Building a Healthcare System from Scratch, Part 8: Fixing the American Healthcare System

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Image credit: thepolicy.us

This is the final installment of the Building a Healthcare System from Scratch series, and it begins with the same caveat as Part 7—to understand the rationale behind the ideas presented, you need to read and understand all the prior parts of the series, beginning at Part 1.

Now that I have explained my framework (Parts 1 through 6) and described what various types of systems would look like that have implemented the principles of it (Part 7), we are ready to look at something more complex: rather than building an optimal system from scratch, how can this framework be applied to an existing system that needs fixing? The American healthcare system will be a perfect case study for this.

Where it sits right now, the American healthcare system seems to land somewhere in between the libertarian-type system and the single-payer system described in Part 7, except that it fails to implement the majority of the principles of the framework. It is also overly complex, which contributes greatly to its impressive administrative expenses. So what could a much-simplified American healthcare system look like that also maximally implements the principles of this framework? With consideration for and much guessing about Americans’ preferences regarding healthcare, here is an imagined description . . .

The United States eventually chose to strengthen its individual mandate. The government now mandates all people, without exception, to have a healthcare insurance plan that covers all services included on its list of “essential health benefits.” For those who forego insurance coverage, they pay a tax penalty that ends up being nearly the same as the premiums they would have paid. If uninsured individuals receive care that they cannot afford, they usually end up having to either go on long-term repayment plans or declare bankruptcy because there is no bailout available for them.

The website healthcare.gov has become the ultimate source for healthcare insurance shopping. All qualified insurance plans (i.e., plans that cover all the essential health benefits) are listed there, along with their coverage level (according to the metal tiers), prices, and a short description that highlights any other benefits the plan offers that may help prevent healthcare expenditures.

Premium subsidies are available to all whose premiums will exceed a certain percentage of their income, and the subsidy amount is pegged to the second-cheapest qualified insurance plan available to them. The subsidies are automatically applied at the time people are choosing a plan on healthcare.gov. Because this system worked so well and was basically duplicative of Medicare and Medicaid, both programs were slowly phased out, which decreased insurance churn and increased time horizons. However, a vestige of Medicaid remains in that, depending on an individual’s annual income, there are also limits on how much they can be required to pay out of pocket for care.

The government also did away with the employer mandate and somehow found the political willpower to repeal all tax breaks for healthcare expenditures, which eventually led to employers getting out of the business of providing healthcare insurance for their employees and just giving that money to employees directly as regular pay.

Altogether, these changes mean that all Americans shop for their healthcare insurance on healthcare.gov. For anyone who is unable to do this themselves, there is a phone number to call to connect with someone who can assist them in selecting the plan that seems best for them.

A few changes were also made to encourage more insurance options. First, many regulations were eliminated, including the medical loss ratio requirement and state insurance department approvals of rates. These became unnecessary after people began to be able to compare the value of different insurance plans and choose based on that because overpriced or low-value plans (either from too much overhead or too high of rates in general) lost market share and profit. State-specific insurance regulations were standardized so that insurers can easily expand to new markets. And a law was passed requiring transparency of all price agreements between providers and insurers, which made the process of forming contracts with providers in a new region easier. These policies led to almost all markets having multiple options for each coverage tier.

In this way, the United States achieved universal access to affordable healthcare insurance relying on the private market while preserving the ability and incentive for all people to select the highest-value insurance plan for them. As a result, insurance plans aggressively innovate to find ways to prevent care episodes so that they can offer lower premiums and attract higher market share. Insurers also found that implementing differential cost-sharing requirements led people to start choosing lower-priced providers, which also enabled the insurer to lower premiums further. Finding provider prices has become easier ever since the price transparency law was passed.

The government has had to help overcome the problems caused by a multi-payer system by enforcing some standardization, including uniform insurance forms/processes, standardized bundles of care that all insurers in a region either agree or disagree to implement together, and standardized quality metrics that providers are required to report. These quality metrics are not used for bonuses, so they have been changed to be more focused on what patients need to know to choose between providers for specific services.

