The 3 (Actually, 2) Problems with the U.S. Healthcare System

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Image credit: Gary Larson

Before something can be fixed, the problem must be defined and the causes of that problem diagnosed.

The generally accepted problems with the U.S. healthcare system are that its prices are too high, its quality is too low/patchy, and not enough people have insurance coverage.

I’m going to change that a little bit. Since price and quality are the two variables that determine value, we could combine them into only two problems: suboptimal value and not enough insurance coverage.

The insurance coverage piece is kind of separate from the value piece because solving it primarily relies on government policies that subsidize the purchase of health insurance for those who wouldn’t be able to afford it otherwise. Those government policies are a (purposeful) distortion to the healthcare market. Distorting a market for a good reason is fine, but before you do it, you need to understand how the market should be structured to optimize value so you don’t accidentally ruin its potential to have higher value in the process.

And the nice thing is that value improvements will primarily come in the form of lower prices —> insurance coverage will become cheaper —> fewer people will be priced out of the market. Therefore, fixing value partially fixes the insurance coverage problem too!

If We Lower Total Healthcare Spending, Who Will the Money Come from?

Image credit: academyhealth.org
Image credit: academyhealth.org

At the recent AcademyHealth Annual Research Meeting in Baltimore, I went to a session on the accomplishments and challenges of community collaboratives. A community collaborative is a pretty cool idea that goes something like this: for a specific community (i.e., city), let’s get all the leaders of the providers and payers in a room (plus a bunch of other stakeholders committed to improving health) and make some decisions collaboratively on how we can fix healthcare in the community. The Robert Wood Johnson Foundation has provided the money to make these things happen in 20 different communities in the U.S. (see Aligning Forces for Quality, and Value-Based Payment Reform).

Sounds like a great idea, right? Well, an interesting challenge has arisen. More and more, these collaboratives are expected to find ways to reduce the total healthcare spending in that community. But so far, they’ve pretty much failed miserably. Why? Well, think about it. Here are all the leaders of payers and providers in that community sitting in a room together saying, “We need to reduce total spending,” but the savings are going to have to come from someone in that room, and none of them are going to say, “Sure, my organization will take one for the team! I’ll have to cut everyone’s pay, but because it’s for a good cause, they’ll love it.”

Does this mean these kinds of collaboratives are utterly useless in terms of lowering total spending in communities? That was the question I (carefully) asked at the end of the session, and one of the panelists gave a really insightful answer. To paraphrase/translate/elaborate on what he said, his answer went something like this:

Yeah, we’re not going to convince anyone in that room to just give up money like that. But what we can do is come up with standardized ways of reporting prices and quality. And when those are standardized across all payers and providers, patients will be better equipped to choose higher-value payers/providers, which, in the U.S., usually means ‘cheaper’ payers/providers. So this standardization will allow total spending to go down by getting more people receiving services from cheaper competitors. Thus, the higher-priced competitors will be the ones who are losing money when total spending goes down, all because we helped standardize quality and price reporting.

I agree. There are still many barriers to getting patients to choose these “higher-value” providers/payers, but this would help solve one of the biggest ones. And with each barrier we overcome, more patients will be enabled to receive higher-value care, which is what everyone wants, right?

Should We Regulate Prices of Hospitals? All-payer Rate Setting’s Allure

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Image credit: time.com

The Bitter Pill article has received a lot of press lately. People reading it have often turned to a simple solution: regulate prices. The most straightforward approach to this is called “all-payer rate setting,” which has been experimented with before in some places in the U.S. and is still used in Maryland. The basic idea is that the government says, “When any provider performs this certain service, he/she will be paid this much for it no matter who the payer is.” And they set prices for every single service. Think of how this would instantly make all chargemasters a thing of the past. And no more worrying about hospitals increasing their bargaining power as they join together to form ACOs. And all that administrative complexity that would be gone (thus decreasing costs a fair amount)!

