How Doctors Make Prices

I’m venturing out a little bit on this post because I don’t know if the pricing process I’m about to explain is used by all providers or not. That’s my disclaimer.

Now I’m going to pretend I’m a doctor with a brand new self-run clinic. I’ve just hired all my nurses and bought all my computers, etc. My next step is to decide on a fee schedule. How do I do it?

I start by checking prices of other doctors in the area. Or not, because I can’t find any of those. So then I ask some of my physician friends, who say they generally charge 100 to 120 percent of Medicare fees. “That’s quite a range,” I say. But then they say it doesn’t matter too much what I set my fees at because my future patients’ insurance companies will basically choose how much they are going to pay me anyway.

Insurance companies decide the price? I guess that makes sense because they have all the bargaining power over me, a lowly solo doctor running my own clinic. So I somehow find a way to take a look at compensation schedules for different insurance companies, including Medicare and Medicaid. Their prices are all over the board for every procedure! For a single billing code (maybe it’s the one for setting and casting a broken arm), Insurance Company X will pay $1,100, Insurance Company Y will pay $1,000, Medicare will pay $900, and Insurance Company Z will pay $1,200.

Now I start thinking strategically about this. If patients are never going to ask me how much I charge, since their insurance companies will handle all of that, I decide to set my price for setting and casting a broken arm at $1,200. Why? Because if I set it at $1,000, I’m only going to get $1,000 from Company X, who was willing to pay me $1,100, and $1,000 from Company Z, who was willing to pay me $1,200. Why would I set my price low and leave all that money on the table? So as long as I set my price at $1,200 or higher, I’ll get the full $1,200 from Company Z, the full $1,100 from Company X, the full $1,000 from Company Y, etc.

So how do the insurance companies decide on these fees? I hear stuff about this specialist-dominated group of physicians who, working as a committee (known as the RVS Update Committee, or RUC), get to update the Medicare fee schedule every year. And people keep telling me that’s why I, as a primary-care doc, don’t get paid as much as I should because those darn specialists in that committee overvalue work done by specialists and undervalue work done by primary-care physicians.

At this point, I give up worrying about prices and just trust that the money that comes in every month will be more than the money that goes out every month. And, after a few years, that seems to consistently be the case, so I just stop worrying about it.

. . . That is, until patients on high-deductible insurance plans start calling my receptionist and asking what our prices are for various procedures. We’re not sure we want her to admit that our price for setting and casting a broken arm is a whole $1,200, so we prepare a canned response to such inquiries: “We’re not allowed to quote prices over the phone. You’ll just have to come in so the doctor can take a look at you first.”

Why Doesn’t the Healthcare Industry Evolve Like Other Industries?

If you think about almost any industry and how it changes over time, you can see an obvious shift from high cost, low quality to lower cost, higher quality (and, thus, greater access to the product/service). Think about computers, or portable music players, or cars, or flat-screen TVs, or indoor plumbing, or airline flights. . . .

Average yearly productivity growth of industries is estimated to be about 2.4%. But healthcare is different–it receives negative estimates year after year. So what’s the cause of this? Why doesn’t healthcare evolve toward higher productivity over time? If we can figure this out, then maybe we’ll know what we should work on changing with how the industry is structured. And then we’ll be able to permanently solve this crazy trend of healthcare spending, which has been increasing at a rate of 2 – 4% faster than the rest of our economy for a long, long time.

People often blame the lack of evolution (toward lower cost, at least) on healthcare providers not having an incentive to compete on price. Patients don’t price shop, so why would they compete on price? And patients don’t price shop because insurance just covers everything for them, even the small, routine things.  We’re all contributing to this because, no matter which doctor we choose, we still have a $15 co-pay, so why would we waste our time finding out which provider will send the cheapest bill to our insurer? It’s reasonable, this argument, which says that the insurance structure is the reason healthcare providers don’t have to compete on price, and that that is causing the industry not to evolve like it should.

Are there any solutions to this?

The most commonly proposed solution is high-deductible insurance plans. It makes sense. If nothing is covered until you surpass a $1,000 or $2,000 or $5,000 deductible, price starts to really matter unless you’ve already surpassed that deductible for the year (which would be unusual for healthy people). The hard part about this is actually being able to find out prices from providers, but we’ll ignore that with the assumption that if enough people start requesting prices, providers will start making them more readily available. So the result would be that providers finally have to compete on price, they now have an incentive to find ways to reduce prices, and problem solved!

Not so fast.

Did anyone ever consider that providers already do compete on price? No, they don’t compete on prices for patients, but they do compete on price to win insurance contracts. How do you think insurance companies choose which doctors will be in their network? By price! Yes, providers definitely compete on price already. They do it to win insurance contracts, which then guarantees them a steady flow of patients and revenue.

But why doesn’t price competition for insurer contracts provide enough of an incentive for providers to find ways to cut costs and help the healthcare industry to evolve like almost every other industry?

