Are Employers to Blame for our High Medical Prices?

In a recent New York Times blog, Uwe Reinhardt places much of the blame for high and rising medical prices on passive employers. He argues that employers should work just as hard to reduce healthcare benefit costs as they work to reduce other input costs. But he then observes:

“One reason for the employers’ passivity in paying health care bills may be that they know, or should know, that the fringe benefits they purchase for their employees ultimately come out of the employees’ total pay package. In a sense, employers behave like pickpockets who take from their employees’ wallets and with the money lifted purchase goodies for their employees.”

I think that Reinhardt gets the economics wrong here and, in the process, he puts too much of the blame on employers. Reinhardt is right in one respect – employees care about their entire wage/benefit packages. If benefits deteriorate, employers will have to increase wages to retain workers. Thus, it seems that if an employer reduces benefit costs, it must increase wages by an equal amount. If that is true, we can understand why employers are passive.

The correct economic argument is a bit more nuanced. Employees do not care about the cost of their benefits; they care about the benefits. If an employer can procure the same benefits at a lower cost, the employer need not increase wages one iota. In this regard, there is nothing special about health benefits. Suppose an employer offers employees the use of company cars. Workers don’t care what the employer paid for the cars, and if the employer can purchase cars at a deep discount, it will pocket the savings.

Reinhardt may be wrong about the underlying economics, but he is correct in the big picture. Employers may have an incentive to reduce benefits costs yet they are passive purchasers. With a few exceptions, nearly every American corporation outsources its healthcare benefits to insurers and ASO providers and then looks the other was as the medical bills pile up. Sure, they complain about the high cost of medical care, but they don’t take direct action by aggressively shopping for lower provider prices. Doesn’t this passivity demonstrate a lack of interest? No more so than the fact that auto makers do not aggressively shop the lowest rubber or silica prices implies that they are disinterested in the costs of tires and windows. Auto makers outsource the production of tires and windows (and most other inputs) and let the Michelins and PPGs of the world worry about rubber and silica prices. By the same token, American companies outsource the production of insurance and let the Blues and Uniteds of the world worry about provider prices. This is entirely appropriate.

Could employers do more to reduce healthcare spending? Employers have dramatically increased deductibles in recent years, and this has had some effect (though no one is certain just how much.) Employers tried forcing employees into narrow network plans in the 1990s, mostly in the form of HMOs, but employees rebelled against the lack of choice. (Some of you may remember the “Patients’ Bill of Rights” that Congress nearly enacted.) I don’t expect too many employers to repeat that mistake. Employers might offer cheaper plans alongside expensive ones, but they probably won’t pass most of the savings on to employees. For one thing, employers want to keep most of the savings for themselves. Perhaps more problematically, there is a growing body of evidence that this could lead to an adverse selection death spiral that would disrupt employee choices.

It is hard to imagine that American businesses have been willfully negligent about healthcare spending. If only by accident, some employers would be worried about health spending. And if worrying about costs was enough to actually lower costs, then those that worried would outperform their competitors and gain market share. By now, every American would be working for a company that worried about health spending. The logic is pretty compelling: America’s firms are worried about health spending and are appropriately outsourcing these worries to insurers.

So why are medical costs and medical prices so high? I could give a list but this has been discussed ad nauseum so I will not repeat it here. Employer-sponsored insurance is on the list, but largely due to tax deductibility. If employers are otherwise on the list, they are towards the bottom.

The Pricing Transparency Puzzle

This past Wednesday, the Kellogg School of Management hosted its annual MacEachern Symposium. In the coming weeks I will tell you how you can view the proceedings, including the MacEachern Lecture given by Professor Martin Gaynor.

The theme for the Symposium was “Integration and Antitrust” and during the day there was a lot of discussion about pricing transparency. At the Symposium’s Healthcare Forecasting Luncheon, an amazing panel of CEOs and faculty unanimously predicted that pricing data will herald a new era of healthcare competition. No one thought to ask when this will happen. Had I been asked, they would have been disappointed by my answer: For a handful of medical services, pricing transparency may be just around the corner. For everything else, transparency remains off in the distance.

