Health Policy

Why the Health Care System Is Incapable of Reducing Its Own Costs: A Brief Structural System Analysis


Leading lights of the health insurance industry are crying that Medicare For All or any kind of universal health reform would “crash the system” and “destroy healthcare as we know it.”

They say that like it’s a bad thing.

They say we should trust them and their cost-cutting efforts to bring all Americans more affordable health care.

We should not trust them, because the system as it is currently structured economically is incapable of reducing costs.

Why? Let’s do a quick structural analysis. This is how health care actually works.

Health care, in the neatly packaged phrase of Nick Soman, CEO of, is a “system designed to create reimbursable events.” For all that we talk of being “patient-centered” and “accountable,” the fee-for-service, incident-oriented system is simply not designed to march toward those lofty goals.

A machine for creating reimbursable events

The health care system is a machine for creating reimbursable events. This means that its systemic business aim is to maximize reimbursable events and to increase their price, that is, to maximize the energy the system can draw in from its customers.

There’s Point 1: health care provider organizations are designed and energized to increase reimbursable events and drive up their costs.

This system is self-limiting, as drawing ever-increasing energy from its customers actually debilitates those customers (individuals, employers, governments) and causes them to find ways to reduce payments or opt out of the system altogether.

Health insurers, on the other hand, have a somewhat more complex situation. Insurers are paid by their ability to finance these reimbursable events, spreading the risks, and keeping a percentage of the flow for administration, marketing, and profit, limited by the Affordable Care Act to 15% or 20% of the total. So the systemic business aim of a health insurance business is to get the risk right, so that the actual payout for reimbursable events comes as close as possible to the lower bound of the medical loss ratio.

There’s Point 2: Health insurers get paid a percentage of the total cost. They have no incentive to reduce the total cost, and every incentive to increase it.

Let’s be honest: In this picture, neither the health care providers nor the insurers find any institutional advantage in providing actual lower costs per life, per case, or per procedure. Incentives are not aligned with outcomes.

The “affordable” part of the Affordable Care Act was about forcing modified community rating on insurance companies (so that at least for older and more compromised people, health insurance would be more affordable) and about getting insurers to compete for the low end of the market. But the many health plan executives I have worked with over the years tell me that they do not want the low end of the market. The ideal customer is the middle of the market, the stable customers, the not-so-sick-or-expensive customers. If you design your premium structure to catch a lot of people who are purely price-shopping, your medical loss ratio will climb above 100%, you will have to raise your premiums next year to recoup, and all those price shoppers will go away.

There’s Point 3: Because of this structure, no one wants to compete for the bottom in healthcare markets.

At the same time, health care providers have by and large avoided opportunities to take on some risk, to be transparent about their costs, or to guarantee their patients anything at all. Instead they have mostly stuck with the fee-for-service model, largely because of institutional inertia. Change can be expensive, difficult, and requires strong leadership. Adjusting internal information silos to provide the complete picture of a patient, to track quality metrics, to transparently measure physician outcomes, and so forth is disruptive—but it is what’s required to win.

Rather than radically move off of the fee-for-service model, health care providers have consolidated enough that in many markets they now hold monopoly-like power. In those markets a health insurer or major employer aiming to build a lower-cost alternative system within the region simply cannot provide its members a full array of health services without paying the high prices of these consolidated health care systems. And the insurer cannot pick apart the provider, which insists on whole-system contracts. This combination of consolidation and lack of transparency means that there is no real competition on price and quality among health care providers—and therefore no possibility of real competition among insurance companies. There is no competitive market in health care.

There’s Point 4: The lock-in between large monopoly-like health systems and the few dominant health insurers makes a true competitive market in healthcare impossible.

All this will remain true as long as the market is dominated by the opaque, fee-for-service, treat-to-code payment system that accounts for the vast majority of healthcare payments today. When that changes, when other payment systems such as competitive bundles, subscriptions, direct pay primary and others gain serious market share, the system will shift, the walls will come tumbling down.

The very structure of health care, as it exists today, means that no major player across the entire market is truly competing to provide the best medical care at the lowest cost.

The only serious way to evaluate any “reform” that lays claim to lowering prices is to ask: How does this reform plan change that?

Joe Flower has 40 years of experience in the healthcare world and has emerged as a thought leader on the deep forces changing the system in the United States and around the world.

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8 replies »

  1. Rand study released in May recommends price transparency combined with reference pricing contracts (%of medicare) and “steerage” where employer payors incent employees to use low cost/high quality health systems. Have to break near monopoly power and secret prices: May require legislation. The forces for change are building…Price transparency is the key. (Rand got some data).