But there are downsides, too, which are not as obvious and may lead people to jump on the bandwagon of all-payer rate setting ignorantly. First, back to basics:

Total spending on healthcare = price * quantity

Yes, we probably have some quantity problems (running too many scans, etc., which regional variation literature attests to quite thoroughly), but the main reason we spend so much more than other countries is because of the prices. So, here’s the prices equation:

Price = Cost + Profit

What’s making prices too high? Brill makes a strong case that, at least in a lot of hospitals, profit is part of the problem [Update: Turns out most hospitals lose money on average, so it’s not as big of a deal as we thought]. But what about costs? Is the actual cost of care too high as well? YES, costs are the major problem, as shown by looking at the average profitability of healthcare organizations. More evidence of this: even in countries that do a pretty good job minimizing unnecessary services and regulating profits to reasonable levels, healthcare spending growth is still unsustainable, which only leaves cost as the primary culprit. Therefore, any policy (whether it’s meant to regulate profits, improve access, improve quality, or whatever) that creates barriers to cost lowering should be reserved as a last resort.

So, would all-payer rate setting create a barrier to cost lowering? If yes, I don’t like it. If no, let’s consider it.

First, since I’m reading The Wealth of Nations lately, let’s ask Adam Smith what he thinks about the subject:

I shall conclude this long chapter with observing, that though anciently it was usual to rate wages, first by general laws extending over the whole kingdom, and afterwards by particular orders of the justices of peace in every particular county, both these practices have now gone entirely into disuse.

By the experience of above four hundred years [says Doctor Burn] it seems time to lay aside all endeavours to bring under strict regulations, what in its own nature seems incapable of minute limitation: for if all persons in the same kind of work were to receive equal wages, there would be no emulation, and no room left for industry or ingenuity.

Particular acts of parliament, however, still attempt sometimes to regulate wages in particular trades and in particular places. (Emphasis added)

What’s he trying to say? All-payer rate setting would leave “no room left for [cost-lowering] industry and ingenuity”? (If you’d like to see my explanation for why I assume innovations by providers are generally cost-lowering, see here.)

I’ve explained before how taking away the freedom to set your own prices also removes much of the rewards for cost-lowering industry and ingenuity. In short (and simplified), lowering costs without sacrificing quality means you can lower prices more than others and therefore offer higher value than others, and higher value will eventually be rewarded with market share and profits. (Another assumption I’m making: patients preferentially choose higher-value providers, which is starting to be more true, but there are still many barriers to it.)

Back to the big picture: All-payer rate setting reduces the potential rewards for cost-lowering innovations, which I can guarantee will reduce the amount of cost-lowering innovation that goes on. So, yes, all-payer rate setting will be a barrier to cost-lowering innovation. And that’s a huge problem, so let’s look for other ways to fix egregious profits and costs. More to come . . .

How to Make the Cost of Care Cheaper

I’ve been leading up to this for a long time. Lowering the cost of the actual provision of care is one of the most important things all countries with unsustainable health spending growth need. And, at the outset, I’ll say I don’t have all the answers. But here’s what I’ve got, explained in maybe a roundabout way, but hopefully it makes sense by the end.

Think about providers’ incentive to innovate. Do they have one? Hopefully your initial response is “yes,” because you’d be right (partially). Assuming this is a provider that operates as most in the country do, its prices are determined based on market power, not costs. So, with the assurance that prices will stay the same regardless of costs, providers have a great incentive to lower costs! Any cost decrease will go straight to their bottom line.

At this point, I picture in my head a little map of the United States with a vertical pin sticking out of it for each hospital, with the height of the pin representing that hospital’s costs of delivering care. The taller the pin, the higher the costs. So, the incentive for each hospital is to lower their costs as much as possible in order to maximize profits, and different hospitals succeed to varying degrees. The pins get pushed down with each successful cost-cutting initiative, some more than others.

