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

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  • CPO_C_Ryback

    1. As long as taxpayers and employers pay the bills, there is no incentive for patients to care, either. Look at all the smokers and dopers in Medicaid clinics — boy, they really care, don’t they? (Not)

    2. And for taxpayers, who is concerned for them? The amateurs and fools behind healthcare(dot)gov! Wow, that’s great! (not)

  • Thomas D Guastavino

    Unbelievable. I have seen a lot of changes in medicine over the past 25 years but the last thing I ever thought would happen would to be accused of being complacent to downright causing complications for financial gain. Do you believe we were blind to the damage that complications could do to our patients and our reputations, let alone the ever present threat of malpractice?
    When the unintended consequences of high risk and uncooperative patient avoidance, avoidance of high risk procedures, and virtual disapperance of ER coverage occurs I expect you, Dr Pearl, to accept full responsibilty.

    • Dr. Drake Ramoray

      It will be worse than you are suggesting.

      There are about 6,000 Endocrinolgists in the United States. There are some 30 million people in the US who have diabetes (granted the majority don’t need an Endocrinologist). The Medicare wait list for a diabetes patient in my office is over 3 mos.

      Considering these numbers patient’s are in for a rude awakening when they are dismissed from practices for non-compliance etc. Yes there is the physician credo to heal the sick etc. but with numbers like the providers in my office aren’t going to be terribly motivated to see that patient with an A1c that remains above 10 secondary to non-compliance for any significan period of time, when there plenty of other patients we can help waiting at the door. All of the proposed new payment schemes will cause physicians to jockey for the healthier patients who pay well. (This is of course unti seeing Medicare/Medicaid is mandated) There have been rumblings of this in the state of Massachussets in the past.

      A fair number of Endocrinologists are now going no diabetes and general endocrine only. There are no metrics for hypothyroidsim, thyroid cancer, pituitary or adrenal dysfunction. Physicians will not only divorce themselves from sicker patients, but from entire diagnostic categories.

      I figure something similar may happen in Cardiology with heart failure patients, Pulmonary with asthmatics, COPD, depending on the specialties representation in the community/United States as a whole. I know several pulmonologists who have moved to intensivist work only with the coming storm.

      Even some PCP’s are getting in on the action. There is a doc in the northease who won’t take any obese patients or patients who weigh over 200 lbs.

      • Thomas D Guastavino

        Most orthopaedists have stopped doing joint replacements on obese patients because of the higher complication rate. I dont whats worse. The fact that the supporters of accountable care are blind to these consequences or the fact that they acknowledge the consequences but say we should ignore them.

        • Deceased MD

          I wonder if this kind of dynamic will affect different fields in different ways. I imagine something like long term care for chronic problems will become even more difficult to treat.

      • Deceased MD

        Well put. I think it’s already happening, but like you said-We haven’t seen anything yet. Given now that HC is a business corporation in and of itself, that feeds the rich, after awhile every doctor is forced to make these kind of practice choices.

      • rbthe4th2

        What about doctors not up on medical research/education and dismiss a patient for “non compliance” when their recommendations didn’t jibe with current research? Or made the patient worse with their recommendations, but said their problems were all in their head? Or one doctor says “do this treatment X” and another “do this treatment Y” that is a 180 difference between the two. You state in writing what is going on and that you have to be non compliant to someone’s treatment, and eventually both docs fire you because you didn’t follow their treatment.
        I can guarantee there are non compliants. My sisters’ best friend scares me with NIDDM and her “treatment”. The sister of this lady has IDDM and I’m afraid to ask most of the time how she is. That being said, I eat fruits, veggies, lean poultry, no sodas for over 2 years, only water and zero calorie beverages, coffee sometimes, and I was dismissed by a doctor for food/drinking non compliance.

        I have the records to prove it.

