Medicare’s Smoke Signals

Can the U.S. health care system do what it does for 40% less than it charges now?

There may be a homeless person shuffling around the subways of New York hearing voices who would say “yes.” But Medicare is hoping that administrators, manufacturer executives and physicians could somehow also get to “yes.” And soon.

Sequestration’s second year is 2014. New budget battles are gathering like thunderheads on the horizon.

It’s a difficult time to be feeding off the government teat.

Directly or indirectly, 60% of orthopedic revenues (for physicians, hospitals and suppliers) emanate from the tax-payer. When Medicare makes a payment change, the spillover hits private health insurers too.

So this past week the annual Prospective Payment Update ritual repeated itself as CMS (Centers for Medicare and Medicaid Services) issued its thousand page tome of payment schedule changes.

Most companies, physicians and hospitals will all see cuts, despite the fact (ironically) that health care spending growth and inflation are at their lowest point in 50 years.

It’s as if Medicare asked its spouse to lose weight after he joined Weight Watchers.

Health Care Spending Growth and Inflation Lowest in 50 years

According to CMS, health care inflation is just 1% on year-over-year basis, the lowest level spending increase since January 1962. (Health care inflation measured using the medical CPI is at levels not seen since September 1972.)

Using CMS’ projections from earlier this year, real per capita health care spending has grown at an average annual rate of just 1.3% over the three years since 2010. This is the lowest rate on record for ANY three year period and less than one-third the long-term historical average going all the way back to 1965. Yes, this is the lowest rate EVER recorded.

Because of these low rates of spending growth—which occurred without the Affordable Care Act, by the way—the Congressional Budget Office (CBO) lowered its projections of future Medicare and Medicaid spending in 2020 by $147 billion (0.6% of GDP). This is a 10% reduction in projected spending. (Source: http://www.whitehouse.gov/sites/default/files/docs/healthcostreport_final_noembargo_v2.pdf)

These Cost Changes Are Structural

Is flat to deflated health care spending temporary or the new normal?

Economists who think this is only a curve in a cycle point to the 2007-2009 recession—which was certainly a deep recession with the largest number of job losses since the Great Depression—and, concurrently, widespread reductions in insurance coverage.

But a funny thing happened after the Great Recession ended in 2009. Health cost growth rates, which had declined during those two years, kept declining—at slightly accelerated rates—over the next four years of job growth and recovery. (Chandra, Holmes and Skinner, 2013. Microeconomic analysis of the effect of income on demand for health care)

Here’s another fun health care anomaly from the Great Recession. According to economists at the CBO (Levine and Buntin, 2013) health claims from senior citizens in the Medicare system, which are more insulated from a weak labor market, slowed during and after the Great Recession.

Something is slamming the brakes on health care cost inflation.

Here are three, maybe four, culprits:

1. Cost-sharing. The Kaiser Family Foundation/Health Research and Educational Trust Employer Health Benefits survey found that recent increases in cost sharing in employer health plans have been substantial—more than 70%. The typical deductible in an employer plan has more than doubled since 2006 (from $584 deductible then to $1, 135 now). Ryu et al. (2013) studied the effects of cost sharing and concluded that this alone accounted for 20% of the reduction in healthcare spending growth from 2009-2011.
2. Shift to Outpatient Care. Hospital profit margins as a percent of revenues are better for outpatient services than those of inpatient services. The opposite is true for Medicare margins where outpatient margins are lower than inpatient margins. With Medicare targeting inpatient reimbursement (where the margins are highest in their view) for cuts hospital administrators are increasingly incentivized to expand outpatient services. For example; Brigham and Women’s Hospital in Boston generated $1, 506 million in revenues in 2009; $993million (66%) inpatient and $513 million (34%) outpatient. In 2010, just one year later the mix had shifted to $878 million (57%) inpatient and $664 million (43%) outpatient.
3. More Physician Employees. According to the Advisory Board 40% of primary care physicians and 25% of all physicians were employed by hospitals in 2010 versus 20% and 5%, respectively, a decade ago. Fundamentally this represents a move by hospitals to gain pricing power and cost control.
4. Replacing Pay-for-Performance Pricing with Pay-for-Outcome Pricing. A growing number of insurers replacing pay-for-performance with pay-for-outcomes are hoping that it will drive greater value and quality of care. Corollary to that is the trend among payers to refuse to pay for “experimental” procedures or implants—and to expand the number of new and even old technologies which are deemed “experimental.”

