Solving US Health Care Cost Problems: Free Market vs Government Policy. Part 1

I apologize in advance for the somewhat scattered nature of this post. I'm trying to work through some ideas. 

What I'm trying to figure out is whether certain cost problems in the US health care system can be solved using free market approaches or whether solutions require government intervention. The nature of the problems I'm looking at arise as a consequence of conflicting interests between insurance companies, hospitals, doctors, and patients. Any solution has to find a way to harmonize the respective interests of each. Recent evidence suggests government action works, although the case is far from certain. Also, supposing there are equally effective free-market solutions we still must ask why we'd chose one type of solution of the other. Let's get some statistics on the table first to get a general overview of the US health care situation.

Give or take a few, total US expenditures on health care in 2013 was 2.9 trillion. When we average that cost over the population the average per person's cost is $9, 225.00 (2013). To give those figures some context, OEDC average per person health care spending is $3, 448. The next highest spender is Switzerland at $6, 080.00 per person. Despite the familiar mantra of "but we have the best healthcare in the world", the US performs comparatively poorly in terms of many health outcomes. (To be fair, there are also a few areas where it doesn't, such as wait times for specialists and surgeries, and for cancer treatment outcomes.) Currently, health care costs represent about 17% of US GDP and is expected to rise to 22%, whereas the OECD average is 9.5% of GDP, the next highest being the Netherlands at 12%.

If you're like me, your thinking, "wait a minute, I didn't consume even close to $9 000.00 in health care this year. Where is this number coming from?" In other words, we can't just look at averages, we need to know how those costs are distributed across the population. That information will allow us to target cost saving policy at the costliest populations and/or health issues.  Are you ready for your head to 'asplode'?

In a single year, what percentage of total health care dollars spent do you think went to the top 5% of health care users? (I.e., the sickest people). Ready? About 49%. That's right. Just 5% of the population consumed almost half of all health care dollars spent in a year.  Now, what percent of the total health care dollars spent do you think went to the top 1% of health care consumers? Ready? The top 1% of health care consumers consumed about 30% of the total health care dollars spent in a single year.

Ok, let's look at the other end of the spectrum. What percentage of total health care spending did the bottom 50% consume? (I.e., the healthiest people or those with the cheapest conditions to treat). Ready? It's 3%. Yup, 50% of the population only consumes about 3% of the total health care dollars spent in a year.

(For more fun facts about the distribution of health care spending, here's a--wicka wicka--breakdown)

So, why--beyond shock value--should we care about these statistics? Because if we're going to set policy to decrease health care costs we're going to get way more bang for our buck if policy is directed at the top 5% of users rather than everyone all at once. There's very little to be gain by reducing the health care costs of the healthiest 50% whereas there are very likely cost savings available from the top 5%.

We might ask why treating this population is so expensive. To figure this out we need to know if their treatment is expensive because of the nature of the conditions for which they need treatment or the way the conditions are treated/billed/managed or they're always in and out of hospitals or it's some combination of all of the above.

It turns out that the 5 most expensive conditions to treat are heart disease, cancer, trauma, mental disorders, pulmonary conditions. But if only a small percentage of the population has these conditions, they won't account for the high costs. What we need to know is both what conditions are the most prevalent in the population and of those, which are the most expensive to treat.

A quarter of the population has at least one of these five chronic conditions: diabetes, heart disease, asthma, mood disorders, or hypertension.  Unfortunately, each of thes conditions is associated with other conditions and illnesses. Treating the primary conditions in conjunction with the associated illnesses accounts for 50% of all health care spending.

How do we put all this information together? If we want to figure out a way to reduce costs, clearly we want to go after the most costly people and conditions to treat. And if those two variables overlap, that's probably a good target. So, how should we do it? Does government need to implement some sort of policy or are there free market solutions? To answer this question I want to use as a case study of one hospital's method of reducing treatment costs. There are other successful models for cost reduction as well which I'll also look at briefly. The point I want to establish is that it is possible. Not only is it possible, but these successful models reduced costs, increased quality of care and health outcomes.

What I really want to know is whether these models were a consequence of government policy (i.e., the ACA) or whether they could have come about without a government mandate. If the reply is the latter, we must ask the obvious question: Then why didn't it happen pre-ACA? The pro-market person can correctly point out that it did in a very small handful of cases. Just look at the Mayo clinic and an HMO in Colorado. But there's a further question lurking. If these models were so successful, why weren't they copied? Presumably, when someone finds a superior business model, other businesses must copy it or lose out.