        • Dr. Drake Ramoray

          Thank you for replying. There will be bad apple doctors under any system. In most states physicians don’t even need a reason to dismiss you (there are timeframe and notification requirements). It could be all states but I am not certain on that (It has been in all the states I have worked in). In my last two practices there are even hospital bylaws that state physicians aren’t required to see patients in the hospital who have been dismissed from outpatient offices.

          There is a doctor in my community who dismisses patient when they become “too complicated.” I have inherited a few of them for specialty care. Usually nice people with 18 point problem lists.

          I understand that you have had a bad experience and are unhappy (I would be to), but as I originally posted dismissals (regardless of the reason) will be all that more common in a pay for performance system as physicians jockey for the healthy well paying patients (well at least moreso than they already do now).

          This of course assumes you don’t live in an underserved rural area where the specialists leave (at which point you have nobody to see) because they can make more money from seeing healthy patients in the affluent suburbs.

          • rbthe4th2

            Yep, your paragraphs sound just like where I live. The doctors have a worse entitlement problem than the people I know as patients.

    • rbthe4th2

      Unfortunately, the HC admins squeeze the docs who then don’t have a lot of choice (thank no compete contracts) but do the bidding of the master. They pay for the malpractice stuff and have RM’s to dump us.

  • PoliticallyIncorrectMD

    It is ironic Mr. Pearl failed to mention that the health care bureaucracy (CEOs like himself) cost Americans $294.3 billion in 1999, and that bureaucracy accounted for at least 31 percent of total U.S. health spending!

  • Bill Viner

    What decade are you from? That may be how it was in the good ol days of medicine, but not any longer old bean!
    We don’t bill for time and we don’t get paid what we bill, we get paid what the govt says we get or we get govt + %age now that insurance reimbursement is tied to medicare. We can’t “mark up” and actually get paid that amount. True FFS stopped in the 90′s or so, didn’t it?
    Informed consent demands giving a patient ALL the options for treatment and all the risks/benefits of each option.
    Costs of running a practice have skyrocketed, so all we can do is see more patients. And I have worked with several docs who would do anything for money, regardless of risk to patient, so don’t make us all out to be angels.
    Lastly, complications are rewarded by pleasant letters from plaintiff attorneys, not a financial gain.
    Get out of your ivory tower, and see what it’s like on the front lines and come up with some real solutions and not this rubbish.

    • rbthe4th2

      Um I would add to that statement, “And I have worked with several docs who would do anything for money, regardless of risk to patient, so don’t make us all out to be angels.”
      THIS: that we’ve seen and know of several HC corporations and their admin who would, will, and have done anything for money, regardless of risk to patient or their reputation, chew up the doctors, and NO ONE thinks they’re angels”.
      I talked to one doctor’s wife about one doctor still in corp med, about how that doctor acted. They shook their head and said yep they were ruined by them. I agreed. Totally. Even though the doctor shafted me, I agreed. 100%.

      • DoubtfulGuest

        Yeah, they do all kinds of corrupt stuff and hold the doctors out front as shields. Doctors get all the raspberries and worse, until patients figure out what’s going on.

  • Dr. Drake Ramoray

    You might be surprised to learn that this isn’t the author’s worst piece.

    • pmanner

      Consistent, though.

  • DoubtfulGuest

    Bigger stuff as in negligence? Same here, by complications I took it they mean the unforeseen/unpreventable stuff. That’s biology for ya — all kinds of things can go wrong.

    • rbthe4th2

      More like cut the wrong leg off. Negligence and the like, that’s more of a you need to learn how to treat your patients.

  • Thomas D Guastavino

    So….you would replace the current system with …what?

  • Matthew Bowdish

    Drake- And only one mention by above of a market distortion caused by government policies…But what about guaranteed issue, community rating, mandated benefits, the AMA’s influence on CPT coding, even Medicare itself that raises costs for everyone by about 25%…And the administrator’s solution, more market distortions that will create even higher costs unless care is rationed significantly. Can we dispense with the idea of “unintended consequences?” All of this is completely predictable.

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