How Can Innovation Lower Healthcare Spending?

I write a lot about how to decrease our inordinate spending on healthcare, and this week I want to clarify a little bit how I see this actually working. This requires me to define a couple terms:

  • Active demand: Demand that is being fulfilled. In other words, we’re expending resources to fulfill a need.
  • Latent demand: Demand that is not yet being fulfilled. It’s something people want and would be willing to expend resources to get, but there is just no technological or pharmaceutical solution to fulfill that demand. For example, activating latent demand could mean finding a treatment for a disease that has no treatment as of yet, or it could mean finding a better (usually more expensive) treatment for a disease that already has other treatment options.

When innovation activates latent demand, it usually increases spending because it’s allowing us to do more things for more people. But about innovation that doesn’t activate latent demand?

Think about provider-led innovation. Providers can only take the medicines and devices available to them and figure out how to apply them to patients as efficiently as possible. When they innovate, they are finding new ways to apply those things more efficiently. Thus, provider-led innovation usually lowers healthcare spending.

Think also about insurer-led innovation. Insurers are paid a fixed premium every month by their enrollees, and if they are able to innovate in ways that prevent care episodes (say, by hiring a community health worker to visit high-risk patients and keep them out of the emergency department), they end up keeping that unspent money in their pocket. So insurer-led innovation also usually lowers healthcare spending.

If providers and insurers can innovate to lower healthcare spending, why is innovation one of the primary drivers of increasing healthcare spending? Because, the way incentives are set up right now in our healthcare system, there are huge rewards available for anyone who comes up with a new medicine or medical device (pharmaceutical companies, medical device companies, etc.), but there are minimal rewards for providers or insurers that find ways to apply those innovations more efficiently to patients.

I’ll talk more next week about why providers and insurers don’t innovate more.

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