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Category: Economics

Making Sense of Geographic Variations in Health Care: the New IOM Report

Since 1973, when Jack Wennberg published his first paper describing geographic variations in health care, researchers have argued about both the magnitude and the causes of variation.  The argument gained greater policy relevance as U.S. health care spending reached 18 percent of GDP and as evidence mounted, largely from researchers at Dartmouth, that higher spending regions were failing to achieve better outcomes.   The possibility of substantial savings not only helped to motivate reform but also raised the stakes in what had been largely an academic argument.   Some began to raise questions about the Dartmouth research.

Today, the prestigious Institute of Medicine released a committee report, led by Harvard’s Professor Joseph Newhouse and Provost Alan Garber, that weighs in on these issues.

The report, called for by the Affordable Care Act and entitled “Variation in Health Care Spending: Target Decision Making, Not Geography,” deserves a careful read. The committee of 19 distinguished academics and policy experts spent several years documenting the causes and consequences of regional variations and developing solid policy recommendations on what to do about them.  (Disclosure: We helped write a background study for the committee).

But for those trying to make health care better and more affordable, whether in Washington or in communities around the country, there are a few areas where the headlines are likely to gloss over important details in the report.

And we believe that the Committee risks throwing out the baby with the bathwater by appearing, through its choice of title, to turn its back on regional initiatives to improve both health and health care.

What the committee found

The report confirmed three core findings of Dartmouth’s research.

First, geographic variations in spending are substantial, pervasive and persistent over time — the variations are not just random noise. Second, adjusting for individuals’ age, sex, income, race, and health status attenuates these variations, but there’s still plenty that remain. Third, there is little or no correlation between spending and health care quality. The report also effectively identifies the puzzling empirical patterns that don’t fit conveniently into the Dartmouth framework, such as a lack of association between spending in commercial insurance and Medicare populations.

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Yes. Employers Really Are to Blame For Our High Medical Prices

I welcome Leah Binder’s earlier post on this blog, written in  response to my blog post in The New York Times. To be thus acknowledged is an honor.

As an economist, I am not trained to respond to Ms. Binder’s deep insights into my psyche, dubious though it may be. Nor, alas, can I delve into hers, fascinating though that might be. Let me therefore concentrate instead just on substance.

First of all, I do not recall calling employers “stupid,” nor did I question their IQ. I do confess to having once called employee benefits managers, when addressing them at some of their usually mournful meetings, “kind-hearted social workers dressed to look like tough Republicans.” At that meeting I contrasted how carefully their company’s tough-minded VP for Procurement, Murgatroid de B. Coverly III, Princeton ’74, purchased paper clips for the company with the much more mellow approach taken by their V.P. of Human Resources to purchase health care for their company’s employees.

Benefit managers – I hate to call them BMs — really are the nicest folks. They care deeply about their employees’ well being (until, of course, the latter lose their job with the company). They worry incessantly about their company’s ever rising outlays for health insurance. And, after a cocktail or two, they regularly lament how rarely they get the attention of top management and of the board of directors – the very folks I once told to go look into a mirror in their search for the culprit behind rising health care costs.

No, when I say “employers” I really mean top management and boards of directors who make the rules. And  I did not even call those mighty ones stupid, but merely “passive payers” as did, by the way, David Dranove on this blog in his critical response to my New York Times piece. Why these usually tough and smart people have behaved so passively in buying health care for themselves and their employees remains a puzzle at the level of economic theory.

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Three Reasons Uwe Reinhardt Blames Purchasers for Everything

Uwe Reinhardt is one of the nation’s most respected health care economists, professor at the prestigious Woodrow Wilson School at Princeton, fellow of the Institute of Medicine, and one of the shining lights in health policymaking circles.

But alas, even the best and the brightest are wrong sometimes. Case in point: Reinhardt’s recent comments in the New York Times on the role of the American business community in fueling our nation’s health care problems. To paraphrase, Reinhardt believes that employer purchasers of health care are 1) dim bulbs and 2) responsible for the escalating costs of care.

