Code Red: Two Economists Examine the U.S. Healthcare System

July 7, 2014

Contraception Stamps

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 9:17 am

There is a broad consensus (and a strong economic argument) that Americans should be protected against the potential financial catastrophe that can result from unexpected costly illnesses. This is the essence of health insurance. We count ourselves among those that broadly agree with this consensus opinion. Put plainly, unexpected medical bills should not be a source of financial insecurity. The Affordable Care Act represents President Obama’s best effort to provide this protection. But the ACA does far more than simply provide financial security in the form of health insurance to a large number of previously uninsured Americans. When the ACA reaches beyond this goal, it tends to get into the most trouble.

Americans like having health insurance, so to serve its broad political goals, the Obama administration has tried to label all aspects of the ACA as elements of health insurance. But the labels do not always fit. Recall that the administration was placed into the awkward position of defending the individual mandate as a tax in court, despite clear statements by various supporters of the ACA that it did not involve new taxes on those earning under $250,000 a year. In some people’s minds this continues to bring into question the legitimacy of the entire legislation.

This week, the debate has been about the mandate that employers include contraception in the basic insurance benefit that they are mandated to provide as part of employee compensation. Plans that do not offer this coverage do not meet the minimum requirements of the ACA and therefore employers would be required to pay steep fines per employee. In the “Hobby Lobby” decision, the Supreme Court ruled that owners of closely held corporations could not be compelled to provide certain types of birth control as part of their employee health insurance plans if they objected. The court then followed this up by granting a temporary injunction that allows Wheaton College to avoid filing a form facilitating the provision of contraceptives to its employees by a third party insurer. A final ruling from the Supreme Court on that issue will come in the future.

This is a fight that the Administration frankly didn’t need to and shouldn’t have picked. Recall that we got in this situation when the HHS (now perhaps our nation’s most powerful agency) decided to include contraception as part of the “essential health benefit that must be offered as part of all qualifying insurance plans.” And with that relatively simple decision, we’re off! Since that point the administration has been attempting to tailor its contraceptive mandate to avoid infringing on the religious beliefs of different groups. First, explicitly religious organizations were exempted. Then religious non-profit organizations were given the accommodation that serves as the center of the recent Wheaton College decision. Finally, as a part of the Hobby Lobby decision, closely held for-profit corporations have access to this potentially problematic non-profit workaround.

Had the administration thought more clearly about the underlying economics, and demonstrated a bit more political boldness (after all, wasn’t boldness one of the reasons America supported the President in 2008), it could have avoided this Rube Goldbergeseque solution. For the sake of argument, we will accept that affordable contraception is an underprovided public good requiring a government subsidy (a point that has a good deal of validity). But contraception is predictable and does not involve substantial expense – compared to say a new child. As such, it is by definition not an insurable product, and tying its provision to insurance is asking for trouble…the type of trouble that the Supreme Court has provided. Besides, tying contraception to insurance all but guarantees that millions of women will not receive the subsidy; witness the millions of Americans who still lack health insurance.

There are better ways to subsidize public goods than tying them to health insurance, especially when the goods in question are not insurable. If the administration believes that contraception is an underprovided public good, then why not carve this troublesome feature out of the ACA and offer contraception stamps? Like food stamps, they could be exchanged at the pharmacy for the purchase of qualified contraception products. This would eliminate the employer middleman and better target the subsidies to the low income individuals who need it the most.

We will tell you why the administration didn’t pursue this path. While we have no qualms about it, we suspect that most Americans would not accept this notion of directly subsidized contraception. By labeling contraception a healthcare service that requires insurance coverage, and rolling the subsidy into the ACA, political acceptance is all but assured. Unfortunately, the rules of the ACA effectively lock most Americans into their employer-sponsored insurance (another problematic provision of the law), so this approach ties contraception to employment, ties the hands of employers, and guarantees legal challenges along the lines of Hobby Lobby. This only serves to further politicize the ACA and assure that far more important reforms to the ACA will be delayed even further into the future.

Contraception is not the only uninsurable good or service that CMS has added to the minimum benefits package, which includes far less controversial preventive health measures that are routine and expected. But, as we previously discussed, it is only a matter of time before lobbyists and weigh in on other benefits that are not cloaked in the legitimacy of prevention. Judging by the experiences of the states, which collectively impose over 2000 “insurance” mandates, most of these mandates will actually be subsidies for uninsurable services. Lobbyists have long known that by labeling these subsidies “health insurance,” political hurdles melt away. In the case of contraception, the Obama administration has learned this lesson well.

Given that this Supreme Court felt confident enough in their economic logic to call the mandate a tax, we are surprised that they did not take this opportunity to question the entire notion of “insuring” contraception. So we are glad to have had this opportunity to do it for them.

June 23, 2014

Business Strategy in Unlikely Places: Why Kobe Bryant is a Strategist and Jurgen Klinsman is Just a Coach

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:35 am

This week we offer a brief interlude from the world of healthcare to kick off a new intermittent series: “Business Strategy in Unlikely Places.” On semi-regular basis we will talk about various topics in business strategy, which is the “other half” of our job here at Kellogg.

In addition to being economists and strategy professors, we are both big fans of sports in general and basketball in particular. Therefore, we couldn’t help but notice the recent tiff between Kobe Bryant (one of the best basketball players in the world over the last two decades) and Jurgen Klinsman (the coach of the United States national soccer team).

It all stems back to an interview in the New York Times magazine where Klinsman said many controversial things. First, he admitted that he thought the United States couldn’t win the World Cup this year, which may be accurate (although for a few minutes yesterday we felt irrationally exhuberant about our chances) but was strange to hear from that source. More interestingly, Klinsman said the following in response to people who were critical of him leaving veteran Landon Donovan off of the 2014 World Cup Roster:

“This always happens in America … Kobe Bryant, for example—why does he get a two-year contract extension for $50 million? Because of what he is going to do in the next two years for the Lakers? Of course not. Of course not. He gets it because of what he has done before. It makes no sense. Why do you pay for what has already happened?”

Perhaps unsurprisingly, Bryant was none too pleased about this comment and had the following response to ESPN Magazine:

“I thought it was pretty comical, actually. I see his perspective. But the one perspective that he’s missing from an ownership point of view is that you want to be part of an ownership group that is rewarding its players for what they’ve done, while balancing the team going forward. If you’re another player in the future and you’re looking at the Lakers organization, you want to be a part of an organization that takes care of its players while at the same time, planning for the future.”

