The right payment structure keeps patients healthy while saving money.

We want healthcare to be abundant, effective, easy, and cheap; for too many of us too much of the time it is scarce, ineffective, and maddeningly difficult. For all of us it is far too expensive. Why? How did we get in this mess? How do we end up paying so much for healthcare and not getting what we want?

It’s a big question, and it’s at the core of the mess we are in. The convoluted way we pay for healthcare in the United States gives too many patients treatments that they don’t need, or treats them for conditions that could have been prevented with much cheaper care, or denies patients services that they actually need. How does this happen? To answer this question, we have to dig into the actual structures of healthcare, and some of the basics of economics. And in that answer we can begin to see how we need to rebuild those very structures in order to survive and thrive beyond reform.

Why Doesn’t Competition Seem to Work in Healthcare?

There certainly seems to be plenty of competition. For example, there are:

· thousands of hospitals of all different types (for-profit and nonprofit, free-standing and chain, general and specialty, teaching, children’s, public and private, military and veterans);

· hundreds of thousands of doctors in scores of specialties organized every way you could imagine (solo practice, small practice, large multispecialty practice, working for hospitals and health systems, running their own centers, in cooperatives like Group Health of Puget Sound and staff-model HMOs like Kaiser);

· hundreds of health insurers;

· scores of pharmaceutical companies, device manufacturers and other healthcare vendors supplying bed pans, gurneys and ambulances; and

· thousands of pharmacy benefit managers, vendor certification companies, disease management agencies, consultants and other companies providing bits of outsourced management expertise.

Though there is plenty of regulation, on most levels of the system there is no central Soviet-style commission allocating resources and deciding who gets which customers. All these organizations are free to compete for the customers’ dollars.

Why, with all that competition, can’t most of us seem to get the healthcare we need when we need it, where we need it, at a reasonable price? For most Americans, though we can see that modern medicine offers a nearly miraculous plethora of cures and therapies, our access to it through the healthcare industry is often arbitrary, often so arbitrary as to be cruel. For those under 65, the price is often so high that even insured people can be one serious disease or traffic accident away from permanent poverty. And even when it works, it can be mind-blowingly inconvenient.

How can that be? How can a “free market” system so blatantly fail to serve its customers? Until we find the answer to that question, we will never be able to find our way out of this mess.

Let’s do a little basic analysis, a little healthcare Economics 101.

What Does the Customer Want?

What do I really want, as a customer of healthcare? Realistically, four things:

· When I’m sick, fix me.

· If you can’t fix it, help me manage it.

· When I am well, help me stay well.

· Be there when I really need you.

So why is it so hard for me to get those four things? Because—here’s the big key—I’m not really the customer. In fact, in most of healthcare, it can be hard to tell who really is the customer.

Who Is the Customer?

What’s a customer? Customers decide that they want something, choose it and pay for it. You decide that a new TV would be nice. You look online, maybe, or go to a big-box store, maybe check out some local independent store. You find what seems a reasonable value for your money, and you plunk down the credit card. You’re a customer.

The customer is the key regulating part of any free-market system. The customer is the reason you never see a plate of scrambled eggs or a new car advertised for $1,000. It’s the customer that enforces all sense of value.

So what’s different between classic economics and healthcare economics? Classic economics pictures a buyer and a seller. There is a constant, dynamic feedback loop between the many buyers and the many sellers in a market that establishes not only what things cost, but even what’s offered for sale, and on what kind of terms.

The core driver of all healthcare economics is the utilization decision, that is, people deciding to make use of some healthcare service. They get a new hip, take a new drug, get an exam, go in for a mammogram. The great majority of healthcare is insurance-supported, whether through government insurance such as Medicare, or through employers’ private insurance. And the great majority of healthcare is provided fee-for-service, that is, the healthcare provider (the doctor or hospital) bills the insurance payer for each separate test, procedure or prescription.

So what happens to that feedback loop in healthcare? First of all, the buyer is split in two, into a chooser and a payer. The organization that pays the bill does not make the decision to use that particular service. So the feedback loop between buyer and seller is obscured. And the chooser and the payer have quite different agendas. If the payer is just there to pay, it can have only one goal: to pay as little as it can get away with. It might set rules and payment schedules, but can never quite get it right, since it is really not there in the transaction, making the choice.

