Costs and revenue: This is the oxygen of any business, any organization. What are your revenue streams? How much does it cost you to produce them? Life is not just about breathing, but, if you don’t get that in-out equation right, there is nothing else life can be about.
Right now this enormous sector is turning itself inside out. It has turned the “transmogrification” setting to “warp.” Why? It’s all about the in-out. It’s all about increasingly desperate attempts to get that right — and the clear fact that we cannot know if we are getting it right.
Let’s do some school on the two sides of this equation. Let’s just go over the new weirdness, and the implications for you and your organization. Revenue first.
Hunting for True Revenue
In traditional health care (the way we did business until about five minutes ago) the revenue side was complicated in detail, but simple in concept: You do various procedures and tests and services, and you bill for them. You bill each item according to a code. You bill different payers; each has its own schedule of payments that you negotiate (or just get handed) every year. There are complications, such as people on Medicare with supplemental insurance, dual eligibles on Medicare and Medicaid, and self-pay patients who may or may not pay.
That’s the basic job: aggregating enough services that reimburse more than their real cost so that you can cover the costs of services that don’t reimburse well. This is cost-shifted, fee-for-service management. Cut back on those low-reimbursement services; pump up the high-reimbursement ones. Corral the docs you need to provide the services, provide the infrastructure and allocate costs across the system.
The incentives all point in the same direction. The revenue streams are all additive. The more you do of the moneymaking items on the list, the more money you make.
The authors’ recent book, Medicine in Denial, briefly mentions the subject matter of this post — the effects of fee-for-service payment. This post examines the issue in more detail, because of its importance to health care reform.
The medical practice reforms contemplated by Medicine in Denial have large implications for a host of policy issues. As an example, consider the issue of fee-for-service payment of providers. The health policy community has arrived at a virtual consensus that fee-for-service is a root cause of excessive cost growth in health care. Payment for each medical service rendered seems to involve an unavoidable conflict of interest in physicians: their expertise gives them authority to increase their own payment by deciding on the need for their own services. This conflict of interest has driven countless attempts at health care regulation. These attempts usually involve some combination of price controls, manipulation of incentives, and third party micromanagement of medical decision making. For decades these attempts have proven to be hopelessly complex, illegitimate in the eyes of patients and providers, often medically harmful, and economically ineffective.
Because regulating the conflict of interest has proven to be so difficult, the health policy consensus is now that the only escape from the conflict is to avoid fee-for-service payment. But this consensus misunderstands the conflict’s origin. The conflict of interest arises not from fee-for-service payment but from physicians’ monopolistic authority over two distinct services: deciding what medical procedures are needed and executing the procedures they select. The conflict does not disappear when payment switches from fee-for-service to its opposite–-capitation. Indeed, then the conflict becomes even more acute–-physicians have an incentive to withhold their expertise from costly patients who need it the most.
Back in 2008, Charlie Baker, then CEO of Harvard Pilgrim Health Care, and I, then head of a hospital, claimed that the market power displayed by the dominant provider system in the state and supported by the state’s largest insurer resulted in a large disparity in health care payments. We argued that this disparity contributed to unnecessarily high health care costs in the state. We both did this publicly, willing to put our assertions to the test. The quotes in response to this in a Boston Globe story were notable, but they did little to undercut our premises.
About a year later, the Attorney General of the Commonwealth published an investigation of this situation, which had the effect of validating our assertions.
Then, the largest insurer in the state said that the solution to the problem was to move towards a capitated, or global, payment regime. This would control the cost trend.
Again, knowledgeable observers, like the Inspector General, raised concerns. What if the global payment regime also created disparities and locked in higher rates? He noted, “[M]oving to an ACO global payment system, if not done properly, also has the potential to inflate health care costs dramatically.”
I pointed out that, while a global payment plan might have certain theoretical advantages, without a transparent exposition of its effects, how could we know if it had been successful?Continue reading…
One of the interesting things I learned in business school is that not only is it typical for a business to earn 80 percent of its profits from 20 percent of its customers, but that 75 percent of its customers may represent 120 percent of its profit. In other words, not only are some customers more profitable than others, but a fair fraction of the customer base is unprofitable. This kind of pattern is evident in a normal (i.e., non-health care) business. The main drivers are usually cost of customer acquisition and cost to serve. For example, some customers demand a lot more service than others and some customers that cost a lot to bring on only buy once. Price is usually a secondary factor, with more powerful or shrewder customers negotiating discounts.
Once businesses understand their true costs and profitability by customer segment they can take steps to improve profitability. For example, if customers recruited through advertising on Facebook are unprofitable, the company can advertise elsewhere. If some customers use a lot of service, the company can start charging for service explicitly.
Health care is a lot weirder than that, as Ambulance-Bill Chasing in the Sunday Boston Globe Magazine illustrates. A non-health care person wrote about how he tried to understand the bills for his mother’s ambulance rides to and from the hospital. The more he dug, the more bewildered he became:
As a reporter, I’m used to dealing with complex material, but this drive down one of the countless, curvy roads that merge into the Health Cost Superhighway left me both more informed and more confused. Maybe it really is easier to remain clueless and indifferent about our medical bills. The alternative, as a friend who has spent decades in the health care trenches told me, is “to be clueless and terrified.”Continue reading…
One aspect of religious dogma that has entered the medical world is that fee-for-service pricing of medical services is bad and should be replaced by a capitated, or global, arrangement that establishes an annual budget for care for different risk groups of patients. Like other religious beliefs, this is often offered without rigorous analytic support. Some insurance companies are particularly pleased with this approach because it shifts risk from insurers to providers and makes it easier for the insurers to create budgets and price their products.
Don’t get me wrong. This may be the right way to go, but the topic is worth more time and discussion than it has received.
It may be illustrative to think about other sectors of our economy and see which of them are characterized by global payments. Not many. Sure, there are products like cellular phone service that are sold in monthly fixed dollar amounts. But that is because it is a high fixed-cost product, where the marginal cost of additional phone calls is essentially zero. Fixed prices offer revenue stability to the vendor and a way to recover those fixed costs.
But most other goods and services in our economy are sold on a piece-work basis. Think of groceries, automobiles, electricity, gasoline, televisions, and clothing. Why is fee-for-service pricing appropriate for these? Or, in economists’ terms, why does such pricing lead to a reasonably efficient solution? The answers are pretty straightforward. Other markets are characterized by open entry and exit and by transparent information concerning quality, value, and pricing. Consumers can make more or less knowledgeable choices based on that publicly available information. New firms enter the market when they see an opportunity. Successful firms grow. Other firms fail.
Lots of people are thinking about the form of payments between insurance companies and providers for health care services, but it is also important to think about how each such approach would be marketed as an insurance product to the population.
The payment model that gets the most attention is capitated, or global payments, combined with accountable care organizations. In this environment, an average annual budget is established for each person served by an integrated health care delivery system (ACO), and that budget is shared among the providers according to some mutually agreed upon arrangement.
But the insurance product that would accompany this kind of payment scheme is often left without much of a description. As I have talked with insurance executives, they often fail to explain how they would offer consumers a desirable choice for a product based on this payment plan. Instead the main focus seems to be on shifting risk from the insurer to the providers, reducing the amount of unnecessary expenses, and sharing the benefits of those changes between the insurance company and the providers. Over time, the theory goes, the cost curve is slowed and premiums go up less quickly. But, it remains unclear what the role is for consumer in this scheme.