Unpacking the Dynamics of Healthcare Cost.
By Cristin Marker
“Despite spending more on healthcare than any other nation, Americans [insert negative fact here].” You’ve probably seen dozens of headlines starting like this over the last four decades. Maybe you blame aging boomers or unhealthy lifestyles for rising healthcare costs, or perhaps you think corporate greed is fueling the fire. But as a professional who has spent the last ten years analyzing healthcare costs, I think we’re better off focusing on incentive structures and technological advancements.
These are complicated problems and, as we consider their solutions, we should be careful not to romanticize other countries; because every developed country is struggling to find a health care system that works really well.
Ours in particular has a lot of room for improvement.
I’ll begin by talking about those first two big problems, starting with the incentive structures.
In most free markets, supply and demand interact to set an equilibrium price. A producer will set a price at the highest point that most consumers are still willing to pay. Then, consumers will purchase a good or service at the lowest price possible, given other factors like quality and convenience. Love it or hate it, a free market does a pretty job of setting prices.
But this isn’t the case in healthcare. The producer (physician or health system) and consumer (patient) often decide on purchases (medical interventions) without consideration of costs. If you have health insurance (private or government sponsored) like most Americans, then the majority of that cost is paid for by a third-party — a health insurance payor. Making decisions in the absence of price leads to both overproduction of medical interventions and their overconsumption.
When your physician says you need a procedure to fix some ailment, you aren’t typically presented with a list of competitive options and prices to help make that decision. Instead, the scene typically plays out like this: Your provider offers a procedure as a potential treatment. You, knowing very little about human physiology and medicine, take her at her word and agree. Anything to help with this awful knee pain, right!? You have Cigna insurance — a well known provider and respected business — surely they will cover most of it. Your physician performs the procedure and it offers only marginal benefit.
Your physician is better off because she made money. You are slightly better off because you didn’t have to pay very much and your pain went from a 7 to a 5. Cigna is worse off because they had to pay for the procedure. But insurance is a risk pool and Cigna expects to pay for hospital visits, surgeries, and expensive drugs all the time, so you figure these costs are factored in — right?
But if they start to incur more costs than expected (or incur enough costs that they’re no longer making a profit), payors have a litany of business strategies they can employ to remain profitable in the face of increased demand.
First and most obvious is to raise premiums or cut benefits. These actions are felt by healthcare consumers most directly. Payors can also alter benefit design to influence patient behavior. The best examples of this are patient cost sharing (like co-pays, co-insurance, and deductibles).
Next are the more insidious strategies, such as increasing denial rates or requiring prior authorization on more services. These strategies tend to be quite effective as less than half of denied claims are actually appealed by the patient or their provider. Patients often don’t realize they can challenge a denial, while health systems and providers simply don’t have the resources to go after every single denied claim.
Other than the obvious downsides of denying services to patients, the big issue with these tactics is that they increase administrative burden on the healthcare market. More denials mean more challenges which means hiring more billing specialists to the back office. This adds no value to patient care, but does impact a health system or provider group’s bottom line. Ultimately, they can make up for that loss by charging more for the services they provide, which adds to the overall cost of healthcare yet again. Are we in a vicious cycle here?
Last and probably worst is consolidation. Payors are consolidating horizontally and acquiring vertically to reduce competition. Can you guess what health systems and provider groups do in response? They consolidate as well so that they have more negotiating power to maintain or increase reimbursement rates on the services they provide. All of this limits consumer choice and increases cost in the long run. And that makes all healthcare consumers worse off.
A compounding situation plays out with technological advancements: prescription drugs and medical devices. When new drugs and devices are developed, they are covered under patents. This means that competitors cannot produce that same drug under a generic name, typically for about 20 years, which leads to monopoly pricing. The profits from monopoly pricing ultimately subsidize the cost of research and development, leading to more life-saving drugs and devices being developed. Stelara, for example, has a list price of $25,000 for a single dose. Not many people are willing to shell out that kind of money, plaque psoriasis and Crohn’s Disease be damned.
But Big Pharma is smart. Janssen Biotech (the producer of Stelara) offers coupons, or ‘co-pay cards,’ to patients to cover their prescription co-pay. This takes the cost component completely off the table, inflating market demand for their new drug despite the exorbitant prices insurers have to pay. That demand curve you learned about in Econ 101? It doesn’t really exist in healthcare.
New drugs, new medical devices, new life-saving surgeries… Health care is great at innovating new cures and therapies where one didn’t exist before. Every year we have more options for treatments to ply against some chronic condition. This year, for example, the FDA approved Percept RC Deep Brain Stimulation (DBS) system to control tremors in Parkinson’s Disease and KarXT as a new treatment for Schizophrenia. To someone living with either of those debilitating conditions, new treatments like those could mean a vast improvement to quality of life, or even saving their life.