It gets even less clear: Who is the chooser? Who is deciding to use the service? Again there’s a split. The chooser is not the patient alone, but the patient (or the patient’s family) in consultation with the provider (usually the doctor). So again, and in a different way, the buyer is split. And the patient and the provider have very different stances. The patients have enormous “skin in the game”—great incentive to use whatever services might seem to help, since it’s the patients’ body, their pain, indeed often their life or death, that is on the line. The provider, on the other hand, has almost all the resources: the knowledge, expertise, equipment and access to drugs and therapies. And in any given transaction, the provider has far less skin in the game: this patient is one of hundreds or thousands. So the feedback loop gets even more obscured and tortuous.

It grows yet more murky: Who is the “seller?” Who is providing the service that is being sold? In most instances, it is the provider. The doctor who is advising the patient on buying the service is often either providing the service or working for the organization that will provide the service—or even owns it. You need a new knee. But you’re in luck, you’ve come to the right place, because I am an expert knee-installer. And the seller, of course, has a completely different agenda from the buyer. The seller’s agenda is simply to sell as much as possible. So the feedback loop between buyer and seller becomes so tortuous and knotted as to be useless, and the system skews, as a normal part of doing business, toward selling the services that make the most money.

Because it is inescapable: You will serve somebody. If it is not the patient, it will be somebody else.

Out of this we get markets in which, for instance, it can be very hard for a Medicaid recipient with diabetes to get (or even hear about) the nutritional counseling that might help her save her feet, but quite easy to get a surgeon to amputate her feet when her diabetes destroys them.

What Are Healthcare Providers Paid To Do?

This may sound overly cynical. Many doctors would protest that they never offer a service just because it would make them more money. But, as one neurologist put it to me: “The more I care about my work, the less money I make. The way for me to make more money is to serve my patients less: Give them less time and attention, and cut them loose as soon as possible.” That’s a terrible bind to put our best medical minds in. Many doctors doubtless choose the path this doctor does: Do better work and make less money. But many doctors feel forced to make the other choice: Do poorer work and make more money.

It is important to remember the two core rules of economics:

· People do what they are paid to do.

· People do exactly what they are paid to do.

People notice in exquisite detail what makes them money and brings them success. They will not as a normal practice do things that cost them money, or put them at risk of getting in trouble. In healthcare, what brings a provider money and success is doing more of the procedures and tests that are well-compensated by payers, and doing less or none of the ones that are not well-compensated—and certainly never failing to do some test or procedure that might keep them out of a malpractice suit, whether the patient really needs it or not. And those well-compensated and malpractice-safe procedures and tests are only indirectly related to the four things we really want when we think we are the customer. Almost no one in healthcare is directly paid to give us what we actually want.

What’s the Structure?

It’s important to notice that this confusion is structural: The ordinary structures of healthcare, with doctors, clinics and hospitals in strict fee-for-service relationships with payers, have great difficulty acting as if the patient is customer. If we are to get out of this mess, we need to tweak those old structures and build new ones. That’s why we are seeing fascinating, weird experimental structures arising across healthcare—“extended medical home” PHOs, “virtual accountable care organizations” like those I cited in my last column. And that is why almost all of these are new forms of partnerships, ad-hoc contractual relationships that cut across the traditional structural lines to deal with the health of particular populations. The contracts set up incentive relationships that guarantee that someone makes a profit specifically by tending to the real needs of the patient, not just by providing services to the
patient. And they are all over the place, taking different shapes to fill niches in the vast ecology of healthcare.

Let me just give you one example. If you were to look around, as an entrepreneur, for a way to make money by helping some population be healthier, what populations would seem like the “low-hanging fruit”? Would you think, “Ah, yes! Frail, elderly people on Medicaid in state-supported convalescent homes! And kids on Medicaid with disabilities!” Probably not. And yet that is exactly what happened in Illinois. McKesson’s disease management subsidiary contracted with the state to provide its Your Healthcare Plus services to just such populations. Teams of doctors, nurses and case managers, many of them on-site across the state, working with the patients’ existing providers, measurably improved the health of these patients. Counting the costs and fees for running the program, McKesson saved the state of Illinois $307 million in the first three years of the program—by giving people more services of the right kind of care and attention, not less.