While we could write this off to sour grapes from Bryant, in reality he is sketching out an important strategic point. To understand this point requires a bit of context. Under the collective bargaining agreement of the NBA, teams are constrained in how much they can pay in salary each year and the maximum amount that can be paid to any player in a year. As a result, star athletes such as Bryant are likely paid less than their actual value to the team. When Bryant led the Lakers to five titles, he brought in hundreds of millions of dollars in additional revenue for the team owners. But his salary has been capped at a bit over $20 million, and he could not receive more than a token bonus for his superlative effort.

The upshot of this is that, as a result of the salary cap, the Lakers could not pay Kobe Bryant his true value during his prime years. Without getting lost in the intricacies of the salary cap, the same is more or less true for all teams trying to hire superstars. The superstars are always paid less than they are worth and they are paid pretty much the same at each team. How then can the Lakers and other teams compete to land top talent?

Unable to up the ante on salary for current superstars, teams engage in elaborate courtships where they sell other attributes. The Miami Heat offer the twin attractions of South Beach and no state income tax. Los Angeles offers its glamorous life style, Boston has tradition, while New York offers, well, New York. Dranove thinks Chicago has much to attract star athletes, including a strong shot at winning a title (Are you reading this Carmelo? No? Why not?). Garthwaite thinks star free agents should be intrigued by the possibility of bringing the Pistons back to their “Bad Boys” glory.

But what if a team could “promise” a current superstar an increase in salary above the cap? League rules prohibit offering this in writing; even verbally committing to pay more would bring down the long arm of the NBA law. However, a team could credibly commit to pay current superstars more than they are worth after their stars have faded (sorry Kobe, we are talking about you). This circumvents the salary cap and effectively allows teams to pay current superstars what they are worth. The question is how can a team do this? Well at least one way is by demonstrating they have done so in the past. This costly signal helps convince future players that they also could ultimately earn more by signing with this team.

Think about it this way. Kevin Durant, the best young player in the NBA, will become a free agent in 2016, exactly when Bryant’s latest contract will expire. The Lakers would love to land Durant. So would every other team. Durant is worth much more than the maximum allowable salary, so no team can outbid any other in the traditional way, and whichever team lands him will pay him less than he is worth. But the Lakers can “outbid” other teams for Durant’s services by demonstrating that they will eventually pay him more than he is worth. How can they assure Durant that statements about “taking care of him” in the future are not just some elaborate cheap talk? By doing the same thing, right now, for Kobe Bryant.

It may appear to Klinsman that the Lakers are paying Bryant for his “past performance.” In reality, they are simply structuring their compensation differently to avoid regulations. Of course, this is most effective in leagues with strict salary caps – something that is not true for European soccer leagues. In an uncapped league, you can just pay players their market value in the current year.

Economists call these types of arrangements implicit or relational contracts. We happen to know a bit about them because our strategy department here at Kellogg has some of the best people in the world who consider these arrangements (Niko Matouschek, Jin Li, and Michael Powell). In situations where firms cannot explicitly write out all provisions of a wage and bonus structure, these types of contracts can be powerful strategic tools. In the NBA, relational contracts might allow a team to effectively attract players who otherwise would view them as interchangeable with their competitors.

June 17, 2014

What Starbucks New Tuition Benefit May Tell Us about the Future of Employer Provided Health Insurance

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 9:31 am

Starbucks, which taught America to love lattes, made news this week with the announcement of a new tuition benefit for its partners (Starbucks-speak for employees).  At first glance this move seems like simply another benefit in Starbucks relatively (for its industry) generous compensation package.  In particular, Starbucks has long been heralded for providing health insurance for all partners working more than 20 hours per week.  It is this connection to health insurance that we wish to explore.  While Howard Schulz the founder and current CEO of Starbucks has long said the firm offers health insurance because it is the “right thing to do” for their employees, we have always suspected a more profit maximizing goal for this compensation decision.  If we put on our strategy hats (we are both members of Kellogg’s Strategy Department), we can deduce that as a profit-maximizing firm, what Starbucks giveth with tuition benefits it may soon taketh away from health insurance benefits.  In the process, Starbucks may be heralding the demise of employer sponsored health insurance, something we have predicted in previous blogs.

While Starbucks is nominally a fast food firm, it seeks to hire a different kind of employee than its competitors.  Starbucks employees are more productive (i.e. they generate more revenue per employee) and they are expected/required to contribute to the warm environment Starbucks offers its customer.  From its creation, Starbucks has positioned itself as the “third place” in American society, i.e. a place to gather that was neither home nor work. This is why chatty and productive employees (think, college educated individuals looking for full-time employment or a struggling actor waiting for his big break) are worth more to Starbucks than they would be to one of its competitors such as McDonalds.  While McDonalds may now offer a competitive latte, no one would mistake it for a third place.  

Starbucks must, on a daily basis, find ways to attract and retain its employees.  Rather than simply pay them more (an expensive proposition), Starbucks has long exploited a unique feature of the American employment and health insurance markets.  Private firms are generally able to offer health insurance for rates that are far less than their employees can obtain in the individual insurance market.  As a result, Starbucks can attract workers with a package of wages and health benefits that is worth more to the employee than a similar amount of compensation paid entirely in wages.  Given that many of their competitors are not seeking to hire the same kinds of employees, Starbucks can retain part of this spread within the firm.  Workers who highly desire health insurance, whom more often than not are the types of workers Starbucks would like to hire, are delighted by this wage/benefit package. 

The Affordable Care Act changes this calculus.  Workers who opt into exchanges can now obtain health insurance at an actuarially fair price. That wage/benefit package from Starbucks doesn’t seem so attractive any longer.  Many would rather take an all-wage package elsewhere – a package that featured higher wages, albeit without health benefits – and apply some of those higher wages towards the price of a cheap silver or bronze plan on the exchange.  This is particularly true when we consider that Starbucks offering health insurance benefits makes their employees ineligible for the large subsidies on the exchanges. 

Facing this situation, Starbucks needs to look to a different fringe benefit with the same two characteristics as health insurance:  (1) that Starbucks can obtain the benefit at a discount, and (2) that the benefit is attractive to the kind of employee that Starbucks wishes to hire.   Enter the tuition benefit.  Starbucks has apparently used its purchasing clout to obtain a discounted tuition from Arizona State University for its online undergraduate degree program, and is passing on the discount to its workers.  Because this program does not make strategic sense unless Starbucks has a purchasing advantage, we expect more details about the discount to emerge in the fullness of time.  

As in the case of health insurance, do not believe for a moment that Starbucks is offering tuition benefits as a public service.  Indeed, the language that CEO Schulz used to describe the tuition benefit is strikingly similar to his description of why the firm offers health insurance benefits: “I feel so strongly this is the right thing to do and Starbucks as a company is going to benefit in ways that probably we cannot identify today.”  We suspect that Schulz knows full well how the company will benefit. We also suspect that, despite its protests the contrary, Starbucks will eventually announce that it is dropping insurance coverage in favor of higher wages.  The company is too savvy about its benefits to miss this obvious move. 

