How to Fix the American Healthcare System

This is the index post for my series on how I would go about fixing the American healthcare system. The link for each post will go live as soon as I’ve written it:

  1. The Problem
  2. The Role of Incentives
  3. Giving Providers the Right Incentives
  4. Giving Insurers the Right Incentives
  5. Proofs

This is what I’ve been wanting to blog about for a long long time, but I wanted to wait until I publish the ideas (thus the scarcity of posts lately). Well, my publication is out! It covers much of the same material only with more nuance. Check it out!

How to Change How Prices Are Set in Healthcare

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In my previous post, I described the three ways prices can be set in healthcare: administrative pricing, bargaining power-based pricing, and competitive pricing. I also bemoaned the fact that the prices paid to providers by private insurers are determined more by relative market share than by anything else* . . . but this post explains how we can change all that.

I see two possible pathways from bargaining power-based pricing to competitive pricing, so here they are.

First Pathway

Let’s pretend a colonoscopy clinic is super innovative in how they do things, and they eventually are able to lower their costs by 20%. This is great for them because the prices they are paid by insurers has stayed the same (remember, those prices are determined primarily by relative market share, not costs), so now they have a really solid profit margin. And yet, the managers of this clinic still aren’t satisfied because they have excess capacity they want to fill.

One day, the managers come up with an idea. They say, “Up to this point, we’ve always maximally leveraged our bargaining power with insurers to win the highest prices we possibly can, but what if we do something radically different? What if we offer to lower our prices by 10% in exchange for the insurers putting us in a new, lower-copay tier? This would induce way more of their policy holders to choose us for their colonoscopies, so we’ll fill up our excess capacity. And, according to our calculations, our increased volume will more than make up for the lower prices. So everyone wins! Our profit increases, the insurer saves money with the lowered prices, and the patients are happy because their copays are less as well.”

Soon, some of the clinic’s competitors would figure out why their volume is starting to drop, so they would probably find a way to offer lower prices to get put into that lower-copay tier as well. Competitors who can’t or won’t lower prices will slowly lose market share until they, too, are forced to either lower price or improve quality enough to convince patients that going to them is worth the extra money.

Voila! Competitive pricing.

I have a friend who manages a large self-insured employer’s insurance plan, and I asked him what he would do if a clinic came to him offering lower prices in exchange for steering more employees to it. He said as long as the provider can show that quality won’t go down with the additional volume and that wait times for appointments won’t increase, he’d probably go for it.

Now, of course this wouldn’t work with every kind of healthcare service. I purposely chose a non-emergency service that already has pretty straightforward pricing. But as a priori quality and pricing information becomes more available, more services will be candidates for this pathway to competitive pricing.

One other point: Hospitals generally do a horrible job of cost accounting (they’re just such complex organizations!), so they usually have no idea if a proposed price reduction will still be profitable or not. Thus, they’ll be left behind in this game until they start to develop better cost accounting methods. If they have some foresight, they’ll start fixing that now.

Second Pathway

An insurer is despairing the fact that many of the providers in the region have combined into a single price-negotiating group, so now the insurer is stuck paying way higher prices than before. But then some health policy-savvy managers figure out a solution. They say, “Let’s implement reference pricing for a bunch of non-emergency, straightforward services. Let’s start with colonoscopies. This is how it works. We’ll tell our policy holders that we’ll put $1,200 toward a colonoscopy (the “reference price”). If a policy holder chooses a provider who charges more than that, they will pay everything over that price. A few clinics in the area offer prices that are lower than $1,200, so policy holders will still have a few options if they don’t want to pay a dime. But, (and here’s the best part) the price the providers in that huge price-negotiating group forced us to accept is $3,000, so they’re definitely going to lose a lot of volume, which will probably force them to lower their price.”

Soon other insurers jump on the reference pricing bandwagon and higher-priced providers who are losing tons of volume will be forced to price competitively.

In conclusion, shifting to competitive pricing is not immediately possible with most healthcare services. But the way to make more healthcare services amenable to competitive pricing is to improve a priori quality and pricing information: quality information needs to be standardized and more relevant to the factors patients should be considering when they’re choosing between providers, and the full price of an episode of care needs to be available beforehand so patients can compare them apples to apples. Only after these changes happen will we be able to rely more on competitive pricing, which, most importantly, will do more to stimulate value-improving innovations in our healthcare system than almost anything else.