By now, everyone knows that the recently released CMS charge data are of limited value because few individuals pay full charges. A lot of the conversation about transparency has thus been about releasing actual pricing data. I think this grossly oversimplifies the problem. Even if patients saw actual prices and paid 100 percent of these prices out of their own pockets, we still would not have pricing transparency. The key question is not “what are the right prices?” It is “what are we pricing?”

By way of explanation, let me define three broad categories of medical services:

1) Commodity services. These may include MRIs, vaccinations, and medicines. Patients should easily be able to comparison shop for these services. For patients paying 100 percent out of pocket, they can turn to CMS data for MRI pricing, or phone up their pharmacy for drug pricing. A few companies are launching apps that will simplify the process. A number of fledgling companies are putting this data out into the hands of consumers, online and through smartphone apps.

2) Acute episodes of illness, with a well-defined beginning and end. Treatment of an infection, joint replacement surgery, and are good examples. Pricing for an episode of illness is far more complicated than pricing a discrete service. Take something as simple as the treatment of a child’s ear infection. A parent could ask various providers what they charge for an office visit. But there are five distinct billing codes for office visits and not every provider will use the same code. Even if they did, this would not be the “price.” Some providers will order tests, others may not. Different providers will order different drugs. Some providers will schedule a follow-up visit. The price of the treatment should include all of these “add-ons.”

That is a “simple” example. Consider a patient pricing out a hip replacement. Someone in the hospital billing department might quote the charge for a day in the surgical ward, an hour in surgery, and a day in intensive care. But this is hardly enough to determine the price. The patient would need to know how many days and hours, which will vary by hospital. And then there are prices for supplies, tests, drugs, therapy, and home care, not to mention all the physician fees. Even that is no enough. The full price should include the expected cost of dealing with complications. A very small number of hospitals are willing to quote a blanket fee for inpatient care. Even fewer include the physician and home care costs. Only a small handful covers the costs of follow-up care.

Trying to figure out the total cost of an acute illness by looking at prices for individual services is like trying to figure out the total cost of a car by looking at prices for individual nuts, bolts, belts, tires, wheels and spark plugs. No one in their right mind would buy a car piecemeal, yet that is what patients must do when buying medical care. Pricing transparency for acute care requires that we redefine the product as the episode of illness and work out the full price for the episode. This requires specialized software and access to insurance claims data; patients cannot do this alone. Insurers have the data and some have taken steps towards generating usable pricing comparisons. They need to pick up the pace.

3) Chronic conditions such as diabetes, asthma, or COPD. All of the issues associated with pricing acute illnesses apply to chronic conditions, and then some. It is much harder to define the episode of illness, figuring out when it begins and when it ends, and deciding which treatments are related to the chronic condition and which are not. It probably makes sense to define the “episode” as a year; it is much harder to sort out which specific treatments are parts of that episode.

Providers have some experience pricing out the treatment of chronic conditions – this is pretty much what capitation does. But doctors in HMOs are capitated for only a fraction of all the treatments delivered to chronically ill patients; inpatient care is rarely included in the capitated fee. I don’t see too many providers going public with all-in prices for a year’s worth of chronic care. (There may be one exception; DaVita is contemplating a “Diabetes ACO” that would assume shared risk for the all-in costs of diabetes patients.) Even if we had all-in prices, they would be suspect, as it would be crucial to risk adjust. (Risk adjustment might also important for acute episodes, but that discussion must be postponed.)

Pricing transparency is the God, Mother, and Country of health policy. Everyone is in favor, no matter their political stripes. But on this issue I am agnostic, orphaned, and exiled. I have for the past decade been writing about the need for meaningful prices. I am glad I didn’t hold my breath waiting for change.

The Rest of the Story about Hospital Pricing

The recent Medicare report on variation in hospital “prices” is not exactly news. In fact, I wonder why anyone (including the NY Times and NPR) covered it, let alone make it a lead story.

As you probably know, Medicare reported that hospital charges for specific treatments, such as joint replacement surgery, greatly vary from one hospital to another. (This includes charges for all services during the hospitalization, including room charges, drugs, tests, therapy visits, etc.) Everyone in the healthcare business knows that charges do not equal the actual prices paid to hospitals, no more than automobile sticker prices equal the prices that car buyers actually pay. Except that for the past thirty years, the gap for hospitals greatly exceeds (in percentage terms) the gap for cars. This is not just a nonstory, it is an old nonstory.