But new therapies do come at a high cost. Not only are many of them covered by patent law, but decisions to purchase them are often made without regard to those costs. So payors (private and government) bear the brunt of that cost directly, which is eventually — and inevitably — passed on to everyone else via increased insurance premiums or increased taxes.
While many of these new treatments are truly beneficial, plenty are adopted without being particularly effective. And the patent system is often abused to extend patents beyond 20 years with strategies like product hop and patent thicket.
So while the advancement of healthcare has been abundant if measured by the proliferation of new products and services, there hasn’t been quite as much improvement in affordable quality care.
If you’re thinking ‘Medicare for all’ (M4A) might solve some of these cost problems, you’d be partially correct. I used to be fervently against this, but I’m finding myself more and more uncertain on this concept as a solution.
Let’s start with what could go well. In an M4A single-payor system, healthcare systems no longer have to bear the administrative burden of dealing with 15 different entities reimbursing them at different rates with different rules. Instead, we would have one payor, with one set of standards, which would cut down significantly on non-clinical staff and I’d be remiss not to mention the potential benefit in that.
Second, a single payor would have monopsony (single-buyer) power to set much lower rates for drugs, devices, physician services, and everything in-between, which would mitigate most of the issues with incentives that I mentioned above.
So, what could go wrong? Again, a single payor would have monopsony power! That’s… not great! We can’t consider the benefit of that system without considering its massive risks.
What many people don’t realize about Medicare right now is that patients with private insurance basically subsidize the Medicare (and Medicaid) population. Medicare reimbursement rates for hospital, outpatient, and physician services alike are about half (or less) of the rates negotiated by private payors. A single-payor system would disrupt that model foundationally, and could wreak inconceivable havoc on the revenue streams of all areas in the health system — which in turn would drive down supply. The United States is already expecting a shortage of about 86,000 physicians by 2036. Access to both primary care and specialists is increasingly difficult, especially in rural areas. That situation would get much worse if future physicians start to view their earning potential becoming more like their U.K. counterparts.
But to play devil’s advocate, it is possible that we end up in a monopsony or duopsony situation anyway (due to the consolidation of private insurance into behemoths like United Healthcare and CVS Health), so it might make sense to get ahead of that. The issue may not be best framed as whether we become a single-payor system, but if we become a public single-payor or a private single-payor system. In that reality, who do you trust more to lower costs while keeping reimbursements reasonable: big government or a private monopoly?
Pick your poison — and take your medicine.
I’ve seen private insurance play enough middleman roles (Pharmacy Benefit Managers, Network Aggregators) that I am initially more inclined to trust the government with this role. But seeing issues in Canada’s system play out gives me pause. Perhaps there is a middle ground, or a different role government can play. Perhaps the role of government in solving these issues is actually to provide some central service — like data centralization and interconnectivity — that could ease administrative burden on healthcare without stifling market competition. Or maybe the transition to single payor could be made gradually by slowly lowering the age that one can qualify for Medicare.
There may be another option, though. The traditional fee-for-service payment model of healthcare creates incentive to always do more, even when there is minimal benefit, and it doesn’t feel sustainable over the next 20 years. However, another type of payment model called ‘Value-Based Care’ has quietly been growing in popularity since 2006 when the term was first coined in “Redefining Health Care” by Michael Porter and Elizabeth Olmsted Teisberg. Since then, the concept has been playing out to varying degrees of scale and success.
Value-based contracts (VBC) are formal agreements (or voluntary programs) between a network of healthcare providers and an insurance company (private or government). These contracts usually involve a cost component, a quality component, and a financial incentive to perform well.
From a cost perspective, VBCs will generally involve some element of shared savings or shared risk. For example, an insurance company will set a target amount for how much they think it should cost to take care of a population, assuming a certain level of health. If the population’s total cost of care is less than that target, the insurance company will share a portion of that savings with the network of providers (often referred to as an Accountable Care Organization, or ACO). Conversely, if cost of care is above the target, the provider network may be subject to financial penalties. This type of agreement incentivizes healthcare providers to provide quality, low-cost care to their patients and do their best to keep them away from expensive care (like being admitted to the hospital).
The quality component of these contracts involves measures like “Percent of Emergency Department Visits that Received Follow-up within Seven Days,” or “Percent of Diabetic Patients with Controlled Blood Sugar.” Most of these measures are fairly standard and defined by a few governing bodies (NCQA, PQA, CMS), but private payors can also create their own measures.
In theory, this all sounds promising. But I’ve been deep in the weeds on this for the past 10 years and it’s safe to say Value-Based Care has its own host of issues to work out before it becomes healthcare’s saving grace.
