Building a Healthcare System from Scratch, Part 5: Getting Market Share to Flow to Higher-value Options

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Image credit: bettergov.org

We established in prior parts of this series that there are specific identifiable jobs we want a healthcare system to do for us, and that there are parties that have incentives to perform those jobs for us. The focus then turned to how to get those parties to perform those jobs in ways that maximize value, which we saw is achieved by rewarding them with more profit when they perform their jobs in higher-value ways. And in part 4, we saw that the only effective way to do that is by getting market share to flow to the higher-value options. In this post, we examine what needs to happen for people to choose those higher-value options.

There are three requirements that all must be in place at the same time to enable someone to choose the highest-value option:

Requirement 1: Multiple options. This one seems straightforward–no market share can flow anywhere if there is only one option available. But there is another, less obvious aspect of this. Parties also need the freedom to vary their price and quality in ways that create unique value propositions, otherwise they will all look pretty similar, so the effective options people have would be severely limited, even if the total number of options is not. For example, if there is a price floor created by some administrative pricing mechanism, it will prevent any innovation that lowers quality a little bit but significantly lowers price. Why? Because those parties contemplating that kind of innovation will know that, without the ability to offer prices significantly lower than their competitors, they will be unable to win the market share necessary to make their innovation profitable.

Requirement 2: Ability to identify the highest-value option. Remember that value is determined by two things: quality and price. People choosing from among multiple providers or insurers need to be able to compare, apples to apples, the quality and price of all their options before they select one. But having apples-to-apples comparable price and quality information is not enough. The quality information would have to be simple enough to be easily understood and also relevant to the specific dimensions of quality people actually care about. And price information would need to reflect the expected total price of the product or service, otherwise it’s mostly useless. Both quality and price can be challenging in healthcare, which creates barriers to people being able to identify the highest-value option, but those barriers will be discussed in part 6 of this series.

Requirement 3: Incentive to choose the highest-value option. Even if people have multiple options and are able to easily tell which is the highest-value option, they will not choose that highest-value option without the right incentives. This applies to both their insurance plan selection and their care providers selection. Consider this example about choosing the highest-value care provider: suppose a patient has the choice to have a procedure at a nearby world-renowned hospital (95% success rate, $80,000) or the local community hospital (92% success rate, $40,000). Further suppose that this patient will pay $10,000 out of pocket (their annual out-of-pocket max) regardless of which hospital they choose. Which will they choose? An additional 3% chance of success for an extra $40,000 seems steep, but since they’re not paying the difference, most people would go for the world-renowned hospital regardless of the difference. Extracting the principle from this example, people need to pay more when they choose a higher-priced provider; this doesn’t necessarily mean they always need to pay the complete difference between the two, but they at least need to pay some more. Same goes for the quality aspect of value. If someone other than the patient (say, the insurance company) is choosing where the patient will receive care, they generally care a lot more about the price than about the quality differences between the options since they aren’t the one who bears the consequences of going to a lower-quality option. So, in summary, regardless of whether the discussion is about choosing providers or choosing insurance plans, the individual making purchase decisions needs to bear the price and quality consequences of the decision.

By now it should be clear that if any of these three criteria are not fulfilled, market share will not flow to the highest-value options, and the whole incentive scheme we are creating falls apart.

There are, you may have figured, many many barriers to these things working in current healthcare systems, some of which would be present even in our optimal healthcare system we are building. But that’s the topic of part 6.

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Building a Healthcare System from Scratch, Part 4: Levers that Determine Profit

leverIn parts 1, 2, and 3, we looked at what we want a healthcare system to do for us (the “jobs”), we figured out which parties in a healthcare system have an incentive to perform those jobs, and then we discussed that, for those parties to have an incentive to maximize value while performing those jobs, they need to make more profit when they deliver higher value.

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Now we’ll look at the different levers that affect profit and see which can be used to reward higher-value parties with more profit.

Let’s review how profit is calculated:

Profit = Revenues – Costs

Profit = (Price x Quantity Sold) – Costs

And since most companies sell more than one product or service, . . .

Profit = ∑((Price x Quantity Sold) – Total Costs)

These are the only four factors that determine a company’s profit: service mix, price, quantity sold, and total costs. So, which can be used to reward higher-value parties with more profit?

Service mix: Companies in healthcare already generally have the freedom to dedicate their resources in ways that maximize the amount of higher-profit services they deliver (why do you think my hospital renovated the orthopedics floor first?), so I won’t go into depth on this one other than to say that we need to allow them to continue doing that.

