Thursday, May 29, 2008

Controlling Costs By Setting Efficient Prices in the Health Care Market

Paul D. Speer, Jr.

I. The Current Environment

Neither national health insurance nor current or proposed federal regulation can control health care costs. "We will pay you a set amount for treatment," they seem to say, "if it falls within cost guidelines." Implicit here is the idea that the government will pay for an unlimited number of treatments. Payment for an unconstrained number of treatments creates its own demand. Bills tendered for such treatments will naturally be clustered at or above the cost ceiling. The health care market is inefficient.

From present experience this is to be expected. The set amount has been determined by government research and been categorized as diagnostic related groups. Even if the research were timely and the range of fees followed a bell shaped curve, the availability of information concerning the level of reimbursement to be obtained from the program would cause the lower tail of the curve to be truncated as fees charged rose at least to the former mean. Like a snake coiling its tail and moving forward these charges would rise and be reflected in the next rate setting.

Further, providers would continue to price services generally above the approved reimbursement rate for all patients. By their so doing, the plan participant would remain liable for fees above the government set reimbursement. If the government reimbursed seventy five percent of allowable costs after an annual deductible, the patient would still be liable for the deductible, the remaining twenty five percent of allowables plus the difference between the total allowable cost and the billed fees. So-called gap policies are available to pay the twenty five percent. Unless the provider has agreed to accept assignment to the government program (and thus cap billings at the government allowed cost), the remainder is still a patient liability. Providers have invested considerable sums to collect the remaining liability.

Consider a simple initial appointment with a specialist, who bills at $200 per visit. The government set fee is $168. The government plan might reimburse seventy five percent of that amount, or $126. If assignment had been agreed upon by the provider, the maximum payment would be $168. In this case, gap insurance, after satisfaction of a deductible, would leave the patient with no additional obligation.

Should assignment not have been accepted by the specialist, the patient would still owe sixteen percent of the bill. If the deductible has been previously paid and gap insurance is not present, the patient pays thirty seven percent of the provider's original charge; if gap insurance is in force, sixteen percent. The additional liability of from sixteen to thirty seven percent of the provider's charge is a surcharge on all patients collected by the provider from those whom it believes can pay.

Most providers with access to middle and upper class patients refuse to participate in government assignment programs. The reason most heard is that reimbursement is too slow and the amounts captured insufficient to cover 'costs.' The true reason why participation is avoided is that it does not make economic sense to give up the opportunity to obtain the maximum level of fees. The provider is willing to assist in processing the claim through the government system; the patient liability remains. Only where there appears to be no chance of collecting the remainder of the unpaid charge will the provider accept assignment. It is not surprising that these providers are located in areas where the patient is unlikely to have assets against which collection can be undertaken.

In these areas, the average charge will be much closer to the charge permitted by the government and the supply of health services will be lower. If additional services are provided, they will have been subsidized by the provider's access to moneys obtained from self-pay and private insurance paid patients.

The good deed by the provider in delivering services to asset poor areas at the government assignment rate has four perverse effects. First, it retards the growth of government allowed costs. If the allowed costs remain below actual costs of delivering service, the supply of services will be affected. Fewer services will be available. Second, it requires the provider to increase his billings in other areas to make up for his costs. These patients in these areas are in effect being taxed to provide this subsidy.

Third, it encourages providers to increase their turnover and maximize the number of billings. Increased turnover results in reduced time for diagnosis and patient control. The relationship between the allowable charges and the assumed patient time necessary to complete the procedure is thrown out of kilter. In repairing automobiles, the mechanics use a flat rate manual to determine the labor charge. Mechanics, however, are usually expected to beat the flat rate time or find a new job.

Fourth, it encourages providers to invest in ancillary enterprises. This investment using captured business directed by the provider is another profit center to increase provider income. Originally limited to patient referral for testing and in patient care at the hospital with which the provider was associated, these profit centers now include the myriad of specialized outpatient facilities owned in part by referring providers and formed by a combination of advances in medical treatment and the spin off by the hospital of certain services which with the advent of the government DRG reimbursement methods were not profitable.

Provider owned medical testing facilities are another profit center. Much of the multiple tests ordered by providers are done as the ultimate liability defense; some may be attributed to the profit motive. At the bottom end of the scale, the relationship between the provider and the pharmacy provides another profit center, especially where unlimited, unquestioned government reimbursement of prescription costs occurs.

This is the system as we know it today. The pricing of services is inefficient and is of little concern to either the patient or the provider. Cost control is solely a function of government fiat. Extraordinary costs are larded into the system to benefit both the legal and the medical profession.

Providers will set fees above the cost ceiling to obtain additional income from persons outside the government assignment system. Hospitals, treatment centers, skilled nursing facilities, specialists, etc., can, if efficient, obtain extraordinary returns. Inefficient providers are encouraged to make profits by stinting on their services to individual patients. Neither outcome is desired by the government, the taxpayer or the patient.