We should also note that this is not a question of “right” and “wrong” or a greedy corporation slashing benefits.  Instead, it is about Starbucks (and likely other firms) realizing its employees are better off getting their wages from their employer and their insurance from and insurance company.  That is why, beyond being an interesting business strategy example, Starbucks’ recent moves offers a glimpse into the future (or lack thereof) of employer health insurance.  Ultimately, what we are seeing is the not so gradual erosion of one of the primary benefits of employer health insurance, i.e. the pricing benefits of group coverage.  With the creation of individual insurance exchanges, Americans no longer need their employer to provide their health insurance.  In fact, given the nature of the fairly generous tax subsidies they may no longer want their insurer to offer them insurance.  As a result, as we have previously predicted, many employers and particularly those with a large number of low-income employees will stop offering health insurance.  To borrow a phrase from Schulz, in this new economic environment this choice will be the “right thing to do” for their employees.

Firms that previously took advantage of the inefficient individual insurance market will have to look to other strategies.  This week the firm that brought us the Frappuccino we have may have also brought us the first strategy for this new context.   

June 16, 2014

What we do in our spare time (i.e. we have a new paper)

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 6:06 am

It seems that you can’t spend more than five minutes socializing with health economists these days without the topic of Sovaldi and the prices of new drugs coming up (we economists are a wild and crazy bunch).  As we blogged a couple of weeks ago, this new cure for hepatitis C is far more effective than existing treatments and has fewer side effects but is also quite expensive (though it should be noted that it is not actually more expensive than many of the previous treatments, it is just more expensive per day and the lower number of side effects has caused a greater number of patients to seek out treatment).  Calls are coming from all quarters to force lower prices on Sovaldi’s manufacturer Gilead.

As we discussed, constraints on the profitability of drugs once they are released, such as price controls, are concerning because they limit future innovation.  A host of previous economic studies have shown that increases in expected profits have caused greater research activity by pharmaceutical firms as measured by new products, clinical trials, or both

What has been generally absent from this existing literature is whether these increased investments result in products that are socially valuable or if they are simply rent seeking by firms.  In general, new products can increase welfare by offering more value than existing products or lowering prices and increasing the quantity sold.  However, if demand is relatively inelastic (as is the case with many pharmaceuticals) lower prices do little to change demand and just represent business stealing by firms. In this setting, new products are only welfare increasing if they are sufficiently differentiated from existing offerings.     

Critics of the pharmaceutical industry often claim that there is little true innovation and most new products are simple modifications of existing blockbusters.  If this were true, most research by pharmaceutical firms is just a very expensive form of business stealing.  We would be remiss not to note that these critics have been noticeably silent in the case of Solvadi, which represents real innovation. 

Previous studies examining the link between profits and research investments for pharmaceutical companies have not directly confronted the question of the social value of these investments. Ultimately the social value of innovation after changes in marginal profits is an open empirical question and one that we hope to help answer.  To that end, we (along with our co-author Manuel Hermosilla) just released a new NBER working paper [ungated] (yes we do something other than blogging or teaching Kellogg’s MBAs). 

In this new paper we examine the social value of changes in research investments by biotechnology firms into drugs targeting the elderly after the creation of Medicare Part D – the pharmaceutical insurance program for elderly Americans.  These biotechnology firms have traditionally been associated with innovative activity.  For example, they disproportionately produce biologic products and the firms in our sample have a history of focusing on products targeting unmet medical needs.  As a result, the products they develop are less likely to be simple modifications of existing products than those from traditional pharmaceutical firms.

Similar to the previous literature, we find a marked increase in clinical trial activity for drugs targeting conditions with a large share of patients that are on Medicare.  This appears to have been caused by the insurance expansion, i.e. prior to Part D there was no noticeable difference in the number of clinical trials based on the elderly patient share.

Given that the increase in clinical trials occurred among biotech firms, they are likely for products that represent a scientific advancement of some type. The question is the degree to which they provide an increase in treatment availability – a key indicator of their contribution to social value.  We therefore examine two indicators of this outcome:  (1) the number of existing treatments for the targeted condition and (2) regulatory indicators of the product targeting an unmet need. 

First, we categorize the conditions in our data based on the number of available pharmaceutical treatments.  We then estimate the response to Part D based on the number of treatments for the targeted conditions and find that the increase in clinical trial activity was primarily for diseases with five or more existing treatments.  Importantly, we find that there was no change in the number of clinical trials for conditions with one or fewer treatments.  While the products aimed at conditions with five or more treatments may be more effective than existing treatments, our results show that marginal changes in profits do not spur investments in products targeting conditions that currently lack treatments.

We recognize that products aimed at conditions with existing treatments may still improve welfare improving the standard of care.  So we next turn our attention to three FDA indicators of products that address an unmet need: priority review, fast track and orphan drug status.  We estimate no increase in the prevalence of products receiving these designations as a result of the creation of Part D.

To understand the mechanism driving our results, we should consider the investment decision facing biotechnology firms.  Regardless of firm size or origin, products make their way to market based on their profit potential.  Truly novel products earn large profits and are there pursued by firms in all time periods.  However, those products offering simply another treatment option in the arsenal or providing price competition for existing products might generate limited profits.  As a result, there may be a large number of products for these conditions which were not sufficiently profitable in expectation prior to an insurance expansion but become profitable after a small change in market size. If this were the case, we would expect a differential response to the creation of Part D based on the number of existing conditions.  This is what we observe.

So this brings us back to the question of price controls and more specifically the case of Sovaldi.  Our results demonstrate that marginal changes in profits do not appear to increase investments in products that serve an unmet need.  However, the question is how large of a change is required to see a change in the incentives to develop truly novel products?  Unfortunately, we (and by that we mean all economists) simply don’t know the answer to that question. What we do know, is that the easiest path is to ignore the negative dynamic incentives for innovation and impose strict price controls on new drugs offering valuable benefits, i.e. the very types of drugs we have been asking the pharmaceutical sector to develop for years.  For example, Doctors without Borders is pushing for Sovaldi to be made available for $250 in the developing world—which is their estimate of the marginal cost.  Certainly this policy would dampen incentives to develop more products that would be socially valuable.

While we must avoid the temptation of draconian price controls, our results provide more nuance to the argument against any action affecting the prices of blockbuster drugs.  Modest efforts at controlling expenditures on these new medications do not appear to dampen incentives to invest in socially valuable products.  Recently, struggling to afford the cost of this new medication, some state agencies are rationing access.  For example, the Oregon Medicaid System is limiting access to the treatment to only its sickest residents with hepatitis C.  The hope is that over time, new products from AbbVie and potentially Merck will emerge.  Importantly, these new drugs may be even better than Sovaldi – as we would expect from the incentives provided by the high prices.  At a minimum, these new products should lower prices and transfer resources from pharmaceutical firms to patients (either through lower future premiums or taxes).  Our results demonstrate that small changes such as the rationing of access based on the progression of the disease might be a reasonable way for health plans to adjust to the high cost of new treatments without foreclosing the development of new treatments. 