Price: Could we use prices somehow to reward higher-value parties with more profit?How about we try giving bonuses to higher-value providers? Those bonuses would effectively raise their prices, which actually lowers their value (remember, Value = Quality/Price). Sure, other providers would be motivated to raise their quality to get the higher prices too, but all we’d end up with is a little better quality at a little higher price, with no clear path to much else. Therefore, this approach doesn’t do a very good job of accomplishing the core goal of rewarding higher value with more profit. It’s not the lever we are looking for. But, while we’re talking about prices, there’s one crucial aspect of price that we need to include in our optimal healthcare system: providers and insurers need the freedom to set their prices themselves. The reasons for this will become clearer in subsequent posts.

Costs: Finding a way to lower the costs of higher-value providers is basically the same as raising their price–either way, more money is given to them, which raises their profit but lowers the value people obtain from them. So, the same problems exist with using costs as a lever to reward value with profit.

Quantity Sold: We’re left with one last lever, and I saved it for last on purpose. What would happen if higher-value insurers or providers all of a sudden were getting more patients flocking to them? They would certainly get more profit (assuming they have the capacity to take on more patients/subscribers). And the patients are happy because more of them are getting higher-value services. Now think beyond that static world. Over time, higher-value parties would continue to make more money and expand, and lower-value parties would be forced to improve their value or just go out of business. Parties would have an incentive to take big risks on innovations that improve value because they would know that, if the innovation ends up improving value for people (lower price, higher quality, or both), it will be rewarded handsomely with profits.

In summary, the best way to reward higher value with more profit is to get more patients to flow to them.

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In Part 5, I will enumerate the core elements required for people to do that.

Building a Healthcare System from Scratch, Part 3: Getting the Incentives Right

carrotIn Part 1, I enumerated the jobs we want a healthcare system to do for us. In Part 2, I explained which parties in the healthcare system (providers or insurers) have incentives to perform each job. Now comes the interesting challenge of figuring out how we can get those parties to perform those jobs well.

To understand this discussion, two key definitions must be absolutely clear.

First, the definition of value.

Value = Quality / Price

High value can be found at any price point. For example, it could be reasonable quality for a super low price, or it could be the absolute best quality for a not-crazy-high price. It just depends on how much money is available to be spent.

And just as a brief sidenote, I’ll mention that “quality” has many facets, and it’s the patient who–as the person consuming the service–ultimately gets to decide what constitutes quality. And “price” denotes the actual total amount of money paid for the service.

Second, the definition of a financial incentive. A financial incentive is something that rewards behavior with increased profit. Profit is the key here. Companies (or, the people who run them) don’t take huge risks and expend great effort that won’t result in more money for them. (This also applies to non-profit organizations, only they call it “surplus.”)

With those two definitions in mind, here is the principle: Our goal is to create financial incentives that reward value for patients. In other words, a provider or insurer needs to make more profit when they provide higher value for patients. This would motivate them to out-compete and out-innovate their competitors. And the form of that competition wouldn’t be destructive corner-cutting and responsibility-avoiding–it would be to actually provide higher value for patients.

Instead of hospitals spending fortunes on beautiful lobbies, they would be competing on how to make care cheaper, faster, and more convenient. Because that’s how they would make more profit.

Instead of insurers climbing over each other to find ways to cream skim the healthiest patients and creatively design networks to get sick patients to avoid them, they would be competing on how to most efficiently provide cost-saving prevention and how to have the best customer experience. Because that’s how they would make more profit.

Some say financial incentives have no place in healthcare. What they don’t understand is that there will always be financial incentives in any industry where people get paid for their work. We can’t ignore the inescapable presence of financial incentives in healthcare. But we can shape them in a way that motivates providers and insurers to maximize the value delivered to patients.

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In Part 4, I’ll enumerate the four levers that affect profit, which will then lead to an explanation of the barriers healthcare systems commonly have to those levers being used to reward value with profit.

Building a Healthcare System from Scratch, Part 2: Parties

In Part 1, I enumerated the five jobs of a healthcare system:

  1. Treatment
  2. Cost-effective prevention
  3. Cost-saving prevention
  4. Risk pooling
  5. Equitable access

This time, I will look at which parties in a healthcare system have financial incentives to perform those jobs.

First, what are the different parties involved in providing services in a healthcare system? It’s not that complicated. There are providers. And there are insurers, which includes not only insurance companies but also large employers who are acting as the insurance company for their employees. And there’s also government, which is potentially available to step in and assist in fulfilling any of the jobs that wouldn’t otherwise be adequately fulfilled just strictly based on financial incentives.

Taking each problem one by one, let’s look at who has an incentive to fulfill them:

Treatment. Providers get paid for doing this, so it’s an easy one.

Cost-effective prevention. Again, providers have an incentive to do this because they get paid for performing the service. The problem is, patients are often unwilling to spend money on things that won’t benefit them immediately. We’re all a little short-sighted now and then. So this is a case where government intervention may be warranted, such as making a policy that all insurers need to cover certain cost-effective prevention services without a copay.

