By MATTHEW HOLT

Humana is out with a report saying that its Medicare Advantage members who are covered by value-based care (VBC) arrangements do better and cost less than either their Medicare Advantage members who aren’t or people in regular Medicare FFS. To us wonks this is motherhood, apple pie, etc, particularly as proportionately Humana is the insurer that relies the most on Medicare Advantage for its business and has one of the larger publicity machines behind its innovation group. Not to mention Humana has decent slugs of ownership of at-home doctors group Heal and the now publicly-traded capitated medical group Oak Street Health.

Humana has 4m Medicare advantage members with ~2/3rds of those in value-based care arrangements. The report has lots of data about how Humana makes everything better for those Medicare Advantage members and how VBC shows slightly better outcomes at a lower cost. But that wasn’t really what caught my eye. What did was their chart about how they pay their physicians/medical group

What it says on the surface is that of their Medicare Advantage members, 67% are in VBC arrangements. But that covers a wide range of different payment schemes. The 67% VBC schemes include:

• Global capitation for everything 19%
• Global cap for everything but not drugs 5%
• FFS + care coordination payment + some shared savings 7%
• FFS + some share savings 36%
• FFS + some bonus 19%
• FFS only 14%

What Humana doesn’t say is how much risk the middle group is at. Those are the 7% of PCP groups being paid “FFS + care coordination payment + some shared savings” and the 36% getting “FFS + some share savings.” My guess is not much. So they could have been put in the non-VBC group. But the interesting thing is the results.

First up Humana is spending a lot more on primary care for all their VBC providers, 15% of all health care spend vs 6.6% for the FFS group, which is more than double. This is more health policy wonkdom motherhood/apple pie, etc and probably represents a lot of those trips by Oak Street Health coaches to seniors houses fixing their sinks and loose carpets. (A story often told by the Friendly Hills folk in 1994 too).

But then you get into some fuzzy math.

According to Humana their VBC Medicare Advantage members cost 19% less than if they had been in traditional FFS Medicare, and therefore those savings across their 2.4m members in VBC are $4 billion. Well, Brits of a certain age like me are wont to misquote Mandy Rice-Davis — “they would say that wouldn’t they”.

But on the very same page Humana compares the cost of their VBC Medicare Advantage members to those 33% of their Medicare Advantage members in non-VBC arrangements. Ponder this chart a tad.

Yup, that’s right. Despite the strung and dram and excitement about VBC, the cost difference between Humana’s VBC program and its non-VBC program is a rounding error of 0.4%. The $90m saved probably barely covered what they spent on the fancy website & report they wrote about it

Maybe there’s something going on in Humana’s overall approach that means that FFS PCPs in Medicare Advantage practice lower cost medicine that PCPs in regular ol’ Medicare. This might be that some of the prevention, care coordination or utilization review done by the plan has a big impact.

Or it might be that the 19% savings versus regular old Medicare is illusionary.

It’s also a little frustrating that they didn’t break out the difference between the full risk groups and the VBC “lite” who are getting FFS but also some shared savings and/or care coordination payments, but you have to assume there’s a limited difference between them if all VBC is only 0.4% cheaper than non-VBC. Presumably, if the full risk groups were way different they would have broken that data out. Hopefully they may release some of the underlying data, but I’m not holding my breath.

Finally, it’s worth remembering how many people are in these arrangements. In 2019 34% of Medicare recipients were in Medicare Advantage. Humana has been one of the most aggressive in its use of value-based care so it’s fair to assume that my estimates here are probably at the top end of how Medicare Advantage patients get paid for. So we are talking maybe 67% of 34% of all Medicare recipients in VBC, and only 25% of that 34% = 8.5% in what looks like full risk (including those not at risk for the drugs). This doesn’t count ACOs which Dan O’Neill points out are about another 11m people or about 25% of those not in Medicare Advantage. (Although as far as I can tell Medicare ACOs don’t save bupkiss unless they are run by Aledade).