June 6, 2014

The Future of the Physician

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:39 am

On Wednesday June 4, the Kellogg School of Management hosted its annual MacEachern Symposium. A packed auditorium listened to an impassioned discussion about The Future of the Physician. Presidential adviser Ezekiel Emanuel and AMA President Ardis Hoven were among the speakers. While Emanuel was optimistic about the impact of the Affordable Care Act on hospital-physician integration and the resulting potential for cost savings and quality improvements, Hoven was concerned about the impact of the business of healthcare on the medical profession. In this blog, we offer our perspective on the evolving role of the physician.

The hit television series Marcus Welby, MD last aired in 1976. Dr. Welby was the physician of every baby boomer’s dreams, whose patients always felt cared for and always got better. By the end of the century, Dr. Welby had been replaced by Dr. House, an MD cum Sherlock Holmes with Narcissistic Personality Disorder and an opiate addiction. While his bedside manner is decidedly not Welbyesque, Dr. House still embodied the basic premise of the all-knowing and dedicated provider that solves problems with little concerns for costs or standard practice.

But in the real world, physicians are evolving along a different—and we argue—better path. The 20th century physician was self-employed, championed the interests of patients, and had complete control over the medical system. But this system had at least two primary problems: (1) ever escalating costs and (2) dramatic variations in physician practice patterns with little connection to outcomes. We shudder to think how much Dr. House spent on his patients. This system is no longer sustainable.

Enter the 21st century physician, who is increasingly an employee of a large provider organization that scrutinizes every medical decision based on both cost and quality. We may all be better off for this transformation – the question is will we accept it? If past is prologue, we fear that American public is still not ready.

This transformation began with the HMO movement of the 1980s, abruptly halted in the backlash of the 1990s, but has returned with a vengeance. Despite their seeming ability to restrain cost growth, the HMOs of the 1990s were vilified. These organizations were caricatured as cruel attempts by insurance companies to deprive Americans of medical care. They’ve even served as the villain in Denzel Washington’s hostage movie John Q.

Given these facts, HMOs needed a reboot. Enter Obamacare’s Accountable Care Organizations (ACOs) – i.e. HMOs 2.0. Organized by physician groups or hospitals, ACOs contract with Medicare and private payers and attempt to hold down costs and meet performance measures in order to reap huge financial returns. To meet these objectives, ACOs are relying on the very top down control of medical decision-making that made people revolt against HMOs. This entire process is made much easier when ACOs employ physicians, many of whom are more than happy to sacrifice their autonomy in order to have a guaranteed income and a better work/life balance. Employment (by group or by hospital) is not just a viable option, it is desirable.

Employment is just the first step. Historically, we have forced many participants in the medical community, such as pharmaceutical companies, to test their products through clinical trials that rely on the scientific method. Physicians, however, develop their practice styles through personal experiences with small numbers of patients and their immediate colleagues. The result has been a patchwork of treatment patterns, broad differences in outcomes, and little consideration of costs.

Increasingly, the medical profession has accepted the idea of routinizing care delivery though protocols, and ACOs are using big data to implement diagnostic and treatment checklists. Some doctors push back against these efforts, saying these checklists effectively force them leave their judgment at the examining room door. They fear that physicians will be transformed from professionals relying on personal experience and judgment to technicians following a user’s manual. That may be, but if these technicians are making the right diagnoses and ordering the correct treatments, saving lives and money in the process, then we are all for it. Protocols are not perfect, of course, because patients are not identical. The best ACOs will use protocols as the default option and allow their physicians to occasionally use their discretion when necessary. But we have erred on the side of unlimited discretion for too long.

Much like lunch, this move to ACOs will not be free. Effective ACOs work by controlling the full scope of medical care delivery, and this will often necessitate restricting patient choice of provider. No longer can we simply shop around for the physician that will provide expensive and unnecessary treatments in order to satiate patient demand. Many fear this world, because they confuse choice with quality. In a world where people seek out physicians based on personal recommendations or Yelp-like rating system where personality matters more than skill, a little less choice might be exactly what we need.

If one of today’s ACOs recruited Dr. Welby, he might run in the opposite direction. To which we say, good riddance. The days of “physician as father figure” are long behind us. But we were looking at those days through rose colored glasses. Tomorrow’s physicians will be grounded with the information they need to make the right medical decisions and the incentives to properly balance cost and quality, even if they must rely on others to guide those decisions. Gregory House once asked, “What would you prefer – a doctor who holds your hand while you die or one who ignores you while you get better?” This may have been the dichotomy that Dr. House inherited from Dr. Welby, but it is false. It is possible for employee physicians to be compassionate and even cost conscious, while making their patients better. There is every reason to believe we are moving in that direction.

May 27, 2014

Is there a just price for pharmaceuticals?

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 6:17 am

In America’s ongoing efforts to address the rate of health care spending, there has been a renewed focus on the prices paid for pharmaceuticals.  The poster child is Gilead’s Sovaldi, a once-a-day oral treatment that represents the first real cure for hepatitis C – a condition affecting over 3 million Americans.  Prior to Sovaldi, treatment for this condition required a painful course of Interferon which had many side effects and was ineffective for many people.  No one doubts that Sovaldi is a breakthrough product, the type of innovation that clearly increases welfare.  In addition, everyone seems to agree that the current cost of Sovaldi – approximately $84,000 for a 12 week course of treatment – is unreasonable and potentially crippling to the nation.  Even the well-known “champion” of price controls and improved access to medical services at low prices, the insurance industry’s trade association America’s Health Insurance Plans (AHIP), has come out against the “unsustainable” price of this medication.

While seemingly everyone agrees with AHIP, don’t count us in.  The pricing of pharmaceuticals is a very difficult economic question and we would like a little bit more caution in the attacks against innovative pharmaceutical firms.  We can all agree that firms developing products that simply imitate existing products are primarily rent seekers (ironically this activity, while decried by many, likely lowers prices for consumers).  We don’t think that we need high prices to reward this behavior. But this clearly is not the case with Sovaldi.  Everyone agrees that this drug is both a true scientific advancement and an expansion of available treatments for a chronic, extremely unpleasant, and potentially contagious medical condition – a combination that almost unequivocally benefits shareholders and patients.  These are the very products we want more of in the future.