Cost-saving prevention. Providers are the ones getting paid to actually perform the services, but really it’s the insurer that stands to gain when a patient gets a service that ends up saving a lot more money down the road by preventing future care episodes. This assumes insurers have long enough time horizons to reap the benefits (long-term savings) of investing in cost-saving prevention.

Risk pooling. Again, this one is straightforward. Insurers get compensated for doing this one.

Equitable access. Do insurers or providers have a financial incentive to deliver care to people who cannot afford it? No. They definitely have cultural incentives to do this, but not financial incentives. So, if society believes that the cultural incentives are not enough to promote sufficient care provision to those who cannot afford it otherwise, this would be another potential role for government to somehow intervene.

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In Part 3, I will write about how these parties can have incentives not just to fulfill those jobs but to maximize the value they deliver when fulfilling them. Bear with me–the utility of the framework isn’t quite obvious yet, but it will come together quickly.

 

Building a Healthcare System from Scratch, Part 1: Jobs

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Image credit: bakingdom.com

This series will explain my framework for understanding healthcare systems. I use it to make sense of everything I see happening in a healthcare system. And one could use it to build a healthcare system from scratch.

I developed the majority of this framework over 5 years (2010 – 2014), during which time I was thinking/reading/studying about healthcare policy almost every spare thinking moment. I just had this insatiable drive to make sense of the evidence I was reading as well as what I was seeing in the world. It was the ultimate puzzle. Luckily, my wife was patient and convincingly interested in my thoughts, which I shared almost daily. Every time I came up against a phenomenon that I couldn’t understand or explain within the context of the greater framework I was developing, it would struggle with it in my mind, sometimes for weeks, until I figured out what it meant and how it fit. Most of the posts on this blog came as a result of those struggles, and everything I now write about health policy is based on the foundational understanding encapsulated in this framework.

The framework starts by enumerating the jobs you want a healthcare system to do for you. Initially, it seems like only two jobs: prevent disease and treat the disease that cannot be prevented. But, because incentives work differently for different kinds of prevention, I will split that job into cost-saving prevention and cost-effective prevention.

Cost-saving prevention saves more money down the road than it costs up front. For example, maybe hiring someone to visit the homes of people with really bad heart failure will prevent enough hospitalizations that it more than compensates for the salary of the person doing the home visits.

Cost-effective prevention ends up increasing total spending–that is, the money saved (if any) doesn’t outweigh the upfront investment–but the benefit is large enough to justify that investment. For example, screening for colorectal cancer costs a lot, but it catches a lot of cancers early and saves enough lives that the investment is worth it. The exact definition of what’s cost-effective and what isn’t depends on the society, but the metric used is the cost for each quality-adjusted life year you gain ($/QALY).

In addition to those three jobs related to maximizing health, and because healthcare is characterized by rare, unpredictable, potentially financially catastrophic treatment episodes, a healthcare system must also provide financial protection in the form of risk pooling.

And, finally, people in most societies believe a healthcare system has a responsibility of providing these services even for people who cannot afford them, so equitable access (as defined by the society) can be added as the fifth and final job of a healthcare system.

The utility of enumerating these jobs will be seen in Part 2, when we will look at which parties in a healthcare system have financial incentives to perform which jobs.

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Does Supply and Demand Work in Healthcare? (Updated!)

This post is an update to my popular post, Does Supply and Demand Work in Healthcare? It explains the same things, but this version is shorter and clearer.

Supply and demand carry with them a few assumptions. When those assumptions are met, supply and demand works. When those assumptions are violated, supply and demand don’t work as we would expect. Healthcare is very different from most markets in the United States, especially in a couple key ways that violate the assumptions of supply and demand. The first violated assumption is that consumers have price and quality information. The second violated assumption is that consumers actually pay the price of what they buy. There are others, but these are the biggest ones, so let’s focus on them one at a time.

Assumption 1: Consumers Have Price and Quality Information

Think about how most markets work. People spend their own money to buy things they want. And because people don’t have unlimited dollars to spend, they’re weighing the value (Value = Quality/Price) of their different options–if something is higher quality but also higher priced, they have to decide if it’s worth it for them to spend that additional money to get that additional quality.

Think about how that impacts companies competing in a market. If one company makes a really high-value product, tons of people will buy it, and the company will increase supply so it won’t miss out on all those potential sales. If another company makes a dud of a product, it won’t get many sales, and it will decrease supply. (Yes I recognize that this is ignoring many complicating factors, but those factors don’t affect the point I’m trying to make here.)

Now, let’s look at how healthcare is different . . .