This seemed puzzling coming from Reinhardt, whose views are widely respected by purchasers.  But I was able to diagnose the problem by drawing on insights from social psychology.

Social psychology investigates “attribution,” our mind’s process for inferring the causes of events or behaviors. It’s how we describe why things happen — to us or to someone else. It turns out, we humans aren’t very accurate in our attribution processes because all of us suffer from at least one of the following problems. In his New York Times piece, poor Professor Reinhardt appears afflicted by all three at the same time. Let’s take a closer look at each:

1. Actor-Observer Bias: This is the notion that when it comes to explaining our own behavior, we tend to blame external forces more often than our own personal characteristics.

Reinhardt is rightfully troubled by a decade of escalating health care cost growth under employment-based health insurance. But seized by Actor-Observer Bias, Reinhardt blames this problem not on the world of health care that he played such an influential role in over the past few decades, but on external forces, the employers who purchase health care.

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The Health Insurance Shell Game

The insurance industry had a rocky start a century ago. It was clear that there were untoward events that could befall any of us with catastrophic results, from the incineration of a home to the loss of the ability to maintain gainful employment from injury or death.

Insurance offers a mechanism to share this risk. The stumbling block was the possibility that the insured might burn down their home to collect. Once it was realized that “moral hazard” could be held at bay by investigating for fraud, there was little to hinder the growth of an industry designed to serve our risk adverse proclivities. Almost every adult has some experience valuing the expense of sharing risk for a variety of hazards. After all, automobile insurance is generally compulsory and most of us are familiar with notions of deductibles and riders when it comes to homeowners’ policies. The possibilities are not an abstraction; we can envision the house or its contents damaged, destroyed, or stolen leaving us bereft. What would reducing that prospect be worth to us? As is true for many value-based decisions, the answer brings a mix of reason and intuition (1)that can produce surprising outcomes (2).

Health insurance is even more complex, and has always been so. The industrial revolution saw the development of “Friendly Societies” in Britain and the Prussian “Krankenkassen”. These were trade-based institutions that allowed advantaged workers to purchase insurance to provide “sick pay” but there was little else. The sea change was the Prussian “welfare monarchy” (3), an extensive insurance scheme that encompassed universal health care and a complex approach to disability insurance (4). Modifications of the Prussian scheme spread across the industrial world. It made landfall in the United States in time for the presidential election of 1912. Only one component took root in America: Workers’ Compensation Insurance but not as a national insurance scheme. It fell to the each state to regulate an insurance scheme to compensate injured workers for lost income and medical expenses.

This set the stage for state-based regulation of employer-sponsored private health insurance schemes going forward. But forward momentum appears anything but swift or linear in a country that trusted physicians to charge “commensurate with the services rendered and the patient’s ability to pay” (AMA Code of Medical Ethics, 1957.) Health Insurance as both an industry and a product has become a frustrating web of inefficiency and confusion.

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Are Employers to Blame For Our High Medical Prices?

In a recent New York Times blog, Uwe Reinhardt places much of the blame for high and rising medical prices on passive employers. He argues that employers should work just as hard to reduce healthcare benefit costs as they work to reduce other input costs. But he then observes:

“One reason for the employers’ passivity in paying health care bills may be that they know, or should know, that the fringe benefits they purchase for their employees ultimately come out of the employees’ total pay package. In a sense, employers behave like pickpockets who take from their employees’ wallets and with the money lifted purchase goodies for their employees.”

I think that Reinhardt gets the economics wrong here and, in the process, he puts too much of the blame on employers. Reinhardt is right in one respect – employees care about their entire wage/benefit packages. If benefits deteriorate, employers will have to increase wages to retain workers. Thus, it seems that if an employer reduces benefit costs, it must increase wages by an equal amount. If that is true, we can understand why employers are passive.

