The high cost of health care: Blame the financial model

The primary debate in health care reform this past year centered on insurance coverage. The next great debate will focus on the cost of providing health care.

For decades, the way we’ve paid doctors and hospitals has driven up health care costs. And while the pace of health care spending has slowed the last four years, it continues to rise faster and more noticeably than improvements in U.S. health care outcomes.

The reason is not the people. It’s the financial model.

U.S. health care rewards quantity over quality

Imagine you’re planning to remodel your kitchen. You hire a contractor and opt to defer entirely to his judgment on the kitchen’s aesthetics and the source of his materials.

Instead of requesting a competitive bid or choosing exactly what you want, you agree to a time and materials contract. By the end of the remodel, the contractor has billed more hours than you expected, marked up the cost of the materials and charged you twice for his construction errors.

Chances are you’d never agree to such a lopsided arrangement for your kitchen. But that’s the approach most Americans take when they go for medical care.

The U.S. health care system pays physicians based on a fee-for-service (FFS) financial model. In short, it’s that “time and materials” contract you’d never agree to for your kitchen.

The result is that health care costs over the past several decades have risen twice as fast as general inflation. Without the right financial disincentives, we would expect both kitchen contractors and physicians to act in ways that maximize their own economic benefit. And they do.

But it’s not the doctors or hospital administrators who are the fundamental problem. It’s the financial model.

Fee-for-service model pervasive yet perverse

The FFS payment model was created long ago, during a time when physicians treated less-complex problems and offered only a few inexpensive therapeutic interventions. It worked back then but a significant percentage of patients today have multiple chronic conditions. Meanwhile, the number of complex and very expensive tests, medications and interventions available are practically unlimited.

Economics 101 teaches that as supply goes up, costs should come down. But this tenant doesn’t hold true in medical care — not when the supplier also controls demand.

In health care, doctors can stimulate demand because (a) health insurance blinds most patients to the costs of services and (b) patients often don’t know whether a complex procedure is as necessary as a non-invasive one.

As a result, we have seen a major increase in utilization of complex services over the past 20 years.

In geographic areas where there is a shortage of doctors, utilization tends to be lower and physicians are more likely to recommend only the interventions that benefit patients the most. But as the number of physicians in a particular specialty increases, the volume and complexity of services and procedures rise in parallel.

Take back surgery, for example. Some procedures are extremely beneficial, particularly when there is nerve compression. But when pain is the main indicator, non-operative treatments often prove as effective over time.

Surgery can be relatively simple or very complex. The latter involves expensive hardware and implants. For many patients, these more extensive procedures add little to the outcome. But where there are more surgeons — paid by the number and complexity of the procedure — there are not only more surgeries per capita, but also a higher percentage of complex interventions.

No physician consciously changes the indications based on personal gain. It just happens.

Perverse model compounded by perverse incentives

Specialty Services Yield Highest Reimbursement

Over the past 15 years, U.S. medical school enrollment has risen by 30 percent. But while the number of specialty residences — and therefore specialists in a community — has grown substantially, the number of primary care residents has remained flat.

The reason is simple: Hospitals receive the same financial reimbursement from the federal government whether they train a primary care physician or an orthopedic surgeon. The orthopedic resident will earn the hospital a lot of money while the primary care physician will bring in little or nothing. As a hospital administrator, which clinical training program would you expand?

Once again, it’s not the deans or the various chairmen who are the underlying problem. It’s the financial model.

Complications are rewarded

All too often, patients acquire any number of conditions from a hospital stay, from pressure ulcers to post-admission infections. In fact, about 4 percent of beds in a typical hospital are occupied by patients who couldn’t be discharged because of a hospital-acquired complication.

While the Medicare program no longer pays doctors and hospitals for such “never events,” hospitals are still paid a significant amount by insurance companies to fund the added care required.

The typical U.S. hospital today generates a 4 percent margin, which is needed to fund capital investments in new medical equipment and updated facilities. Without the revenue created by patient complications, many hospitals would teeter on bankruptcy.

As an example, a recent study found that privately insured surgical patients with one or more complications provided hospitals with a 330 percent higher profit margin than those who had no complications.

Free rein drives personal gain

Just like the contractor who’s given free rein over a kitchen remodeling project, little limits doctors from making decisions that boost their bottom line.

Oncologists routinely purchase the chemotherapy they administer, mark up the price substantially and keep the difference for themselves. Surgeons often buy into ambulatory surgery centers or “surgicenters,” and earn guaranteed double digit returns provided they commit to bringing their fully insured patients there. Meanwhile, drug and device companies pay physicians to talk up new medications or devices.

And until the passage of the Sunshine Act, the U.S. health care system didn’t require any visibility or disclosure.

Traditional insurance masks the root of the problem

The typical third-party health insurance policy helps insulate patients from the exorbitant — and often unnecessary — cost of their procedures.

From the perspective of the patient, it is easy to assume that (a) more care is better care, or (b) that any added expense is essentially free. But in practice, neither assumption is true.

For starters, when something goes wrong during a complex procedure, the complications can be physically and financially disastrous. High-risk procedures sometimes produce high rewards. But sometimes high-risk procedures yield only marginal improvements or, worse, serious complications. Either way, patients pay the price.

Second, health care premiums have tripled over the past decade while median employee incomes have risen only 34 percent. The “free” health care so many patients enjoy isn’t really free. Employees have paid for the rapid rate of inflation with modest salary increases. They just never knew it.

You get what you ask for

Of course, no physician would consciously recommend an operation that would harm a patient. No hospital administrator would welcome a patient complication simply to generate more revenue. And most physicians who invest in facilities truly believe their patients will benefit.

But in each case, the financial advantage belongs to the provider while the costs belong to employers and patients.

No one in health care consciously decides to do anything inappropriate. It’s just the result of the current financial model.

Robert Pearl is a physician and CEO, The Permanente Medical Group. This article originally appeared on Forbes.com.

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