Code Red: Two Economists Examine the U.S. Healthcare System

June 23, 2010

Physician Hospital Organizations

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 1:08 pm

Book writing has begun! I will be away from my blog for a few weeks (taking a much needed vacation). This is an excerpt of material I have prepared on Physician Hospital Organizations (PHOs), one of the precursors to today’s Accountable Care Organization movement.

The Alexian Brothers is a lay Catholic Order dedicated to healing. At one time there were four Alexian Brothers Hospitals scattered across the United States. One might not expect it, but the Alexian Brothers system was rather innovative and in the late 1980s, the flagship hospital in Elk Grove Village, Illinois became one of the first in the nation to form a Physician Hospital Organization (PHO). In fact, the first time I had heard about PHOs was in 1990 at a talk given by Alexian, Elk Grove’s CEO, Brother Philip Kennedy.

During their heyday in the mid-1990s, there were a number of designations given to hospital/physician partnerships. They all took a similar path to solving the cost containment– getting providers to take financial responsibility for medical decision making. This seemed reasonable enough. If Kaiser could save money by “reversing the economics” of fee-for-service medicine, why couldn’t hospitals and their medical staffs do the same thing? As a pioneer in the PHO market, Alexian Brothers Hospital in Elk Grove would soon find out.

Most businesses entering a new market have already figured out how to make their product. Their biggest challenge is attracting new customers. Alexian’s problem was quite the reverse; it had lots of customers but it had to figure out how to “make” a PHO product. The basic financial arrangements were fairly straightforward. Primary care physicians affiliated with Alexian contracted with HMOs. Patients who signed up for these physicians received their primary care from their designated PCP and their hospital care from Alexian (unless Alexian did not have the necessary facilities, such as for transplants.) HMOs paid single capitated fee to Alexian, which in turn, paid a portion to each PCP, with withholds for prescription drug costs and specialist fees. Alexian used the remainder of the funds to cover facilities costs.

Designing the contract proved to be the easy part. Making money under the contract was rather more difficult. Brother Philip convened a series of monthly dinner meetings with medical staff, including department heads, leading specialists, and top referring PCPs. The goal of the first few meetings was to familiarize the doctors with the changing landscape and to solicit their feedback about the new PHO. Brother Philip watched and listened. He understood that the specialists had to be on board or the PHO would fail. And if he pushed the specialists too hard, they might take their practices elsewhere.

Over the next few months, the physicians discussed ways they might reduce costs. One notion that was popular among all the doctors was that better quality and lower costs often go hand in hand. Brother Philip floated the idea of rewarding high quality doctors. Alexian could pay bonuses or perhaps PCPs could base referrals on specialist quality. But the specialists zealously guarded their autonomy from Alexian and questioned whether these steps would move them one step towards becoming employees.

As the meetings moved from theory to implementation, newer, even less tractable problems emerged. Everyone got hung up on the definition of quality. Some of the top surgeons identified the critical need for risk adjustment. Their patients often fared poorly but that was because they took the toughest cases. They doubted whether any system could fairly judge their performance.

In their final meetings, the group tried to find practical ways to reduce costs. Capitating PCPs for specialist fees was supposed to change incentives and sharply reduce unnecessary care. But PCPs and specialists alike argued that capitation was badly flawed. The PCPs pointed out that capitated payments were adjusted for the patient’s age and sex but not for their clinical condition. The PCPs also complained that the most costly medical decisions were in the hands of the specialists, who were still being paid fee for service. This put the PCPs at grave financial risk if they had patients with chronic illnesses and the specialists did not hold the line on costs. The group debated whether the specialists should be capitated but no one could quite figure out how that would work.

Brother Philip would not give up. Given adequate information about risks, costs, and outcomes, he was convinced that he could construct a viable incentive system. He asked for help from the hospital’s medical records and financial officers. Could they improve upon the age/sex risk adjusters? Could they properly measure costs and outcomes? Could they devise an incentive system that would address the many concerns expressed by the doctors? Their response was devastating. The hospital did have computerized data, but only enough to satisfy billing requirements. This data included a handful of diagnostic and procedure codes for each patient, billed charges (which everyone knew were totally unrelated to costs) and physician identifiers. No outcomes. No realistic cost information. Brother Philip was in a corner. How could he reward quality and efficiency when he couldn’t measure either one? How could he encourage doctors to take on high risk patients when he couldn’t adequately measure risk?

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