  2. Agree with above comments, the article is a nice summary of our current state – but take exception to the depiction of health insurers. Their clients are the employers that are becoming increasingly fed-up with the spiraling costs of care. Many insurers are pushing hard to introduce value-based payment models, and success here will interpret into a significant grab of market share as employers flock to get on board. We are moving toward the tipping point where some provider organizations will see a significant portion of their revenue derive from focusing on quality and controlling cost of care. Old ways do die hard, however, and transactional medicine is the familiar business model which remains more attractive for many than the unknown realm of value-based care. Speaking as a PCP, fee-for-service medicine is contributing to burn-out and profound dissatisfaction for many of my colleagues in primary care.

  3. Nicely summarized; I agree that you get the behavior (system, organizational, clinical, and individual) that you incent…and large markets, systems and cultures that consciously (and unconsciously) self-organize to achieve those incentives get set in what we think and feel are concrete…making them mighty hard to change even at the local level, nevermind broader system change. Disruption is a nice idea, and I have seen good success at the level of clinical service lines or with service coordination…but in almost every case, even when the clinical and experience measures improve, the financial, workforce, and cultural pressures prevent even breakthrough programs from inspiring additional innovation and change.

    …and remember, transaction-based health care has quite a head start on outcomes or value based health care…and as a recent Humana-sponsored Delphi panel found ( , there is not even consensus across government and industry about what “population health” and “value-based care” and “value-based payment” really are. Until we can agree on what they are and how to share responsibility and reward for achieving them at the system level, habits, customs, mores and inertia will be working against any broader systematic change.

    Thanks again for a nice, concise summary. This is going into my OneNote….

  4. Check out Medicare Advantage. Solves all of these concerns; not a lot of folks do it right, but the business model is at least set up correctly and someone will. We are certainly going to give it a shot

  5. “One must look at demand for healthcare services.” Do Canadian, French, and German citizens use less health care than Americans? If so is that the reason their health care is about 10% of GDP while we are approaching 20%? Are those systems less regulated?

  6. There are several reasons why healthcare costs in the U.S. are significantly higher than in other developed countries none of which are likely to be affected by a Medicare for All or other single payer healthcare system.

    First, due to our litigious society, the medical specialty societies define the standard of care for most diseases and conditions to be more testing intensive and thus more costly than is likely the case in other countries. It would take medical tort litigation reform including safe harbor protection for doctors who follow evidence based guidelines and protocols where they exist while still letting them deviate from the guidelines with appropriate documentation to move the needle on this and it would probably take a number of years for that to happen.

    Second, we provide a lot more heroic care at the end of life which is often marginally useful at best, futile at worst and costly for sure. In the more socialistic countries with a culture of solidarity, part of the social compact is that you don’t impose unreasonable costs and expectations on your fellow citizens. In America, the prevailing attitude is I want what I want when I want it and I expect someone else to pay for it regardless of cost. It’s a cultural problem that’s not going away anytime soon though increasing the percentage of the population, especially the elderly population, that have executed a living will, advance directive or POLST would be helpful.

    Third salaries for virtually anyone who works in healthcare from doctors, nurses and pharmacists to IT specialists, administrators and executives are as much as double what they are in other developed countries. Since healthcare is a labor intensive business, that’s not likely to change anytime soon either.

    Finally, the lack of price transparency makes it more difficult than it needs to be to direct care to the most cost-effective high quality providers. For example, an ambulatory surgical center can provide low risk surgical procedures for half the cost of a hospital outpatient surgery department. Why? It’s because hospitals have to operate around the clock and ASC’s don’t which makes hospital costs inherently higher. We need to drive as much care as we can out of hospitals without compromising safety or care quality. Robust price transparency tools in the hands of doctors and / or their staffs can make that happen more easily.

  7. People like to say “disruption” is the key to price reduction. All I’ve seen of price reduction carrots offered by those who really don’t want change are methods which don’t change the “system”.

    To find lower costs look to those countries with some form of universal/government control system and you’ll find lower prices. The closer you get to a private, for profit system, the higher the costs – like the Swiss model.

    Universal or Medicare for all would bring down costs – but would not be painless. But Americans have grown soft and satisfied for too long to always want change without pain – childish expectations.

    Recent TV commercials say wait times for care would be crushing with Medicare for all, but offer no reason why this has to be a given. The people advocating against a universal system are those who get the biggest health care subsidies, which makes their access painless and threatened by real change.

  8. The article explains a few major reasons healthcare costs are not easily tamed…the tension between insurers and providers and the stubbornness of the fee for service model. But there are other reasons. One must look at demand for healthcare services. It’s virtually impossible to bend the demand curve. Fixed costs that can’t be eliminated because it costs billions dollars just to keep the doors open and lights on every day regardless of patient volumes. Pharmacy and medical device costs that almost never decrease and are born by the providers regardless of price (excluding retail pharmacy). Ridiculous regulation from a time when there was actually State sponsored health planning. In many states virtually no barriers to capital intensive entry (no CN). Let’s explore these factors and others.

    Retired CFO

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