I did a survey in 1997 which some may recall as the height of the (fake) managed care revolution. Those around at the time may recall that managed care was how the health insurance industry was going to save America after they killed the Clinton plan. (Ian Morrison used to call this “The market is working but managed care sucks”). At the time there was still a lot of excitement about medical groups taking full risk capitation from health plans and then like now there was a raft of newly publicly-traded medical groups that were going to accept full risk capitation, put hospitals and over-priced specialists out of business, and do it all for 30% less. The Advisory Board, bless their very expensive hearts, put out a report called The Grand Alliance which said that 95% of America would soon be under capitation. Yeah, right. Every hospital in America bought their reports for $50k a year and made David Bradley a billionaire while they spent millions on medical groups that they then sold off at a massive loss in the early 2000s. (A process they then reversed in the 2010s but with the clear desire not to accept capitation but to lock up referrals, but I digress!).

In the 1997 IFTF/Harris Health Care Outlook survey I asked doctors how they/their organization got paid. And the answer was that they were at full risk/capitation for ~3.6% of their patients. Bear in mind this is everyone, not just Medicare, so it’s not apples to apples with the Humana data. But if you look at the rest of the 36% of their patients that were “managed care” it kind of compares to the VBC break down from Humana. There’s a lot of “withholds” which was 1990s speak for shared savings and discounted fee-for-service. The other 65% of Americans were in some level of PPO-based or straight Medicare fee-for-service. Last year I heard BCBS Arizona CEO Pam Kehaly say that despite all the big talk, the industry was at about 10% VBC and the Humana data suggests this is still about right.

So this policy wonk is a bit depressed, and he’s not alone. There’s a little school of rebels (for example Kip Sullivan on THCB last year) saying that Medicare Advantage, capitated primary care and ACOs don’t really move the needle on cost and anyway no one’s really adopted them. On this evidence they’re right.

Matthew Holt is the Publisher of THCB and is still allowed to write for it occasionally.

Costs and revenue: This is the oxygen of any business, any organization. What are your revenue streams? How much does it cost you to produce them? Life is not just about breathing, but, if you don’t get that in-out equation right, there is nothing else life can be about.

Right now this enormous sector is turning itself inside out. It has turned the “transmogrification” setting to “warp.” Why? It’s all about the in-out. It’s all about increasingly desperate attempts to get that right — and the clear fact that we cannot know if we are getting it right.

Let’s do some school on the two sides of this equation. Let’s just go over the new weirdness, and the implications for you and your organization. Revenue first.

Hunting for True Revenue

In traditional health care (the way we did business until about five minutes ago) the revenue side was complicated in detail, but simple in concept: You do various procedures and tests and services, and you bill for them. You bill each item according to a code. You bill different payers; each has its own schedule of payments that you negotiate (or just get handed) every year. There are complications, such as people on Medicare with supplemental insurance, dual eligibles on Medicare and Medicaid, and self-pay patients who may or may not pay.

That’s the basic job: aggregating enough services that reimburse more than their real cost so that you can cover the costs of services that don’t reimburse well. This is cost-shifted, fee-for-service management. Cut back on those low-reimbursement services; pump up the high-reimbursement ones. Corral the docs you need to provide the services, provide the infrastructure and allocate costs across the system.

The incentives all point in the same direction. The revenue streams are all additive. The more you do of the moneymaking items on the list, the more money you make.

Hybrid revenue streams in the Next Health Care. Fast forward to five minutes in the future, and the picture becomes not only complicated, but complex, in some ways irremediably so. Now you’re not just thinking about the revenue structure of a hospital; more often you are thinking about a system, with not just multiple revenue streams but multiple types of revenue streams. You may already have had clinics, labs, ambulance services, imaging services, primary care physician groups — in fact, a whole array of different businesses. What’s different now is how you get paid for things.

You may still mostly be working fee-for-service, but maybe now you have an insurance arm, and maybe some percentage of your patients are capitated through it: You have an incentive to provide excellent care, but any unnecessary emergency department visits or surgeries, any preventable heart attacks or diabetic shock episodes are now simple costs, while before they were revenue opportunities as well.

You may have developed a new set of revenue streams in per-patient, per-month prospective payments for “medical home” services but, the more you do that and the better you are at it, the more you keep people out of your ED and your surgical suites. That’s what those payments are for — to lower the overall costs by taking better care of the patient up front. And the costs you are lowering are your revenues.