So let’s stop patting ourselves on the back for attacking the evil pharmaceutical firms and their high drug prices and instead ask a deceptively simple question:  Why is the price for Sovaldi (and other recent lifesaving treatments) so high in the first place?  While there are many factors, two predominate.  First, these branded drugs are provided by firms that have monopoly production rights as a result of their patent protection.  Second, these drugs provide what most people value more than anything else – healthier and longer lives.  Even more so than prior blockbuster drugs like the statin Lipitor, there is a direct connection between the latest generation of expensive products like Sovaldi, and the substantial health benefits they deliver.

Okay, so these drugs save lives and are therefore incredibly valuable.  Why do we allow pharma companies to extract so much of this value, in the form of patents?  For one thing, patents do not last forever, as the effective patent lives of most new drugs is only about 8-10 years.  After that, these innovations become available to all, forever, at a fraction of the original price.  If we take the long view, the innovators reap just a small portion of the benefits they deliver.  But much more importantly, the patent system promotes innovation.  Take away monopoly pricing, and you take away the profits that motivate research.  (Even this statement, which appears to come straight from the PR department of a pharmaceutical firm, has important limits and nuances that we discuss below.)

Let us be clear, patents create a trade-off between different inefficiencies: one static and another dynamic.  Patents create a static inefficiency because they allow firms to charge monopoly prices and therefore an inefficiently low quantity is sold in the current time period.  We can easily solve that problem by instituting price controls or allowing the government to use its monopsony power to bid down prices – as they do in Europe and Canada where the same drugs are often sold at less than half the U.S. price.  However, this “solution” creates its own inefficiency – a low quantity of products developed for the future.   Here is another way of looking at it: Someone who is sick with something for which there is a cure today would naturally be a proponent of price controls.  But someone with an untreatable condition might want to be a bit circumspect about the long arm of government in this setting.  And the same is true for anyone who might, in the future, develop an untreatable condition.  And that means all of us!

If innovation is so great, then perhaps we should support price increases.  Let Gilead double its price! Triple it!  We could have every scientist in the world working on the next $300,000 pill.   Without trying to be stereotypical economists, it isn’t at all clear that drug prices are too low, and this is not what we are claiming.  Here we make two points.  First, we note that Gilead has not been granted the power to just arbitrarily pick a price out of the air.  If that were the case they, they wouldn’t have stopped at $84,000.  Instead, Gilead gets to pick the profit maximizing price for a monopolist.  Second, we are not claiming that any price is justified just that mandated price reductions may lead us down a slippery and dangerous slope.  Certainly, a “modest” reduction in pharmaceutical prices will not stop all lifesaving treatments from coming to market.  We will have new research coming out addressing this point in the coming weeks.  But much like Justice Potters Stewart’s difficulty with pornography, the definition of a “modest price decrease” is hard to pin down.  And here is the point:  We do not have faith that government bureaucrats can appropriately account for the variety of incentives necessary if they were in charge of either setting prices by fiat or effectively setting prices by exploiting their monopsony power.  It is indeed a slippery slope, and we fear the consequences if we take the first step.

Isn’t it unfair that drugs are so much less expensive in other nations?  Certainly!  But as we tell our children and MBA students, life isn’t fair. If prices were higher in Western Europe and Canada, the case for reducing prices in the U.S. would be more compelling.  There would still be enough of a profit incentive to motivate R&D.   But we shouldn’t hold our breath waiting for others to raise prices.  Americans are stuck in a bad equilibrium in which we have to choose among two options: subsidizing innovation for the citizens of the world, or allowing innovation to grind to a halt?  While our cold economist hearts give a resounding slow clap to the free riding strategy of the Europeans, given the wide range of conditions for which we still lack effective treatments, we would rather err on the side of caution – even if it means that American consumers must serve as the greater fool. 

We should also caution that even a limited attempt at setting prices for drugs like Sovaldi might have a chilling effect across the market.  Firms will make their investment decisions with the specter of price controls lurking overhead.  We worry about the potential long terms effects of this decision.

We finally note that this is a problem that the market appears poised to address.  AbbVie is readying a competing product to Sovaldi and Express Scripts, the nation’s largest pharmacy benefits manager is readying plans to pit these two products against each other in order to lower prices.  This seems like a much better means of achieving a lower price for Sovaldi, though we can’t help but recognize the irony that it puts the opponents of Gilead and Sovaldi in the position of rooting for “me too” products. 

May 19, 2014

If We Want Lower Health Care Spending, We Are Going to Have to Pay for It

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 7:43 am

Ultimately, spending less on health care is a relatively easy task: We either need to consume fewer services, or spend less on the services that we consume. But much like we teach our Kellogg students about maximizing profits, the devil is in the details. It’s certainly tempting to ask the government to swoop in on a white stallion and solve the all our problems by fiat. For example, we could have the government simply exploit its monopsony power and set prices, but an artificially low price will lead to an inefficiently low quantity of services and future innovation (stay tuned, we will have more to say about this next week). Similarly, we could explicitly ration quantities (as opposed to implicitly doing it through a large uninsured population). But how could we hope to determine the right level of care? Ultimately, if we ask the government to unilaterally fix this problem, instead of a white stallion we could behold a pale horse and all that it entails.

The good part, perhaps the best part, about the Affordable Care Act is that it attempts to address this problem using market forces. The question is whether we are ready for what these market forces will entail. We will focus today on the role of market forces in the insurance market to control prices in the newly established ACA exchanges. This month the Obama administration announced that it would allow insurers to use “reference pricing” for insurance programs in the exchanges. Under a reference pricing system, insurers set the maximum price they will pay for a specific set of services and if patients go to a facility that costs more than that amount they are required to pay the difference. This system has recently been implemented by the California Public Employee Retirement System (CalPERS) and there were two main effects: (1) surgical volumes decreased at high price facilities and increased at low price facilities, and (2) the prices paid by individuals covered by CalPERS decreased at high price facilities but were essentially unchanged at low price facilities. While this is only one study for a single insurance system, it does provide the pattern that we would expect following a reference pricing system and is therefore provides encouragement.

In many ways, reference pricing is a close cousin of the narrow network systems that we previously described. Under narrow networks, insurance companies choose a limited set of facilities that are willing to accept their prices. Patients who want more choices can pay higher premiums for plans with wider networks. Under reference pricing, patients can go to a wider range of providers but they bear more of the cost of these choices. The organizing principal is the same for both systems: if patients want choice they are going to have to pay for the privilege.