The proposals by this and prior administrations would do nothing to alleviate the inefficient pricing mechanism but merely transfer costs to another sector of the market -- businesses. Existing businesses which are labor intensive must raise their prices to cover increased costs. This is a one time inflationary effect. There will be some effect on the creation of new businesses and their ability to weather the crucial first two years. The cost of health care must be contained. But to do so, a change in perspective is needed. The Health Care marketplace can become more efficient in its pricing and as a result deliver more services at a lower cost. This can occur only if market discipline is placed on that pricing.

II. Using Financial Markets to Price Health Care Benefits

Consider the best example of efficient pricing of financial assets -- the Dutch Auction process the U.S. government uses to price its borrowings. The U.S. Treasury at the time of each issuance announces the size of its offering. Prospective purchasers can bid a price (or an interest rate) at which each bidder wishes to purchase a certain amount of securities. Alternatively, the bidder can put in a bid of the 'average rate.' The government tabulates the amounts bid from the highest price to the lowest. After the amount to be accepted at the 'average rate' is subtracted from the original size, the government accepts offers, starting with the highest price (lowest interest rate) until all bonds are purchased. Those who wish to profit the most and those bidders which serve an inefficient sector of the market are excluded.

Now consider how this might be applied to health care. For each specific service -- say, a skilled nursing facility bed/year -- the government would periodically determine a finite number of bed years which it would purchase; at the outset it would probably use the level of services subsidized in the prior period. It would indicate its willingness to 'purchase' that number of units and solicit proposals with an offering price from providers. In this example, a health care institution would offer so many bed/years for a price -- say, 150 bed/years at $50,000 each. When the offer was accepted, the government would provide a fixed percentage of the total cost to reserve the indicated capacity -- an option contract. The institution would provide the government with a contract. Each contract would be good for a fixed time period and would be for one or a multiple of bed/year(s) and might be further subdivided into bed/months, much as coupons used to be placed on bonds.

The government would sell these contracts to health care users in the usual ways. Intermediaries such as private insurance companies would buy the option from the government at a market clearing price. Medicare and state Medicaid systems would receive contracts based on demand in lieu of cash payments. Individuals might purchase contracts as well. Hopefully, that price would be equal to or greater than the price paid to the provider. The contract would be delivered by the purchaser to the provider in exchange for the indicated service. The government paid reservation fee would be deducted from the cost of service indicated in the contract. The contract could be transportable. That is, it could be delivered to and care given by any certified provider. Local and state health agencies would apply for and receive annually contracts based on anticipated demand by needy individuals and maintain an inventory for use or for sale. The provider might invest the proceeds from sale of the option in services to the uncovered.

The user and provider would jointly certify the services used. When the user left the institution, the unused portion of the contract would be returned and payment for the days used would be made, after deducting the pre-paid government reservation fee. The days remaining would be available on an amended contract.

Each specific service in a Dutch Auction would specify the standards required under that service. The provider would be certified as meeting the facility standard and the personnel standard. For example, the bidding for units of open heart surgery from a professional corporation would include the identification of the facility to be used, facilities costs including acute care hospital days, all medical professionals to be used, the pre-treatment examinations and tests, the post-operative care, drugs, terminating with discharge into a lesser facility or to home. The professional corporation would be responsible for bidding the complete package as a single unit price and would bear all costs above that price. As above, the government would pay a reservation fee for that service.

The health care industry would be free to make individual or collective arrangements with users in the traditional way. Individuals capable of supplementing the value of the contract with other sources of revenue would be able to retain freedom of choice in purchasing health care services.

We indicated that the government would be the initial market maker. There is no reason why, over time, a private agency could not assume this task. Nearly all of the mechanisms to implement this system are in place. Facilities and medical personnel are already certified. Within the hospital care area, diagnosis related groups have been identified. Medical-surgical teams have long been organized, although without apparent competition.

As an incentive to participation in the auction, the government should require the health care voucher users to forego the right to sue the provider for other than actual damages. Punitive, pain and suffering, loss of conjugal services, etc., would be foregone. Insurance costs and testing costs would surely be lowered. Finally, the use of inefficiently bundled profit center services would be minimized.

Costs cannot be controlled in an inefficient market without additional inefficient regulation and rationing. What we propose above is to make the market more efficient and in so doing minimize both regulation and rationing and deliver services to all persons at the lowest possible cost.

(The author is president of Municipal Finance Consulting Services, Inc., Indian Creek, Illinois. The firm provides services to state and local entities, including hospitals.)


Blogger Paul, just this guy, you know? said...

It was good talking to you last night! This is a very interesting piece, I believe I'll link to it on my blog.

5:18 AM  

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