Similarly, your primary care arm may have an at-risk contract like the Alternative Quality Contract from Blue Cross Blue Shield of Massachusetts, which literally pays primary care providers to keep patients from needing to use EDs or needing surgery or other high-end services, while holding them to quality standards that assure they are getting excellent care. It’s a revenue stream, but it’s at the cost of other revenue streams. Or it may not be your revenue stream. It may be an independent primary care physician group in town that has the contract, paid extra to deprive you of fee-for-service patients.

Or you may have dedicated clinics servicing specific groups on a per-patient, per-month basis (like, say, a spine and pain clinic for a company’s warehouse workers) in which working efficiently and well cuts into what otherwise may have been fee-for-service operations and imaging services.

Unknown factors. These scenarios lie against a background in which it is likely that actual fee-for-service reimbursement rates from Medicare and private payers will be held tightly in check. The future landscape has a number of new opportunities for revenue streams, but most of them make money by cutting into your (or someone else’s) more conventional business. But we cannot know by how much, or how the interaction between different revenue streams will play out over time.

In planning for the new environment, this tells us three things:

• These systemic risks are not quantifiable, and so cannot be hedged. They are risks because we are entering new territory. We simply do not know how these different parts of the market will interact. Revenue estimates for most parts of the business have to be treated as “high-variance” projections, which were much harder to pin down in the past.

• If some types of risk contracts make money by cutting into other types of business, you want to own that contract. If some organization is going to make money by costing you money, you want to be that organization. It may be cutting into your ED, surgery and imaging business, but at least you get the revenue stream for doing that. If you don’t, someone else will.

• For any business that includes a hospital, bigger is better. At greater size, you can absorb more high-variance risk from a greater variety of revenue streams, and from different contracts serving different populations. You can spread the revenue base and try more alternatives. You have the space and breadth to try, fail forward quickly and try again.

If the revenue side is so hard to pin down, you need to create some space to try different options. The cost side can give you some of that space.

Getting Our Arms around Cost

Compared with revenue, the cost side of things seems relatively straightforward. So why can’t we get our arms around it?

When we are talking about the costs of health care, we are talking about two different types of costs. One is the cost of doing things, such as: How much does it cost to do a complex back fusion operation? Think of these as internal costs. The other is the cost of producing an effect, such as: How much does it cost to reduce back pain? Think of these as system costs.

If you are at risk for a population (as in, perhaps you have a spine and pain center with a per-patient, per-month risk contract), then both kinds of costs are true costs to you. If you can satisfy the patient and end his or her back pain through medical management instead of surgery, you have dropped a bunch of money to your bottom line.

On the other hand, if you are in a fee-for-service environment, the back operation is not just a cost, it’s also an income opportunity, and only the internal costs are actual costs to you.

More unknowns. In any environment, then, reducing your internal costs improves your bottom line. The problem here is that we typically do not actually know what our internal costs are, or what we could do to reduce them.

Some things obviously reduce internal costs — better coordination, reduced duplication, more efficiency in moving the patient through the system (not adding the cost of an extra inpatient day just because someone neglected to sign off on the discharge form, for instance), or fewer mistakes and infections.

But beyond these efforts, to truly reduce costs we need to drive our analysis to the individual patient and case level, differentiating between the general system costs imputed to the case, or the average costs that such cases are thought to generate, or the sunk costs of the facility and equipment, and the actual incremental costs that this case generated: How much did it cost us to replace Mr. Herndon’s hip? Much of the costs attributed to particular types of operations are averages, or imputed costs representing the whole organization’s overhead. These obscure the costs that are particular to Mr. Herndon’s case.

Fine-grained cost analysis. Why do we need such fine-grained cost analysis? Because if the team who handled Mr. Herndon’s workup, surgery, post-surgery and rehab did something different that actually cost less and worked better — a different kind of wound dressing, say, or a more aggressive schedule of getting him up and walking afterward — more general cost analysis would not let us pick up that difference, track it and replicate it.

Further, we need to track the costs by activity (how much did the post-surgical care actually cost, say) and across the entire care cycle.

Similarly, we need to drive the cost analysis to the team level: If a given hip-replacement team is able to find ways of doing things that are better and cheaper, we need cost analysis that can pick up that difference so we can find out what teams are doing differently, try the improvement with other teams, measure the improvement and propagate it.

