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

October 28, 2013

The Web Site Meltdown is Just the Opening Act

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 7:48 am

That past month of debate over the botched launch of the health care exchanges has brought the programming geeks, and their hired mouthpieces, out in the open to defend the indefensible. As painful as this has been for so many Americans, we cannot help but be amused to hear so many commentators doing their best impression of Captain Renault and expressing their shock that the federal procurement system could have produced such an outcome. Of course, most of this is a sideshow, the opening act to an even more serious drama in the making. Let us be clear from the outset, the rollout of Healthcare.gov is an embarrassment. However, this only becomes a real problem if it dissuades enough people who were already marginal customers with respect to their purchase of health insurance on the exchanges to simply pay the penalty and avoid the hassle of staring at a computer screen, waiting on hold for hours, or refusing to try again once the geeks get this all sorted out.

While the self-appointed technology experts on both sides of the aisle have been debating the causes of the web site debacle, attention has been diverted away from the necessarily frank discussions we must have about the real potential benefits and looming costs of the exchanges.

In a valiant attempt to steer the conversation towards the benefits of the ACA, President Obama held a rose garden press event where he repeatedly claimed that the health insurance on the exchanges is good product. But as is all too often the case, the President talked about the benefits and side stepped the difficult conversation about the costs. At least he is half right. If they can ever fix the web sites, people with pre-existing conditions who shop on the exchanges will gain access to insurance at a more affordable price. Enrollees may save thousands of dollars. But let’s not kid ourselves. The exchanges do not reduce the cost of medical care; they only change who pays for it. And we all know who that is.

If we think way back to the debate about the ACA in 2009, policymakers and pundits waited with bated breath for the Congressional Budget Office score of the budget impacts of the bill. The CBO estimated the ACA would be effectively revenue neutral over its first 10 years. Both sides had a number of quibbles with this analysis. Supporters of the bill felt that not enough credit was given for savings from preventative care while opponents thought the Medicare cuts would ultimately prove illusory. But we believe both sides of this budget scoring debate refused to acknowledge the elephant in the room.

The CBO assumed that the ACA would cause relatively few employers to stop offering health insurance. CBO estimated that only 3 million people with employer provided benefits would end up on the individual exchanges. This assumption, which directly fed into the CBO’s budget score, was based in part on the experience in Massachusetts. But there are dangers in assuming that the experiences of any one state will translate to a Federal policy change.

Given the economic incentives created by the ACA, we expect that well over 3 million Americans will lose employer-sponsored coverage. A recent paper by Doug Holtz-Eakin and Cameron Smith provides a simple calculation of the large number of Americans who would be made financially better off by their employer no longer offering health benefits. These numbers are compelling. Consider the case of a family of four earning 150 percent of the poverty line. If these individuals are currently receiving employer provided insurance, they will lose out on approximately $13,000 in federal subsidies. If your workforce is primarily made up of people eligible for subsidies, why continue to offer them insurance “benefits” in the face of these economic facts.

While numerous employers and employees would be made better off under this setting, and our previous commentary discusses why we think the economy might be better off, there is no free lunch here. Someone has to pay the piper, and in this case it will be the American taxpayer. Holtz-Eakin and Smith estimate that there could be an additional $1 trillion in additional subsidy payments as a result of these employer decisions. We both think that number is likely an over-estimate. However, we also realize that employer responses to the ACA are going to represent a real and growing cost to the American budget for which we are not adequately preparing. (Had the ACA cut the tax benefit for employer-sponsored insurance, we could have seen the same shift to exchanges with far less severe budget implications.) To make matters worse, the web site debacle will likely keep healthy enrollees out of the exchange unless additional subsidies are forthcoming.

The President clings to his belief that “good” employers should continue to offer health insurance. But employers aren’t in business to do good…they rightly leave that to the community and the church. Most employers are savvy, however, and are figuring out that they can increase profits by curtailing health benefits (to cut costs), increasing wages (to retain employees), and encouraging their employees to sign up for the exchanges (to take advantage of taxpayer-funded subsidies.) Perhaps more importantly, the new economic reality of the ACA is that it’s no longer even morally good for employers to provide health benefits to low income employees. This might have been the case before a real non-employer option, but now many employees will be far worse off financially if their “good” employer offers them benefits.

October 22, 2013

Broad Thinking about Narrow Networks

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:59 am

It wasn’t long ago that the newly established health exchanges were being celebrated. Before the ongoing website catastrophe, politicians and policymakers were lauding the low premiums in these new health insurance market places. On September 24, President Obama said, “And the premiums are significantly lower than what they were able to previously get … California — it’s about 33 percent lower. In my home state of Illinois, they just announced it’s about 25 percent lower.”

