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

May 19, 2014

If We Want Lower Health Care Spending, We Are Going to Have to Pay for It

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 7:43 am

Ultimately, spending less on health care is a relatively easy task: We either need to consume fewer services, or spend less on the services that we consume. But much like we teach our Kellogg students about maximizing profits, the devil is in the details. It’s certainly tempting to ask the government to swoop in on a white stallion and solve the all our problems by fiat. For example, we could have the government simply exploit its monopsony power and set prices, but an artificially low price will lead to an inefficiently low quantity of services and future innovation (stay tuned, we will have more to say about this next week). Similarly, we could explicitly ration quantities (as opposed to implicitly doing it through a large uninsured population). But how could we hope to determine the right level of care? Ultimately, if we ask the government to unilaterally fix this problem, instead of a white stallion we could behold a pale horse and all that it entails.

The good part, perhaps the best part, about the Affordable Care Act is that it attempts to address this problem using market forces. The question is whether we are ready for what these market forces will entail. We will focus today on the role of market forces in the insurance market to control prices in the newly established ACA exchanges. This month the Obama administration announced that it would allow insurers to use “reference pricing” for insurance programs in the exchanges. Under a reference pricing system, insurers set the maximum price they will pay for a specific set of services and if patients go to a facility that costs more than that amount they are required to pay the difference. This system has recently been implemented by the California Public Employee Retirement System (CalPERS) and there were two main effects: (1) surgical volumes decreased at high price facilities and increased at low price facilities, and (2) the prices paid by individuals covered by CalPERS decreased at high price facilities but were essentially unchanged at low price facilities. While this is only one study for a single insurance system, it does provide the pattern that we would expect following a reference pricing system and is therefore provides encouragement.

In many ways, reference pricing is a close cousin of the narrow network systems that we previously described. Under narrow networks, insurance companies choose a limited set of facilities that are willing to accept their prices. Patients who want more choices can pay higher premiums for plans with wider networks. Under reference pricing, patients can go to a wider range of providers but they bear more of the cost of these choices. The organizing principal is the same for both systems: if patients want choice they are going to have to pay for the privilege.

The theory behind reference pricing is fairly clear. But will it work in practice? That is less clear. There are two main threats that we can see: (1) poor implementation and (2) political backlash. When it comes to implementation there are several important points to consider. Perhaps most important, reference pricing is not a panacea. It is most applicable for encounters with the medical system which involve a defined episode with relatively easy to understand quality measures. Think knee replacements and MRIs and not the management of Type II diabetes. This system is not well suited for managing chronic conditions. In addition, reference pricing is only as effective as the level of competition in the marketplace. Without a robust and competitive local provider market, patients lack sufficient options to shop around and this system won’t lead to reduced prices. Finally, price competition in the absence of good information about quality can create a race to the bottom, in which providers skimp on quality (e.g., reduced staffing and training, shorter therapy sessions, etc.) in order to drive down costs and, as a result, compete better on price. Patients must have sufficient information to make choices across providers based on price and quality. Obviously the first step here is some form of price transparency – a feature that is generally absent from today’s health care system. A recently announced partnership between major health insurers and the independent Health Care Cost Institute could go far to fix this problem. Perhaps more difficult is that reference pricing requires readily identifiable quality metrics (that can’t be easily gamed by providers or lead to perverse outcomes) that can be easily communicated to patients. For this, we need to think beyond standard outcomes like infection rates and incorporate important patient reported measures of quality such as pain reduction, ability to perform activities of daily living, and perhaps some measure of customer service. Given the experiences on the exchanges, where narrow network plans have been unable to accurately communicate information on which providers are in their networks, we have some fears as to whether these firms are ready to provide this type of critical quality information. Without a good quality reporting system, patients might end up choosing solely on price – an outcome that few would herald as a success.

Beyond the potential problems of implementation, we fear that the bigger threat to reference pricing will ultimately be politics. We first note that these systems are very similar to the HMO systems of the 1990s, which appeared to limit the growth of health spending before they were stamped out by a combination of a consumer protests and political handcuffs. Much like the backlash to HMOs and the more recent narrow network plans, it will only take a few patients being “forced” to pay high bills in order to get access to their preferred provider before the complaints will surface. Or perhaps it will happen before the first bill is even sent. Expect that the nation’s priciest providers will band together and speak out on “behalf” of consumers. Either way, it will take some national courage to stand up to these august providers and their feigned concerns for consumer welfare.

In the end it boils down to the proverbial lack of free lunches. It we want to lower health care spending we have to give up something. If we don’t accept some market based solutions, we will find a lunch menu filled with far worse options.

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