The right payment structure keeps patients healthy while saving money.

(Originally published in Hospitals and Health Networks Weekly, 11/30/2010)

We want healthcare to be abundant, effective, easy, and cheap; for too many of us too much of the time it is scarce, ineffective, and maddeningly difficult. For all of us it is far too expensive. Why? How did we get in this mess? How do we end up paying so much for healthcare and not getting what we want?

It’s a big question, and it’s at the core of the mess we are in. The convoluted way we pay for healthcare in the United States gives too many patients treatments that they don’t need, or treats them for conditions that could have been prevented with much cheaper care, or denies patients services that they actually need. How does this happen?

To answer this question, we have to dig into the actual structures of healthcare, and some of the basics of economics. And in that answer we can begin to see how we need to rebuild those very structures in order to survive and thrive beyond reform.

Why Doesn’t Competition Seem to Work in Healthcare?

There certainly seems to be plenty of competition. For example, there are:

  • thousands of hospitals of all different types (for-profit and nonprofit, free-standing and chain, general and specialty, teaching, children’s, public and private, military and veterans);
  • hundreds of thousands of doctors in scores of specialties organized every way you could imagine (solo practice, small practice, large multispecialty practice, working for hospitals and health systems, running their own centers, in cooperatives like Group Health of Puget Sound and staff-model HMOs like Kaiser);
  • hundreds of health insurers;
  • scores of pharmaceutical companies, device manufacturers and other healthcare vendors supplying bed pans, gurneys and ambulances; and
  • thousands of pharmacy benefit managers, vendor certification companies, disease management agencies, consultants and other companies providing bits of outsourced management expertise.

Though there is plenty of regulation, on most levels of the system there is no central Soviet-style commission allocating resources and deciding who gets which customers. All these organizations are free to compete for the customers’ dollars.

Why, with all that competition, can’t most of us seem to get the healthcare we need when we need it, where we need it, at a reasonable price? For most Americans, though we can see that modern medicine offers a nearly miraculous plethora of cures and therapies, our access to it through the healthcare industry is often arbitrary, often so arbitrary as to be cruel. For those under 65, the price is often so high that even insured people can be one serious disease or traffic accident away from permanent poverty. And even when it works, it can be mind-blowingly inconvenient.

How can that be? How can a “free market” system so blatantly fail to serve its customers? Until we find the answer to that question, we will never be able to find our way out of this mess.

Let’s do a little basic analysis, a little “Healthcare Economics 101.”

What Does the Customer Want?

What do I really want, as a customer of healthcare? Realistically, four things:

  • When I’m sick, fix me.
  • If you can’t fix it, help me manage it.
  • When I am well, help me stay well.
  • Be there when I really need you.

So why is it so hard for me to get those four things? Because—here’s the big key—I’m not really the customer. In fact, in most of healthcare, it can be hard to tell who really is the customer.

Who Is the Customer?

What’s a customer? Customers decide that they want something, choose it and pay for it. You decide that a new TV would be nice. You look online, maybe, or go to a big-box store, maybe check out some local independent store. You find what seems a reasonable value for your money, and you plunk down the credit card. You’re a customer.

The customer is the key regulating part of any free-market system. The customer is the reason you never see a plate of scrambled eggs or a new car advertised for $1,000. It’s the customer that enforces all sense of value.

So what’s different between classic economics and healthcare economics? Classic economics pictures a buyer and a seller. There is a constant, dynamic feedback loop between the many buyers and the many sellers in a market that establishes not only what things cost, but even what’s offered for sale, and on what kind of terms.

The core driver of all healthcare economics is the utilization decision, that is, people deciding to make use of some healthcare service. They get a new hip, take a new drug, get an exam, go in for a mammogram. The great majority of healthcare is insurance-supported, whether through government insurance such as Medicare, or through employers’ private insurance. And the great majority of healthcare is provided fee-for-service, that is, the healthcare provider (the doctor or hospital) bills the insurance payer for each separate test, procedure or prescription.

So what happens to that feedback loop in healthcare? First of all, the buyer is split in two, into a chooser and a payer. The organization that pays the bill does not make the decision to use that particular service. So the feedback loop between buyer and seller is obscured. And the chooser and the payer have quite different agendas. If the payer is just there to pay, it can have only one goal: to pay as little as it can get away with. It might set rules and payment schedules, but can never quite get it right, since it is really not there in the transaction, making the choice.