These quality metrics are now reported on an additional section on healthcare.gov that lists all providers, their quality metrics, and their prices (seen as your expected out-of-pocket cost if you log in) in an easy-to-compare format. Due to patients’ differential cost sharing requirements for most services, as well as broad common knowledge of the existence and utility of this website, most patients have begun to refer to it before choosing providers. This part of healthcare.gov has even been developed into a highly rated smartphone app.

In response to these changes, providers found that their value relative to competitors largely determined their market share and profitability, which unleashed an unsurpassed degree of value-improving innovation. The cost of care in the United States was previously so high that the majority of those initial innovations led to much cheaper care, which led to much lower insurance premiums and eased the premium subsidy burden on the federal government. Thanks to these changes, the federal deficit has begun to sustainably diminish quicker than any budgetary forecasting model could have predicted, which has also helped stabilize the American economy.

There are still barriers to people being able to identify and choose the highest-value insurers and providers. There are many important aspects of quality that are unmeasurable. Many people do not have the health literacy required to figure out which insurance plan or provider would be best for their situation and preferences, despite the ease of comparison enabled by healthcare.gov. There are medical emergencies that do not allow shopping (although the number of these has turned out to be much less than was previously thought because most of what used to present to emergency departments were not actually emergencies).

In spite of these lingering barriers, enough patients are choosing the higher-value options that providers and insurers still have a strong incentive to innovate to improve their value so they can win the market share and profit rewards available to higher-value competitors. And the result is that Americans are being kept healthy more often and are receiving care that is higher quality and more affordable.

That concludes my imagined description of how the American healthcare system could look with the principles from this framework fully applied. Just as a reminder, it represents merely a guess of how it could end up given the current system. This is by no means the only way to apply the principles of my framework, nor is it my secret idealized version of how it could end up. But I hope it was useful and thought provoking as a case study!

We have come a long way in this series. Throughout it, I worked hard to make the principles of my framework clear, and I hope the concrete examples have helped solidify those as well as demonstrate their potential for sustainably fixing healthcare systems around the world. If you want a more academic treatment on this framework (at least the part of it that applies specifically to providers), I published that as a medical student.

I intend to help policy makers of all types find ways to apply the principles discussed in this series. Please contact me if you have questions or would like me to help work through potential applications. Contact info is on my About Me page. In the meantime, I hope you will follow along as I continue to blog about how to fix our healthcare system!

Building a Healthcare System from Scratch, Part 7: Concrete Descriptions of Some Optimal Systems

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Image credit: Rattanachat

In Parts 1 through 6, I explained my framework for understanding the necessary ingredients of an optimal healthcare system. Those are the pre-requisite readings to understanding this post, and I will not fully summarize or provide the rationale for them here. But, just as a reminder, Parts 1 through 6 culminated in the goal of getting market share to flow to higher-value providers and insurers, which would be enabled through three critical inputs to decision makers/patients: (1) multiple options, (2) the ability to identify the highest-value option, and (3) incentives to choose the highest-value option. As barriers to those three inputs are minimized, any healthcare system will begin to evolve to deliver higher and higher value. This is the only way to unlock sustained value improvement in healthcare systems.

An important point about this framework is that it is, in a sense, welfare-spectrum neutral, meaning the principles apply to healthcare systems that sit at any point on the welfare spectrum, from libertarian-type systems to fully government-run systems.

Now let’s imagine up some concrete examples of what different types of systems might look like if we built them from scratch using the ingredients from that framework.

A Libertarian-type System

In this system, there are many private insurers all offering creative and innovative health insurance plans. Their efforts are focused on trying to maximize cost-saving prevention so they can lower their costs and then outprice their competitors. This has led to many ways of keeping people out of hospitals and emergency departments. But since health insurance is an inherently complex product, there are some standardized levels of coverage that have been agreed upon to help people compare those plans apples to apples. This standardization has been implemented in a way that maximally improves comparability with minimal limitation on plan design flexibility. Multiple health insurance comparison shopping websites have arisen, all highlighting those standardized coverage levels, differences between plans, and clear pricing.

