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The Way Out of the Wilderness

In 1932, the Committee on the Cost of Medical Care identified rising medical costs as a threat to the financial security of millions of Americans. In a series of studies that created the field of health services research, the Committee recommended several strategies for cost containment that reads like a blueprint for today’s cost containment efforts: prevention, price controls, capitation, elimination of unnecessary care, and integration. If it sounds like a précis of my previous two blogs – cut prices and cut quantities – it should. We have known for a long time that those are the only ways to cut spending. And yet here we are, 80 years later, facing a spending crisis that threatens to take down the entire economy.

In my lifetime, we have been subjected to a steady drumbeat of rising medical costs. There have been respites – for a couple of years after Medicare introduced DRGs and for about five years in the 1990s during the heyday of HMOs. While DRGs and HMOs shifted costs down, they did not seem to reverse underlying growth trends, although HMOs did not thrive for long enough to be certain.

Not for lack of trying have medical costs continued to increase. We promote prevention, regulate prices, capitate providers, and review utilization to eliminate wasteful spending. We have seen horizontal integration that led to market power and higher costs, and vertical integration that more often than not created unmanageable bureaucracies. Most of today’s proposals for cost containment can be encapsulated by two words: “Try harder.” The Affordable Care Act gives us free preventive care, stricter price controls, ACOs, and the Comparative Effectiveness Institute. We need radical change but all we get is creeping incrementalism. I will take creeping incrementalism over the do-nothing approach of the previous decade, if only because we could use another respite. But the ACA is no permanent fix.

The problem is that no one in the system has an incentive to embrace radical change. Obama and Romney are arguing about who will do less to change Medicare. Dominant health insurers have been among the least innovative companies imaginable. (Is it a coincidence that exceptions can be found in states like California and Minnesota, where the health insurance market remains reasonably competitive?) Physicians and hospitals have been in positions of power for a century or longer, an extraordinary length of time when compared with dominant firms in other industries. (I admit that universities have enjoyed similar longevity, but look at our rising tuitions.) Patients still put their physicians on pedestals, ignorant of the data on medical errors, practice variations, demand inducement, and all of the other ways that our providers fritter away our healthcare dollars. And why should patients care, with someone else paying the bills and tax subsidies helping to pay for expensive insurance plans?

We won’t fix this system until people with power have much more skin in the game. The astonishing response to the announcement of Romney’s selection of Paul Ryan tells me that we still have some way to go before we see a game changing redesign of Medicare. Providers will not propose any radical change from a system that has served them so well for so long. This leaves things up to us – the consumer. We must be open to new forms of medical care delivery. Rethinking our hostility to HMOs would be a start. While we are at it, we could embrace narrow network health plans. DaVita wants to create a health plan just for diabetics. Why not? And what about plan that only pays for treatmetns that pass rigorous cost-benefit criteria? Some consumers may welcome such an opportunity to save money without sacrificing quality.

This is just a short list of health plan innovation. Who knows what breakthrough innovations in healthcare delivery are waiting to be discovered? I don’t, but that hardly matters. I didn’t imagine the iPhone, the Prius, Amazon, Netflix, or Sam’s Club, but that didn’t stop someone else from inventing them. We will continue to see breakthrough innovations throughout the economy, because the market will reward them. That is not a leap of faith. That is reality. In the same way, we will see breakthrough innovations in healthcare delivery if the market will reward them. That too is a reality. And that is where we must steer our healthcare economy.

We can get there in one of two ways. We can let the government be the “market,” through its ongoing control of Medicare (or even within a single payer system.) But the notion of breakthrough innovation emerging from Washington may strike some as oxymoronic. Besides, if Washington controls everything, we will at best get one set of innovations. The main thing about innovation is that one rarely knows in advance which will work best.

Truly breakthrough innovation comes from the cauldron of market competition. This is why health economists have time and again offered the same simple prescriptions:

– Eliminate the tax exemption for health insurance, or at least limit the exemption to the cost of some base plan. If some consumers want more generous coverage, let them pay for it with their own dollars. (Paul Ryan has a similar idea for Medicare. But this by itself is not nearly enough.)
– Relax laws that restrict entry of providers and insurers. Certificate of Need is number one on this list, but there are many others.
– Vigorously enforce antitrust laws against payers and providers. The appointment of Leemore Dafny as Deputy Director in the FTC Bureau of Economics is an exciting step in this direction
– Find a way to reduce the power of dominant insurers. This is easier said than done and I cannot say more about this for reasons that many of you might guess.
– Relax rules on insurers that require them to cover virtually all medical services regardless of cost-effectiveness.

As important as these steps are, I think we need to do more one thing. Patients have delegated power to their doctors and hospitals for a reason – they need someone they can trust who will not place cost above quality. As we know, this system went too far, virtually ignoring costs without necessarily assuring quality. A system that emphasizes cost competition without proper quality controls will go too far the other way and could be just as disastrous. We must strike some balance in the marketplace, and for this we must have reliable measures of quality of care that can be used to hold our providers and our payers accountable. More importantly, patients cannot continue to ignore these measures.

In my next blog, I return to the theme of healthcare quality – how to measure it, how to report it, and how to reward I, and how to hit patients over the head with it.