So reporters tried to give it a new spin. One angle concerns the uninsured, who may have to pay full charges. I will write about this in a future blog. Another angle is that by publishing these charges, Medicare will encourage patients to shop around. That is the subject of this blog.

I suppose it is okay to tell patients that the amount they might have to pay out of their own pockets may vary from one hospital to the next. But the published charge data is useless for computing out of pocket payments; in fact, it may be worse than useless. As even the NY Times noted, insured patients make copayments based on prices that their insurers negotiate with hospitals. These prices are essentially uncorrelated with charges. So a patient who visits a hospital with low charges may well make higher out-of-pocket payments than a patient who visits a high charge hospital. It is a crap shoot.

Even if charges did correlate with prices, a simple comparison of charges for a given treatment is useful only if hospital care is a commodity. You can compare the prices of a Toyota Prius or my latest book from one seller to another because they are selling identical products. But the cost of treating a patient, and therefore the price of treatment, depends a lot on the severity of the patient’s condition. This can make for very misleading comparisons.

Here is a simple example. Suppose there are two types of patients receiving joint replacements – those with simple problems and those with complications. Suppose that Community General Hospital and Doctors Township Hospital both set prices of $20,000 for simple cases and $40,000 for complicated cases – they have identical prices. But suppose further than 25 percent of CGH’s cases are simple, whereas 75 percent of DTH’s cases are simple. We would report that CGH’s “price” for joint replacement is $25,000, while DTH’s “price” is $35,000. The failure to control for complexity makes the pricing comparison all but useless.

To make matters worse, publishing prices without publishing information about quality may encourage patients to pretend that hospital care is a commodity and choose providers that skimp on quality. As I showed in a 20 year old paper with Mark Satterthwaite, this can also encourage a disastrous race-to-the-bottom where hospitals deliberately disinvest in quality in order to bring down their prices. Medicare has published hospital quality report cards, but these receive little media attention, certainly not like the lavish attention given to this new report on charges. Most consumers remain unaware of Medicare’s hospital quality ratings and, those who do take a look may find the data-filled tables too much to handle. Many consumers will be tempted to shop only on the basis of price.

So what is a consumer to do? It is all but impossible for individuals to comparison shop for the best hospital price; with rare exceptions hospitals cannot and will not tell anyone their prices in advance of admission. (They will tell you their charges.) Fortunately, market forces may be coming to the rescue. As more consumers enroll in health plans with high deductibles and large copayments, there is demand for information about actual prices. And where there is demand, supply usually follows. Some private insurers are beginning to post pricing comparisons on their websites, allowing consumers to determine which hospital is likely to offer lower out-of-pocket costs. Insurers are naturally reluctant to disclose the actual amounts they have contracted to pay hospitals, so this information is somewhat sketchy. Several consulting firms have sprung up to work with self-funded employer-sponsored health plans. They use employers’ own data to help employees find the best prices. To my knowledge, these insurers and consultants are not doing much in the way of risk adjustment; the real world equivalents of my fictional CGH will come off poorly in such comparisons when, in fact, they may offer very good deals. But it is still early days and such refinements to the data are sure to follow.

By intelligently shopping around, employees can save hundreds or even thousands of dollars in copayments for costly hospitalizations. But in order to shop around they require valid data. Employees should demand this information from their employers. A nascent market for pricing data has already formed. It only needs an extra nudge.

And, with apologies to the late Paul Harvey, that is the rest of the story about hospital pricing.

Restoring Medicare Advantage Payment Rates: A Lesson in Procurement

The big health policy news this week is the CMS decision to postpone a scheduled 7 percent cut to Medicare Advantage (MA) plans. CMS acted in response to a bipartisan plea from 160 legislators whose jurisdictions include a large number of seniors enrolled in MA plans and, especially, the big insurers that stood to lose billions of dollars had the cuts survived. The Wall Street Journal cheered the support for a private sector alternative to traditional Medicare, but many health economists are disappointed.