An important aspect of these insurance plans is that most of them require the enrollee to pay some part of the price differential between providers; this did not need to be mandated because insurers found that they are able to price premiums more aggressively when they have implemented those cost-sharing characteristics. The plans that do not have this feature are much more expensive, but some people prefer them because they don’t ever need to worry about prices when choosing providers.

There is no requirement for people to buy health insurance, but because there is also no guarantee of care if someone without insurance has a catastrophic medical expense, many people are motivated to buy catastrophic coverage. The rest of their care they buy a la carte out of pocket.

Many of the poor, as well as people with chronic expensive medical conditions, are priced out of the insurance market, but private charities have cropped up that assist with this for most of them.

Looking at the provider side, nonprofits have played a leading role in establishing standards in provider quality metric tracking and reporting. These nonprofits also certify the quality information being reported by providers, so patients are able to compare the quality of different providers apples to apples. The quality metrics being reported and certified are determined by what patients find most relevant in helping them decide between providers for each service they are shopping for. Similar to the health insurance shopping websites, there are provider shopping websites presenting those standardized metrics alongside providers’ advertised prices.

Because providers are assured increased market share when their value goes up relative to competitors, there is a great variety of innovation toward crafting high-value care experiences for patients. Most of the value improvements are in the form of cost-lowering innovations because of the downward pressure on price exerted by the uninsured population and the price-sensitive insured population. Providers have particularly found that shifting the location of care to less expensive settings (including even the patient’s own home) and shifting to relying more on narrowly trained provider types (particularly for treatments that are relatively algorithmic) is very effective at lowering costs. Suppliers of healthcare devices have also found that they are more successful as they focus on developing lower-cost devices, even if that means sacrificing some amount of quality or features. And since government regulations have been kept to a minimum, all these innovations have been allowed to progress and flourish quickly. This occasionally results in unsafe practices and devices cropping up, and individuals have been hurt in the process, but people have felt that the rapidity of innovation that has improved so many lives has been worth that cost. And any practice that proves to be unsafe is exposed quickly in this marketplace.

Providers have also found that, when patients are shopping for a provider, they are looking for a specific well-defined service or bundle of services, such as a year’s worth of chronic disease management, a CT scan, a hip replacement (including all the pre-op workup and the post-op rehab), or a diagnostic evaluation. This has led to standardized bundles of services (also certified by those non-profits), which has made shopping for healthcare services easier and also enhanced the ability to compare the prices from one provider to another.

This system is not perfect. Some people choose not to buy insurance and then have to declare bankruptcy when they have an expensive care episode (or end up not getting care due to inability to pay), and some people want to buy insurance but are frustrated that they cannot afford it, although this number is decreasing each year. Providers face challenges dealing with multiple insurance plans with different reimbursement schemes and coverage rules. And unsafe practices or innovations crop up every so often that harm patients. But, overall, the value delivered by insurers and providers increases rapidly as insurers find new ways to prevent care episodes, and, for the care episodes that cannot be prevented, providers find ways to make care safer, more convenient, and more affordable.

A Single-payer System

With the government running the single insurance company for this system, they have been able to easily implement many of the needed aspects of an optimal healthcare system. They automatically cover all known cost-saving and cost-effective preventive services without copays, which includes population-based preventive services but also focuses more and more on targeting extra services to high-utilizing patients to prevent hospitalizations and ED visits. Their cradle-to-grave time horizon has helped this immensely.

The prices the insurer assigns to services are not firm but are rather considered to be the “maximum allowable reimbursement,” so any provider that wants to charge a lower price will have the freedom to do that. And providers who innovate and find ways to charge less win market share because the insurance plan’s cost-sharing policies require people to pay less out of pocket when selecting a less expensive provider. The insurer has also found that paying a single fee for standardized bundles of services has motivated a great deal of provider innovation and cooperation.