When patients choose a healthcare provider, they mostly aren’t using price and quality to make their decision. So even if a hospital is super high value, it won’t generally win the market share that it should, so it isn’t building additional wards like it would if it were competing in almost any other industry. Conversely, a low-value hospital will continually get more patients than it should, and it will keep its wards open.

Taking this one step further, a hospital will have a hard time investing in value-improving innovations if it’s not going to win more market share (i.e., additional profits) as a result. And, unfortunately, our current system often financially penalizes value-improving innovations. See here for more explanation on that.

Assumption 2: Consumers Actually Pay the Price of What They Buy

As I said above, a consumer in almost any other market will think carefully before buying a really expensive good or service. “This is way more expensive than the other one. Is it better enough to be worth it?” Same goes for deciding how much of something they’ll buy; people (usually) won’t buy more of a good or service than they think they can afford.

So, in other words, when customers actually have to fork out the dough for the thing they’re buying, their demand is appropriately limited. And, when demand is limited, that in turn constrains the quantity supplied–companies don’t want to spend a bunch of money making tons of goods that are unlikely to ever get sold without drastically reducing the price.

Now, let’s look at how healthcare is different . . .

The most obvious example I could bring up is end-of-life care. Think about a patient who had a massive stroke and is now in the ICU on life support, showing no signs of life for multiple days. There’s always the slightest chance they could recover some function, so it’s not unreasonable for families to cling to that hope and keep dragging it out. . . . Except that estimates of the cost for each additional day in the ICU run around the $5,000 mark. But, the family has probably already hit the out-of-pocket max for the year, so they won’t be paying a single cent more even if they drag the ICU stay on for another few days. My point is that demand is almost unlimited in a situation like this, and the hospital is happy to continue supplying the care as long as they’re getting paid for it. I’ve written elsewhere about the problems that arise when the party choosing how much care to get is not the same party that foots the bill.

These are just two examples of broken assumptions of supply and demand in healthcare. I am not saying that supply and demand will never work in healthcare; I’m just saying that the way our system is currently organized violates some of those assumptions. I’ve also written about how to fix that.

I’ll end with one other implication of all of this. Critics of “market-driven healthcare” abound because they say we’ve been trying it for a long time and look where it’s gotten us. But we actually haven’t truly tried it yet because we haven’t ever made the changes necessary to remove the barriers to supply and demand. Without explaining it fully here, I’ll assert that we can remove enough of those barriers for supply and demand to work well in healthcare. And the changes that would be required to accomplish that are compatible with any structure of healthcare system, be it a private system, a single-payer system, a fully government-run system, or whatever.

Why Drug Companies’ Medication Coupons Are Bad for the Healthcare System

Have you had the experience where you need a medication, and the brand name actually is cheaper for you because your doctor gives you a coupon for it? It’s great for you, but it’s bad for the healthcare system, and here’s why.

I have written before about the principle that is relevant to this, but it bears repeating: The party making a purchase decision must be the one who also bears the price differential between those options.

To understand why, let’s pretend you have a medium risk of heart attack or stroke in the next 10 years, so your doctor recommends you start a moderate-intensity statin medication. They’re all pretty close to equal in terms of efficacy and side effects, so the best money-saving decision would be to choose the cheapest one, right? Well, if your doctor says, “I’m happy to prescribe any of these for you. Which would you like?” You are the party who now gets to make a purchase decision. So you look at the monthly prices below (these are real prices):

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But then your doctor hands you a pitavastatin $100 off coupon some drug rep from Kowa Pharmaceuticals (the manufacturer) dropped off. You, a rational person, opt for that one since it’s now the cheapest (free)!

Now the monthly cost to the healthcare system for you to be on a statin totals $0.00 (your copay) + $101.36 (what your insurer has to cover) = $101.36. That’s about 20 times more expensive than it should have been!

What just happened here? The party making the purchase decision (you) did not bear the price differential between the options. Your insurer originally set it up so that you would pay more if you chose a more expensive statin, but the coupon interfered with that.

This same situation plays out over and over every day in our healthcare system with medications and with every other health service. It’s why I keep saying that we need to make the party who makes the purchase decision the same party who bears at least some part of the price differential between the options, which leads to a value-sensitive decision. Reference pricing does it, high-deductible insurance plans do it (for services below the deductible, at least), multi-tier prescription programs do it (when they’re not being subverted by manufacturer coupons). But these, collectively, are not influencing nearly enough of the purchase decisions being made in our healthcare system! And we waste money. Even worse, the higher value options are not rewarded with market share, the lower-value options are allowed to persist as is, and the overall value delivered by our healthcare system remains much lower than it could be.

So that’s why medication coupons–and any other thing that interferes with purchasers bearing the price differential between options–are bad.