* I also complained about how administrative prices don’t encourage (and actually stifle) innovation toward higher quality and lower prices. Check out the Uwe Reinhardt quote in this blog post and then think, “Uwe must have been reading Taylor’s blog.”

How Backward Integration Is Starting to Fix Healthcare Delivery

A good friend just told me about Montana’s state-run clinics that are only for state employees. Going to the clinic is free for state employees, which means the state is paying for everything. And yet, despite paying for everything, the clinics are doing such a good job of managing diseases that the state is actually saving more money than it’s spending on the clinics.

I’ve talked about the importance of cost-saving prevention before, but my point in describing this example is to illustrate a growing trend in healthcare–a trend that is largely unrecognized, but is starting to fix healthcare. So let’s break it down.

Think of the Montana state government as a company. This company, just like most companies, has suppliers that sell it critical inputs it needs to perform its services. And one of the most important suppliers to this company isn’t obvious: healthcare providers. Think about it–they are supplying the healthcare that keeps employees productive, which is surely a critical input.

And here’s the interesting thing about the relationships companies have with their suppliers: if the supplier’s product is too expensive, or isn’t good enough in some way, companies will sometimes just take over the production of that critical input themselves. This is called “backward integration.” Think of all the ways employers are backward integrating into healthcare, whether it’s having their own salaried physicians or working closely with providers to redesign care processes; they’re all variations on the same theme.

But employers aren’t the only ones with a supplier-buyer relationship with healthcare providers. Insurers depend on providers to supply the healthcare they are guaranteeing to their customers. So are insurers backward integrating as well? YES. Any time an insurer joins up with a provider, it could be seen as an attempt by insurers to backward integrate (ahem, ACOs). And insurers are also going crazy trying all sorts of hands-off approaches to backward integration (if it’s hands-off, can it still be called backward integration?) with things like pay for performance, bonuses for starting medical homes, and probably hundreds of other experiments I’ve never heard of. They are all attempts to exert some degree of control over the unsatisfactory supplier. Or, in other words, to fix healthcare delivery.

So, I guess we could say that employers and insurers are fixing healthcare delivery. Strange, isn’t it?

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

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

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

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

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

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

Why Aren’t Prices Transparent in Healthcare?

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I had a friend ask me that (the title of the post) a few days ago. He prefaced the question by saying he’s asked a few different people and knows already that there isn’t a simple answer to it. But those other people he asked misled him. The answer actually is quite simple. And why nobody is explaining this clearly, despite all the talk about price transparency in healthcare these days, is a symptom of a general lack of understanding of how industries actually function.

Prices are transparent in healthcare–the insurer knows exactly how much they’ll pay each healthcare provider for every service they cover. The problem isn’t transparency. The problem is that the party making the decision on where to seek care is not the same party that bears the financial consequence of that decision. Who chooses where to seek care? The patient. Who bears the financial consequence of that decision? The insurer. Therein lies the rub.

Think about two different scenarios. In the first, the patient will have both responsibilities. Patients would start to actually consider whether the extra $5,000 they would have to pay to go to Provider B for their cholecystectomy would be worth it as opposed to just going to Provider A. Is Provider B’s quality actually that much better to make it worth the extra $5,000? If not, patients will probably choose Provider A. And what happens when patients all start being unwilling to pay unjustifiably high prices? Provider B will either have to lower prices (goodbye crazy price variations!) or continue to deal with a large number of unused operating room hours. Patients win because they get better value, and high-value providers win because they get patients. In this situation, the decreased expenditures on healthcare are taken from the low-value providers. Who would argue against that? In this case, even the “I’m better than the average physician” belief that 100% of physicians have (statistically impossible as it may be) will help to decrease healthcare expenditures.

This pairing of both responsibilities in patients is actually happening, by the way. Why do you think insurers are trying out reference pricing, where they just commit to put a set dollar amount toward a given procedure and have the patient cover the difference if they choose a provider who charges more than that? And what about tiered plans, where patients choosing to go to the more expensive hospitals (the ones in the higher tiers of the insurance plans) have to pay a larger copay? And what about high-deductible plans for services below the deductible? These are all doing the exact same thing but in different ways: making the person who chooses where to get care the same person who bears the financial consequences of the decision. And providers with higher value are being rewarded with increased market share (volume).