Together, all these reimbursement policies help to prevent as many care episodes as possible and minimize the cost of the episodes that are not preventable.

The insurer’s fee schedule also includes a multiplier to adjust for regional cost variations, and they leverage this to increase reimbursement in underserved areas as well, which has especially helped rural areas maintain enough providers.

As a condition of being accepted as in-network by the insurance plan, providers are required to use an electronic medical record that is able to decode and record to the patient’s secure cloud-based personal health record. Providers are also required to report specific quality metrics. These quality metrics are never used for giving bonuses, but they instead focus on the aspects of quality that patients find most relevant when they’re trying to decide between provider options. The insurer operates a single website that lists all in-network providers along with these risk-adjusted quality metrics and each provider’s prices (displayed as the amount the patient will be expected to pay out of pocket).

Providers appreciate this system for many reasons. They only deal with a single insurer, which minimizes insurance-related overhead expenses and gives them a single set of incentives to respond to. They are completely free to build hospitals and clinics wherever they think they will be most profitable. And they can organize care however they want provided they adhere to the safety and reporting regulations.

Now, having seen the main aspects of this system, let us consider the impact of not adhering to the framework’s requirement of having multiple insurer options. Recall that the jobs insurers are primarily responsible for are risk pooling and cost-saving prevention. And the reason having multiple options is desirable is because—assuming patients can identify and then choose the highest-value insurance plans—insurers will have a profit motive driving them to innovate to find ways to increase the value they deliver, which especially means finding ways to do more cost-saving prevention that will result in more care episodes being prevented, thus lowering the total cost of care and insurance prices. With a single government-run insurer, that innovation and its attendant benefits will be curtailed. Clearly there are many compensatory benefits, including simplicity, reduced administrative overhead, uniform incentives, and a straightforward way of achieving a society’s goal of universal access to insurance. Depending on the priorities of the country, these benefits may outweigh the costs. It is a question of values. But the decision becomes easier when the costs and benefits of each option are understood.

A Government-run System

This system, like the single-payer system described above, has a single insurer that is run by the government. But here the government also owns all the healthcare facilities and employs all the healthcare providers.

On the insurance side, reimbursement policies are familiar, with “maximum allowable reimbursements,” bundled pricing, differential cost-sharing for patients, and a website reporting the quality metrics and prices (out-of-pocket costs) of providers. The insurer also has a robust department working on preventing care episodes by finding innovative ways to keep people healthy.

But what about the provider side? Initially it may seem that patients only have a single healthcare provider option, but just because a single entity owns all the hospitals and clinics does not mean they are all the same. In this system, the government determines where healthcare facilities will be built and what services they will provide, but it allows great freedom in their operation. At every facility, providers are able to organize care however they like, and they are also free to charge any price as long as it is at or below the maximum allowable reimbursement for each service. They have great motivation to put in the effort required to find ways to lower costs (thereby enabling them to charge lower prices) and improve quality because they receive bonuses that are calculated based on the amount of money they saved the system (the number of patients treated multiplied by how much less than the maximum allowable reimbursement each of those patients was charged).

Because the insurer and providers are all operating under one roof, the billing in this system is particularly simple. Some specific requirements are in place for the purpose of accumulating data that will help track for problems in the healthcare system, but there are no complex billing codes or arcane documentation requirements. When providers document a patient encounter, they do so for the purpose of communicating to other providers what they thought and did.

Government healthcare expenditures in this system are sustainable mostly because providers are actively innovating to improve value—much of which results in them being able to lower prices so they can earn bonuses.

Overall, this system has been organized in a way that, despite the government ownership of providers, maintains the ability to reward value with market share, which drives value improvement. The insurance side also innovates to prevent care episodes by leveraging its cradle-to-grave time horizons and connections with other non-healthcare public health sectors.