First, the sentiment among physicians is not positive, and their buy-in is important. If you can’t listen to physicians complain in real life, try searching ‘value based care’ in r/medicine — many think it’s a sham. Physicians don’t want too much of their predictable salary to be replaced by something that is at least partially out of their control. However, when it’s structured as a bonus layered on to a salary, there’s not as much angst. The public is quick to say we should tie physician compensation to outcomes; but outcomes can be subjective and often the most relevant outcomes aren’t apparent until the long term. Because of that, VBC incentive structures tend toward less meaningful measures simply because they are easily measurable in the short term.
Second, the way these contracts and programs are structured is very complex. It can seem like a strategy game of Dungeons and Dragons as opposed to just doing the right thing for the patient. As an example, ‘Quality Gateways’ are common in VBC. You might have to meet a threshold on 10 out of 12 quality measures in order to be ‘eligible’ for the shared savings component mentioned earlier — and you either hit that threshold, or you don’t. One patient meeting one measure could be the difference in whether you receive thousands or millions of dollars in shared savings.
That’s just one of countless ways that these programs can be structured, which can still create perverse incentives. A health system might recognize early in the year that their chances of doing well in a contract are abysmal, which can incentivize them to “cut their losses” and stop focusing on an entire population.
I mentioned earlier that shared savings/shared risk involves a target cost given a certain level of health — but that level still has to be measured. VBCs use risk scores to help determine total cost of care targets (these risk scores also help the Centers for Medicare & Medicaid determine how much money to give to private insurance companies who administer Medicare Advantage plans, more on that some other time).
The unfortunate truth is that, when choosing between pulling the levers of decreasing cost/utilization of healthcare services or documenting to manage risk, most of the industry tends to focus on the latter — it’s easier to just cover liabilities than to enact major reforms.
Even the measures themselves, despite being widely adopted across the industry, are corruptible. There is a concept in education called Campbell’s Law, which holds that the more a measure is used for social decision making, the more likely it is to be corrupted. That same principle is at play here.
Measures often sacrifice clinical relevance for ease of measurement. Some of the most widely used quality measures in value-based care are the notorious ‘Medication Adherence’ measures: Patients with prescription fills of certain medications (like Statins) are placed into a denominator. Then the rest of their fills are monitored throughout the year to see if they ultimately had enough pills to get them through the year. Patients with > 80% of their days covered by a pill will meet the measure. However, these measures fail to consider even the most basic of caveats: If a physician discontinues the medication halfway through the year due to side effects, that patient fails the measure. If a patient starts using coupons instead of insurance to pay for medication, that patient no longer has evidence of prescription fills and therefore fails the measure (and yes, it is indeed sometimes less expensive to pay cash for a prescription rather than using insurance, due to the most perplexing of middlemen in healthcare, Pharmacy Benefit Managers).
Conversely, some measures are clinically relevant but administratively burdensome to prove. If they want to perform well in VBC, health systems are forced to spend inordinate amounts of time hunting down documentation to prove things like Colonoscopies and ED follow-ups.
Related to that program complexity, doing well in these contracts requires a significant investment in technology and non-clinical resources — as an analyst, this is what keeps me up at night. Studies suggest that these programs save a modest amount in healthcare costs, but none of these studies factor in the costs to participate in these programs.
What if we end up spending more money trying to measure all of this complexity than we actually save from undertaking it? You need an army of suits to negotiate the contracts and another army of nerds to help design and run the reporting. Then finally you’ll have an army of consultants coming out of the woodworks, promising to help you succeed in these arrangements. As more people insert themselves between provider and patient, we’d have to figure out who is really providing value.
As much as I want VBC to fix healthcare spending, every time we consider the benefits, we need to consider the additional cost too. And systems of measurement are rarely in perfect alignment with real-life value.
As if Campbell’s Law weren’t enough, any large-scale reform to our healthcare system will also have to abide by Godhart’s Law, which states that “when a measure becomes the Target, It ceases to be a good measure.” Anytime we tie an enticing incentive to a metric, we must be open to the idea that the target audience may find a way to optimize their metric success in a way that doesn’t solve the problem or create value in real life. Hinge enough healthcare revenue on VBC measurements and I assure you, it will be gamed.
Like a true curmudgeon of industry, I’ve pointed out lots of problems without offering any real solutions. If anything, I hope to convey that this is complex, and there is no cure-all for the healthcare system’s ailment. Several large companies have been attempting to disrupt the healthcare system for the past several years — Google, Amazon, CVS and more, all with some flavor of value-based care. Many have already tried and failed.
The complex issues that plague our healthcare system are incredibly nuanced when you approach them with a non-partisan eye, and it's going to take creative ideas from the left, right and center to make meaningful change.
Cristin Marker is an analytics architect with 15 years of experience in healthcare. After a long day of analyzing data, she deals with the overwhelming complexity of the healthcare system by painting watercolor and taking long walks with her dog.