January 31st 2012 healthcare cost reform

Gnostam LLC January 31st, 2012 Newsletter
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Independent Research & Management

US HEALTHCARE COSTS:
Why US Healthcare is most expensive in world and yet ranks 37th in developed
world in terms of effectiveness

In 2008 the US spent 16.2% of its resources services they provide.
[as measured by overall cost of health care
as % GDP]. Yet quality in US is consistently An alternative business model is for each
ranked lower than Holland, Great Britain patient to be provided a lifetime healthcare
and Germany which have ―socialized‖ budget, over and above which the patient is
healthcare systems. In a 2008 survey of responsible for the costs. If a patient stays
quality of Healthcare service provided, the healthy his entire life, his lifetime budget
US ranked 37th. would not be drawn down. What would
happen to these funds dependson the type
US healthcare is primarily of ―fee for of approach one takes; in theory this should
service‖[FFS] business model. Healthcare accrue to the patient for use whatever way
providers are paid on the basis of the they choose.
amount of services they provide. Doctors
as entrepreneurs, make money on The choice of business model has a huge
treatments that they can provide; the more impact on the overall economic sustainability
service or drugs they can prescribe, the of the payers of health care, ~ patients and
more money they make. Clearly in a FFS insurers.
world it is in the interest of Medical service
providers to maximize the volume of

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Since 1960 the cost of healthcare in the United
States as % GDP has tripled. The Congressional
Budget Office has estimated that in 2025 is
expected to quadruple to 24% of GDP, if the
business model that has been adopted by the
healthcare providers does not change. If
unchecked in 2080, Healthcare will consume >
40% of GDP.

It is inherently dangerous for one sector of the
economy to account for >40% of national
resources, as we saw when the financial system
crashed in 2008. By 2008 the US financial system
accounted for > 40% of all S&P 500 profits.

The cost of healthcare in the United States is
borne principally by employers, who pay
premiums to insurers and by individuals who
either un-insured or have own insurance.

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This paper examines ways in which patients
and insurers can contain healthcare costs.

STRUCTURE OF HEALTHCARE IN US:

The US system as we have discussed is a
fee for service system, [FFS]. This
business model is a payment model in
which services are unbundled each service
is paid for separately. In an entrepreneurial
healthcare system, it incentivizes physicians
to provide more treatments (including
unnecessary ones) because payment is
dependent on the quantity of care, rather
than quality of care. Similarly, when patients
are shielded from paying (cost-sharing) by
health insurance coverage, they are
incentivized to welcome any medical service
that might do some good. A variety of
reform efforts have been attempted,
recommended, or initiated to reduce its
influence (such as moving towards bundled
payments and capitation, or per capita
services).

The table on the left demonstrates the
effects of the FFS. The US system
essentially costs 3 times for the same
healthcare than it would cost a patient in
New Zealand, considered one of the top
countries in the world for quality of life and
living standards.

A simple check up in the US costs double
what it costs in Canada or the Netherlands.
Canada has the highest quality of life index
in the world, and is a developed country.

A hospital visit in America costs three times
what a hospital visit costs in France. Many
Hospitals in America have extensive art
collections on the walls, plush facilities and
extra-ordinary overhead expenses, all of
which are being paid for by the patient and
the insurer.

WHY THE COSTS ADD UP UNDER FFS:

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FFS payments are issued retrospectively, primary care physicians to invest in radiology
after the services are provided. One of the clinics and perform physician self-referral in
main features of FFS, is that no cost order to generate income.This vertically
savings are negotiated for an entire integrated business model creates very large
procedure up front.FFS causes an barriers to entry and local heathcare provider
inflationary pressure on costs, as no monopolies are very common in regions all
bundled services can be priced, raising over the USA. FFS has been a barrier to
health care costs. FFS also creates a coordinated care, or integrated care—
potential financial conflict of interest with exemplified by the Mayo Clinic—because it
patients, as it incentivizesoverutilization— rewards individual clinicians for performing
treatments with either an inappropriately separate treatments.FFS also does not pay
excessive volume or cost, nor does it providers to pay attention to the most costly
incentivize physicians to withhold patients,ones that could benefit from
services. When bills are paid under FFS interventions such as phone calls that can
by a third party, patients (along with make some hospital stays and 911 calls
doctors) have no real incentive to consider unnecessary. FFS became the main
the cost of treatment.When patients ―are healthcare business model after WWII when
insulated from the cost of a desirable there was need for a business model that
product or service, they use more", such could deal with high inflation; thus was born
as endless medical tests, diagnostics and the inflation monster ~ FFS. The familiarityof
procedures. There is a large body of FFS to doctors and patients in the USis the
evidence that suggests primary care main reason FFS is seen by many patients as
physicianspaid under a FFS model, tend the only or main payment method, [e.g.
to treat and refer patients to more Medicare is FFS]. Doctors as entrepreneurs
procedures than those paid under want to be reward for output not
capitation or a salary. FFS incentivizes effectiveness, so FFS does just that. The