The theory behind reference pricing is fairly clear. But will it work in practice? That is less clear. There are two main threats that we can see: (1) poor implementation and (2) political backlash. When it comes to implementation there are several important points to consider. Perhaps most important, reference pricing is not a panacea. It is most applicable for encounters with the medical system which involve a defined episode with relatively easy to understand quality measures. Think knee replacements and MRIs and not the management of Type II diabetes. This system is not well suited for managing chronic conditions. In addition, reference pricing is only as effective as the level of competition in the marketplace. Without a robust and competitive local provider market, patients lack sufficient options to shop around and this system won’t lead to reduced prices. Finally, price competition in the absence of good information about quality can create a race to the bottom, in which providers skimp on quality (e.g., reduced staffing and training, shorter therapy sessions, etc.) in order to drive down costs and, as a result, compete better on price. Patients must have sufficient information to make choices across providers based on price and quality. Obviously the first step here is some form of price transparency – a feature that is generally absent from today’s health care system. A recently announced partnership between major health insurers and the independent Health Care Cost Institute could go far to fix this problem. Perhaps more difficult is that reference pricing requires readily identifiable quality metrics (that can’t be easily gamed by providers or lead to perverse outcomes) that can be easily communicated to patients. For this, we need to think beyond standard outcomes like infection rates and incorporate important patient reported measures of quality such as pain reduction, ability to perform activities of daily living, and perhaps some measure of customer service. Given the experiences on the exchanges, where narrow network plans have been unable to accurately communicate information on which providers are in their networks, we have some fears as to whether these firms are ready to provide this type of critical quality information. Without a good quality reporting system, patients might end up choosing solely on price – an outcome that few would herald as a success.

Beyond the potential problems of implementation, we fear that the bigger threat to reference pricing will ultimately be politics. We first note that these systems are very similar to the HMO systems of the 1990s, which appeared to limit the growth of health spending before they were stamped out by a combination of a consumer protests and political handcuffs. Much like the backlash to HMOs and the more recent narrow network plans, it will only take a few patients being “forced” to pay high bills in order to get access to their preferred provider before the complaints will surface. Or perhaps it will happen before the first bill is even sent. Expect that the nation’s priciest providers will band together and speak out on “behalf” of consumers. Either way, it will take some national courage to stand up to these august providers and their feigned concerns for consumer welfare.

In the end it boils down to the proverbial lack of free lunches. It we want to lower health care spending we have to give up something. If we don’t accept some market based solutions, we will find a lunch menu filled with far worse options.

April 18, 2014

Is Higher Spending Truly Wasteful?

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:56 am

Two weeks ago, the Kellogg School of Management was privileged to host Joe Doyle, an outstanding economist from MIT. In a broad research portfolio, Joe has focused on the effects from differing intensity of medical treatments. This research is shattering some long held beliefs about the relationship between health spending and outcomes. We think that Joe’s work is not known widely enough outside of the academic community, so we are using our blog to let you know what you have been missing and, in the process, perhaps change the way you think about healthcare spending.

It is well known that the U.S. far outspends other nations on healthcare, yet the outcomes for Americans (in terms of coarse aggregate measures such as life expectancy, infant mortality, and other dimensions) are quite average. Of course, these outcomes are not the only things that we value in health care. A lot of our spending is on drugs and medical services that improve our quality of life and won’t show up in these aggregate outcomes. For example, more effective pain management can decrease pain and improve quality of life – often with important economic benefits. Despite this fact, most health policy analysts have concluded that we can cut back on health spending, without harming quality on any dimension. This is not a new idea, of course. In a famous 1978 New England Journal article, Alain Enthoven coined the term “flat of the curve medicine” to describe how the U.S. had reached the point of diminishing returns in health spending. And for nearly 30 years the Dartmouth Atlas has documented how health spending dramatically varies across communities without any apparent correlation with outcomes.

The question has always been, what health spending to cut? Garthwaite’s previous work has shown that broad regulations requiring longer hospital stays for new mothers and their babies have provided only limited benefits and that more targeted rules could save money without sacrificing quality. Beyond some wasteful regulations, we can always point to gross examples of overspending such as the rapid proliferation of proton beam treatments, beyond those clear examples how can one identify what is waste and what is medically necessary?

In two important papers, Joe Doyle and co-authors ask a more fundamental question – is the often cited broad variation in health spending actually wasteful at all? They find that even in healthcare, there really is no such thing as a free lunch. His work should be mandatory reading for everyone who believes that broad spending cuts will have no adverse consequences. For those who lack the time to read these papers, we provide the “Cliff’s Notes” versions.

The settings for Joe’s two studies are broadly similar. He compares the outcomes for patients who receive emergency treatment at different hospitals, some of which are much more costly than others. Getting unbiased results from such a comparison is not as simple as it seems. At the aggregate level, hospitals with more spending may simply be systematically treating sicker patients. This will tend to make the outcomes look worse for the patients at high cost hospitals. Of course, this says nothing about efficiency or whether these sick patients would have fared as well had they been treated at low cost hospitals. Any fair comparison of hospitals must control for severity of illness in order to avoid what statisticians call “omitted variable bias.” Unfortunately, the available data is not usually up to this task, so prior to Joe’s work, nearly all studies that compare costs and outcomes have been subject to this bias. (This is certainly true for cross-nation studies.)

From a research perspective, the best way to remove omitted variable bias is to conduct an experiment in which patients are randomly assigned to hospitals with different costs. For pragmatic and ethical reasons, researchers are unable to perform such experiments. Therefore, Joe has identified situations in the real world that meet the statistical requirements for random assignment – statisticians call these “natural experiments.” Through these natural experiments, Joe removes omitted variable bias and provides compelling evidence that contradicts the conventional wisdom that variations in health spending are pure waste.

In one study, Joe examined what happened to individuals who had medical emergencies while vacationing in Florida. Joe argues (quite plausibly) that when individuals choose a vacation spot, they give little thought to the potential for a medical emergency and the relative quality of healthcare providers in their chosen destination. (That is, visitors to Florida choose Orlando over Fort Lauderdale because they love Mickey Mouse and not because they are worried about having a heart attack and perceive that Orlando hospitals have better emergency medical services.) If one believes this argument, then vacationers who are treated in high cost areas of Florida will be no more or less sick than vacationers who are treated in low cost areas – Joe provides convincing evidence to bolster this claim. What does he find? Vacationers who have medical emergencies in high cost areas in Florida have better outcomes than vacationers who have emergencies in low cost areas. The effect is not subtle. On average, additional spending of $50,000 (in billed charges) is associated with saving one year of life. This falls well within the range used by stingy governments in Europe when determining whether to allocate additional money towards healthcare.