David Dranove, PhD, is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red.” This post first appeared at Code Red.

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Vernie Goldfield

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Barry Carol
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Barry Carol

“Finally, if the market is so competitive why does CIGNA Healthcare (whose headquarters are in Philadelphia) not write coverage in SE Pennsylvania?” The health insurance market in PA is dominated by non-profit insurers, especially the Blues. Independence Blue Cross is market dominant in the Philadelphia area while Highmark Blue Cross is the leader in the western part of the state. It’s hard for smaller insurers to negotiate discounts with hospitals that are as favorable as the market dominant insurer can negotiate which, in turn, makes it difficult to offer policies on terms competitive with insurers that command a large market… Read more »

Paradigm Outcomes
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RUcertain
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RUcertain

The insurance industry may be highly competitiive but not in the sense that Dr. Dranove is seeking more competition. California and Wisconsin get some of the fruits of competition he’s talking about.

Similarly, the use of the term “profit margin” makes me cringe. If you believe margins are truly less than 5% then why were minimum MLR’s even included in the ACA?

Finally, if the market is so competitive why does CIGNA Healthcare (whose headquarters are in Philadelphia) not write coverage in SE Pennsylvania?

Barry Carol
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Barry Carol

Doug Arnold – As I and others have pointed out before, the insurer anti-trust exemption only applies to sharing claims data, not to setting prices. The purpose of the exemption to share claims is to make it possible for smaller insurers with less comprehensive claims data to price their products more accurately. Thus, it enhances competition rather than restricts it. The insurance industry is highly competitive and profit margins as a percentage of premium revenue rarely exceed 5% after taxes and are usually less. For non-profit insurers, which control 40%-50% of the private insurance market, profit margins range from 1%-2%… Read more »

Doug Arnold
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Doug Arnold

How about repealing the federal antitrust exemption for insurance? In most markets a few dominant insurers set prices and contract terms and refuse to deal with organized physicians, except on ther insurer’s terms. Dranove seems most worried about providers’ clout, but seems not to fret one bit about abusive behavior by a few large insurers.

Peter1
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Peter1

Are you saying large insurers strong arm providers to pay them less, then charge insured inflated prices for coverage?

That should show up in financial statements as profit. I think Barry Carol may dispute this.

Barry Carol
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Barry Carol

Correction:

Should read: Colorado governor, Richard Lamm.

Barry Carol
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Barry Carol

“Keynes suggested that we bury gold notes and dig them up again, just to provide employment.” Bob – Do you really think the Chinese or anyone else would lend us money to do this or that working Americans would be willing to pay taxes to finance this? I don’t think so. It would be the equivalent of throwing $50 or $100 bills out of the backs of pickup trucks in low income and moderate income neighborhoods in order to create demand. The WPA at least built a lot of useful things including the high school that I went to which… Read more »

bob hertz
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Good points by Barry and Peter. My only contribution might be that government jobs may be useful to society even if they are inefficient. That was certainly true with the CCC and WPA in the 1930’s. Keynes suggested that we bury gold notes and dig them up again, just to provide employment. As for an entitlement to home health care……….. Germany provides this to all citizens, as part of its public nursing home insurance, and last I checked the cost is 1.7 per cent of payroll for all workers. In America, that would raise about $100 billion a year. Germany… Read more »

ClinEval
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I have read your article that is about the way out of the wildernes and i am very much imporessed from your ideas i am sure you will be keep updates.

Barry Carol
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Barry Carol

Over seven million people currently receive home healthcare at an annual cost of more than $50 billion of which about 37% is paid for by Medicare and another 19% by Medicaid. At a meeting I attended last year with former CMS Administrator, Tom Scully, he noted that many of the freestanding agencies are enormously profitable with profit margins of more than 30% of revenue. He added that there were over 600 such agencies in Dallas alone with the nationwide total as of the end of 2007 being around 9,300. There is also significant fraud in this program. It’s also important… Read more »

bob hertz
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I have no training in economics and it shows, but here goes anyways………

Say we add $1 billion to Medicare spending for home health care (just to use a simple example)

At $33,000 a year in salary, that hires 30,000 home health care aides.

Beats the heck out of getting 4,000 high tech jobs out of a green technology company.

(assuming that the goal of federal spending was to create jobs)

Peter1
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Peter1

“Say we add $1 billion to Medicare spending for home health care”

You’d be taking away employment from nursing homes and other facilities – unless those workers could be transferred to home health. Certainly I would agree that for some patients it would be more comfortable and enjoyable at home, it may also be cheaper than institutions which may pay for the extra staff required. But that would not be considered “wasteful” spending from my point of view – just better spending. You’d also have the added burden of riding hurd on more care givers to prevent fraud and mistreatment.

Barry Carol
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Barry Carol

Bob – My estimate of the number of jobs created per $1 billion of infrastructure spending is, in fact, too high. I probably got the number from a grandstanding politician but can’t remember specifically. However, President Obama’s Jobs Council on Competitiveness, a non-partisan group, contends that infrastructure spending is the sort of public spending that would create more jobs per dollar spent than other potential federal economic stimulus spending because it has the highest multiplier effect. Depending on the type of project, it could create as many as 18,000 well paid jobs per $1 billion spent or as few as… Read more »