earn little more than their counterparts from 1979, but the best paid dentists earn almost three times as much.

Mankiw rightly dismisses Frank's "superstar" hypothesis for why this should be the case, but doesn't try to explain it himself. So let me explain it with two words: health insurance.

I've thought for a while that what I'd really like the market to provide would be a very low-cost health and dental insurance plan with a 100% deductible, and then an extra plan on top for catastrophic expenses.

Why would I be willing to pay money for a plan with a 100% deductible? That's easy: the insurance companies pay much less money than the health-care providers charge. I recently got an "explanation of dental plan reimbursement", for instance, which broke down like this:

Amount claimed: $765
Amount allowed: $250
My co-pay: $59.50
Amount paid by the insurance company: $190.50

In other words, the cost of the treatment is $765, but the amount that the dentist ends up getting paid is just $250 – less than one third of the total.

This, I think, helps to explain why some dentists get paid three times more than others. Most dentists accept insurance, which means they end up being paid roughly one third of what they bill out. A few dentists, on the other hand, don't accept insurance, which means they get paid in full.

And if I had a 100% deductible, I'd end up paying $250 for my dentistry. If I had no insurance at all, the bill would be $765.