There are barriers to provider innovation compared to other systems. Providers face the upside of potential bonuses for doing well, but there is not necessarily much downside risk in providers who are mediocre or worse and still getting paid their stable salary. In any other market, the risk of being forced out of business due to lost market share drives competitors to innovate to improve their value so they can become profitable, but in this system the worst-case scenario is that the government closes their clinic and relocates those providers elsewhere. Additionally, many innovations require new types of facilities or caregivers, or they require cooperation between multiple types of providers, which can be difficult when providers have limited control over facility design, placement, and reimbursement contracts.

The effects of these innovation barriers are difficult to quantify, but they need to be balanced with the benefits of a reduced documentation burden, a simpler billing system, and a more reliable dispersion of healthcare services across the country.

Conclusion

Policy makers overseeing any type of system need to understand their system’s current barriers to the three critical inputs: multiple options, ability to identify the highest-value option, and incentive to choose the highest-value option. (Many of the most common barriers to those three inputs are outlined in Part 6.) They need to understand that those barriers are the primary inhibitors of their healthcare system evolving to deliver increasingly higher value for patients over time. And as they enact policies that eliminate those barriers, they will see a predictable chain reaction of more patients choosing higher-value insurance plans and providers, those higher-value competitors earning more profit, and parties in the healthcare system beginning to innovate to deliver higher value, all of which will result in the healthcare system transformation that is sorely needed the world over. Policy makers who understand this framework are also empowered to propose and support policies that expand access in ways that do not create new barriers to those three critical inputs.

As healthcare reforms begin to take this focused direction, the innovations and value improvements will be exciting to watch!

In Part 8, I will conclude this series by imagining how the U.S. healthcare system might look with this framework fully implemented.

Building a Healthcare System from Scratch, Part 6: Barriers to Choosing the Highest-value Options

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Image credit: changingpaces.com

In Part 5, we talked about the three requirements for getting market share to flow to the highest-value options, which is necessary if we want higher-value parties (insurers and providers) to be rewarded with profit. The context for why this is the crucial feature of our optimal from-scratch healthcare system is discussed in parts 1, 2, 3, and 4.

As a reminder, those three requirements were for patients to have (1) multiple options, (2) the ability to identify the highest-value option, and (3) incentives to choose the highest-value option. Let’s look at examples of the common barriers to each of them so we will know what to avoid when we build our optimal healthcare system.

Multiple Options

Our goal: Avoid any policies that directly or indirectly limit the number of competitors in a market.

For providers, this means allowing them to build hospitals and clinics whenever and wherever they want. They will not do this with reckless abandon because they will know that, if they choose to build in a new region and end up delivering lower value than the incumbents, they will not get many patients and their new endeavor will not be profitable.

For insurers, this means avoiding regulations that make it difficult for them to enter new markets. Nationally standardized regulations will simplify the process of selling insurance in multiple markets, but  this does nothing to ease insurers’ greatest challenge of entering new markets, which is the challenge of negotiating prices with providers in that region. But having many provider options in a region should help with this.

And as for things that affect both providers and insurers, we will need good antitrust laws to prevent too much consolidation. And we will need to avoid policies that limit the freedom of them to vary their price and quality so that they can offer unique value propositions (otherwise we end up with many options that all are effectively the same, which defeats the purpose).

Identifying the Highest-value Option

The barriers to this are different for providers and insurers.

On the insurer side, the most difficult aspect of identifying the highest-value option is being able to predict which mixture of premium, copay, deductible, coinsurance, etc. will cover what you need in the cheapest way possible, as well as identifying/predicting which services will be needed and whether they are covered in the benefits. Having some standardization can make this much simpler (but still challenging), such as what healthcare.gov does with multiple standardized quality tiers of insurance plans and grouping all those options together to be compared apples to apples.

On the provider side, one of the first challenges is getting people to recognize that they have multiple options that are of very different value. In almost every other industry, people are great value shoppers, but they have been conditioned historically not to even think about it when choosing healthcare providers, which is probably a consequence of the chronic unawareness of the huge variations in the quality of providers as well as the third-party payer system that so often causes people to pay the same no matter which provider they choose. This is one reason why healthcare provider quality reporting websites are so infrequently used even when they are available.