The correct economic argument is a bit more nuanced. Employees do not care about the cost of their benefits; they care about the benefits. If an employer can procure the same benefits at a lower cost, the employer need not increase wages one iota. In this regard, there is nothing special about health benefits. Suppose an employer offers employees the use of company cars. Workers don’t care what the employer paid for the cars, and if the employer can purchase cars at a deep discount, it will pocket the savings.

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The Rest of the Story About Hospital Pricing

The recent Medicare report on variation in hospital “prices” is not exactly news. In fact, I wonder why anyone (including the NY Times and NPR) covered it, let alone make it a lead story.

As you probably know, Medicare reported that hospital charges for specific treatments, such as joint replacement surgery, greatly vary from one hospital to another. (This includes charges for all services during the hospitalization, including room charges, drugs, tests, therapy visits, etc.) Everyone in the healthcare business knows that charges do not equal the actual prices paid to hospitals, no more than automobile sticker prices equal the prices that car buyers actually pay. Except that for the past thirty years, the gap for hospitals greatly exceeds (in percentage terms) the gap for cars. This is not just a nonstory, it is an old nonstory.

So reporters tried to give it a new spin. One angle concerns the uninsured, who may have to pay full charges. I will write about this in a future blog. Another angle is that by publishing these charges, Medicare will encourage patients to shop around. That is the subject of this blog.

I suppose it is okay to tell patients that the amount they might have to pay out of their own pockets may vary from one hospital to the next. But the published charge data is useless for computing out of pocket payments; in fact, it may be worse than useless. As even the NY Times noted, insured patients make copayments based on prices that their insurers negotiate with hospitals. These prices are essentially uncorrelated with charges. So a patient who visits a hospital with low charges may well make higher out-of-pocket payments than a patient who visits a high charge hospital. It is a crap shoot.

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The Gold Plated Health Care System: What the New Numbers Tell Us about the State of the Economy

For the third year in a row, national health spending in 2011 grew less than 4 percent, according to the CMS Office of the Actuary.  However, the report said modest rebounds in pharmaceutical spending and physician visits pointed toward an acceleration of costs in 2012 and beyond.  CMS’s analysts make much of the cyclical character of health spending’s relationship to economic growth and also forecast a doubling of cost growth in 2014 to coincide with the implementation of health reform.

This non-economist respectfully disagrees and believes the pause could be more durable, even after 2014.   Something deeper and more troublesome than the recession is at work here.  As observed last year, the health spending curve actually bent downward a decade ago, four years before the economic crisis. Health cost growth has now spent three years at a pre-Medicare (indeed, a pre-Kennedy Administration) low.

More Than The Recession Is At Work

Hospital inpatient admissions have been flat for nine years, and down for the past two, despite compelling incentives for hospitals to admit more patients. Even hospital outpatient volumes flat-lined in 2010 and 2011, after, seemingly, decades of near double-digit growth.  Physician office visits peaked eight years ago, in 2005, and fell 10 percent from 2009 to 2011 before a modest rebound late in 2011 — all this despite the irresistible power of fee-for-service incentives to induce demand.

The modest rebound in pharmaceutical spending (2.9 percent growth) in 2011 appears to have been a blip.  IMS Health reports that US pharmaceutical sales actually shrank in 2012, for the first time in recorded history, and that generic drugs vaulted to the high 70s as a percent of prescriptions!

There is no question that the recession’s 7-million increase in the uninsured depressed cost growth.  But the main reason health cost growth has been slowing for ten years is the steadily growing number of Americans — insured or otherwise — that cannot afford to use the health system.  The cost of health care may have played an unscripted role in the 2008 economic collapse.  A 2011 analysis published in Health Affairs found that after accounting for increased health premium contributions, out-of-pocket spending growth and general inflation, families had a princely $95 more a month to spend on non-health items in 2009 than a decade earlier.  To maintain their living standards, families doubled their household debt in just five years (2003-2008), a debt load that proved unsustainable.  When consumers began defaulting on their mortgages, credit cards and car loans, the resultant chain reaction brought down our financial markets, and nearly resulted in a depression.