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Soviet Union’s economic system also providers a set amount for each enrolled
rewarded output not effectiveness in meeting person assigned to that physician or group
consumer demand. The ―heaviest‖ TV sets of physicians, whether or not that person
in the world were produced in the Soviet seeks care, over time, such as lifetime of
Union, because output = weight. So in the the patient.
US we have the ―heaviest‖ healthcare
system, a result of FFS. Providers are contracted through health
maintenance organizations (HMO) known
as an independent practice association
It is important to note that General (IPA). The providers contract with the HMO
Practitioners have less autonomy after to take care of patients enrolled in the
switching from an FFS model to integrated HMO.
care.Patients, who moved from an FFS
model saw their choice of physicians The amount of remuneration is based on
restricted, as was done in the Netherlands in the average expected health care
their attempt to move towards coordinated utilization of that patient (more
care. remuneration for patients with significant
medical history). Other factors considered
In a business model where physicians include age, race, sex, type of
cannot bill for a service, it serves as a employment, and geographical location, as
disincentive to perform that service if other these factors typically influence the cost of
billable options exist. In an electronic referral, providing care.
for example, a specialist evaluates medical
data (such as laboratory tests or examination
of images) to diagnose a patient instead of MOVING OFF AN FFS SYSTEM:
seeing the patient in person;this has been
found to improve health care quality and
lower costs. The economies of scale of this Proponents of leaving an FFS system
approach might finally be passed onto the argue that this increased efficiency,
payer of the service, patient or insurer. It improved overall quality standards, leading
should be noted that, "in the private fee-for- to a better understanding of the economic
service context, the loss of specialist income relationship between costs and quality,
is a powerful barrier to e-referral, a barrier cost and volume of services provided.
that might be overcome if health plans According to a 2002 Juran Institute study,
compensated specialists for the time spent there is no consistent, direct correlation
handling e-referrals". between the cost of care and its quality.
The "cost of poor quality" is in effect
In Canada, the proportion of services billed
caused directly by FFS overuse, misuse,
under FFS over the period of 1990 to 2010
and/or waste amounts to 30 percent of all
shifted substantially. Less care was paid out
direct health care spending.The emerging
for patients under the age of 55 while for
practice of evidence-based medicine is
those over 65, payment for diagnostic
being used to determine when lower-cost
services was sharply increased.
medicine may in fact be more effective.
Critics of managed care argue that "for-
ALTERNATIVE BUSINESS MODELS: profit" managed care has been an
unsuccessful health policy, as it has
Capitation: Capitation is defined as a contributed to higher health care costs (25-
method for paying health care service 33% higher overhead at some of the

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largest HMOs), increased the number of bonuses depending upon patient
uninsured citizens, driven away health care performance. Utah's Intermountain
providers, and applied downward pressure Healthcare, the Cleveland Clinic, and Kaiser
on quality (worse scores on 14 of 14 quality Permanente also use a coordinated
indicators reported to the National healthcare system in alternative to FFS.
Committee for Quality Assurance). However while coordinated care can
produce cost savings of ~ 50% when
The most common managed care financial
compared to FFS programs, long term
arrangement, ~ capitation, places health
savings may be compromised by Physicians
care providers in the role of micro-health
wanting higher base compensation because
insurers, assuming the responsibility for
of the loss ―volume‖ business relative to
managing the unknown future health care
FFS. [See interesting study by Peter Zweifel
costs of their patients. Small insurers, like
(March 2011). "Swiss experiment shows
individual consumers, tend to have annual
physicians, consumers want significant
costs that fluctuate far more than larger
compensation to embrace coordinated
insurers.
care". Health Affairs (Project Hope)30 (3):
510–518].
"Professional Caregiver Insurance Risk‖
describes the inefficiencies in health care
finance resulting from the inefficient transfer ACCOUNTABLE CARE
of insurance risks to health care providers ORGANIZATIONS:
who are expected to cover such costs in
return for their capitation payments. As a One of the goals of accountable care
study by Thomas Cox Ph.D RN (2006) organizations (ACOs), part of the 2010 U.S.
shows, providers may not be adequately Patient Protection and Affordable Care Act
compensated for their insurance risks, (PPACA), has been to move from FFS to
without forcing managed care organizations integrated care.ACOs, however, fit largely
to become price uncompetitive vis-à-vis risk into a FFS framework, and do not abandon
retaining insurers. Cox (2010) also shows the model entirely, as has been pointed out
that smaller insurers have lower probabilities by John K. Iglehart (April 2011) in"The ACO
of modest profits than large insurers, higher regulations – some answers, more
probabilities of high losses than large questions". The New England journal of
insurers, provide lower benefits to medicine. This approach suggests
policyholders, and have far higher surplus policymakers are attempting to avoid
requirements. All these effects work against provoking public outcry, as happened with
the viability of health care provider insurance managed care in the 1990s by giving
risk assumption. providers incentives to give less care.The
Moving away from FFS towards pay for PPACA aims to first move Medicare away
performance introduces quality and from FFS, then other payers.A Swiss Peter
efficiency incentives, instead of solely Zeiwfel study showed physicians wanted
rewarding quantity. significant pay raises to leave FFS for an
integrated care model, while patients wanted
The famous Mayo Clinic, has among others, lower premiums before they would choose
offered a system that serves as a one, results that hint at difficulties for
coordinated/integrated care alternative to PPACA aims.
the FFS model. The Pennsylvania
Geisinger Health System has a system In China—where FFS resulted in costly,
where the physicians, residents and fellows inefficient, and poor quality health care with
are paid a salary with the potential for a degeneration in medical ethics—reforms