How times have changed! Even supporters of the exchanges have rightly criticized the technical problems that have prevented millions of Americans from signing up. However, many critics are also complaining about the large number of health plan offerings with “narrow networks” of physicians that enrollees can visit for medical services. The Missouri Health Advocacy Alliance expressed “major concern” when Anthem excluded BJC HealthCare from its narrow network. Seattle Children’s Hospital, which was excluded from several exchange plans, has sued the Washington State Office of Insurance for “failing to ensure adequate network coverage.”

Criticism of narrow networks is misguided and counterproductive. As we explain below, narrow networks will be of little consequence to most of the individuals who sign up for the exchanges, and the elimination of narrow networks could eliminate our single best opportunity to harness market forces to reduce costs and improve quality. Indeed, narrow networks are largely responsible for the low premiums that were being celebrated just one month ago.

We admit that narrow networks may seem like a bad idea. They limit where patients can go to receive care and threaten to interrupt the physician/patient relationship. But there are two major flaws with this line of thinking. First, patients have a choice of many different health plans in the exchanges and these plans all have different network options. A provider who is not in one plan’s narrow network is likely to be another. Patients whose providers are not in any plan’s narrow network can always choose broad network plans in exchange for paying a higher premium. They will be no worse off than they are today, and if competition in exchanges works out as planned they may even be better off.

Once they sign up for a narrow network plan, there is no guarantee that patients will receive care from in-network providers. Big medical bills may result. But we doubt this is likely to be a big concern for very long, as patients learn to navigate the new networks. Seattle Children’s Hospital is rightly worried that some enrollees in narrow network plans will end up at their doorstep. But there are other high quality providers of pediatric services in Seattle. Once patients and referring doctors get used to the new networks, the only children who show up at Seattle Children’s Hospital will be those whose networks include the hospital, or those whose parents are willing to pay for out of network care.

If more of us move into exchanges (something that the Affordable Care Act actually stifles…see our previous op-ed on this topic), we may all have to get use to narrow networks. Employers rarely offer narrow networks because it is very hard to find a single network that appeals to all (or even a large fraction) of their employees and too expensive to offer a large number of different plans. Once individuals are buying insurance for themselves, one-size-fits-all insurance will go by the wayside and people can select the plan and network that best matches their needs.

Narrow networks are not some cruel attempt to limit patient choice foisted upon us by the insurance industry. Instead, these plans may provide our best opportunity for harnessing market forces to lower prices. Even high priced providers know they stand a good chance of being in broad networks. But insurers offering narrow networks can be picky about which providers they select. Across the nation, high quality/high price sellers like Seattle Children’s Hospital will have to prove their worth.

What if insurers ignore quality? If we have learned anything about quality in the past decade, it is that insured patients making their own provider choices have done little to reward measurable high quality, instead relying on more on brand names that may or may not indicate true quality. Will insurers be any worse? While it is theoretically possible that narrow network plans will focus on low costs, quality be damned, we are unaware of any narrow networks that include only the bottom of the quality barrel. It is also hard to imagine how it would be profit maximizing for all insurers or potential entrants to the exchanges to offer only low-quality narrow network plans. Rival insurers will surely be quick to point out the shortcomings of low quality competitors.

As a nation we have reached a consensus that we must lower medical spending. While this is often presented as a choice without trade-offs, that simply is not the case. Making our lower health care cost omelet is going to require breaking some eggs. Most Americans do not place must trust in insurers, but through narrow networks, insurers can introduce some much needed cost discipline on providers. And narrow networks can even include ACOs, should they offer proof of concept.

The intensified competition from narrow networks will be messy…patients will make mistakes, and quality will sometimes go unrewarded. This is not unlike our current system, only it will be less expensive and with greater access. The only sure fired alternative way to controlled cost is centralized planning. While some have faith in the ability of bureaucrats to choose what services to cover and how much to pay for them, we are less sanguine about the role of central planning in this and other settings.

October 11, 2013

When Talking about the Exchanges, It Pays to Keep Your Socks On

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 9:46 am

(Note: This blog was coauthored by my colleague Professor Craig Garthwaite.)

It was an up and down week for supporters of the Affordable Care Act. Republicans appear to have stopped linking government funding with partial repeal of the ACA. And well-publicized software problems plagued the 36 federally managed exchanges, making it difficult for enrollees to complete the application process. Still, supporters could crow about the large number of insurers who are offering products and the millions of Americans who visited the online exchange enrollment sites as a clear sign of the success of the Affordable Care Act.

