Healthcare Reform – Aligning Incentives

Published July 13, 2011

Setting the Stage

Spending on health care in the United States has been growing exponentially, representing a challenge not only for the government but also for the private sector. The Congressional Budget Office estimates that in the absence of any changes, total spending on health care would rise from 16% of gross domestic product (GDP) in 2007 to 25% in 2025 and 37% in 2050. Federal spending on Medicare and Medicaid would rise from 4% of GDP in 2007 to 7% in 2025 and 12% in 2050. As health care spending consumes a greater and greater share of the nation’s economic output in the future, Americans will be faced with increasingly difficult choices between health care and other priorities. However, a number of opportunities exist to constrain health care costs without adverse health consequences.

The emergence, adoption, and widespread use of new medical technologies and services are a major factor contributing to the rise in cost of care. Advances in medical science allow providers to diagnose and treat illnesses earlier and more effectively than were previously possible. Many of those innovations rely on costly new drugs, equipment, and skills while other innovations are relatively inexpensive but add up as a growing numbers of patients who make use of them. Although technological innovation in the form of prevention can sometimes reduce spending, most advances and the resulting changes in clinical practice have generally increased the cost.

In today’s healthcare environment, both providers and patients facilitate the adoption of expensive treatments and procedures, even if the evidence about their effectiveness relative to other therapies is limited. For doctors and hospitals, those incentives stem from fee-for-service reimbursement. This type of financial arrangement can encourage health care providers to deliver a given service in an efficient manner as long as the payments exceed the costs. Insured individuals generally face only a portion of the costs of their care and thus have only limited financial incentives to seek lower-cost treatments. Private health insurers have incentives to limit the use of ineffective care but are also blinded by a lack of information (outcome studies) about what treatments work best for which patients.

Remuneration – One of the Golden Keys

Historically healthcare providers have been paid based on fee for service, capitation or salary. One of the key debates in health care reform is the impact of provider incentives on the quality, cost and access to patient care.

As one might infer, outcomes are generally different under retrospective and prospective scenarios for physician payment since the incentives favor different physician behavior.

Fee-for-service – which has long been the traditional physician remuneration mechanism – is a retrospective payment system, which reimburses providers for service provided, according to a pre-determined fee schedule. In contrast, capitation is a prospective payment scheme and pays providers a fixed fee per patient on the understanding that the physician must provide all necessary health care services to the patient. A capitation fee is usually negotiated and varies according to some observable characteristics of a group of patient’s health status (e.g., age, gender, etc.). The prospective nature of capitation will encourage providers to accept healthy patients rather than patients with complicated health conditions. However, on average, healthy patients make fewer visits to their physician than patients with complicated health conditions.  This practice is known as “cherry picking”.

Many groups have compared fee-for-service and capitation payment schedules. It is argued that fee-for-service does not provide incentives for cost-minimization in the selection of medical services and may even induce demand for unnecessary services. Fee for service does, however, improve access to care.  In contrast, capitation provides physicians with powerful incentives to minimize costs and access to care. Opponents of capitation argue that this mechanism leads to lower quality of care, and in the extreme case, to the denial of services to high-cost patients. Because of the shortcomings of each model, more groups are considering (and adopting) a more optimal blended payment mechanism in order to mitigate problems associated with each pure system.


What’s Next?

The health care reform debate in the United States has been a political issue for many years, focusing upon increasing coverage, decreasing the cost and social burden of healthcare, insurance reform, funding, and government involvement. Various general and specific reform strategies are under debate in the Congress and media including comparative effectiveness research, independent review panels, doctor incentives (paying for quality rather than quantity of healthcare), tax reform, reducing defensive medicine, insurance regulation, prevention and wellness, incentives to educate more doctors and nurses, expanded use of technology, rationing of care, single-payer systems, etc.  No one is quite sure where we will land but it is certain that politics and legislation will continue to evolve and shape the landscape.

The world of health care was complex enough when everyone understood the rules. Now the old rules are gone, some new ones are here, and others are still a work in progress. Politics and legislation will continue to shape specific elements and timing, but the trajectory of health reform is unlikely to change and the momentum is not likely to slow. As more evidence on the options for reform are developed, specific ways to reduce costs, especially for targeted subsets of beneficiaries, may become possible. To affect medical treatment and reduce health care spending, the behavior of doctors and patients would need to change—that is, to get them to use fewer and less intensive services than are currently consumed.  For now, the possibility and scope of savings remain unclear.  Are you prepared?

About The Author

David Frankel headshot
Dr Frankel an innovative strategic leader with a proven track record of identifying global market opportunities to drive revenue, profit and market share growth. He has over 15 years industry experience in consultancy, start-ups and fortune 100 companies in a number of different roles from business strategy, pricing, competitive intelligence, system development and operations. During his career he has helped companies deliver multi-million dollar improvements on profitability via pricing and business intelligence while increasing market share and maintaining customer satisfaction. He has a BS and PhD in biophysical organic chemistry from the University of Arizona and an MBA from Washington University Olin School of Business in St. Louis.