Two things make this currently impossible in most of health care: Our cost aggregation software is mostly designed for billing purposes, not for discovering actual costs. It doesn’t ask the questions to which we need answers. And typically in health care, we do not work in persistent, dedicated clinical teams. We rotate people through various assignments. When there are no persistent teams, it is not possible to notice which variations of practice actually cost less and get better results. Having no teams obliterates the possibility of learning.

Still, though tracking real costs to the patient, case and team levels is difficult, costs are ultimately more discoverable than future revenue streams. With the right strategies, one can drive down costs much more dependably than one can predict revenue.

Cost and Revenue as Change Drivers

The struggle to get the cost-revenue respiration right is the prime driver of the enormous structural changes that we are seeing in health care. Recently, the head of health care for a major Wall Street bank told me that up to just a few years ago, mergers and acquisitions amounted to 5 percent of his practice. Today it is 67 percent.

Big systems, including for-profit systems, are expanding rapidly, acquiring hospitals and other health care services by the bunch. They see these acquisitions not as “revenue plays” largely, but as “cost plays.” The big systems believe they can create value and enhance their survival by mitigating the “high-variance” risks of the new environment through size and diversity, while wringing cost out of the services and hospitals they acquire through tighter coordination and more aggressive management.

These same factors make it increasingly difficult for small and rural hospitals to survive as independents. They need the scale, greater coordination, access to clinical excellence, ability to support experiments in driving cost and quality, and ability to rationalize high-variant risk across a larger system that only a partnership of some kind with larger organizations can provide.

The new era of costs and revenues likely spells the end of any notion of the hospital as a cottage industry. It is on the balance sheet and the cash flow sheet that the idea of “coordination across the full cycle of care” stops being a buzzword and becomes a structural reality.

With nearly 30 years’ experience, Joe Flower has emerged as a premier observer on the deep forces changing healthcare in the United States and around the world. As a healthcare speaker, writer, and consultant, he has explored the future of healthcare with clients ranging from the World Health Organization, the Global Business Network, and the U.K. National Health Service, to the majority of state hospital associations in the U.S. You can find more of Joe’s work at his website, imaginewhatif. This post was first published in the American Hospital Association’s H&HN Daily, November 27, 2012.

The authors’ recent book, Medicine in Denial, briefly mentions the subject matter of this post — the effects of fee-for-service payment.  This post examines the issue in more detail, because of its importance to health care reform.

The medical practice reforms contemplated by Medicine in Denial have large implications for a host of policy issues. As an example, consider the issue of fee-for-service payment of providers. The health policy community has arrived at a virtual consensus that fee-for-service is a root cause of excessive cost growth in health care. Payment for each medical service rendered seems to involve an unavoidable conflict of interest in physicians: their expertise gives them authority to increase their own payment by deciding on the need for their own services. This conflict of interest has driven countless attempts at health care regulation. These attempts usually involve some combination of price controls, manipulation of incentives, and third party micromanagement of medical decision making. For decades these attempts have proven to be hopelessly complex, illegitimate in the eyes of patients and providers, often medically harmful, and economically ineffective.

Because regulating the conflict of interest has proven to be so difficult, the health policy consensus is now that the only escape from the conflict is to avoid fee-for-service payment. But this consensus misunderstands the conflict’s origin. The conflict of interest arises not from fee-for-service payment but from physicians’ monopolistic authority over two distinct services: deciding what medical procedures are needed and executing the procedures they select. The conflict does not disappear when payment switches from fee-for-service to its opposite–-capitation. Indeed, then the conflict becomes even more acute–-physicians have an incentive to withhold their expertise from costly patients who need it the most.

The conflict of interest can be avoided only by disaggregating physician authority. Whoever executes medical procedures must not be the party who decides what procedures are needed. Who should make those decisions? Here we need to distinguish between two situations: (1) situations of relative certainty, where assembling the right information reveals only one reasonable option, the option that would be selected regardless of who makes the decision, and (2) situations of genuine uncertainty, where assembling the right information reveals several medically reasonable options and the choice among them is inherently personal to the patient. In neither situation should physicians have decision making authority. The situation of greatest risk (medical and economic) is the second one, and there decision making authority should rest in the informed patient.

That shift to patient-driven decisions would replace the conflict of interest with heightened practitioner incentives to improve pricing and quality from the patient’s perspective. Improving either one enhances the practitioner’s competitive position in a fee-for-service environment driven by patient decisions.