We should never confuse activity with accomplishment. A few software updates will not be sufficient to assure the success of the exchanges. Two more important things must happen: Visits to web sites must translate into enrollments, and enrollees must represent the kind of cross-section of risks that will keep insurers in the exchanges in years to come.

Not surprisingly, enrollment figures vary considerably by state, with some states operating their own exchanges reporting some of the highest enrollments to date. But upon even minimal inspection, current enrollments leave much to be desired. In New York, 40,000 individuals completed applications in the first week, not bad until you consider that several million state residents are eligible for insurance. Washington State has 1 million eligible residents and just over 10,000 applicants. Reporting that 29,000 California residents had completed their enrollment applications, exchange Executive Director Peter Lee stated that this “blew his socks off.” Let’s put this in perspective. With 7.1 million uninsured in California, an application pool of 29,000 shouldn’t knock any garments off of anyone! These are the “success” stories. At the other end of the spectrum, at last count Maryland had a whopping 566 applicants. And lest we forget, applications are not the same thing as enrollments. Some insurers have claimed that applications are incomplete – potentially leading to a troubling situation where uninsured individuals may incorrectly think that they have secured insurance.

Before patting themselves on the back, exchange supporters should stand back and see what happens. Coming from the nation’s entertainment capital, California’s Mr. Lee should be especially aware of the dangers of judging success from opening week returns. Will the exchanges be like The Lone Ranger, which topped the box office in its opening week and then quickly faded away? Or will they be more like Argo, which gradually built its audience over time? Time will tell.

In addition, it is important that we have accurate indicators of success. In terms of the success of the exchanges, all enrollees are not created equally. It is perhaps more important to know who is enrolling than to know how many people are in the pool. Millions of Americans with chronic health problems are eligible for substantial subsidies for enrollment. It would be shocking (and a sad statement about the marketing and management of exchanges) if most of these individuals were not beating down the doors of the exchanges on day one. However, it would be bode very poorly for the sustainability of the exchanges if on January 1, 2014 the risk pools of the exchanges were flooded only with relatively old and sick individuals. The true success of the exchange hinges on the enrollment of younger, healthier, and wealthier Americans.

While the software glitches are troubling, they will become truly disturbing if they have raised the search costs of insurance to the point that low risk enrollees decide to take a pass and pay the $95 fine this year. While the fine goes up in subsequent years, we both fear that the premiums necessary to cover the health costs of a risk pool filled with individuals who have been previously locked out of the individual market will rise even faster. It took private insurers many years to figure out how to establish stable risk pools, often through the use of controversial practices such as preexisting condition exclusions. The government exchanges are relying on their own controversial practices, such as sliding scale subsidies and purchase mandates. Will these be equally or even more successful in establishing risk pools? Once again, time will tell.

These questions are critically important because we believe that the exchanges represent a vital and necessary change to the provision of health insurance in the United States. A well-functioning non-employer option will liberate an American labor market that has suffered from the linking of health insurance to employment. For the first time, small businesses will be able to compete on an equal footing with their larger counterparts, and entrepreneurs will be able to focus their attention on innovation without dwelling on how they will afford health insurance. Given how essential these exchanges are, it is frustrating and frankly galling that the federal procurement system has produced such a dysfunctional outcome. Given that the United States is a center for technological advancement on the Internet and the home of a wide variety of innovating firms, we deserved better than this outcome.

October 6, 2013

Dr. Strangelaw, or, How I Learned to Stop Worrying and Love Obamacare

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 4:38 pm

There is an ancient Arabic proverb: “The enemy of my enemy is my friend.” With this in mind, I can’t help but think that whatever Senator and leading Tea Party blowhard Ted Cruz opposes must be good. When Cruz decided to try to shut down America because he opposes Obamacare , well that sealed the deal for me. I say “Obamacare forever.”

Readers of my blog know that I think Obamacare has too many rules that create problems for payers and providers alike, and relies on some questionable practices for funding. I don’t like the rush to form ACOs or the lack of serious cost-effectiveness analysis (admittedly a concession to Republicans.) But Obamacare beats the hell (sorry Ted) out of Cruzcare, which, as far as I can tell, goes something like this: “Didn’t put aside enough money for that life-saving operation? Here is a prayer that might help.”