Media coverage has focused on whether MA plans are profitable without getting into the underlying economic rationale for the cutbacks. To make real sense of the proposed cutbacks, it is necessary to spend a few moments considering how the federal government buys stuff. The government can’t let a “purchasing agent” decide what to buy; that approach is too easily corrupted. So the government usually allows open bidding in a process known as procurement. Whether buying bomber planes or mechanical pencils, the government tends to be very careful, because procurement has many pitfalls. Suppose the government wanted to purchase computers and made the following proposal: “We will purchase 10,000 computers from the lowest bidder.” We can imagine what would happen. Someone would make a lowball bid and then dump onto the government some third rate computers (Commodore 64s?). To avoid this, government procurement contracts for computers are highly detailed, specifying processing speed, memory, operating system, and so forth.

For much the same reason, CMS specifies a long list of requirements for MA plans. But there are two important distinctions between MA and other goods and services procured by the government. The first is that CMS is already in the business of health insurance, through the traditional Medicare program. So CMS not only specifies MA plans must look like, it also sets the price based on what it costs to cover enrollees in traditional Medicare.

This is where the second distinction comes in. Unlike bomber planes, mechanical pencils, and personal computers, the cost of health insurance depends, to a large extent, on who is buying it. Simply stated, it costs more to insure sicker enrollees. CMS uses a price setting formula that is based on enrollee health information. But this formula is far from perfect – there are simply too many variables affecting health spending. Health economists have shown that MA plans exploit these imperfections by enrolling members whose costs are lower than what is predicted by the formula. Such favorable selection allows MA plans to prosper without necessarily being more efficient.

The rollback in payments to MA plans was meant to correct this flaw in the CMS formula. If MA plans could deliver care more efficiently, they could still prosper. But they would no longer be able to take the easy way out by enrolling relatively healthy enrollees.

This is sound reasoning, but there is another aspect of procurement to consider. The government doesn’t like to entrench monopolists, so it often awards contracts to two or more bidders, even though this raises the short run cost of the contract. In the same way, there is great virtue in having private MA plans compete with traditional Medicare; public monopolies are no better than private monopolies. A generous CMS formula encourages such competition. This may drive up costs in the short run (and boost profits of MA plans), but it provides much needed market discipline for traditional Medicare.

The CMS formula for MA pricing has always been a moving target. Perhaps in the past CMS has been too generous. But it may be too stingy in the future, and when that happens MA plans will quickly disappear. I suspect that this is the real political motive for cutting MA reimbursements – to restore the federal Medicare monopoly. In my book that would be a far bigger problem than the profits enjoyed by private insurers.

Illinois’ Regulatory Dinosaurs

The Illinois hospital dinosaurs continue to defy evolution and prove that they are not extinct. I am talking about our health facilities planning board, which just turned down another Certificate of Need application for a new hospital, this time in the northwest suburbs of Chicago. The board justified the decision by stating that the new hospital would harm existing hospitals.

I know that the Chicago School of economics tells us that regulators serve the interests of those they regulate, usually at the expense of the public. But just because the Illinois planning board sits in Chicago, that doesn’t mean they have to slavishly follow the Chicago School. They could act in the public interest at least once in a while! (Though if the board started approving too many new health facilities, someone might notice that they are not needed and put them out of a job.)

The thing is, I am not 100 percent convinced that this is regulatory capture. I think the board actually believes that this decision helps the public, because they believe hospital competition is bad. This idea was floated in the 1960s and 1970, but it is now as extinct as Tyrannosaurus Rex. Studies by the Robert Wood Johnson Foundation, the U.S. Department of Justice and the Federal Trade Commission, and countless academics conclude that competition leads to lower medical prices and, often, higher quality. Numerous federal court judges have blocked hospital mergers on the grounds that competition is good. The Seventh Circuit Court of Appeals in Illinois recently approved class certification against a hospital system whose formation reduced competition in the north shore Chicago suburbs. And a unanimous Supreme Court recently blocked a hospital merger in Georgia, in the process affirming the benefits of hospital competition. Countless independent arbiters, including Supreme Court justices from across the political spectrum, have voiced their support for hospital competition. Whom are you going to believe, all of these independent arbiters, or a bunch of political appointees (appointed by Illinois governors, no less)?

Illinois is the laughing stock of the nation in so many ways — imprisoned governors, a broken pension system, and the Chicago Cubs. Do we have to show off our incompetent regulatory process? With taxpayers on the hook for so much government inefficiency, adding higher medical prices is just one more reason for Illinoisans to think about moving somewhere else, somewhere where government officials have evolved beyond the Cretaceous period.

