If We Want Lower Health Care Spending, We Are Going to Have to Pay for It

Craig GarthwaiteUltimately, spending less on health care is a relatively easy task: We either need to consume fewer services, or spend less on the services that we consume. But much like we teach our Kellogg students about maximizing profits, the devil is in the details.

It’s certainly tempting to ask the government to swoop in on a white stallion and solve the all our problems by fiat. For example, we could have the government simply exploit its monopsony power and set prices, but an artificially low price will lead to an inefficiently low quantity of services and future innovation (stay tuned, we will have more to say about this next week).

Similarly, we could explicitly ration quantities (as opposed to implicitly doing it through a large uninsured population). But how could we hope to determine the right level of care? Ultimately, if we ask the government to unilaterally fix this problem, instead of a white stallion we could behold a pale horse and all that it entails.

The good part, perhaps the best part, about the Affordable Care Act is that it attempts to address this problem using market forces. The question is whether we are ready for what these market forces will entail.

We will focus today on the role of market forces in the insurance market to control prices in the newly established ACA exchanges.

This month the Obama administration announced that it would allow insurers to use “reference pricing” for insurance programs in the exchanges. Under a reference pricing system, insurers set the maximum price they will pay for a specific set of services and if patients go to a facility that costs more than that amount they are required to pay the difference.

This system has recently been implemented by the California Public Employee Retirement System (CalPERS) and there were two main effects: (1) surgical volumes decreased at high price facilities and increased at low price facilities, and (2) the prices paid by individuals covered by CalPERS decreased at high price facilities but were essentially unchanged at low price facilities.

While this is only one study for a single insurance system, it does provide the pattern that we would expect following a reference pricing system and is therefore provides encouragement.

In many ways, reference pricing is a close cousin of the narrow network systems that we previously described. Under narrow networks, insurance companies choose a limited set of facilities that are willing to accept their prices. Patients who want more choices can pay higher premiums for plans with wider networks. Under reference pricing, patients can go to a wider range of providers but they bear more of the cost of these choices.

The organizing principal is the same for both systems: if patients want choice they are going to have to pay for the privilege.

The theory behind reference pricing is fairly clear. But will it work in practice? That is less clear. There are two main threats that we can see: (1) poor implementation and (2) political backlash. When it comes to implementation there are several important points to consider.

Perhaps most important, reference pricing is not a panacea. It is most applicable for encounters with the medical system which involve a defined episode with relatively easy to understand quality measures. Think knee replacements and MRIs and not the management of Type II diabetes. This system is not well suited for managing chronic conditions.

In addition, reference pricing is only as effective as the level of competition in the marketplace. Without a robust and competitive local provider market, patients lack sufficient options to shop around and this system won’t lead to reduced prices. Finally, price competition in the absence of good information about quality can create a race to the bottom, in which providers skimp on quality (e.g., reduced staffing and training, shorter therapy sessions, etc.) in order to drive down costs and, as a result, compete better on price.

Patients must have sufficient information to make choices across providers based on price and quality. Obviously the first step here is some form of price transparency – a feature that is generally absent from today’s health care system. A recently announced partnership between major health insurers and the independent Health Care Cost Institute could go far to fix this problem.

Perhaps more difficult is that reference pricing requires readily identifiable quality metrics (that can’t be easily gamed by providers or lead to perverse outcomes) that can be easily communicated to patients. For this, we need to think beyond standard outcomes like infection rates and incorporate important patient reported measures of quality such as pain reduction, ability to perform activities of daily living, and perhaps some measure of customer service.

Given the experiences on the exchanges, where narrow network plans have been unable to accurately communicate information on which providers are in their networks, we have some fears as to whether these firms are ready to provide this type of critical quality information. Without a good quality reporting system, patients might end up choosing solely on price – an outcome that few would herald as a success.

Beyond the potential problems of implementation, we fear that the bigger threat to reference pricing will ultimately be politics. We first note that these systems are very similar to the HMO systems of the 1990s, which appeared to limit the growth of health spending before they were stamped out by a combination of a consumer protests and political handcuffs.

Much like the backlash to HMOs and the more recent narrow network plans, it will only take a few patients being “forced” to pay high bills in order to get access to their preferred provider before the complaints will surface. Or perhaps it will happen before the first bill is even sent. Expect that the nation’s priciest providers will band together and speak out on “behalf” of consumers.

Either way, it will take some national courage to stand up to these august providers and their feigned concerns for consumer welfare.

In the end it boils down to the proverbial lack of free lunches. It we want to lower health care spending we have to give up something. If we don’t accept some market based solutions, we will find a lunch menu filled with far worse options.

David Dranove, PhD (@DavidDranoveis 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.”

Craig Garthwaite, PhD is an assistant professor of management and strategy at Northwestern University’s Kellogg Graduate School of Management.

Dranove and Garthwaite are the authors of the blog, Code Red, where this post originally appeared.

13 replies »

  1. I also think that we have to be honest about ‘health care’.

    If we want people to live longer, then you have to understand that healthcare is going to cost more.

    If you want to cure all things, then the costs are going to go up.

    If life expectancy is increased to 85 & 89 for each sex, then you’re going to run into higher costs.

    If we are going to put everything under the ‘healthcare’ umbrella. Should birth control be a ‘healthcare’ issue? Why should Viagara?

    Quite honestly, I just had an operation that fixed my lazy eye of 53 years. I should have listened to my heart on it as it cost too much. I increased the cost of health care for all my fellow employees because I wanted a straight eye. Does it look better? Sure… but …… isn’t that vanity?

    Maybe those should be completely on our own dime?

  2. Anyone who has skin in the game tends to be cognizant. I do believe the easiest way to rid this is to charge people for their RISK just like other insurances. You don’t take care of yourself, you have a higher premium. If you start taking care of yourself, lower premium.