That environment should involve open competition among practitioners, coupled with mandating high standards of performance within a safe and effective system of care. Innovative practitioners could compete at exceeding the mandated standards of quality but could not gain a pricing advantage by falling short of those standards. Within that constraint, most providers would compete on non-medical factors such as price, location, convenience, amenities, cultural compatibility and personal rapport. A marketplace of this kind might turn out to have huge benefits, tangible and intangible. The tangible benefits would be not only lower prices but also higher medical quality and thus cost avoidance. Informed patients would drive greater demand for high value services and lesser demand for low value services, while avoiding the medical harm and costly responses so often triggered by low value services.

To reiterate, the essential change is to break the system’s dependence on the monopolistic authority of physician practitioners. This becomes feasible with the infrastructure and institutions described by Medicine in Denial. The book describes a system of care where practitioners would be credentialed based on their demonstrated competence at performing discrete medical procedures, where their personal knowledge would not be a basis for credentialing, where patients and practitioners would jointly use tools designed to elicit objective knowledge individually relevant to patient problems, where knowledge tools would not be contaminated with vendor marketing, where patients would decide what medical procedures meet their personal needs, where patients could safely choose among highly competent practitioners who offer the specific services needed, where other practitioners could specialize in helping patients navigate the decision making process. In such a system of care, fee-for-service payment would reward the most productive practitioners, those who deliver the most in terms of money, time, and other patient needs.

The point of this discussion is not to advocate fee-for-service payment. The point is simply that the pros and cons of fee-for-service depend on the environment in which it occurs. John Goodman points out that in most market environments fee-for-service coexists with other payment approaches. On his view, third party involvement seriously distorts fee-for-service payment in the health care environment. He would minimize third party payment by shifting payment authority from third parties to patients. Our point is that this shift in payment authority needs to be aligned with a similar shift of medical decision making authority, which in turn depends on fundamental medical practice reform (see especially part II.B.2.d of Medicine in DeniaI). In both contexts, medical and financial, the health care system must equip patients with the information tools and funding needed for them to safely assume the risks and burdens involved in health care decision making. The information and funding they need can be placed in their hands, in a manner that offers them reasonable trade-offs but shelters them from the trade-offs now faced by the uninsured and underinsured.

The reforms presented by Medicine in Denial would do more than change the dynamics of fee-for-service payment. The entire marketplace for health professional services would be transformed. The current severe shortages in the primary care workforce might well disappear. No longer would practitioners enter an out-of-control, demoralizing, non-system of “care”; no longer would they be deprived of the emotional, intellectual and financial rewards that caregiving should naturally produce. The health professions could attract countless individuals with the interpersonal skills and technical aptitudes needed to become compassionate and skilful practitioners. They could freely enter into competition for patients by acquiring high levels of skill in clearly defined roles. Costly, prolonged, knowledge-based education would no longer block entry into medical practice. Individual practitioners would be free to find niches that offer the best fit between their own abilities and patient needs. They would be free to expand their expertise as their abilities and drive permit. They would be free to innovate in delivery of services. Virtuoso performers would be rewarded in money and status without regard to formal education. Upward mobility would then become part of the health professions, unlike the status quo, where few upward career paths exist for non-physician practitioners.

Freed from physician hegemony over medical practice, institutional providers could organize highly efficient teams of skilled practitioners. Underserved communities would be similarly free to develop practitioners from their own populations. And more innovation in health care delivery would occur as more providers and new organizations have greater opportunity to pursue innovation and its rewards.

Physicians may find such a marketplace deeply threatening. But they are also threatened by the status quo. Their monopolistic credentials burden them with unaffordable education debts, incomprehensible third party demands, unattainable standards of care, unpredictable litigation exposure, and unbearable risks of error for their own patients.

Larry Weed is a physician who originated influential standards for organizing medical records more than 50 years ago. His son Lincoln practiced employee benefits law in Washington, D.C. for 26 years and now specializes in health privacy at a consulting firm.

Back in 2008, Charlie Baker, then CEO of Harvard Pilgrim Health Care, and I, then head of a hospital, claimed that the market power displayed by the dominant provider system in the state and supported by the state’s largest insurer resulted in a large disparity in health care payments. We argued that this disparity contributed to unnecessarily high health care costs in the state. We both did this publicly, willing to put our assertions to the test. The quotes in response to this in a Boston Globe story were notable, but they did little to undercut our premises.