In a second study, Joe (working with John Graves and Jon Gruber) exploits an institutional feature of New York State’s ambulance service, namely, that most communities have several competing ambulance services. A central dispatcher who receives an emergency call examines availability before assigning an ambulance from a particular company. This creates an effective random assignment of patients to ambulances. As Joe and his coauthors discovered, each company tends to take their patients to different hospitals, which introduces an effectively random assignment of patients to hospitals. They develop a statistical method that teases out the purely random part and then compare outcomes for patients who, due to purely random chance, are taken to low cost versus high cost hospitals. Once again, they find that emergency patients do better when they are taken to higher cost hospitals, and once again the effects are not subtle. For every 10 percent increase in spending at the high cost hospitals, there is a 4 percent reduction in the one year mortality rate. Importantly, these differences in outcomes cannot be accounted for with standard measures of hospital quality such as indicators for the use of “appropriate care” after a heart attack.

Joe Doyle will be the first to admit to the limitations in his work. He only studies emergency patients and does not compare across states. But the results in Joe’s studies did not have to come out as they did. If the conventional wisdom was unconditionally correct, then Joe would have found no relationship between spending and outcomes. Joe has produced two studies, free of omitted variable bias, that show conditions where the conventional wisdom fails.

A hallmark of excellent economic research is the ability to provide bias-free estimates of relationships of great social importance. It has been our pleasure to introduce you to Joe Doyle and his excellent work.

March 31, 2014

Taking Stock of the ACA

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 11:09 am

With the ACA exchange enrollment deadline behind us, this is a good time to take a look at the big picture. Three years after the first baby steps of implementation, what has the ACA accomplished?

When we consider the ACA, we can think of two broad goals. The “easy” goal was expanding coverage to the uninsured. We say “easy” because regulators should be able to succeed by simply throwing money at the problem, and that is a task our elected officials seem particularly adept at accomplishing. The “hard” goal was bringing down the rate of growth in health care spending. This has proven to be a difficult task for policy makers, who have been trying (and failing) for decades and have often done more harm than good.

We first consider the goal of expanding coverage to the uninsured. From its onset, the ACA chalked up a small victory by requiring plans to continue coverage for dependents under age 26. This provided coverage to as many as three million uninsured, albeit the healthiest members of the population. The lion’s share of the reduction in the numbers of uninsured was supposed to come from Medicaid expansions and private exchanges. And here is where the problems emerge.

Medicaid ranks have swelled in the 27 states (including DC) that have chosen to expand the program. Republican leadership in other states continue to assert they will not expand Medicaid, but given the exceptionally generous federal funding for this expansion, we find it hard to believe that most of these states won’t soon join the expansion. After all, even Louisiana eventually raised its drinking age to 21 to get its share of federal highway funding. Similarly, we can’t imagine that the red states will turn down billions of dollars in federal funds.

Even with half the states sitting out Medicaid expansion, as many as nine million Americans could be added to Medicaid rolls, half of whom reside in California, Illinois, and New York. While this seems like a sizeable percentage of the nearly 50 million Americans who were uninsured when the ACA was enacted, we should not celebrate too soon. If experience from previous Medicaid expansions is a guide, then most of these new enrollees previously had private health insurance. Research studies put the Medicaid crowd out rate from prior expansions at about 60 percent. If past is prologue, then perhaps only 3.6 million new Medicaid enrollees were previously uninsured. Of course the number of newly enrolled that were previously uninsured might be higher, but many of these may have already been eligible for Medicaid and simply failed to take up coverage. Tennessee’s state Medicaid system has seen a large enrollment increase even though it has yet to expand eligibility. While getting these individuals to sign up is a laudable outcome, these enrollees are covered by the less generous non-ACA matching rate and will further strain state budgets – which already unable to cope with the ever growing cost of public health insurance. Perhaps the folks boasting about the large expansion of Medicaid should wait for all the data to come in.

And that is the good news. By now most people are well-versed in the troubled roll out of the private exchanges. It is currently estimated that enrollments will top six million, although it is also estimated that less than five million of those enrollees will pay their first month’s premiums. And at least one survey suggests that only 14 percent of exchange enrollees were previously uninsured. Let’s be generous and double the McKinsey estimate. This suggests that about 1.4 million individuals who will purchase insurance through the exchanges were previously uninsured. The other 3.6 million previously footed the bill for their own insurance; now many of them are enjoying public subsidies. While these subsidies may make care more affordable, we must remember that they come at the expense of even more federal expenditures on health premiums and a growing disconnect between the cost of health care and the cost of health insurance. The cost of these subsidies could continue to rise if, as we expect, many employers scale back their offering of health insurance benefits.

By our count, the ACA has brought coverage to 8 million previously uninsured. This is somewhat smaller than the 9.5 new enrollees reported elsewhere in a study that seems to assume that all exchange enrollees will pay their premiums and does not speculate about crowd out. But both figures are low, representing less than 20 percent of the uninsured, with a large fraction of this coming from enrolling young adults on their parents plans – something that could have been accomplished by a one page regulation. So what did the remaining 2000 pages of legislation bring us? Apparently, the biggest accomplishment of the ACA is to take millions of people who were willing and able to purchase their own health insurance and place them on the public dole. While ACA supporters would say that many of these people now have “better” insurance, and they may be right, but that was certainly not how the ACA was sold. In any event, the limited data that we do have about the characteristics of new enrollees suggests that we must be careful before we state the ACA has unequivocally provided insurance to a large fraction of the uninsured.

What about the future of the exchanges? Some have argued that we have reached the number of enrollees necessary for sustainable risk pools. But, it isn’t the number of enrollees that necessarily matters here; the ultimate success of the risk pools hinges on the mix of healthy and sick enrollees. It is too soon to tell but there are certainly enough young enrollees to give hope. If insurers can make a profit off of the current pricing and enrollment mix, then premiums could remain stable and enrollments could climb. But the big problem will remain that millions of the uninsured might rather pay a modest penalty and remain uninsured than purchase subsidized insurance.

This raises a related issue. One benefit of coverage expansion is that it eases the burden on providers who must treat the uninsured regardless of their ability to pay. In many ways, these providers have served as an underfunded source of public insurance. It will be interesting to see whether those who choose not to buy insurance can continue to obtain charity care from these providers. This is particularly true given that the ACA will drastically redistribute the disproportionate share payments these facilities depend on. Ultimately, we believe that access to care, more than anything else, will determine whether the uninsured choose to remain uninsured.

Now that we’ve discussed the “easy” goal, let’s talk very briefly about the hard goal – the ACA as a blueprint for cost containment. On this dimension, casual empirical evidence was encouraging, as healthcare spending seemed to have leveled off. But there is considerable evidence that most of the slowdown in spending was due to the lingering effects of the downturn in the economy, particularly the sluggish labor market. Indeed, the most recent data reveals a sharp uptick in spending, which coincides with a rebounding economy. On the other hand, there is considerable evidence that providers are taking very seriously the challenge of cost containment. Hundreds of Accountable Care Organizations have signed up to share the financial risk of caring for Medicare and privately insured individuals. In the process, providers are organizing into large regional healthcare systems that present many promises and perils. While advocates of integration believe that this is the only way to bend the cost curve, economists who have studied the theory and evidence on integration are less sanguine. A recent Brookings Institute report notes that the benefits of integration are uncertain, but that giant systems, which are hard to undo, may obtain market power that allows them to resist market pressures for cost containment. This is ironic, as market power is completely antithetical to the purported ACA goal of achieving savings through a competitive health economy. Even more than the evidence on raising coverage, it will take many years to understand how this restructuring of our health economy will turn out. We just hope that regulators and policymakers take heed of the literature on this point.