Now let’s say there is a hospital that finds a really innovative way to deliver care, and their costs are way lower than everyone else’s. They want to get more customers in an effort to continue generating more wealth, but they’re stuck! Why are they stuck? Because even though their costs are so much lower, they don’t really get to set the prices the patients actually pay when choosing which hospital to go to for care. High-value providers can’t expand to new cities because they’d have to set their prices lower than existing providers’ prices, steal a whole bunch of the market share, and most likely force some of the lower-value incumbents out of business. But if they could, do you see what would happen to the pins? The one really low pin would start spreading, making the tallest pins get taken off the map completely with each market that it spreads to. It would be beautiful! Different kinds of cost-saving innovations would be spreading all over the country.

So, to repeat David Cutler’s question, Where are all the healthcare innovators? They’re out there, all over the country, but they’re stuck in their current markets; thus, we don’t see or even hear about most of them.

In summary, think of the two ways a company can make more money:

  1. Sell items at a higher margin
  2. Sell more items

Providers in our healthcare system can only do the first one. The second one is mostly not functioning, and thus we don’t have the harsh (and absolutely crucial) evolutionary force of putting lower-value providers out of business and lowering the cost of healthcare.

I’ll admit, the proliferation of high-deductible plans and new kinds of deals between providers and insurers are starting to overcome this. But there are probably other ways to increase the pace of the elimination of these barriers, and I would think the government should be focused on figuring out what they are if they want to solve this country’s budget problems. Or they could continue to argue over how to how to reduce volume and price while largely ignoring costs.

How to Think About a Healthcare Reform’s Impact on Total Spending

I know I left off my last post with a cliff-hanger about how to lower the cost of delivering care, but I realized I’m explaining this in an out-of-order way, so I’m going to back up a bit and lay the foundation.

I’ve posted before that there are actually three ways to lower health spending. Again, here’s the equation:

Total Spending = Volume x Price

To lower total spending, we could lower volume or lower price. And, again, we can only lower price so much without actually lowering costs of delivering care.

But what about the third way? A more complete equation would look like this:

Total Spending = Volumea x Pricea + Volumeb x Priceb + Volumec x Pricec + . . .

Get it? Our total spending is the total amount we’ve spent on hip replacements and on metformin and on office visits. . . .

So, the third way for us to lower total spending would be to adjust our mix of services so we’re choosing low-cost treatments instead of high-cost ones. Instead of buying brand-name drugs, we’d buy generics. Instead of full knee replacements, we’d opt for physical therapy.

Okay, good. Now, whenever you hear anything about a reform that’s aimed at lowering total health spending, you should be able to easily place it into one of those three categories.

So what about the Affordable Care Act? There are a zillion different provisions, all with different effects on total spending. Increasing insurance coverage = increased volume. Requiring preventive care coverage = changing services mix (more preventive services, fewer preventable complications we have to fix). Insurance exchanges = lower price through increased price competition among insurers. . . . To mention just a few.

(The Framing of) How to Solve the Healthcare Cost Problem

“The cost problem” in healthcare is referring to the fact that our country is making itself go bankrupt based on overspending on healthcare, and we’re not even getting amazing outcomes that justify that spending. I’ve blogged before about how this overspending problem can really be broken down into two separate problems:

Spending = Volume x Price

To really get a good solution, we need to both (1) lower the volume of care delivered and (2) lower the prices we’re paying for everything. Lowering the volume, I’ve already argued, would substantially be achieved by giving providers an incentive to profit from long-term wellness. People at Dartmouth say 30% of all care is unnecessary, so, if true, that would mean big savings. But I’ve never said much about how to lower price, so let’s talk about price now:

Price = Cost + Profit

If we want to substantially lower prices, we need to actually lower costs, and then make sure prices follow them down. What I’m saying is that any price-lowering reform needs two components:

  1. Costs to go down
  2. Prices to follow

We’ve actually seen people try to only lower costs (think: tort reform) and other people try to only lower prices (think: all-payer rate setting).

I’ve also explained before that we should expect providers to be the main drivers of cost-lowering innovations. But provider-driven, cost-lowering innovations don’t seem to be happening much in our (or anyone’s!) healthcare system, so why not? The answer to this question is what every health system in the world needs. So I’ll tell you. Next time.