I don’t know. But here’s my guess:

Management is in charge of negotiations to win insurance contracts, so they feel the pressure to find ways to lower costs, but that pressure isn’t conveyed strongly down to the people who have the knowledge required to actually recommend cost-cutting changes: doctors and nurses. If management isn’t working with the current business model’s routines and processes day in and day out, they aren’t going to see the inefficiencies in how things run. Doctors and nurses need to do that, so maybe most healthcare organizations aren’t giving doctors and nurses enough/any incentives to do that.

But, management’s specialty is figuring out completely new processes, routines, and business models that can achieve the same job for the patient but at a way lower cost. So why aren’t healthcare management people figuring out and experimenting with those in an effort to secure more insurance contracts (and, thus, market share and higher profitability)? You’d think the price competition for insurance contracts would at least motivate those kinds of experiments.

The answer may lie in the fact that healthcare provider organizations are known as some of the most complex organizations conceived by man. Possibly this complexity deters innovations like that. They’d be so hard to predict financial outcomes and market response! And with fewer ideas being tested, the evolution of healthcare will necessarily be slower than most industries. I’d love to see some research comparing the complexity of organizations with their speed of productivity growth. And I’m also interested to see the results of all sorts of government-funded “pilot programs” that allow providers to test new ideas out.

So, those are my conjectures, that price competition for insurance contracts isn’t enough because doctors and nurses aren’t given enough incentives to root out inefficiencies and because healthcare organizations are so complex that they deter business model innovations. Maybe I’m way off. Ideas?

UPDATE: I’m wrong. Providers don’t compete on price to convince insurers to add them to their networks. I’ve since learned that prices between insurers and providers are pretty much decided by Medicare prices as an anchor and adjusted up or down depending on bargaining power. This means prices will stay the same even if providers find lower-cost ways to deliver care. So, the question remains: Why aren’t providers finding all sorts of ways to lower costs if any cost reduction would not be followed by price reductions and, therefore, go straight to their bottom line? I still haven’t figured this one out, but Clay Christensen seems to think providers need to encompass the whole value chain to be successful at it, so maybe that has something to do with it.

Our Healthcare Spending Trend and Why It’s Killing Us

I wrote a post a little while back explaining that there are two types of healthcare costs: care costs and non-care costs. Well, taking a step back, those are actually both related only to our level of spending. But there is another aspect of spending that is not talked about nearly as much, and about which I am much more concerned: trend.

The U.S. Department of Labor keeps track of the U.S. inflation rate, and they say it has been under 4 percent every year since 1991. Estimates of yearly health spending growth range from 5 to 15 percent, but most come in over the 10 percent mark. If you’ve done your math correctly, you probably figured out that healthcare spending is increasing faster than inflation.

So, is this bad? Well, as a country, we’re getting wealthier, and with more wealth comes more health spending, which is a great thing. There are tons of things that people choose to get healthcare-wise when they have more money. Maybe it’s plastic surgery, maybe it’s other cosmetic surgeries, maybe it’s eye surgery, maybe it’s weight-loss surgery, maybe it’s the more expensive treatment option for longtime joint or back pain, . . . you get the picture.

So yes, some spending increases are a good sign. But that crazy spending growth can’t all be attributed to wealth increases in our country. Two other big causes of spending growth can probably be labeled as (1) medical technology and (2) chronic diseases, and both of these are causing me some concern. First, a little explanation of each.

Medical technology causes spending growth because it allows us to spend tons of money saving someone or fixing someone when we used to have to just watch from the sidelines. It also allows us to treat things more effectively and more expensively. For example, a robot for use in surgeries is super expensive, but it reduces invasiveness and increases the range of things that are considered operable. These are positive things as well.

And as for chronic diseases, this refers to kidney disease, heart disease, diabetes, those sorts of things. And some estimates say that two thirds of our healthcare expenditures are generated by them. Crazy, I know.

So there’s a basic overview of why healthcare costs are increasing faster than our economy is growing. And here is why I’m concerned about it: it’s pricing low-income Americans out of healthcare insurance and contributing to a growing national debt.

As insurance companies have to deal with more expensive beneficiaries (especially the ones with chronic diseases), they have to raise insurance rates. And as new (more expensive) treatment options become available, they have to cover many of those (or risk losing beneficiaries), which means (again) raising insurance rates. All of this raising insurance rates business means it gets too expensive for people and employers, so they just make the decision to just get rid of health insurance and hope for the best.

And then there’s the government debt. Medicare and Medicaid are not immune to all the insurance cost increases. Yeah, they get to decide how much they pay providers, but they still have to decide what to do about new expensive treatments, and they also have to fork out more dough for people with chronic diseases, especially since the over-65 population is the main chronic-disease population. It’s just getting more expensive for the government to pay for healthcare!

So there you have it. Our spending trend is causing some major problems, and it is definitely exacerbating our quality and access problems. But never fear! There are some amazingly good solutions out there for all of this, but I’ll save those for another post, same bat time, same bat channel.

Does supply and demand work in healthcare?