In the second scenario, the insurer will have both of those responsibilities. It’ll still bear the financial consequences, of course, but now it’ll also be the one that tells patients exactly where to go for care. Patients wouldn’t like this, of course, but what would happen? Insurers would send every patient to the cheapest provider that meets minimum quality standards. Unlikely to ever happen? For run-of-the-mill procedures, probably it won’t ever happen. But for incredibly expensive one-time procedures, it already has. I heard a story about an insurer that did this with liver transplants (which, all told, is estimated to cost over $500,000 dollars). The insurer asked around to all the reputable local hospitals and got the cheapest bid for each patient. Then they sent each patient to the lowest-bidding hospital. The insurer saved a bundle. And the hospitals that could offer lower prices (possibly because they had lower costs somehow) were rewarded with volume. Ah, that whole reward value with volume thing again. It’s beautiful.

One final real-world example. ACOs. So far, one major way they’ve saved money is by sending patients to cheaper specialists. Let’s apply the principles we’ve just talked about to understand what’s going on. The referring provider is generally the party charged with making the decision of where the patient will go for a specialist visit. (The doctor says, “You need a specialist to look at this. Here’s the phone number for a good doctor, so go see her.” The patient says, “Okay, Doc, whatever you say. I’ll go see her.”). And when the referring provider is getting a bonus for keeping overall costs down, he now also bears the financial consequence of sending patients to expensive specialists because it’ll cost him his bonus. Now that you understand the principle of those two responsibilities needing to be invested in the same party, the world starts to make sense; you start to actually be able to predict whether something will work or not.

So now when you hear people complaining about our “horrendously evil system of third-party payment,” you’ll know that it’s not intrinsically a bad thing. It’s only bad when it results in a separation of those two responsibilities, the decision-of-where-to-seek-care responsibility and the financial responsibility.

How to Reward Value Instead of Volume

Who has heard the favorite healthcare reform saying these days? “We need to reward providers for value, not volume!” It has almost become cliche. And conventional wisdom would teach that something touted frequently would be well thought through by the people touting it; but we all know conventional wisdom is often wrong. (Did I just say that the knowledge that conventional wisdom is often wrong is conventional wisdom?) I admit that I have not read everything by everyone doing the touting, but I’ve never heard anyone break down exactly how we can reward value instead of volume. So I’ll tell you.

There are only two ways to do it: a dumb way and a smart way. But first, let’s review how a healthcare provider makes money:

Revenue = Price x Quantity

Do you see that there are only two components (that we can control, at least) that determine how much money a company makes? We can change the prices we pay them or the quantity they sell.

Now, let’s suppose we are able to identify an objectively highest value healthcare provider out there. Let’s further suppose that we want to reward this high-value health system for its amazingly high value so that it can be financially rewarded for being so awesome and so (we hope) others will copy them to have high value and be rewarded, too. How can we do it? Let’s look at our two options:

Increase price: You’ll recognize this as what Medicare is trying to do. Will it have the intended effect? Probably. High-value providers will be rewarded with higher prices. But hold the phone–isn’t our true intended effect to get society the highest-value healthcare we possibly can? So how are we maximizing value if we’re raising prices? Raising prices lowers value. So we’re identifying the highest-value providers and then lowering their value. Hm. Ah, but maybe there will be an overall aggregate effect of higher value because we won’t raise prices much, but we’ll get lots of low-value providers to improve their quality. I guess. But all this seems to be doing is increasing the total money we pay on healthcare, which is not a good idea right now. So I call this the dumb approach. But people haven’t thought hard enough to know there’s also a smart approach . . .

Increase quantity: What this means is getting more people to the highest-value providers, so now we’re rewarding value with volume. Their hospital beds are full, their specialists are performing lots of high-margin surgeries, etc., and they are rewarded handsomely for being high value. Not only does this reward the high-value provider, but look what happens to patients–they get to have higher-value care because they’re going to the high-value providers! In other words, society collectively will be receiving higher-value healthcare. And the low-value competition, meanwhile, will not be so busy anymore, they’ll start to lose money, and they might actually go out of business UNLESS they improve their value as well. That’s quite an incentive to change (probably the most powerful one, actually).

So why aren’t we doing this rewarding value with volume thing? I could list a bunch of reasons why we’re not, but that wouldn’t be very clear thinking now, would it? Instead, I’ll ask this: Who is deciding which providers patients will go to? Whoever is making that provider selection (sometimes it’s the insurer or employer, sometimes it’s other providers, usually it’s the patients themselves) needs to (1) have the price and quality information necessary and be able to determine which provider they think is the highest value and (2) bear the financial consequences of their choice (otherwise they’ll just choose the highest quality every time without regard for price!). If the provider-selecting party can meet both of those conditions, they will be making what I call value-sensitive provider selections.