The PROMIS of Market Forces

On Monday, my health economics students were treated to a guest lecture by NU Professor David Cella, the director of the Patient Report Outcome Measurement Information System (PROMIS) project. The PROMIS project is the culmination of decades of research into measuring the health of patients through carefully worded questions about physical, social, and emotional well-being. Through an intelligent, interactive questionnaire, PROMIS can deliver accurate and reliable measures of the quality of life at minimal time and expense. (You can try out PROMIS at http://www.nihpromis.org) I believe that PROMIS will be a key element of an efficient, market-based, health economy.

For decades, markets and regulators alike have been stymied in their efforts to assure quality while controlling costs. Fee-for-service incentives increase costs without commensurate increases in quality. (This is Enthoven’s famous “flat of the curve argument.”) Capitation, prospective payment, even shared savings, can lead to too much cost cutting at the expense of quality. Then there is the matter of helping patients find the right providers for their specific needs and giving providers the right incentives to boost quality, whether that means that physicians keep up with the latest research, nurses receive extra training, or integrated systems make sure that patients are assigned to the most appropriate staff providers on staff. There is a broad consensus that a major obstacle has been our inability to adequately measure and reward quality.

The current thinking, as exemplified by ACOs, is to reward quality through a lengthy list of pay for performance measures. This may improve upon the status quo, but it can never work to anyone’s real satisfaction. Providers will respond to incentives as they always have, in ways that we will find wanting. As providers focus on rewarded behaviors, they will give short shrift to unrewarded behaviors – there is already a lot of evidence that this is occurring. Payers could respond by lengthening the list of rewarded behaviors, but this will never prevent multitasking unless payers remove from providers all discretion about how to deliver care; for all intents and purposes, payers will become the providers.

The only way out is to measure what really matters, outcomes, and let providers find the best way to improve them. But outcomes data in medical records is inadequate. Can the asthmatic patient climb a flight of stairs? Can the hip replacement patient walk without pain? Is the cancer patient depressed? Medical records won’t answer these questions. PROMIS can.
Imagine being able to measure, with considerable precision on a standardized scale, the mobility of an asthmatic or hip replacement patient, the mental health status of a cancer patient, or the fatigue of a morbidly obese patient. And then imagine being able to convert these measures into a single score analogous to a Quality Adjusted Life Year. It is not difficult to use these numbers to answer questions of fundamental importance: Which orthopedic surgeon’s patients see the biggest improvement in mobility? Which providers and which drugs are best at combating clinical depression? Which endocrinologists and dieticians are doing the best job helping their obese patients to cope? We might even ask, in fact, we should ask, bigger and bolder questions. Which ACOs generate the most QALY gains for the patients? Which health plans are best for which types of patients? I believe that PROMIS scores work best at this high level, where it is not necessary to assign credit to any particular provider.

If we can answer these bold questions at the highest level of care, ACO or health plan, then the market will take care of itself. ACOs and health plans will be accountable for cost and quality and will have limited ability to game the performance measures. With this accountability, ACOs and plans must find ways to balance cost and quality throughout the vertical chain or they will fail to compete in the market. (This assumes, of course, that there are competing ACOs and plans.)

ACOs and plans will find it difficult to assign credit to individual providers using PROMIS. They may turn to P4P measures, but these will still invite gaming. How does the ACO promote quality? How can the health plan improve its PROMIS ranking? The answer is really very simple.

It is well known in the economics of organization that the best way to hold individuals accountable for quality is through a combination of hard and soft incentives. ACO managers who are responsible for the quality of their organizations, and health plan managers who are responsible for the quality of their networks, should feel free to use P4P process measures. But they should accompany them with a qualitative review. If managers suspect that their medical staff is gaming the P4P rules, they should act on those suspicions. Ask the medical staff what they think of each other’s quality and act on this as well. Health plans should drop providers from networks, or reduce their rates, based on quantitative and qualitative measures. If managers act consistently and in good faith, doctors and other providers will learn to trust them and strive to be their best. This is how it works in most professional services firms, where rewards are usually based on a combination of hard and soft incentives. Healthcare organizations must move towards the same model or forever be stuck in a world of command and control, and gaming and inefficiency.