The pro-market person might reply that the regulatory environment pre-ACA interfered with market forces such that efficiencies weren't realizable. But their own example--the Mayo clinic seems to undermine this argument. I'll have to investigate this claim. On the other hand, the ACA (government action) brought in (Medical) Accountable Care Organizations (ACOs). ACOs are voluntary programs that reward Medicare and Medicaid providers (e.g., hospitals, clinics, doctors, etc...) for cost savings through innovation.  Health care economists and pretty much anyone else that works in health care policy have known for decades that preventative medicine and coordinated/managed care (this is when groups of specialists are paid as a team to manage patient outcomes) is the best way to bring costs down and improve patient outcomes.  So, why wasn't anyone doing these things pre ACA? Why didn't market forces converge on this more efficient model?

My answer is that there were two prisoner's dilemma-like situations. The first is between health insurance companies, the second is between doctors and hospitals. Let's take a look at the first. The health insurance business is an odd one.  You're trying to sell a product that you hope your customer will never use.  And so, the best customers from the insurance companies' point of view are the healthiest ones. Every one wants the healthy customers. No one wants the sick ones. Here's the deal with preventative care and managed care programs: Setting up these programs requires up-front investment that won't see returns for up to 5 years.

Here's the problem. If you're the only insurance company that invests in a preventative and managed health system you're going to have lots of healthy customers. This might seem good until you realize that you're the only one that invested in the program. What are the other companies going to do? They're going to try to poach your customers! You invested all that money and created healthy customers and now all the other insurance companies are going to swoop in and steal all the healthy customers you created. Seeing how this might happen, no insurance company wants to be the sucker--even though they want to have healthy customers! And so no insurance company makes the up front investment and we end up with no cost saving measures.

It looks like the only way you can get the health insurance companies to make the up front investment in these cost saving measures is if somehow "someone" gives each company assurances that all the others will do the same. This way, no one will end up a sucker by being the only one to make up front investments only to have the new healthy customers poached. It looks like the government is that "someone" who can offer the assurance by mandating preventative care be part of health care insurance policies. Doing so allows the insurance companies to exit the prisoner's dilemma.

The second prisoners' dilemma occurs between doctors/care providers and insurance companies (I'm less sure if this is technically a prisoner's dilemma, it might just be a more general case of conflicting interests). Doctors and care providers (e.g., hospitals) want to get paid more money rather than less. Insurance companies want to pay less rather than more. This leads to high costs. For example, if a doctor is charging for every test he orders and every minor consultation, he's likely to order more tests than is necessary. In fact, there's good evidence that this happens. Consider this data from 2012. For some types of tests, US doctors order significantly more than their OEDC counterparts.  So, how do we get doctors and hospitals to move to a managed care model? I.e., where they aren't necessarily under a fee-for-service model or at least where they're under a model that doesn't incentive ordering unnecessary tests and procedures?

Again, it looks like at least one answer is through government mandate. ACO programs under the ACA are voluntary for hospitals to enter.  Hospitals get to share whatever cost savings the hospitals generate through managed care initiatives. Interestingly, the hospitals are free to experiment with whatever managed care models they want. So, if the hospitals save medicare and medicaid 2 million compared the previous year, the hospital gets to keep just over half of the savings. The program has been a huge success.  Here are a couple highlights:

In the first year of the program 58 Shared Savings Program ACOs held spending $705 million below their targets and earned performance payments of more than $315 million as their share of program savings. Total net savings to Medicare is about $383 million in shared savings, including repayment of losses for one Track 2 ACO.

In the second year Pioneer ACOs generated estimated total model savings of over $96 million and at the same time qualified for shared savings payments of $68 million. They saved the Medicare Trust Funds approximately $41 million. 

Where We At?
So far it looks like there's a strong case to be made that government action can solve many of the cost problems with the US health care system.  Of course just because the government can solve these problems it doesn't follow necessarily that a market-based solution couldn't solve these problems. Some might even argue that the problems arose in the first place as a consequence of government intervention in the market. I'll look at these arguments in the next post. For now, amaze your friends with your new-found knowledge of healthcare statistics.