Overall, supporters of the ACA boast how payers, providers, and even patients are actively changing the U.S. healthcare system. But coaching legend John Wooden reminded us not to confuse activity with accomplishment. On the latter score, there is less for supporters to cheer.

March 12, 2014

Finding Common Ground on Narrow Networks — Sort Of

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 9:11 am

In a recent New York Times opinion piece, Obama advisor Ezekiel Emanuel attempts to ease the minds of millions of Americans who may be selecting narrow network plans in the exchanges. In defending narrow networks, Emanuel cites the well-known example of Kaiser, which has for decades required enrollees to choose among only Kaiser-owned hospitals and Kaiser-employed physicians. He goes on to propose some “safeguards” for plans in the exchanges such as mandating that insurers disclose the criteria used to establish their network of providers and requiring that insurers pay for second opinions from elite out-of-network providers.

Perhaps surprisingly given our previous commentary, we agree with the general thrust of Emanuel’s argument, which is that freedom of choice is overrated. And while we do not agree with many of his recommended safeguards, our quarrel today is not with his proposals for even more new rules and regulations. Rather, our primary quarrel is with the vast majority of the individuals who chose to comment on, and often lash out at, Emanuel’s article. These comments are emblematic of the general misunderstanding of the role of narrow network plans in controlling the future growth of health care expenditures.

In a nutshell, this is the archetypal response against Emmanuel’s claim: “Evil insurers have given us narrow networks. The government must intervene in this bloodthirsty lust for profits. Give us freedom of choice! (And preferably with the government taking over the business of insurance altogether).”

Given previous comments on this site, we suspect that many readers of our blog might share similar sentiments. So we would like to take our readers on a stroll down memory lane to explain how insurers ended up creating networks, and why we are all better off for it.

Prior to the 1980s, states forbade health insurers (who were not HMOs) from restricting provider choice. The result was disastrous. Prices rose precipitously year after year – noted antitrust economist Dennis Carlton predicted (only half facetiously) that prices would soon reach infinity. And why not. Insured patients had no reason to shop around, and so price was irrelevant. Even with today’s high deductibles, most hospital patients and many ambulatory care patients reach their deductibles and pay only a fraction of their medical bills. If patients don’t care about prices, then providers will charge what they want. Some states responded by regulating prices, but these barely put a dent in medical price inflation.

Self-insured plans were exempt from state laws governing access, and by the mid-1980s some of these plans were offering narrow networks. Providers who wanted to be included in the networks had to offer much lower prices, which ate into profits but also encouraged efficiencies. By the early 1990s all states had revised their laws to permit narrow network fully insured plans and perhaps as a result of this development, for at least five years during the 1990s, health care prices (and the premiums that we paid for our health insurance) were virtually flat. Never before had Americans enjoyed such a respite from healthcare cost inflation. And then the managed care backlash hit.

Patients complained about unpaid bills and missing referral forms. Mostly, they complained that they couldn’t see their favorite provider. And that seems to be the essence of the ongoing opposition to narrow networks. What good is a low cost insurance plan if the quality of care is compromised? Networks expanded, and healthcare inflation returned.

But here is where the critics made their (literally) fatal error. Over a decade ago, the Institutes of Medicine published two landmark studies documenting serious deficiencies in the quality of care offered by American doctors and hospitals. Most of the deficiencies result from medication errors, lack of sterility, and poor surgical technique, with a toll that could exceed 100,000 unnecessarily fatalities annually. This does not even capture all the needless pain, suffering, and death resulting from botched diagnoses. If we value our health as much as we claim, it is absolutely essential that we seek out quality providers, especially those of us with complex conditions for which skill and experience can be the difference between life and death. But when it comes to how Americans think about the quality of healthcare providers, we are reminded of humorist Garrison Keillor’s fictional Lake Woebegone, where “all of the children are above average.” In the real world of health care, only half of the doctors are above average.

We have asked hundreds of people, in all walks of life, whether they agree or disagree with the following: “My primary care physician offers higher quality care than the average PCP.” Nearly 100% agree. The truth is that about half of them are wrong. If you agreed with this statement, there is about a 50% chance that you are wrong! We have asked cardiologists whether they agree or disagree with the following: “The thoracic surgeons that I refer to offer above average quality.” They all agree, but again, about half are wrong. So are half the surgeons who agree with the statement that their hospital offers above average quality.

The fact of the matter is that we implicitly restrict our own networks and we often do a bad job of it. We choose a primary care physician recommended by a friend. We choose the specialist recommended by the PCP. We choose the hospital recommended by the specialist. Yet time and again, we make lousy choices. Seen in this light, one has to wonder if restrictions imposed by insurers would be any worse than the restrictions we impose on ourselves. In fact, the (admittedly limited) empirical evidence suggests that insurer networks tend to exclude lower quality providers. This makes sense. Low quality healthcare often leads to more complications and higher costs. Choosing a high quality provider can be a win-win for insurers and patients.

Americans who are frustrated by our high cost and complex healthcare system may get some measure of satisfaction by criticizing insurers for restricting access. But how satisfied would they be if they understood that mandating broader access will drive up costs and maybe even harm quality?

So what can be done to improve the way we select our providers? It is well-known that when it comes to medical care, experience and quality are highly correlated. So when one of us learned of a family history of a deadly condition, he sought out a provider who has extensive experience diagnosing and treating this condition. Does this guarantee a good outcome? Of course not, but it does improve the odds. We can also turn to one of the many quality report cards available on the Internet. Some report cards are better than others, and all are far from perfect. But these report cards are not useless – high ranking providers are likely to offer better quality than low ranking providers. Yet to this day, most Americans ignore this information, as if putting one’s finger in the air is a better way to find a high quality provider than checking the empirical evidence.

Until we demand and act on information about quality, it is pointless to complain about narrow insurer networks. And when the time comes that we become savvy consumers, and not just belly achers, we can start to criticize insurers whose networks really are substandard.

And, this is where we differ from Dr. Emmanuel, we can do more than criticize, we can vote with our purses and take our business elsewhere. That is how we ought to be punishing insurers whose narrow networks fail to serve our interests.

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