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.