About a year later, the Attorney General of the Commonwealth published an investigation of this situation, which had the effect of validating our assertions.

Then, the largest insurer in the state said that the solution to the problem was to move towards a capitated, or global, payment regime. This would control the cost trend.

Again, knowledgeable observers, like the Inspector General, raised concerns. What if the global payment regime also created disparities and locked in higher rates? He noted, “[M]oving to an ACO global payment system, if not done properly, also has the potential to inflate health care costs dramatically.”

I pointed out that, while a global payment plan might have certain theoretical advantages, without a transparent exposition of its effects, how could we know if it had been successful?

Well, the latest chapter has just been written. The Attorney General has issued a follow-up report saying, “Our examination found that paying providers on a global basis has not resulted in lower total medical expenses.” Further, “Wide price disparities unrelated to the quality of care still persist from one Massachusetts hospital to another, largely dependent on the providers’ clout in the marketplace.”

The whole country is watching the Massachusetts experiment of providing universal health care coverage and is wondering how we will deal with the cost issues inherent in providing that coverage. The Attorney General has now offered, twice, a cogent and thoughtful review of the situation. The Inspector General has done likewise. How will the other parts of the government respond? When will the business community get engaged? What about the patient advocacy organizations?

DAVID E. WILLIAMS

One of the interesting things I learned in business school is that not only is it typical for a business to earn 80 percent of its profits from 20 percent of its customers, but that 75 percent of its customers may represent 120 percent of its profit. In other words, not only are some customers more profitable than others, but a fair fraction of the customer base is unprofitable. This kind of pattern is evident in a normal (i.e., non-health care) business. The main drivers are usually cost of customer acquisition and cost to serve. For example, some customers demand a lot more service than others and some customers that cost a lot to bring on only buy once. Price is usually a secondary factor, with more powerful or shrewder customers negotiating discounts.

Once businesses understand their true costs and profitability by customer segment they can take steps to improve profitability. For example, if customers recruited through advertising on Facebook are unprofitable, the company can advertise elsewhere. If some customers use a lot of service, the company can start charging for service explicitly.

Health care is a lot weirder than that, as Ambulance-Bill Chasing in the Sunday Boston Globe Magazine illustrates. A non-health care person wrote about how he tried to understand the bills for his mother’s ambulance rides to and from the hospital. The more he dug, the more bewildered he became:

As a reporter, I’m used to dealing with complex material, but this drive down one of the countless, curvy roads that merge into the Health Cost Superhighway left me both more informed and more confused. Maybe it really is easier to remain clueless and indifferent about our medical bills. The alternative, as a friend who has spent decades in the health care trenches told me, is “to be clueless and terrified.”

The gist of the story is:

• A public (Town of North Andover) ambulance charged $650 for a 4-mile trip to the hospital. Medicare and supplemental insurance will pay $316 and $79 respectively, or $395 in total
• A private (Patriot) ambulance charged $1153 for the return trip. Medicare won’t pay, because it doesn’t consider such trips medically necessary, and Patriot is apparently allowed to charge his mother the full amount. However, they are only planning to charge her $257

Here’s the interesting nugget:

So if Patriot is unlikely to collect its initial steep fees, why bill for them in the first place? Because in this Alice in Wonderland health care world, some people actually do pay them. Car insurance companies, for example, may cut such checks when their clients are in accidents, a windfall [the ambulance company owner] says he needs to offset lower payments from Medicare.

The example here isn’t particularly extreme, because the $1153 for Patriot is only about 3x what Medicare pays. It’s not unusual to see health care charges at 5x negotiated rates. What’s interesting is that there are still quite a few health care businesses that operate in this mode, earning a modest margin on their core business that’s reimbursed by Medicare and commercial insurers with which they have contracts, losing money on the fairly high percentage of patients who don’t pay anything –either because they’re uninsured or just don’t pay–, and making almost 100 percent of their profit on the occasional out-of-network sucker whose insurance pays full boat or who actually pays the bill himself or herself. Some ambulance companies operate in that mode as do other businesses, such as kidney dialysis centers and providers of mail order medical supplies.

It’s not healthy to operate in such a skewed mode, where the normal 80/20 rule cited above doesn’t apply. Price transparency and consumer-directed plans can make some impact here.