The other issues with identifying the highest-value providers can be divided into barriers to knowing price beforehand and barriers to knowing quality.

Barriers to knowing price beforehand: The biggest one is uncertainty about what services will be needed—for example, most people do not present to the emergency department with a diagnosis already, nor can they predict what additional complications might arise during a hospitalization. But for specific, well-defined episodes of care, such as an elective surgery, there are great ways to make prices knowable beforehand (look up bundled pricing for an example).

Barriers to knowing quality: People do not know where to find quality information even if they do go looking for it. And if they find it, most of what they find are quality metrics geared specifically toward comparing providers for the purpose of allocating bonuses rather than quality metrics that actually provide metrics that are relevant to helping a patient choose between providers. For example, a hospital’s overall mortality rate or readmission rate has little bearing on the quality of care a patient will receive for something like a straightforward elective gallbladder removal. Standardized, easy-to-understand, appropriately risk-adjusted, patient decision-oriented quality data are needed.

And the last thing to mention in this section are the barriers to identifying the highest-value option that will not likely be overcome. For example, medical emergencies don’t allow time to make a thoughtful decision about which hospital to go to. And low health literacy is a barrier for many people. And there are many important aspects of care that cannot easily be measured, such as a primary care doctor’s ability to diagnose the cause of ambiguous symptoms. Does the presence of these more insurmountable barriers mean that no health system will ever be able to get market share to flow to the higher-value options? No—even if many decisions about which provider to go to are not particularly logical or value-focused, as more people start choosing providers based on price and quality information, higher-value providers will begin to win more market share and the desired incentive scheme that motivates value-maximizing behaviors will arise.

Incentives to Choose the Highest-value Option

Even when people (1) have multiple insurer and provider options and (2) are able to identify the highest-value options, there are still barriers to them choosing the highest-value options.

The first barrier is when anyone but the patient is acting as the decision maker. These alternative decision makers typically have a financial stake in the decision and want to choose the cheapest option without regard for quality. For example, insurers that offer very narrow networks act almost like a first-cut decision maker to narrow patients’ possible provider choices down to only providers that are willing to accept the lowest prices. Patients/patient advocates should be the decision makers because only they will adequately weigh the quality aspects that are most important to and impactful on them.

But even when the patient is the decision maker, they will ignore prices if they are required to pay the same amount regardless of the provider or insurer they choose. This is usually not an issue with insurance plan selection, but it is a major issue with provider selection. For example, flat copays require the same payment from the patient regardless of the full price of the providers. High-deductible plans solve this problem for any service below the deductible, but, once that deductible is surpassed, they have the same problem. Ideas such as reference pricing, multi-tier provider networks, or even paying patients for choosing lower-cost providers can help with this.

Summary

If the above discussed barriers to the three requirements for getting market share to flow to the highest-value options are minimized, the healthcare system will naturally and continuously evolve toward higher value because it will motivate providers and insurers to perform their jobs in value-maximizing ways. Government interventions may still be considered for areas where natural incentives will not motivate those parties to do all the jobs we want them to do (particularly in the area of equitable access), but the “healthcare market” will start functioning to benefit patients and what they value.

This concludes the big-picture explanation of this framework. In other words, we have now discussed all the ingredients that need to go into an optimal from-scratch healthcare system. In Part 7, we will solidify the implications of this framework by imagining up a few examples of different types of healthcare systems with this framework implemented to show how all those ingredients can come together.

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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 (or less when they choose a lower-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 of that difference. 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 essentially 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. This is how to permanently “bend the cost curve” and weed out low-quality options.

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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. Next comes the biggest challenge: how do we shape those incentives so that they don’t just reward parties for merely performing those jobs, but so they also encourage them to perform their jobs in the best way possible? (“Best way possible” will be more precisely defined below.)

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.”) So a project that is projected to increase revenues but also increase costs just as much is a waste of effort from a company’s standpoint.

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.

valuewithprofit

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.

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.