[Update: This is one of my first posts on this blog, and it’s also one of my most popular. Too bad it’s a long post that isn’t the clearest. So here’s a shortened and clarified version.]

On Wednesday, I went to the Health System Reform Task Force meeting at the Utah State Capital building. I recently learned that most governmental meetings are open to the public, so you can go to them whenever you want! During the meeting, they often have someone present some kind of informational presentation to help them get a better idea of what’s going on in healthcare. Last month, a physician from Intermountain Health Care presented on prescription drug abuse in Utah. (It’s pretty bad, if you didn’t know. Actually, I think he said that Utah is the worst state for prescription drug overdose fatalities.) This month, a physician talked about some “demonstration project” he’s leading to improve pediatric care in Utah. It was pretty interesting, but the most interesting part was when he said the following: (These are direct quotes transcribed from the audio recording of the meeting.)

“Supply and demand, which in most markets works perfectly, doesn’t work so well in healthcare. The demand for healthcare really sees no limit, especially if cost is not a factor for the consumer, and that is the case, of course, in most third-party payment situations. But I think it’s also the case in situations where life is in the balance. It’s hard to put a limit on how much you’re going to demand. And also, I think consumers can’t adequately evaluate their options. Shopping around for a physician, shopping around for a surgeon is not easy. Shopping around for emergency care when you really need it is impossible. So the ability really to be a wise and educated consumer and make conscientious choices is difficult. And also the supply of physicians and providers is not driven by normal market forces. We see a lot of increasing specialization for reasons that aren’t necessarily fitting with the supply-demand curve. Specialization is driven by income, especially because specialists make considerably more in most cases than primary care physicians.”

This got me thinking, and I started evaluating his statements and typing notes on my phone. Then I was surprised when the senate chair of the committee challenged him on it after the presentation.

“I just had one comment, and maybe you could clarify if it was an intended comment. You mentioned in your presentation that supply and demand did not apply.”

Physician’s interjection: “I didn’t say it did not apply, I said it didn’t work, like it does in most markets. So, just to clarify your question.”

The Senate Chair continued, “Well, the comment I have on that is that supply and demand function, whether we want it to. It functions, it’s natural law, whether we want it to or not. We can try and interfere with it, but, a lot of the things, I believe I could demonstrate a lot of the problems you presented there are a result of interfering with supply and demand. And so, the idea that it doesn’t function and we can try and overcome it, I think that’s a basis for failure in the long run, that we’re just going to have to control healthcare more and more because if supply and demand is going to function, and its results are, the unintended consequences we’re trying to control. So we continue to regulate more and more. . .”

And the physician’s response, “I’m probably not sophisticated enough economically to speak to the question, but I hear what you’re saying and I agree.”

At this point, I almost raised my hand, walked to the microphone, and answered his question. I should have. But I wasn’t sure if I was allowed to do that, so I hesitated and missed the opportunity. That means I get to say here what I would have said there:

My honorable legislators, supply and demand carry with them a few assumptions. When those assumptions are violated, supply and demand don’t work as well as we would expect. Two key assumptions are violated by our current healthcare system. The first is that consumers have price/quality information so they can shop around for the best value. The second is that consumers actually pay the price of what they buy.

The First Broken Assumption. Let’s think about an example of digital cameras. Without important information like how much a camera costs or how many mega-pixels it has and how many times zoom it can do, how do consumers choose the best value? They can’t! And thus, there’s not much incentive for camera manufacturers to take risks to improve cameras because it won’t help them make more money. Innovation is stifled without that incentive. To bring this back to healthcare, why would a doctor’s office make an innovation like install an electronic medical record that would temporarily disrupt process flows and require a large upfront cost if it won’t help convince more patients to come?

The Second Broken Assumption. This is a tricky one. Yes, consumers pay the full cost for their healthcare–they have already done it through insurance premiums or reduced salary. But they don’t see that full price directly like it’s coming straight out of their wallet, so they don’t perceive that they’re paying the price. Thus, they don’t care so much what the price is. This inflates demand in a big way! Think about the man whose father is about to die. He’ll tell the doctor to do whatever it takes to keep the father alive, but how willing would he be to do that if the man knew he was going to have to pay $600,000 right out of his own bank account?

That’s what I would have said. It’s almost exactly what the physician said, but I don’t think he understood it quite well enough to realize that the things he was talking about were actually just the broken assumptions of supply and demand in healthcare.

After I thought this, I understood a part of the health bill in an entirely new light. It’s requiring states to form these “health insurance exchanges” that are essentially websites that list all the state’s available insurance plans, their prices, and their benefit packages. What will this do? Help people know prices! Help people know value! It’s a way to solve the first broken assumption.

There are many critics of “market-driven healthcare.” They say it has never worked in the U.S., so how can advocates of it be so ridiculous? Well, I guess now we know why it has never worked, and now all you conservatives can understand your argument for less government in healthcare, assuming (as does the Senate Chair for the Health Reform Task Force) that it’s the government that is causing those assumptions to be broken.

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