In summary, policy ideas to reward value with higher prices will not do much for aggregate healthcare value our society is purchasing. But policy ideas that can get those 2 conditions fulfilled for the parties making the provider selections will successfully reward value with volume and concomitantly provide low-value providers with an ultimatum to either improve value or go out of business.

So the questions we should be asking ourselves if we want to “reward providers for value, not volume” is How can we remove the barriers to value-sensitive provider selection?” When will I write another post that enumerates all of the most salient barriers and how to remove them? Ask me tomorrow, but not today.

Customers Determine the Financial Incentives

This is one of the great non-understood truths about how industries work: (see title). [Brief pause to let the words sink in.] Let me illustrate:

I was at the 2012 Healthcare Conference at Harvard Business School and heard H. Lawrence (Larry?) Culp, the President and CEO of Danaher Corporation, speak. Danaher Corporation, just so you know, is one of the big suppliers to the healthcare industry. It’s the parent company for a ton of brands that make really sciency devices and diagnostic stuff. And now that I’ve slaughtered the description of the company. . . . So, Mr. Culp spoke about how profitable they are and how successful they are and whatnot, and then he opened it up for questions at the end.

Now, before I tell you what I asked him, you should know that I’ve always believed, based on what I learned in my business strategy education, that if we could fix the financial incentives in the healthcare system itself, the suppliers to the healthcare system will have their incentives fixed for them as well. So, if doctors all of a sudden start making tons of money by providing really high-value care for patients, but the big thing limiting them from improving their value by decreasing their prices even more is the cost of MRI machines and diagnostic tests, I’ve thought that the makers of those MRIs and diagnostic tests would see that, if they want to kill their competition, all they’d have to do is find a way to make much cheaper stuff to sell to the doctors, and the doctors would jump all over it. But, before the suppliers will invest money into developing those cheaper MRIs and diagnostic tests, they have to know that the doctors really want and will preferentially purchase cheaper stuff that still gets the job done.

So, with that background, I asked my question to Mr. Culp: “I see your company as a supplier of devices and diagnostics to the healthcare industry; in other words, you are providing a lot of the innovation to the industry. This is awesome, because it will help me do so much more for my future patients. But the discussion about how innovation is the main thing driving unsustainable health spending has become more and more important lately, so I’m just wondering, does that conversation affects how you choose to focus your R&D money by pushing you to start developing more cost-lowering innovations, or are R&D investments just determined by what customers are requesting?”

He gave a very professional and politically correct answer, and this is what it boiled down to: We’re a company, and just like every other successful company in this country, we’re trying to make money by making what customers will buy. As soon as customers start demanding cheaper devices and diagnostics, we’ll “pivot” our R&D investments toward those. (Yes, he actually used the word “pivot,” and it was very articulate of him.)

What’s the message in all of this? Customers determine the financial incentives.

Pop quiz: If everyone thinks MRIs are remaining unnecessarily expensive, how should we fix it?

  • A: Tell the MRI makers that they’re not providing high value machines, and then regulate them into developing cheaper technology
  • B: Realize that they’re not investing in developing cheaper MRIs because customers aren’t demanding cheaper MRIs, so figure out why customers aren’t demanding cheaper MRIs and solve that problem

I hope you chose the second option. Now apply this to what we’re seeing with all these regulations to try to fix the value provided by doctors and hospitals. Shouldn’t we be looking at the doctors’ and hospitals’ customers and fixing whatever is keeping them from choosing high-value doctors? The regulations will likely help, but they’re not going to be a sustainable solution to our providers’ value problem. We need to understand and fix whatever’s going on with their customers (ahem, patients and insurers). Oh, insurers aren’t providing the highest value insurance they could provide? Why could that be?

Parting thoughts:

In the medical devices/diagnostics-provider relationship, the provider is the customer. But in the insurer-provider relationship, the provider is the supplier. Remember, there is a whole chain of customer-supplier relationships in every industry, so this means if we want to fix the financial incentives in the healthcare system, we have to go all the way back to the very beginning customer in the chain and fix what they’re doing, which will then fix what the next party in the chain is doing, which will then fix what the next party in the chain is doing, . . .