By sucking up consumers’ income since 2008, the rising cost of health benefits has weighed heavily upon the recovery.  According to the 2012 Milliman Cost Index, the cost of health coverage rose by 32.8 percent from 2008 to 2012, while family income did not grow at all in real terms.  The total cost (employer and employee contributions plus OOP spending) of a standard PPO policy for a US family of four was $20,700, almost 42 percent of the US household median income in 2012.

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Could Wasteful Healthcare Spending Be Good for the Economy?

Suppose I throw a rock through a store owner’s window. You admonish me for this act of vandalism. But I reply that I have actually done a good deed.

The store owner will now have to employ someone to haul the broken glass away and someone else, perhaps, to clean up afterward. Then, the order of a new glass pane will create work and wages for the glassmaker. Plus, someone will have to install it. In short, my act of vandalism created jobs and income for others.

The French economist, Frédéric Bastiat called this type of reasoning the “fallacy of the broken window.” All the resources employed to remove the broken glass and install a new pane, he said, could have been employed to produce something else. Now they will not be. So society is not better off from my act of vandalism. It is worse off — by one pane of glass.

But there is a new type of Keynesian (to be distinguished from Keynes himself) that rejects the economist’s answer. Wasteful spending can actually be good, they argue. If so, they will love what happens in health care.

By some estimates one of every three dollars spent on health care is unnecessary and therefore wasteful. ObamaCare’s “wellness exams” for Medicare enrollees — so touted during the last election — is an example. Millions of taxpayer dollars will be spent on this service, yet there is no known medical benefit. Similarly, ObamaCare is encouraging all manner of preventive care — by requiring no deductibles or copayments — which is not cost effective.

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In Defense of Narrow Networks

It wasn’t long ago that the newly established health exchanges were being celebrated. Before the ongoing website catastrophe, politicians and policymakers were lauding the low premiums in these new health insurance market places. On September 24, President Obama said, “And the premiums are significantly lower than what they were able to previously get … California — it’s about 33 percent lower. In my home state of Illinois, they just announced it’s about 25 percent lower.”

How times have changed! Even supporters of the exchanges have rightly criticized the technical problems that have prevented millions of Americans from signing up. However, many critics are also complaining about the large number of health plan offerings with “narrow networks” of physicians that enrollees can visit for medical services. The Missouri Health Advocacy Alliance expressed “major concern” when Anthem excluded BJC HealthCare from its narrow network. Seattle Children’s Hospital, which was excluded from several exchange plans, has sued the Washington State Office of Insurance for “failing to ensure adequate network coverage.”

Criticism of narrow networks is misguided and counterproductive. As we explain below, narrow networks will be of little consequence to most of the individuals who sign up for the exchanges, and the elimination of narrow networks could eliminate our single best opportunity to harness market forces to reduce costs and improve quality. Indeed, narrow networks are largely responsible for the low premiums that were being celebrated just one month ago.

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The Hoax of Entitlement Reform

It has become accepted economic wisdom, uttered with deadpan certainty by policy pundits and budget scolds on both sides of the aisle, that the only way to get control over America’s looming deficits is to “reform entitlements.”

But the accepted wisdom is wrong.

Start with the statistics Republicans trot out at the slightest provocation — federal budget data showing a huge spike in direct payments to individuals since the start of 2009, shooting up by almost $600 billion, a 32 percent increase.

And Census data showing 49 percent of Americans living in homes where at least one person is collecting a federal benefit – food stamps, unemployment insurance, worker’s compensation, or subsidized housing — up from 44 percent in 2008.

But these expenditures aren’t driving the federal budget deficit in future years. They’re temporary. The reason for the spike is Americans got clobbered in 2008 with the worst economic catastrophe since the Great Depression. They and their families have needed whatever helping hands they could get.

If anything, America’s safety nets have been too small and shot through with holes. That’s why the number and percentage of Americans in poverty has increased dramatically, including 22 percent of our children.

What about Social Security and Medicare (along with Medicare’s poor step-child, Medicaid)?
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