The problem with healthcare management these days is that there is too little management. Managers address problems using hard-edged incentives that have never worked in isolation and never will. PROMIS gives us an opportunity to hold health care organizations accountable for their overall performance. But the managers of these organizations must trust themselves to manage, to use their own judgment, and not be automatons. When this happens, we will at long last see market forces fulfill their promise.

Physician Entrepreneurs

I have been taking a vacation from blogging as I try to get through a very busy academic quarter. But my last blog, “My Son the Electrician” elicited a lot of comments and I have always wanted to follow up. And today I see that the Chicago Sun Times has generously quoted me, in particular noting how I liken physicians to entrepreneurs. Lest anyone get the wrong impression, let me briefly explain what I mean.

Like entrepreneurs, physicians launch their careers by making large investments – up to ten years of post-graduate training. Such investments do not come with a guarantee. Entrepreneurial physicians – those who own their own practices or work in small partnerships, must build their practices and maintain relationships with other physicians. All successful physicians, whether entrepreneurs or employees, enjoy personally and professional satisfying careers and comfortable, sometimes more than comfortable, incomes. But only physicians entrepreneurs have ultimate responsibility for their practices and their patients. This is what defines entrepreneurs – risk takers who assume full responsibility for their successes and failures. I have no doubt that with that added responsibility comes harder work and greater professional fulfillment.

The era of the physician entrepreneur may be coming to a close. For any number of reasons – the costs of maintaining a practice, uncertainty about future market conditions, or a waning desire for the long hours and administrative tasks that come with entrepreneurship – most new physicians are opting for employment at large hospital systems and multispecialty medical groups. As employees they will continue to care for patients and save lives, but they will no longer have ultimate responsibility for their successes or failures. The physician-patient relationship cannot help but evolve, and not necessarily for the better.

My wife saw the Sun Times article today and reminded me that she has recently experienced just what I have been writing about. After a long search, she had finally found a primary care physician whom she liked very much. Last month, that PCP, who is affiliated with a large local hospital system, informed her patients that she was moving her office to be closer to the parent hospital. I am sure this makes business sense for the hospital system, but it means a 30 minute commute for my wife and for many other patients. The PCP will have to rebuild her practice. Had she owned her own practice, had she been an entrepreneur, I am sure she would put her heart and soul into the effort. But who would blame this PCP/employee if she lets her hospital system build her practice for her? Unfortunately for my wife and many others, the hospital system does not have a heart or soul. That PCPs’ relationships with her patients is bound to change.

So you see, I have nothing but the highest regard for physician-entrepreneurs. After all, the iconic Marcus Welby, MD was an entrepreneur, and no physician, fictional or real, had a bigger heart or more compassionate soul. As our healthcare system moves ahead, let us mark the passing of the physician-entrepreneur as a signal moment, one when the physician-patient relationship that members of my generation came to know and cherish, headed into uncharted waters.

My Son, the Electrician

I grew up in a solidly middle class neighborhood of second and third generation Jewish immigrants. Our grandparents lived in enclaves like Bensonhurst and the South Bronx. Our parents moved to Queens and Long Island where they became salesmen or shop owners. It fell to my generation to earn advanced degrees and join the professional class. We had a few lawyers, some accountants, and one or two dentists. (My best friend Billy Ebenstein and I were the only ones to become professors.) Becoming a doctor was the pinnacle of success, with prestige, guaranteed financial security, and a lifetime of professional fulfillment.

As kids, our iconic physician was Marcus Welby, the eponymous lead character of television’s top rated drama series. Dr. Welby’s world of an independent private practice, free from interference from administrators and insurers, has ended. Not coincidentally, Marcus Welby was portrayed by Robert Young, who had previously played the lead role of Jim Anderson on Father Knows Best. Our doctors were parent figures, get it?

Physicians can no longer expect to enjoy similar relationships with their patients. Even the world of Gregory House, where the practice of medicine was reduced to finding the best application of diagnostic skill and modern technology, seems a distant memory. At least Dr. House held sway over his boss, Dr. Cuddy, and he never let costs get in the way of his medical decisions. When we last saw Dr. House, he was motorcycling off into the sunset with his dying friend Dr. Wilson. House got out just in time.