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have been initiated to realign health care legislative mandate to come up with a plan
provider incentives, see Winnie Chi-Man to tackle costs (the Massachusetts Payment
Yip, William Hsiao, Qingyue Meng, Wen Reform Commission); they unanimously
Chen&Xiaoming Sun (March 2010) and concluded the FFS model must be done
"Realignment of incentives for health-care away with. Their plan included a move away
providers in China". The Lancet . from FFS to a global payment system that
Experimentation with new payment models had similarities to a capitated system. No
is ongoing with recommendations including U.S. state, up to 2009, had attempted to do
a strengthening of medical ethics, alignment away with FFS. The Medicare Payment
of provider's profit motives with patient Advisory Commission(MedPAC), in their
needs, and, in cases where hospitals retain mid-2011 report to Congress, called for a
their profit motive, segregating physicians mechanism so that Medicare
from the goal of profit. beneficiaries would have disincentives to
In the 1990s the move in the US from FFS undergo discretionary care, but not
to pure capitation provoked a backlash from needed care.
patients and health care providers. Pure
capitation pays only a set fee per patient, WHY CONSOLIDATION IN INSURANCE
regardless of sickness, giving physicians an INDUSTRY HAS NOT BROUGHT LOWER
incentive to avoid the most costly patients.In COSTS:
order to avoid the pitfalls of FFS and pure
capitation, models of episode-of-care One of the mysteries of Healthcare
payment and comprehensive care payment Insurance is why consolidation resulting in
have been proposed.In 2009, the U.S. state larger insurers has not provided lower costs,
of Massachusetts (with the then highest as we should have expected had the
health care costs in the country) had a group Thomas Cox Ph.D RN ―case‖ studies of
of ten health care experts who worked under 2000 2011. Two studies published by Health

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Affairs, the bible of health policy, document business professor at the University of
the shortcomings of health industry California at Berkeley, have also weighed in
consolidation. with their study of hospital mergers two
years out. It shows that costs increased, not
James Robinson, a professor of health decreased, that there was no improvement
economics, calculates that the top 3 health in basic quality measures such as mortality
insurance companies control two-thirds or and adverse safety events, and that prices
more of the business in all but 14 states, increased 7.7 percent for managed care
with numbers reaching as high 92 percent in customers and 4.1 percent for fee-for-
Maryland and 98 percent in the District and service plans.
Northern Virginia.
How do we explain these data?
Robinson juxtaposes these numbers with
the 2000 to 2003 financial results of the top In the case of hospital mergers, Cuellar
five national firms. He shows a decline in the states that administrative efficiencies wind
percent of each premium dollar that goes to up being minimal, while efforts to realize
cover medical costs, along with an even operational efficiency often run into a stone
stronger trend toward higher premiums, wall of opposition from doctors uninterested
profit and stock prices. While this doesn't in changing the way they practice. That was
prove causality, it certainly raises serious the undoing of the merger between Mount
questions about the consumer benefits of Sinai and New York University hospitals in
consolidation. New York, she said.

Alison Evans Cuellar, an economist at Meanwhile, the effort to gain negotiating
Columbia University, and Paul Gertler, a leverage through mergers often proves to be

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an arms race with no winners. Insurance based medical practices that hold out the
mergers beget hospital mergers, and vice best promise for lowering costs and
versa, neutralizing any negotiating advantage. improving medical outcomes. In the few
places where such innovations have
One result of all this consolidation is the taken hold, it turns out that management
reduced chance of a new entrant coming along and culture are the key factors, not scale.
to shake things up with a new technology or
business model. In a world where giants deal
only with giants, that's not likely. CONCLUSIONS:

An emerging source of competition has come There is undoubtedly a need on the part
from regional companies deciding to grow the of insurance companies to be pro-active
old-fashioned way, moving into geographically with both patients and healthcare
adjacent markets to win new customers. But providers so as to formulate a strategy for
now that national insurers have gobbled up cost reduction in healthcare.
most of the regional players, there aren't many
left. [UnitedHealth's purchase of MAMSI and In the view of the authors of this paper, it
Oxford in the Virginia/Maryland areas]. is very likely that the very same
experience curve effects that exist in any
As for the newly merged hospital "systems," other industry exist for healthcare
some -- like Inova Health System's nicely providers as well. [An example of the
profitable "nonprofit" operation in Northern ―effect‖ of an experience curve on overall
Virginia -- are now so dominant they have costs is shown overleaf].
become somewhat immune to competitive
pricing pressures. We submit that it is likely that healthcare
providers have deliberately promoted the
FFS business model because it
Others have discovered that they so overpaid
maximized revenues, while allowing them
for recent acquisitions, or have become so
to ―privatize‖ almost all the gains from
stymied by integration issues, that they have
―experience effects‖ for the provider.
neither the time nor money to leverage the
benefits of size to install computerized record
In order to reduce the rate of increase of
systems or introduce the kind of evidence-

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healthcare costs for patients, it is essential accept these types of new business models,
to begin to move the industry off FFS and to and how to reconcile the conflicting priorities
a capitation business model. Employers are of patient needs, health-insurers and the
pushing this change of business model, as profit motives of health care providers is the
the healthcare insurance costs are the subject for another paper.
highest benefit cost facing employers.
Gnostam LLC
Many employers like for example Pitney
Bowes who have a young healthy hourly Philip Corsano
work force, are insisting that these Patrick Kelly
employees do not opt out of healthcare
coverage while at the same time promoting
a form of capitation.

For more than a decade Pitney Bowes has
provided subsidies that make coverage
more affordable for lower-wage workers. It
seems to work: 78 percent of U.S.
employees opt for health coverage at Pitney
Bowes. Starting this year, the company took
a step that ties health coverage costs even
more closely to pay. In its consumer-
directed health plan, the company sets the
deductible, out-of-pocket maximum and
company contribution based on salary.
Hourly workers, for example, have a $1,500
deductible and $3,000 out-of-pocket
maximum, while employees at the director
level or higher have a $2,500 deductible and
$5,000 out-of-pocket maximum.

How to drive a patient and provider to

Bibliography:

Gosden T, Forland F, Kristiansen IS et al [2000] “Capitation, salary, fee-for service and mixed
systems of payment: effects on the behavior of primary care physicians, Cochrane Database
Syst. Rev;
Thomas Bodenheimer [March 2008] “Coordinating care – a perilous journey through the
healthcare system” The New England Journal of Medicine [358-10];
Medicare Option in Biden Budget talks get a boost. NPR, Associated Press June 2011;
Rachel Mendleson [Oct 25th 2010]. “The worst run industry in Canada – Healthcare. Canadian
Business;
Phil Galewitz: Jordan Rau and Bara Vaida [March 31st 2011]. Accountable Healthcare expected
to save millions, Kaiser Health New, [McClatchy];
Peter Zweifel, [March 2011] “Swiss Experiment shows that physicians, consumers want
significant compensation to embrace coordinated healthcare, Health Affairs, [Project Hope]

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510-518;
Thomas Cox Ph.D RN, 2011 “Exposing the true costs of capitation financed healthcare” Journal
of Healthcare Risk Management 30-34;
Thomas Cox Ph.D RN, 2011 “Standard Errors of our failing healthcare [finance] systems and
how to fix them;
Thomas Cox Ph.D RN, 2010 “Legal and Ethical Implications of Healthcare Provider Insurance
Risk Assumption. Jona’s Healthcare Law, Ethics and Regulation 106-114;
Thomas Cox Ph.D RN, [2000] “Professional care giver insurance risk. A brief primer for nurses,
executives and decision makers, Nurse Leader 48-55.
Harold D. Miller [September – October 2009]. “From Volume to value: better ways to pay for
Healthcare” – Health Affairs, Project Hope.

Diagram of flows of a FFS Business Model

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Debt Explosion in US is not unique. See European experience in graph below, in
part because of unfunded liabilities in the public healthcare sector.

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Differening share of Profit and Labour 1947 to 2011
United States

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Disclaimer:

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believe to be reliable, but we do not represent that they are accurate or complete, and they should not
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than the performance data quoted.

Investment Disclaimer  All investments involve different degrees of risk. You should be aware of
your risk tolerance level and financial situations at all times. Furthermore, you should read all
transaction confirmations, monthly, and year-end statements. Read any and all prospectuses carefully
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is not a guarantee for the successful performance of an investment and we are expressly prohibited
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from guaranteeing accounts against losses arising from market conditions.
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January 31st 2012 healthcare cost reform

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