Hospitals can form these OWAs (“other weird arrangements”) in all kinds of shapes, from at-risk contracts with insurers or CMS, to shared-risk medical-home arrangements with PHOs, to disease-management contracts with government agencies. And increasingly they are, across the country, because in the new environment the overburden of high cost and low capacity is killing us. We simply must find more efficient and more effective ways of serving our customers.

Structure matters. With the right structure, you make money by saving money. You help the customers meet their objectives, and you get paid for it.

With nearly 30 years’ experience, Joe Flower has emerged as a premier observer on the deep forces changing healthcare in the United States and around the world. As a healthcare speaker, writer, and consultant, he has explored the future of healthcare with clients ranging from the World Health Organization, the Global Business Network, and the U.K. National Health Service, to the majority of state hospital associations in the U.S.  He has written for a number of healthcare publications including, the Healthcare Forum Journal, Physician Executive, and Wired Magazine.  You can find more of Joe’s work at his website, Joe Flower – Healthcare Futurist, where this post first appeared.

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23 Responses for “The Problem with Free Market Healthcare”

  1. Dead on, thanks for the post. If we could solve this fundamental market failure, the free market would do a great job of solving everything else. Too bad policy makers worry more about sound-byte-friendly implementation details than (admittedly more complex) aligning of incentives.

  2. BobbyG says:

    “Every misspent dollar in our health care system is part of someone’s paycheck.”
    - Brent James, MD, MStat

  3. Steve says:

    Killer article. I think you’ve nailed the economic choices that the major players in our healthcare system are making. Thank you.

  4. Steve says:

    I agree with what you’ve written here, but perhaps I’m overly cynical. Do we really need someone with the experience you have to tell us that Adam Smith was right for people to finally believe it? This is what is so frustrating to people who understand basic economic principles. Fixing health care does not mean dropping rules on health care insurers to band aid the system where people are falling through the cracks (pre-existing conditions and people without jobs after college, for example.) The solution is to move away from a convoluted supply and demand relationship and closer to a relationship between a person selling a service, medicine, or consultation to a person who needs it.

  5. Nate Ogden says:

    Did you mean to be ironic with the title? There has been nothing free market with our healthcare since 1965 and probably even older.
    “All these organizations are free to compete for the customers’ dollars.”
    Joe this doesn’t even begin to tell the truth. There are states I can not sell in and types of groups I am forbidden from writing. Trying selling a MEWA for example. States restrict the insurance carriers that can sell in their state, some regulate and limit UR. There is little freedom to compete like you claim.
    “For those under 65, the price is often so high that even insured people can be one serious disease or traffic accident away from permanent poverty.”
    No shortage of hyperbole in the system I see. We have millions of accidents and illnesses every year and a very small percent of them end in permanent poverty. What is the constructive benefit of such exaggerated claims?
    “If we are to get out of this mess, we need to tweak those old structures and build new ones.”
    I would disagree we need to eliminate the new structures and revert to the old ones. Assignment of benefits only became predominate 20-30 years ago. It was standard for insurance policy to reimburse the policy holder. It was when assignment of benefits became standard that the detachment started.
    “And that is why almost all of these are new forms of partnerships”
    Which are new? PHOs and gatekeepers go back 20+ years. We aren’t looking for a miracle solution to these problems, things use to be done right then we regulated them into a mess.
    Curious do you really think we have a free market healthcare system? With all the regulation dictating who can sell insurance to who and what it looks like and cost and how doctors and hospitals run their praticies where is the free in this free market label?

  6. Maggie says:

    I have heard this explanation time and time again. It’s spot on but the problem is, what IS the solution? I would like to hear more ideas on how to bring the customer-supplier relationship in healthcare more inline.

  7. James says:

    Milton Friedman summarized it well some years ago:
    “There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you’re doing, and you try to get the most for your money. Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I’m not so careful about the content of the present, but I’m very careful about the cost. Then, I can spend somebody else’s money on myself. And if I spend somebody else’s money on myself, then I’m sure going to have a good lunch! Finally, I can spend somebody else’s money on somebody else. And if I spend somebody else’s money on somebody else, I’m not concerned about how much it is, and I’m not concerned about what I get. And that’s government. And that’s close to 40% of our national income.”