However, global capitation would be even more effective. Not only would it give provider systems (such as Accountable Care Organizations) the incentive to negotiate with ambulance companies and their ilk, it could also encourage a more rational view on utilization. If that ambulance trip home really wasn’t medically necessary, why not call a cab instead for $10? Even throw in a nurse or attendant for another $50 or $100 to help mom get settled back into the home…

David E. Williams is co-founder of MedPharma Partners LLC, strategy consultant in technology enabled health care services, pharma,  biotech, and medical devices. Formerly with BCG and LEK. He blogs regularly at the Health Business Blog, where this post first appeared.

One aspect of religious dogma that has entered the medical world is that fee-for-service pricing of medical services is bad and should be replaced by a capitated, or global, arrangement that establishes an annual budget for care for different risk groups of patients. Like other religious beliefs, this is often offered without rigorous analytic support. Some insurance companies are particularly pleased with this approach because it shifts risk from insurers to providers and makes it easier for the insurers to create budgets and price their products.

Don’t get me wrong. This may be the right way to go, but the topic is worth more time and discussion than it has received.

It may be illustrative to think about other sectors of our economy and see which of them are characterized by global payments. Not many. Sure, there are products like cellular phone service that are sold in monthly fixed dollar amounts. But that is because it is a high fixed-cost product, where the marginal cost of additional phone calls is essentially zero. Fixed prices offer revenue stability to the vendor and a way to recover those fixed costs.

But most other goods and services in our economy are sold on a piece-work basis. Think of groceries, automobiles, electricity, gasoline, televisions, and clothing. Why is fee-for-service pricing appropriate for these? Or, in economists’ terms, why does such pricing lead to a reasonably efficient solution? The answers are pretty straightforward. Other markets are characterized by open entry and exit and by transparent information concerning quality, value, and pricing. Consumers can make more or less knowledgeable choices based on that publicly available information. New firms enter the market when they see an opportunity. Successful firms grow. Other firms fail.

Dartmouth Atlas have noted, this leads to supply-driven treatment patterns. If there are more radiologists in a given community, the usage of imaging will be greater than in less well staffed communities.

Likewise, hospitals generally do not come and go. They, too, represent huge investment in fixed costs, and they stay in the marketplace for decades.

But in addition to this, the main attribute of the practice of medicine is opacity. You and I as consumers (patients) have no idea what a given service costs because it is covered by insurance, and the actual rates paid to doctors and hospitals by each insurer are confidential. You and I also have no metrics by which to judge the quality of the service being provided. You have every incentive to request or demand more service for your medical problem.

If you are an insurance company holding a hammer, every problem looks like a nail. What is the most direct thing you try to do to influence levels of care that might be excessive? Design a pricing system that shifts risks to providers and is subject to an annual budget.

But, that is not the only solution. In the post below, I discuss the path being taken by Harvard Pilgrim Health Care. It is good for Massachusetts that two of the largest insurers are trying different approaches. It establishes the possibility of comparing results across the two populations.

Now, though, let me let you in on a little secret with regard to capitated care. Underneath the global budget, there is still a fee-for-service arrangement establishing the transfer prices among the providers in a network. That GI specialist will still get paid for each colonoscopy. The big thing to work out in this system is the allocation of any surplus or deficit in the annual budget among the various specialists.

Unless that allocation is skewed heavily towards primary care doctors, decisions about the level of care given will not change. But, if the allocation is skewed too heavily towards the PCPs, there is no real income signal for the specialists, leading to a danger that they will not feel invested in the end result. Unless the system is accompanied by intensive, real-time reporting, along with clear penalties for excessive care, it will not work.

Did I say penalties? You bet. Without those, there is no enforcement of the global budget. But with those, global budgets are likely to raises hackles and resentment among specialists. I predict that the biggest issue facing physician groups in the coming years is the perceived interference by the global payment risk unit in the clinical decisions made by specialists.

If we were designing the health care system from scratch, I am guessing that the HPHC approach would be more likely chosen than a global payment approach. It would be accompanied by a shared savings mechanism, where physician groups and hospitals that beat an annual budget target would get a cash reward. It would also have a hefty dose of transparency with regard to clinical outcomes, so that the pricing levels charged by each provider would be accompanied by meaningful medical information that could help consumers make more rational choices. In short, a lot of the opacity of the health care delivery system would be eliminated.