In the blink of an eye, the world of medicine has changed. We are witnessing massive vertical integration as providers try to make money from ACOs. At the same time, Medicare and private insurance have gone all-in on pay-for-performance. Only they have forsaken outcomes measurement and instead given us strict process guidelines. As a result of these changes, newly minted physicians can expect to spend the bulk of their careers employed by a hospital or a large multi-specialty group practice. They will not build and maintain a practice – their employer will do that for them. And they will have little discretion over diagnostic testing and treatment plans – they will instead follow strict treatment guidelines.

As a result of these changes, I see the end of professionalism. Tomorrow’s doctors will not be in loco parentis, instead, they will be more like carpenters or electricians, applying their tradesman-like skills to blueprints laid down by others. No one will place tomorrow’s doctors on a pedestal. Parents will no longer brag to their neighbors, “Let me tell you about my son, the doctor.”

Medicine will still be a financially rewarding career path. But if money is what matters, there will be far better choices. It will still take 8-10 years to finish medical school plus residency. During that time, a bright young college graduate could have instead completed three years at a top ranked law school and taken up with a big law firm, or worked at a financial firm, gone to a top business school, and taken a job in consulting. Not only would they earn money sooner, as a lawyer or consultant, they would not have to worry about Medicare slashing their fees.

Recent increases in marginal tax rates make medicine even less attractive. College students who choose medicine may give up 8-10 years of good income, but they could reasonably expect to make even more money once they finish their residencies. The net present value of a medical degree just might be worthwhile. Yet if you combine new federal marginal income tax rates that approach 45 percent with state income tax rates that often exceed 5 percent, then the net present value calculations do not look so good. Many college students will be wondering why they should give up a solid, steady income today in for a higher income as a doctor in the future, when the government is going to take over half of that higher income.

When I grew up, I was always told that medicine was a “calling.” Perhaps it was, though the money didn’t hurt. I don’t know how many young people will be “called” to become technicians. But technicians they will be. And with no real financial argument to support the choice, I wonder why anyone would choose to become a doctor.

Unleashing Innovation in Healthcare Markets

I have been absent from the blogosphere for about two months. The fact is, there just isn’t all that much new to write about. Healthcare spending growth continues to moderate, but not by enough to stave off forecasts of doom for Medicare and Medicaid. Nor can employers begin to shift money from health benefits back into wages. But wheels are turning. Health networks are expanding as providers prepare to offer ACOs and/or increase their bargaining clout. A handful of states are poised to start up exchanges with the feds ready to take the reins in the laggard states. Aon/Hewitt is about ready to launch a private sector exchange. We will start to learn whether exchanges save or destroy private health insurance.

The Affordable Care Act has had many detractors but at least it has disrupted the status quo. We needed to see fundamental changes in how we pay for and deliver healthcare services and the ACA has delivered. But ACA has brought us a very particular set of changes. Time will tell if we have chosen the right path.

Even as the industry changes the way it does business, one critical aspect of change is missing. The faces are all the same. The same large systems that dominated the fee for service world seem poised to dominate the shared savings world, and the same insurers that dominated the traditional employer-based insurance market stand ready to dominate exchanges. Value might be created when old businesses play by new rules, but even more value is created when new players are free to enter and perhaps even break the rules.

Entry is the engine that drives economic progress. Entrants bring new technologies to manufacturing and new service models to sales. Threatened by entry, incumbents strive to innovate and improve customer service. This is as true in high tech industries as it is in the service economy. Research confirms that entry is ubiquitous – in a typical manufacturing industry, fully one third of established firms are replaced by entrants within five years. Though the data is not as readily available, turnover in the service sector is likely even higher.

If entry is the engine that drives change, the healthcare sector is out of gas. Turnover in the healthcare sector is slow to nonexistent. Ask yourself, who are the biggest health insurers today? In nearly all states, the answer is the Blues. Who were the biggest health insurers 50 years ago? The Blues. Now name the biggest hospital in your home town and then look up historical data to find the biggest hospital in your town in 1960. Odds are good it is the same hospital.

I have long wondered why turnover is so slow in healthcare, and I think I know part of the reason. In most industries, successful entrants find lower cost ways to deliver products and services. Think Wal-Mart and Lenovo. But find a way to reduce the cost of delivering healthcare and where does that get you? Insured patients won’t take their business to you. Insurers might add you to their provider network, but not if it means excluding traditional providers that dominate the market. And if an insurer did find a way to cut costs, employers would be reluctant to exclusively offer the plan, in part because the tax code makes cheap health care plans seem not so cheap. Given a choice between a cheap and expensive plan, employees would also be reluctant to choose the cheap plan, both because of the tax code and because employers usually subsidize part of the cost of choosing the expensive plan.

