Code Blue

Why are Costs so High? Chapters 8 through 14

Chapter Nine

• A Lesson in Medical Economics

Two reasons for high healthcare costs

• Technology– Heavy investment in facilities and

equipment

• Duplication of resources– Too many hospital beds– Too much equipment

Price elasticity

• 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 ?

Purchase Decision

• 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

Price Comparison

• Consumers didn’t shop on the basis of quality and price– They have difficulty judging

quality– Price information is not available

Price Negotiation

• 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

Excess Capacity

• 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 life-saving 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. pre-certification, 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.

Chapter 10

• 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

Chapter 11

• 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.

New Approach

• 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

Concerns

• 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?

Chapter 14

• Summary– 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