It gets even less clear: Who is the chooser? Who is deciding to use the service? Again there’s a split. The chooser is not the patient alone, but the patient (or the patient’s family) in consultation with the provider (usually the doctor). So again, and in a different way, the buyer is split. And the patient and the provider have very different stances. The patients have enormous “skin in the game”—great incentive to use whatever services might seem to help, since it’s the patients’ body, their pain, indeed often their life or death, that is on the line. The provider, on the other hand, has almost all the resources: the knowledge, expertise, equipment and access to drugs and therapies. And in any given transaction, the provider has far less skin in the game: this patient is one of hundreds or thousands. So the feedback loop gets even more obscured and tortuous.

It grows yet more murky: Who is the “seller?” Who is providing the service that is being sold? In most instances, it is the provider. The doctor who is advising the patient on buying the service is often either providing the service or working for the organization that will provide the service—or even owns it. You need a new knee. But you’re in luck, you’ve come to the right place, because I am an expert knee-installer. And the seller, of course, has a completely different agenda from the buyer. The seller’s agenda is simply to sell as much as possible. So the feedback loop between buyer and seller becomes so tortuous and knotted as to be useless, and the system skews, as a normal part of doing business, toward selling the services that make the most money.

Because it is inescapable: You will serve somebody. If it is not the patient, it will be somebody else.

Out of this we get markets in which, for instance, it can be very hard for a Medicaid recipient with diabetes to get (or even hear about) the nutritional counseling that might help her save her feet, but quite easy to get a surgeon to amputate her feet when her diabetes destroys them.

What Are Healthcare Providers Paid To Do?

This may sound overly cynical. Many doctors would protest that they never offer a service just because it would make them more money. But, as one neurologist put it to me: “The more I care about my work, the less money I make. The way for me to make more money is to serve my patients less: Give them less time and attention, and cut them loose as soon as possible.” That’s a terrible bind to put our best medical minds in. Many doctors doubtless choose the path this doctor does: Do better work and make less money. But many doctors feel forced to make the other choice: Do poorer work and make more money.

It is important to remember the two core rules of economics:

  • People do what they are paid to do.
  • People do exactly what they are paid to do.

People notice in exquisite detail what makes them money and brings them success. They will not as a normal practice do things that cost them money, or put them at risk of getting in trouble. In healthcare, what brings a provider money and success is doing more of the procedures and tests that are well-compensated by payers, and doing less or none of the ones that are not well-compensated—and certainly never failing to do some test or procedure that might keep them out of a malpractice suit, whether the patient really needs it or not. And those well-compensated and malpractice-safe procedures and tests are only indirectly related to the four things we really want when we think we are the customer. Almost no one in healthcare is directly paid to give us what we actually want.

What’s the Structure?

It’s important to notice that this confusion is structural: The ordinary structures of healthcare, with doctors, clinics and hospitals in strict fee-for-service relationships with payers, have great difficulty acting as if the patient is customer.

If we are to get out of this mess, we need to tweak those old structures and build new ones. That’s why we are seeing fascinating, weird experimental structures arising across healthcare—“extended medical home” PHOs, “virtual accountable care organizations” like those I cited in my last column. And that is why almost all of these are new forms of partnerships, ad-hoc contractual relationships that cut across the traditional structural lines to deal with the health of particular populations. The contracts set up incentive relationships that guarantee that someone makes a profit specifically by tending to the real needs of the patient, not just by providing services to the patient. And they are all over the place, taking different shapes to fill niches in the vast ecology of healthcare.

Let me just give you one example. If you were to look around, as an entrepreneur, for a way to make money by helping some population be healthier, what populations would seem like the “low-hanging fruit”? Would you think, “Ah, yes! Frail, elderly people on Medicaid in state-supported convalescent homes! And kids on Medicaid with disabilities!” Probably not. And yet that is exactly what happened in Illinois. McKesson’s disease management subsidiary contracted with the state to provide its “Your Healthcare Plus” services to just such populations. Teams of doctors, nurses and case managers, many of them on-site across the state, working with the patients’ existing providers, measurably improved the health of these patients. Counting the costs and fees for running the program, McKesson saved the state of Illinois $307 million in the first three years of the program—by giving people more services of the right kind of care and attention, not less.

Hospitals can form these OWAs (“other weird arrangements”) in all kinds of shapes, from at-risk contracts with insurers or CMS, to shared-risk medical-home arrangements with PHOs, to disease-management contracts with government agencies. And increasingly they are, across the country, because in the new environment the overburden of high cost and low capacity is killing us. We simply must find more efficient and more effective ways of serving our customers.

Structure matters. With the right structure, you make money by saving money. You help the customers meet their objectives, and you get paid for it.