Why are Costs so High?
Chapters Eight through Fourteen Accounting Version
• A Lesson in Medical Economics
Two reasons for high healthcare costs
– Heavy investment in facilities and equipment
• Duplication of resources
– Too many hospital beds – Too much equipment
• When price goes up • Volume goes down • Price elasticity provides an incentive for companies to control costs • There is little price elasticity in healthcare
What conditions must exist for a free market?
• • • • An informed consumer Who makes the decision to purchase, who Shops on the basis of quality and price, and Negotiates an arms-length purchase decision
For the most part, these conditions didn’t exist in the traditional healthcare industry. Why ?
• The purchase decision was made by the physician, not the patient
– The patient lacked the technical background to judge the necessity and quality of many of the medical goods and services provided – The physician and not the patient selected the hospital the patient would be admitted to
• Consumers didn’t shop on the basis of quality and price – They have difficulty judging quality – Price information is not available
• Patients didn’t negotiate an arms-length purchase price
– Price was equated with quality – Patients are reluctant to drive a hard bargain for price with one who provides life saving services
• What factors mitigate against unnecessary capacity in most industries?
– Increased costs, which – Increase prices, which – Hurt sales volume and therefore overall profitability – Too high a price can make on non-competitive – Price competition keeps prices down
Why didn’t these same factors prevent duplication of expensive facilities and equipment in the traditional healthcare industry? There is little price elasticity for many lifesaving or health preserving healthcare goods and services. Increased capacity still leads to increased fixed expense, but the resulting increase in the price of the product to the patient does not heavily influence demand.
Managed Care Tries to Create a Market Mechanism by . . .
• Educating consumers on the necessity and quality of healthcare services.
Assume the role of the informed consumer for the patient. Review and approve the necessity and quality of healthcare products and services provided (i.e. precertification, peer review, utilization review).
Managed Care Tries to Create a Market Mechanism by . . . Assuming the role of shopping for healthcare services including negotiating the prices with hospitals and doctors. Providing a financial incentive for physicians and hospitals to act in the best economic and medical interests of the patient.
• Gaming the System
Disparate Information . . .
• Can allow physicians to increase personal income by ordering unnecessary lab and x-ray tests
– Some states now prohibit physician owned laboratories
• Adverse Incentives
Previous attempts to control healthcare costs
• Regulatory attempts
– Certificate of Need: Hospitals had to receive permission to built new beds, or buy expensive equipment – Rate Review: In some states hospitals had to get approval for rate increases similar to the utility industry – Regional Medical Planning: Attempted to reduce unnecessary duplication of facilities and equipment
Regulation didn’t work
The healthcare industry is too complex to regulate like a utility. There was little evidence that regulatory efforts reduced costs.
• Managed care which included:
– Incentive reimbursement to change physician behavior – Prospective and retrospective review – Use of gatekeeper physicians to limit unnecessarily access to expensive specialists
The objective was to create a market mechanism
• If the patient doesn’t make the purchase decision, lets not let the physician do it without prior approval • If the patient can’t judge quality, have the insurance company do it
• If the patient can’t judge the necessity for services, make the physician get approval in advance
The objective was to create a market mechanism
• If the patient can’t shop on the basis of price because information is not available, have the insurance companies perform that function
• If the patient is not comfortable negotiating a price for services, let the insurance company do it
Types of incentive reimbursement
• DRG reimbursement---hospital is paid a fixed amount per diagnostic admission to the hospital • Capitation payment--healthcare provider is paid a fixed monthly premium to provide comprehensive services
• The primary concern with incentive reimbursement is quality
– Will it cause physicians and hospitals to provide
• Too few medical goods and services? • Goods and services of substandard quality?
– As costs increased, the government, employers, and patients demanded that hospitals be run more like businesses and less like charities – As this occurred, some feel the industry lost its traditional characteristic of quality and compassion