  8. DeterminedMD says:

    “We want healthcare to be abundant, effective, easy, and cheap.” Really, and for the majority of commenters here who champion for the business model of health care, what other industry or service strives for these goals, to survive?
    Easy and cheap? Go back to using leeches and trephination, as some people need those burr holes in their skulls to let out all those evil demons and negative essences, maybe start with politicians?
    Always easy for non clinicians to advocate for making care easy and cheap. Especially when you haven’t spent one moment in the shoes of a provider! The point is not cheap, but, affordable.
    Hey, go into a store or service and ask for the “cheap” product or intervention. Watch the person either roll their eyes or just give you the look of “then why are you here?”
    You get what you pay for! Is that adage gone from society!?

  9. BobbyG says:

    “You get what you pay for! Is that adage gone from society!?”
    ___
    Well, actually you pay, and you get whatever you get. According to the latest NCQA data, there is ZERO correlation between cost and quality, at least for the major chronic conditions.
    e.g.,
    http://4.bp.blogspot.com/_gdUOaDXBVdY/TNjUdm7j0uI/AAAAAAAAYRg/WRMS8FNpp6o/s1600/CADcost_x_Quality.png
    About as random a scatter as you’re likely to see. The plots for DM, HTN, and COPD all look just like that, too.
    In that graphic, I am interested in the upper right quadrant, though. What are those people doing right?

  10. BobbyG says:

    Duh, I meant upper left quad. More caffeine, please…

  11. Nate Ogden says:

    catostrophic insurance and no assignment of benefits. Pay for your care then submit for reimbursement if there is any or payment out of your savings account. Worked extremly well for 100+ years.
    Our 12% out of pocket liability is one of the lowest out there, this needs fixed

  12. Nate Ogden says:

    if you broke down our liability in regards to healthcare and how we handle it since the passage of Medicare we have been painfuly overinsured on routine and first dollar care and woefully underinsured on large dollar and catostrophic insurance.
    the outcome manifested just as one would expect, over utilization, inefficiency and diare financial outcomes for those with sever loses. It could be compared to homeowners buying renters insurance and how they end up after a fire or flood.

  13. Paolo says:

    I’m very much in favor of free-market solutions for any market where all parties involved have good information and similar market power.
    However, if one of those two conditions does not apply (e.g., one vendor has monopoly power or one side is uninformed) an unregulated market will lead to abuse of power and outcomes that are not globally efficient.
    There are probably a number of areas in health care where information transparency can be improved to enable rational decision-making necessary for an efficient free market. However, there will always be areas (e.g., emergency medicine) where you can never meet the conditions necessary for an efficient free market.

  14. Paolo says:

    “Our 12% out of pocket liability is one of the lowest out there, this needs fixed”
    True, and one of the main reasons for this our tax-subsidized employer-based health care system, with its low deductibles for people who can often afford to pay out of pocket. The system is actually backward. The wealthier firms (with the wealthier employees) have the lowest deductibles, coinsurances, and copays(and get the biggest tax exclusion).
    If we all had unsubsidized individual insurance, our deductibles and out-of-pocket expenses would be higher than in Switzerland.

  15. RTO says:

    HSA is/was the option that marries individual incentive and the protection of risk pooling. At the same time most HSAs promote routine preventive care through 100% coverage. If you look at the data well funded HSAs really are the solution. They do break when covered individuals choose them for the low premium but choose not to fund the account, but that could be regulated.
    Once again it is bad choices by individuals that break the system and not the system itself. If you take the study listed in the article and look at it another way. When forced to make healthy choices about care and lifestyle the cost of care for the low income population drops. To much is being spent to treat chronic illness for people who refuse to listen to the medical advice of their doctors, refuse free preventive care, and refuse even the slightest adjustment to their lifestyle.
    I believe in a system that has a safety net but at the same time using the safety net might need to mean your freedom to make individual choices must be limited.

