Risk Flows Downhill

At $63, 413 California has the highest average Medicare charge in the United States. The national average Medicare charge is $34, 399. New Jersey is #2. Interestingly, the Army Post Office AP is #3. Four years ago New Jersey was higher than California. Between 2004 and the first half of 2008, California’s average Medicare charge has increased 29.7% (from $48, 894). 

But that is not what California received. In 2007, California sent 844, 905 claims up to Medicare and received $9.763 billion or an average of $11, 555 per claim. While the average charge was $63, 413 in California, the average reimbursement was $11, 555. 

That’s a big financial gap for someone (the state of California, the hospital, surgeon, surgery center or patient) to cover.

California has another distinction; it is probably bankrupt. California’s public purse broke some months (or years) back and the headlines today are about how much to cut costs and how much to increase fees. Tuition at the University of California college system, for example, will rise 9.3% this year―higher, incidentally, than the expected rise in Medicare charges.

Medicare actually spends more in California than it does in the rest of the country―about two-thirds more than the national average per enrollee. Yet that spending doesn’t even cover 20% of the average amount California requests of Medicare.

If California’s Medicare charges rise 29.7% between 2008 and 2012, the same rate as the last four years, then the Medicare charges in California will rise to $82, 000 per enrollee. Unfortunately, Medicare is not planning to increase its payments to California. 

Funding Medicare in an environment where claims are rising 30% every four years, as in California, is risky business. In an era of record deficits and looming state insolvencies, Medicare desperately needs to manage this risk.

Private health insurance companies manage risk. They are, actually, risk managers. Risk is what insurance companies calibrate, charge for and protect their customers from. 

Risk management is different from providing health care. Washington policy makers and a fair percentage, we suspect, of the general public equate payers and insurance companies with health care. In this paradigm, if health care is not available then it is the fault of the insurance company. But, they are wrong. Insuring health care is not the same as providing health care. 

The average health insurance premium for a family in 2008 was $12, 680 a year. That’s a fair amount of money. What if a family decided to save it instead of buying health insurance? That model actually works pretty well for routine office visits plus a couple or three emergency room visits per year. But add in ambulance trips, specialists, follow-up visits, MRIs, and medications, and the costs can jump to $30, 000 or more. Then there’s the cost of heart disease, arthritis or cancer.

Insurance replaces large unpredictable risks with small but known payments by distributing the small risk over a large pool of insured policies.

To illustrate this further: here are some events that are NOT appropriate for insurance coverage since they entail NO risk, they are 100% certain―a flat tire, an empty refrigerator, snow or rain or a dropped pass in the big football game. A policy that covers predictable and recurring events would have to charge at least as much as the event itself plus more for the cost of claims processing. 

Predictable events that cost a lot require a savings account or a term loan―not an insurance policy.  Like an auto purchase. Residential property destruction, auto-related (liability for injury; theft) catastrophes, and accidental death or permanent disability are classic insurable events because they are unpredictable and comparatively rare events. Insurance works when it is used as a hedge against a contingent loss and that loss can be spread out over many policyholders.

So, in health care there are certain events that are unpredictable and lend themselves to insurance as a risk management tool. There are other events―cut fingers, cold and flu, cavities or pregnancies―that are not risky items in need of insurance. They are more suited to savings accounts or loans.

Some of the techniques that healthcare insurance companies (aka payers) have relied upon to manage healthcare risk are going away. Pricing for risk by risk-adjusting each patient (i.e., not paying for pre-existing conditions) is probably going away. An aging population with rising rates of chronic conditions like diabetes, obesity, arthritis, and heart disease puts more health events into the routine category. 

This process of adjusting for new and shifting levels of risk means, we think, that systemic healthcare reform is happening regardless of any bills in Washington. What is, in effect, passing for organic reform is really risk shifting from the insurance companies to hospitals and from hospitals to patients and manufacturers. 

For example:

1. Risks that shift to the hospital
   1. Medicare will no longer pay for the additional cost of hospitalization if the condition was hospital-acquired and “reasonably preventable” (CMS quotes). That is, if a condition is not present upon admission, but is subsequently acquired during the hospital stay, Medicare will no longer pay the additional cost of the hospitalization.
   2. Medicare has identified eight preventable conditions for which it will no longer reimburse, such as:
      1. Surgical site infections following certain elective procedures, including certain orthopedic surgeries, and bariatric surgery for obesity
      2. Certain manifestations of poor control of blood sugar levels
      3. Deep vein thrombosis or pulmonary embolism following total knee replacement and hip replacement procedures
   3. Medicare will also no longer pay for the following mistakes:
      1. A mistaken surgery or other invasive procedures performed on a patient·
      2. A surgery or other invasive procedures performed on the wrong body part
      3. A surgery or other invasive procedures performed on the wrong patient
2. Tools that push decisions down to the patient level
   1. Health Savings Accounts (HSA). Eight million people have these in the United States. In two years, experts estimate, the number will rise to more than 12 million. HSAs were put in place in 2003 to help encourage the use of savings to pay for healthcare costs. HSAs are tax advantaged medical savings accounts where the funds are used by patients to pay for their own medical expenses. The patient makes the purchase decisions. Furthermore, the purchases are made with cash. In theory at least, cash purchases should lower healthcare prices because the consumer is making the choices and providers compete for that business.
   2. Cost comparison tools for patients to use when spending their cash / HSAs on health care.
3. Less money to pay for healthcare products and services—thereby forcing routine care expenses to be paid for outside of Medicare or the private insurance programs.  Medicare and Medicaid funding will be cut by hundreds of billions of dollars (The House version has cuts totaling $400 billion over 10 years).

The professional risk managers, the insurance companies, are preparing for an era where insurance will be more explicitly separated from healthcare services. So, for example, hospitals―not insurance companies―will begin to risk-adjust their patients and start to charge varying amounts for products and services depending on the risk profile of patients.

Patients will begin to shop around for routine services that are not well suited for classic insurance coverage and use their HSA or other savings or term loan payments to pay for those services.

Where might this affect suppliers and manufacturers of medical products?

We suspect that it will hit under the rubric of comparative effectiveness or the discipline of justifying the cost of a product with the patient outcome.

Comparative effectiveness will be the reasoning, we think, behind hospitals, Medicare and others to move at least part of the payment risk to manufacturers. 

The concept of a third-party payer that will provide unlimited health care at minimal or no cost to the patient, if it ever really existed, is likely dead. 

The concept of the hospital, the patient and the manufacturer shouldering more and more of the payment risks is very much alive and will, we expect, become the mechanism whereby the current healthcare system discontinuities are reconciled. Regardless of what happens in Washington.

As for California, nothing focuses the mind like no money in the bank. It differs from the rest of the country only in magnitude. In its extremes of cost and budget strife, California highlights exactly the problems that are pushing risk managers (the private insurers and, increasingly, Medicare) to narrow their focus and move payment and other risks downstream.