    People who do not take care of themselves tend to cost more up to death. They die earlier as well.

  3. Asking people to be accountable and contribute financially to their own health can be a difficult task. It is one thing when someone has a clogged artery and has to have surgery to live and function, their hands are tied and they must pay whatever the cost to survive. However ask that same patient 10 years earlier to participate in preventative healthcare options and they may have more excuses as to why they cannot afford it or believe it should be given freely.

    I work in an outpatient physical therapy clinic and we see a variety of patients with a variety of insurance deductibles with varying co-pays and co-insurances. I find those that pay something per visit typically find more value in their sessions than those who have no co-pay or deductible. They usually are more compliant with home exercise programs, show up on time and ready for their appointments, and really work hard to get better. Those that don’t pay anything for our services have a higher no show/cancellation policy and tend to shirk off their therapeutic exercises/activities and tend to have poorer outcomes. If these people paid even a small portion, $5 per visit even, perhaps then they would be more accountable.

    My concern with the implementation of the ACA and having more insured individuals is ensuring the quality of care for each patient remains high. It is tempting as reimbursement rates drop to schedule more patients in the same time frame and/or overload facilities and clinics to make ends meet. However if people are having to contribute more to their healthcare and the services are deemed sub-par those individuals will feel cheated out of their money. If people don’t see the value in their healthcare services they will find other places to spend their money and personal health becomes secondary until it become life threatening and ends up costing much more in the long run, defeating the purpose of widespread access to healthcare in the first place.

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  5. Great point Stephanie. Trying to contain the costs of acute care medicine with reference pricing instead of allocating resources to decrease the need for acute care medicine misses the mark what is most needed now.

  6. In order to make a significant dent in health care costs while ensuring high quality care and outcomes, we need to shift the emphasis of health care to disease prevention and the promotion of wellness.

    One only need look at reimbursement practices to see where the current focus lies. Procedures are reimbursed at a much higher rate (in the context of time and health promotion) than the prevention of disease.

    For example, a provider is reimbursed $104-$135 to burn off a wart – a 5 minute procedure with little impact on a patient’s overall health. In contrast, providers who manage patients with a myriad of complex health issues, focusing on health promotion and disease prevention, and bill for the highest code possible can expect to be reimbursement about $133.

    More than 75% of the country’s health care costs go to the treatment of chronic conditions, many of which are preventable. If an ounce of prevention is worth a pound of cure, it seems like a no-brainer where our efforts should be focused.

  7. I’m a big supporter of both reference pricing and of special rules around how much can be charged for care that must be delivered under emergency conditions. Good and robust price and quality information available to both patients and referring doctors is also needed.

    One issue that patients need to understand and insurers need to make sure patients understand is that any payments by patients to hospitals or other providers above the reference price do NOT count toward the insurance policy’s out-of-pocket maximum limit. The reference price also needs to be set high enough to ensure adequate choice among good quality providers as was the case with CalPERS in Southern CA.

  8. Bob, you are on the right track, but I think one should orient themselves to what makes a good contract and the laws might be changed to make sure the patient is fairly treated. There has to be a meeting of the minds and if there i no meeting of the minds there is no contract.

    Thus the burden of proof should be on the physician to adequately inform the patient of all costs and maximum oop expenditures. If no such contract exists then other metrics should be used such to determine the fee. The allowance paid by the insurer is one, average patient cost in the community is another. There are a whole bunch of metrics that can be used separately or as a group and a decision could even be proposed by a neutral party outside of the court system.

    I don’t understand why this is not done today. Lawyers are accustomed to retainers and the fees are not always transparent. Judges are lawyers so their mindset might be in the wrong place when determining legitimate fees.

  9. It seems like reference pricing will be little more than conceptual in a narrow networks environment where there are very strong disincentives to going outside of one’s network, and everyone in the network has agreed to a price as a condition of being in the network.

  10. Note:

    The above law would apply to discretionary care only.

    For emergency and non-discretionary care, a patient’s liability would be limited to 115% of the Medicare fee schedule, less any insurance reimbursement.

    The ER surgeon who charges $20,000 to operate on a desperately ill child would be out of luck financially.

    And boy, is it about time.

  11. Reference pricing would move along much faster if we had firm laws to protect consumers from surprise balance billing.

    I have proposed the following law in my writing:

    – if a patient asked for a price quote, and for insurance pre-approval of that quote, and the patient was not supplied this information…..

    then the provider would be barred from collecting anything beyond the insurance company reimbursement and any deductible.

    Actually some parts of Medicare work approximately that way now.

    We just need to extend the protections of Medicare into the under age 65 markets.

  12. I agree with you that we have to give up something to lower healthcare costs. We can start by giving up these things:

    1. Give up our existing definition of “healthcare provider.” Do we really need doctors, physician assistants, nurse practitioners, or any other type of trained healthcare provider to treat pre-hypertension, pre-diabetes, and the road to depression? A good friend can often do better.

    2. Give up what we mean by “healthcare.” Right now healthcare means allopathic healthcare. As an emergency physician, I am an allopathic physician. One of the things allopathy is great at is acute emergencies, including trauma, infections, and certain types of strokes. Other systems of medicine are better at certain things. One example is that some people find great relief from chronic pain with acupuncture or Reiki. These treatments are offered at leading U.S. medical centers. But they are often not reimbursed or considered as part of healthcare.

    3. Give up healthcare being being the road to health. The road to health is through nutrition, movement, rest, and connection, not through healthcare for the most part. Nutrition alone has been shown to not only halt, but reverse heart disease – a monumental feat that should be front page news everyday given our country’s state of health.

    When we start giving these up, solutions and cost savings will fill in the spaces.