  16. DeterminedMD says:

    “Too much is being spent to treat chronic illness for people who refuse to listen to the medical advice of their doctors, refuse free preventive care, and refuse even the slightest adjustment to their lifestyle.”
    Well said, and why is it this issue is still swept far under the rug by providers and significant others to the patient? I think it is applicable to other services; if my plumber tells me to call him to have the water softener serviced every year, and I call him back next 3 years later and complain it is malfunctioning, am I in position to tell him fix it and bill me for routine maintenance rates?
    Maybe closer to home, if my vet tells me to give the dog antibiotic for 10 days and I stop after 5, then the dog gets sick and dies from the infection initially treated, can I sue the vet for substandard care, because I did not know that not giving the antibiotic for the full 10 days would more likely treat the problem?
    If you do not change your oil in your car every 3-5,000 miles and then take it back to the dealer when the engine collapses after driving for 20,000, do you think you’ll get a new car or refund? This actually happened at the dealership I bought a car a few years ago!!!
    And yet people will minimize, rationalize, and dismiss these analogies. Because they do not defend their hypothesis for legitimacy: doctors have no outs, either save or be punished. Let’s see any profession accept those terms!
    And, show me the contract I signed that I agreed to them in the first place!!!

  17. dave says:

    The greed and overweening prde of both academia and the health care industry got us into this mess and it is unlkikely it will be fixed anytime soon. My guess is healthcare will implode in the next 15 years.
    AS Jefferson sai- confidence is everywhere the parent of despotism-and Americans ave been too confident in a health care system thats grown furtherremoved from legitimate expectations of the public. The sooner the health care industry implodes- the better- for then we can start over and hopefully fully learn the lessons that are needed to have a viable health care system

  18. John Ballard says:

    *Sigh*
    So many words, so few remedies…
    As an old guy, a layman, who has been following healthcare discussions for the last three years, here are my three inputs.
    ►As long as healthcare is treated as a commodity the price will always be high and the outcomes variable. Commodity prices rise and fall with supply and demand. Healthcare should not be priced the same way as wheat, pork bellies or orange juice.
    ►The roles of providers and insurers are routinely misunderstood. The mission of providers at all levels is to manage health care. The mission of insurance is to manage financial risk. (It is a serious mistake to imagine that the mission of insurance is to provide health care when its main responsibility is the profitable operation of a corporation. Whether competing in a marketplace crowded with competitors or where the company enjoys a virtual monopoly — neither will result in lower prices and certainly not the delivery of better health care.)
    ►Many, if not most medical professionals are better at healing than business. PROFESSIONAL COMPENSATION is routinely confused with CORPORATE PROFITS.
    They. Are. Not. The Same.
    Professional compensation should be as high as the market allows. But on the corporate balance sheet ALL COMPENSATION is an EXPENSE, and expenses do not increase profits. They reduce profits. Your can be certain that business people understand this principle quite well, including hospital administrators as well as insurance executives.

  19. Al Kennedy says:

    Interesting Blog, even though this was not what i was looking for (I am in search of clinics like this one> http://www.ccsviclinic.ca/ )… I certainly plan on visiting again! By the way, if anyone knows of a good clinic that does CCSVI Screenings? BTW..thanks a lot and i will bookmark your article: The Problem with Free Market Healthcare…

  20. Leon DeWitt says:

    “OWAs (“other weird arrangements”) in all kinds of shapes,” Thanks Joe, that’s one I will remember.
    Speaking of “OWAs”, a group called LyfeBank has found a way within the current tax law which allows employers to contribute healthcare payments into employee-owned accounts. The employees then purchase their own health insurance and pay for other qualified medical expenses all with pretax dollars.
    When the employee takes ownership, the dynamic changes in healthcare spending. This new business model works with the current structure, reduces the number of uninsured, and promotes cost control. Is this an “OWA”?

  21. Peter says:

    “The employees then purchase their own health insurance and pay for other qualified medical expenses all with pretax dollars.”
    “This new business model works with the current structure, reduces the number of uninsured, and promotes cost control.”
    Only reduces the number of uninsured if their employer contributes. Leon, have you looked at the price difference between group policies and the individual market? Not to mention pre-existing conditions pricing and exclusion from insurance. If you mean employees forgo necessary health spending due to cost, then I guess that’s cost control – it’s just not healthcare.

  22. pcp says:

    BobbyG asks:
    “In that graphic, I am interested in the upper right quadrant, though. What are those people doing right?”
    Probably hiring lots of nurse-managers to massage their data. Most of the NCQA criteria have nothing to do with better health.

  23. New Information about health care in 2011 HERE

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