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Reflections on the Revolution in Health Care

Rita E. Numerof, Ph.D.
Medical Progress Today
November 13, 2009

As our national debate over healthcare reform rages, there are some things everyone agrees on: We all agree that the dual goals of better care at lower costs are appropriate and achievable. There is also a growing recognition that our third-party payment system, which relegates payments for routine health care services to insurers rather than consumers, drives up costs and penalizes providers who offer cost-effective care.

Indeed, the current payment system actively encourages the inefficient use of resources and even fraud. Across both the public and private sectors there is suddenly agreement that this is an unsustainable business model. Consumers can and must become central players in health care markets.

How We Got Here…

Both the federal government (through Medicare and Medicaid) and private payers (which generally follow Medicare's lead) have contributed to a payment model that distorts the use of health care resources and erodes incentives for cost-effective preventive and primary care in favor of specialists and high-tech treatments that are reimbursed more generously.

For instance, CMS (the federal Center for Medicare and Medicaid Services) has chosen to underpay Medicare providers through DRGs (diagnosis-related groups) by 15-20% relative to market rates and the actual cost of care delivery as its way of "managing" costs. Because of its massive market power, providers have no choice but to accept this compensation, which naturally leaves them feeling abused.

But the flip side of CMS’s disregard for market prices is its flaunting of sound claims management: it's "business model" of paying promptly and relatively uncritically claims received (which seniors like), combined with a Byzantine pricing scheme, serves as an invitation for everything from out-and-out fraud (which is rampant) to gaming the system through "upcoding" (finding the most expensive diagnostic coding for Medicare payments), which is at least as widespread.

Private payers have fallen victim to the opposite vice, earning the ire of physicians and patients. They overly scrutinize claims, challenging, denying, and downcoding payments. When combined with excessive payment delays, this again leaves some hospitals and physicians feeling victimized, setting the stage for rationalization of any reform (including a Canadian style single-payer system) that allows providers to avoid the administrative headaches and financial humiliation forced on them by insurance companies.

The combination of these dynamics has created a system at war with itself, where physicians, hospitals, and even manufacturers more easily find excuses for over utilization of diagnostics and procedures, for devoting resources to building volume for those services that pay more generously, rather than those that are more cost-effective, and for stringing up a convoluted series of cross subsidies where some services pay for less generously reimbursed services, making it nearly impossible to answer the question of what things really cost and who is really paying.

The pervasive reach of payers has created an entire industry that revolves around payment practices rather than delivering the most innovative and cost-effective care to the patient. This is a fundamental departure from the true concept of insurance as a hedge against catastrophic financial loses—morphing it into something it was never meant to be, a straight-jacket for the delivery and design of health care services.

...And How We Get Out

A critical requirement for a free market to actually work is accountability for the cost consequences of decisions, in this case the treatment decisions between a physician and a consumer. Across stakeholders, this accountability is actually very difficult to find, and more the exception than the rule.

When we remove accountability for the consequences of our actions we realize unintended negative consequences. For instance, the implementation of DRGs by CMS in essence removed any organizational or individual responsibility for cost and quality decisions. The doctors who make the decisions generally don't have any stake in the cost to treat their patients—and often have a positive stake in more procedures. This has stimulated a tendency to test more, to treat more, and to consume more health services... with little if any incentive to save costs. Not surprisingly, costs have gone up without any necessary improvement in health outcomes.

The consumers who have had employer-based healthcare coverage also don't have any accountability for costs. They have no real line of sight to how increasing healthcare costs have negatively impacted their salary, so they don't even know that they should be participating in an informed way to make decisions that balance cost vs. outcomes. As a result, they have no meaningful incentive to reduce costs.

If there were incentives for consumers to manage costs, including modifying their own health behaviors, they would demand much better information than basic mortality and morbidity outcomes data—a snapshot at 30,000 feet—that is still the health care industry norm. Imagine if the auto repair industry competed for customers on such a "mortality and morbidity" value proposition. Repair garages would run commercials advertising that "your car is less likely to never run again if you come to our garage," or "come see us because we're less likely to remove your engine when you come in for a simple oil change!"

There is an important role for government in this new business model, but it isn't legislating the new model, as policymakers are trying to do now. Instead, we need to foster legislation that enables more health insurance competition and transparency by empowering consumers to own and control their own portable health insurance.

With a requirement for everyone to have insurance—perhaps starting out of college or age 25—and financial help for those who truly can't afford it, insurance companies can design and offer tailored solutions to meet the myriad needs of consumers.

Individual mandates are not the only option here: as in the Medicare Part D program, anyone who doesn’t sign up for at least basic, catastrophic coverage starting at a young age could face a penalty—say 2% per year—that would encourage them to purchase low-cost coverage while still young and relatively healthy. This would also give insurers a long-term incentive to keep these people in coverage and offer wellness and preventive care programs.

As we’ve noted, CMS has historically been a mechanism of payer industry change—sometimes with negative consequences. Recognizing this, CMS can serve as a powerful accelerant for implementing a better model for valuation of and payment for healthcare services by giving Medicare patients the tools for choosing the best and most cost-effective care models available.

But CMS should defer to the private sector in the design of a better model. Design of a valuation model aligned with better care and lower cost is most likely to come from organizations with experience and capability in being accountable to customers for such results... namely private enterprises. The key is to create a national, competitive market for health insurance and to ensure transparency across competing products.

Finally, government doesn't need to raise more money for healthcare via new taxes or more debt. There is over $500 billion dollars in annual savings ripe for the picking, more than enough to redeploy to help people buy healthcare insurance or increasing CMS compensation for primary care. Eliminating medication errors, reducing unnecessary length-of-stay across 5700 hospitals, and eliminating just half of unnecessary care accounts for $500 billion. And we are not yet counting any reduction in fraud or abuse.

Put consumers in the drivers seat, and insurers will produce the new, accountable care models that will align cost, quality, and access. Insurers will be forced to create networks with real economic and clinical value and meaningful outcome information in order to help consumers make good cost/benefit choices.

This is the only sustainable path towards health care reform that improves quality and "bends the cost curve". Restricting the choice of insurance products, isolating consumers further from the impact of their health care decisions, and increasing the role of price controls in the system—as current legislative proposals in both the House and Senate do—will only exacerbate our current problems.

Rita E. Numerof, Ph.D., is President of Numerof & Associates, Inc. (NAI), a strategic management consulting firm. Dr. Numerof can be reached via email at For more of Dr. Numerof's writings on health care reform, see Practical Strategies for Healthcare Reform and Healthcare Reform: Strategy, Myths and Solutions.

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