All of these trends are occurring independently of and before “Obamacare.”

The 40% Solution

So where are we heading in this health care system? It is entirely possible that what we’re going to is a system with much narrower range of costs for services and, on average, a 40% reduction in costs of service. On average.

The problem with averages…ever hear the story of the guy who drowned in a lake with an average water depth of 6 inches? Yeah, he drowned in the 20-foot section.

“Averages” mislead, for sure and we know that it’s really the variability that counts. With that in mind, check out this table.

This table compares life expectancies in various countries with the amount spent in each country for health care per person. Some country’s flags are way down at the lower left end of the chart. But there is an outlier flag. The Stars and Stripes…off to the right. This table is about five years old but it illustrates the essential health care cost dilemma in the United States. For $7, 290 per capita in healthcare spending, Americans get a lower life expectancy rate than about 18 other countries and pay roughly 40% more for the privilege.

(Yes, these are averages.)

The invisible hand of economics is pushing the U.S. health care system upward and to the left.

Ergo:

To get in line with the other major countries in this chart, U.S. per capita health expenditures would either have to decline by 40% or everyone else would have to rise by 40%—or meet somewhere in the middle.

Such a number seems ridiculously outrageous.

The surprising answer is that we may be in the middle of this shift right now. And the current disruptions are the consequences of healthcare spending deflation.

It’s the Variability Stupid

This table is based on average amounts. Using averages to compare countries creates an apples to oranges mis-match since virtually every country in the upper middle section has a more unified health care reimbursement and pricing systems than the U.S. This is not a point of pride, however. In fact, probably the most dysfunctional aspect of the U.S. system is its variability.

In a major research brief, the Center for Studying Health System Change assessed the pricing variability and power of provider systems within eight healthcare markets. What they found is that claims payment rates by Aetna, Anthem BCBS, Cigna and United HealthCare varied widely across all eight markets. The average inpatient reimbursement rate, as a percentage of Medicare, ranged from 147% (Miami-South Florida) to 210% (San Francisco), whereas the average outpatient reimbursement rate ranged from 234% (Cleveland) to 366% (San Francisco).

Chopping the Tail Off

The bell curve for U.S. payments is flat and wide. It’s like the six inch deep lake. And the medical system is gasping for air in the six inch deep health care lake.

Here a picture of the typical bell curve.

One standard deviation above and below the average (center line in this image) encompasses roughly 68% of all data points in the bell curve. But, the two tails of the bell curve holds 31.6% of the data points.

If one were to chop off the area from 1 to 3 standard deviations above the average, the effect would be to lower the average dramatically.

And that is what appears to be happening in the U.S.

Wal-Mart and Lowe’s, for example, are offering their 1.5 million employees free hip and knee replacements. No deductibles, no co-pays. The catch is that the employees have to have their procedure performed at one of four hospitals in the United States. Wal-Mart and Lowe’s will pay for the transportation, the hotel, the cost for one caregiver to accompany the patient and, of course, the entire surgery and rehab costs—100% paid for.

Those four hospitals that have contracted to take on the volume of patients from Wal-Mart and Lowe’s are among the best in the United States as measured by low complication rates. Yet the prices they’ve agreed to charge are well below national averages. Yes, these are Wal-Mart priced hip and knee replacements.

Then there are the rise of the super-practices like the recently announced combination of Rothman, Cleveland Clinic, OrthoCarolina and The Core Institute. This group, with its 600 surgeons, is offering standard pricing, standard protocols and full-risk capitation!

And then there is Dr. Haar with his private clinic in the Upper East Side of New York who has decided to go cash all the way and is posting his prices on his website—prices, by the way, that are also well below the national average.

Logistics over Implants

In an earlier, simpler time hamburgers cost $5 or $6 and were at the corner soda shop. Books were sold at the bookstore down the street. And computers had floppy drives and cost $10, 000. Process innovation is what this country does very well. Think McDonald’s, Amazon, UPS or Wal-Mart.

Medicare’s new round of formula tweaking and cuts are part, we think, of a larger set of changes which, in the aggregate, are pulling the system to reduce variability of costs and outcomes. Narrowing the U.S.’s health care bell curve will necessarily reduce the average per capita cost of health care while also improving outcomes. In other words, process innovation may be the next great economic driver of medicine.