I used to sort of be a Republican. I voted for Bush (I won’t say which one in order to avoid embarrassment) and voted against Obama more than once (living in Illinois I had several opportunities.) And I hate that Obama is playing at President like someone playing poker with a winning hand. This isn’t supposed to be about which politician claims the biggest pot for himself. But I will take a selfish and somewhat scornful Obama over Ted Cruz and the Tea Cozies any and every day of the week. And I will work to find the best Democratic leaders if all the Republicans can offer is Cruz and his TCs.

Shut down the government to finally fund Medicare and Social Security? Maybe. Shut down the government to achieve a rational tax code? Sure. Shut down the government to balance the budget? Now we are talking. But shut down the government to block the opening of the health insurance exchanges? How absurd! This may be the most pro-market thing to emerge from this administration. Maybe the Tea Cozies think that if God had wanted exchanges He would have given CMS sufficient computer capacity to handle the opening rush of enrollees. More likely the TCs are afraid that the exchanges might work. (Speaking of computers, I can’t help but wonder if some savvy TC programmer – an oxymoron? – is sabotaging the open enrollment period.)

The shame of it is that there are plenty of ways to tweak Obamacare for the better. Changes to enhance market forces and promote alternative delivery systems would please everyone to the left of the TCs; i.e., most Americans. But thanks to Cruz and the TCs, any chance for debating how to improve Obamacare has been lost, at least for now.

Obamacare is not going away. I admit that I have gotten used to the idea and think it might not be such a bad thing after all. With luck, many of the TCs are going away; I am actually rooting for the Democrats to retake the House. When they do, I hope that Congress tries its hand at Obamacare 2.0 and takes this flawed but promising program to the next level.

July 19, 2013

The News from New York

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 10:28 am

While sitting in the crowded waiting room of a medical specialist’s office I was forced to listen to the television set directly over my head. Cranked up so that everyone could listen above the din of conversation, Wolf Blitzer introduced a video clip of the President hailing the latest news from New York about health insurance exchanges. Speaking as if he was still on the campaign trail, the President’s words came through loud and clear over the television: thanks to his health reform, premiums in the New York exchange would be half that of premiums in the individual market. This was a model the entire nation should embrace. No one heard me mutter under my breath that this was a model for New York and a small handful of other states that previously regulated their individual insurance markets effectively out of existence.

What the President undoubtedly knows, but dared not say, is that New York’s individual insurance market is unlike any other state. In New York, insurers cannot charge higher premiums to high risk enrollees. As a result of this aggressive community rating, high risk individuals are disproportionately represented in New York’s individual policy risk pools. This drives up premiums, which drives away low risks, driving premiums even higher. Insurers in New York are counting on the purchase mandate, combined with purchase subsidies, to lure low risks into the pool. This is why they have lowered premiums.

That may be how things play out in New York, but will they play out that way in Peoria, or anywhere else? Elsewhere in the U.S., insurers can experience rate to varying degrees. The result is that low risks are able to purchase insurance at rates far below the rates in New York. The Affordable Care Act places limits on experience rating, forcing the pooling of low risks and high risks. For many, perhaps most individuals, the result will be higher rates. What happens in New York stays in New York.

I am not saying that such pooling is either good or bad. In an economist’s dream, we would have one market for short term health insurance and one market for insurance against premium reclassification risk. Under this system, if you get sick, the premiums on your short term health insurance will go up, but you receive a payout from your reclassification risk insurance to cover the higher premiums. John Cochrane has long argued for such a system, which protects against reclassification risk without introducing distortions into the short term health insurance market. But this system has some practical complications – I’d pity anyone who gets sick and now has to argue with two insurance companies! Barring the emergence of such a market, I favor some forced pooling to protect against some reclassification risk. New research by Igal Handel, Ben Hendel and Mike Whinston even suggests that within health insurance exchanges such pooling will be vastly welfare enhancing. (In effect, I like a system where my older self is subsidized by my younger self. But I wonder if I would feel the same way if I was not 57 years old sitting in a specialist’s office?)

What I am saying is that the President was grandstanding about something of no substance and that he surely knew it. I am not surprised that that the President was working this nonstory for all the political benefit he could. But I don’t have to like it.

June 16, 2013

Are Employers to Blame for our High Medical Prices?

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:02 am

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.

June 7, 2013

The Pricing Transparency Puzzle

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 9:07 am

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.

May 9, 2013

The Rest of the Story about Hospital Pricing

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 1:25 pm

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.

April 5, 2013

Restoring Medicare Advantage Payment Rates: A Lesson in Procurement

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 8:08 am

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.

March 28, 2013

Illinois’ Regulatory Dinosaurs

Filed under: Uncategorized — David Dranove and (from Oct. 11, 2013) Craig Garthwaite @ 6:40 pm

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.

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