There is also a host of regulatory barriers. Many states still enforce Certificate of Need. There are rules governing what allied medical personnel can and cannot do, stifling the search for innovative care models. ACO payment rules under Medicare limit the incentives to cut costs by allowing only for “shared savings” (apparently in recognition of theoretical studies that suggested, contrary to much available evidence, that the HMO full savings model would lead to excessively low quality care.)

I also see a lack of vision in the healthcare management realm. Nearly every sector of the general economy is dominated by “virtual” organizations that keep vertical integration to a minimum. Apple designs products but outsources production and sales. Nike doesn’t make or sell anything (it does design and brand management in-house). Likewise, Wal-Mart and CostCo produce nothing. Pharmaceutical companies outsource research, clinical trials, and even sales and marketing; government relations remain the only task that is nearly always performed in-house. The virtual corporation works because modern telecommunication technology allows independent businesses to coordinate even complex processes, relying on the skills of highly motivated specialized independent business partners, without the need for a vertically integrated corporate bureaucracy.

But healthcare is different. Faced with uncertainty, healthcare providers circle the wagons. They go on acquisition binges and then go business only with the set of providers in the same giant bureaucratic organization. In the Balkanized market that results, entrepreneurs become employees, agile independent firms become part of large bureaucratic structures, and efficiency suffers. We have seen this movie and it does not end well.

I have mentioned how some regulations stifle innovation. Let me mention one more regulation that stands in the way of efficient production. Anti-kickback laws effectively prohibit hospitals from providing financial incentives to independent doctors who deliver efficient care. I suspect the latter is the biggest reason why hospitals are acquiring doctors rather than dealing with them at arms length.

Ironically, the key to unlocking the power of market forces may be a bit more regulation. Of course we need more vigorous antitrust enforcement. But we also need to bring order to the world of electronic medical records. One advantage enjoyed by the integrated firm is the ability to get all of its providers to use the same EMR platform, thereby facilitating the exchange of information that is vital to improving efficiency and quality. Independent physicians are reluctant to adopt EMR, due to the cost, but they also are reluctant to choose a particular EMR system for fear of aligning themselves with a particular hospital that uses the same system. (This would weaken the physician’s bargaining position.) President Bush established a commission to develop EMR standards, but the result was unsatisfactory and incompatible systems continue to coexist. Without enforced compatibility (and either carrots or sticks to assure adoption), the virtual healthcare organization will remain a pipe dream. Even the most visionary healthcare executive will be reluctant to do business with an independent provider if the potential for information exchange is limited.

Beyond the Fiscal Cliff

Interesting article at Yahoo Finance about WalMart’s health benefits. Read down to the discussion of Colby Howard, a young smoker making somewhere less than $20k annually who may drop his employer-sponsored health insurance coverage rather than pay the $720 annual contribution. This may be a rational decision for Mr. Howard; if he drops his coverage, he may qualify for Medicaid.

It is easy to take shots at Mr. Howard. If this Texan purchases one pack of cigarettes a day, he will spend $2000 annually on his smoking habit, yet he won’t spend $720 annually on health insurance. And now, the Affordable Care Act gives this free-rider-in-the-making an out. We may feel more sympathy for Barbara Andridge (apparently a non-smoker with an out-of work husband) who may also get government health insurance rather than make her contributions to the WalMart sponsored plan. But the implications for our healthcare system are similar. As much as policy analysts discuss the health insurance exchanges, it is the expansion of Medicaid that seems likely to blow out the budget. There are likely many Colby Howards and Barbara Andridges out there, especially during an economic downturn where many folks would be happy to be working at WalMart.

A few years ago I wrote a research paper about medical bankruptcy. I noted that critics of the US Healthcare system complain that Americans should not have to pay even $1000 annually for their medical care. But no one complains that we spend more than this on food, clothing, and housing. Until we have a mindset that we need to budget for healthcare in the same way that we need to budget for other necessities, we will continue to make taxpayer-funded insurance our default option. And as the size of the healthcare entitlement continues to grow, the upcoming fiscal cliff will seem rather puny.