That does not solve the problem of friction with regard to market entry and exit by doctors and hospitals. But global payments are weak on that front, too. Such friction may be an inherent characteristic of this sector for some time to come — unless, as appears likely, overall payment rates for Medicare, Medicaid, and private insurers fail to keep up with the cost of living. In that case, the future will belong to the efficient, hospitals and doctors who implement Lean or other front-line driven process improvement.

Paul Levy is the former President and CEO of Beth Israel Deconess Medical Center in Boston. For the past three years he blogged about his experiences in an online journal, Running a Hospital. He now writes as an advocate for
patient-centered care, eliminating preventable harm, transparency of clinical outcomes, and front-line driven process improvement at Not Running a Hospital.

Lots of people are thinking about the form of payments between insurance companies and providers for health care services, but it is also important to think about how each such approach would be marketed as an insurance product to the population.

The payment model that gets the most attention is capitated, or global payments, combined with accountable care organizations. In this environment, an average annual budget is established for each person served by an integrated health care delivery system (ACO), and that budget is shared among the providers according to some mutually agreed upon arrangement.

But the insurance product that would accompany this kind of payment scheme is often left without much of a description. As I have talked with insurance executives, they often fail to explain how they would offer consumers a desirable choice for a product based on this payment plan. Instead the main focus seems to be on shifting risk from the insurer to the providers, reducing the amount of unnecessary expenses, and sharing the benefits of those changes between the insurance company and the providers. Over time, the theory goes, the cost curve is slowed and premiums go up less quickly. But, it remains unclear what the role is for consumer in this scheme.

Eric Schultz, the CEO of Harvard Pilgrim Health Care, is offering a different view. I heard him give a talk the other day and have read some of his company’s materials. I will try to offer a fair representation here.

Eric recognizes that changes in the payment and insurance system will have to evolve over an extended period. Noting that the current system has been in place for decades, he views that time frame as being well over five years, and more like ten. He seems to be advocating a step-wise plan, one that allows time for consumer and provider education and one that envisions mid-course corrections when the inevitable unintended consequences emerge. He is keen to avoid the kind of consumer and physician misunderstanding and resentment that characterized previous adventures in capitation.

His approach is exemplified in two new product lines being offered by HPHC. The first is called Focus Network^SM and is described here. It is being tried out first in Central Massachusetts (see map). In essence, this is a plan that offers consumers less choice, relying on service from lower cost providers, and it enables HPHC to offer a premium that is 10 to 14% below the standard product.

How is it sold? While the Focus Network offers less choice, the consumer gets a clear choice between it and the standard plan. In a side-by-side comparison, a subscriber can see the difference clearly. Very importantly, HPHC advises its corporate customers to offer employees a defined dollar contribution towards their health care benefit. Doing it this way, rather than offering a defined percentage, ensures that the price differential between the two plans is not watered down in the eyes of the subscribers.

The second product line is a tiered network, where providers are grouped according to their cost. Well, not cost — price — i.e., the negotiated rates between HPHC and the providers. Physician groups (not individual doctors) are to be put in a tier based on the total medical expense of their patients (including hospitalization costs.) Hospitals will be specifically tiered based on their own expenses. Then, consumers get to choose their site of service, knowing that their personal co-pays and deductibles rise or fall depending on the tier chosen.

Under both schemes, the fee-for-service payment regime remains in effect, with a healthy dose of pay-for-performance incentives. In other words, global payments are not viewed as being necessary to change practice patterns or to influence consumer choice.

As I see it, Schultz is willing to bet that his approach will bend the cost curve with potentially less public outcry and backlash than might occur with others. I also am guessing that he wants to maintain HPHC’s reputation among consumers as an excellent HMO, something that is important as employers choose between HPHC and other insurers. He is doing so in a way that engages and educates consumers — and offers elements of choice — rather than imposing a new system that will appear to some as taking it away.

Paul Levy is the former President and CEO of Beth Israel Deconess Medical Center in Boston. For the past three years he blogged about his experiences in an online journal, Running a Hospital. He now writes as an advocate for
patient-centered care, eliminating preventable harm, transparency of clinical outcomes, and front-line driven process improvement at Not Running a Hospital.