Perverse Incentives

In a recent piece in the Wall Street Journal entitled Perverse Incentives in Health Care, John Goodman describes the environment in today's healthcare system that disincentivizes efficiency and quality in healthcare and rewards the status quo. Goodman places the blame for this on a system in which the payer calls the shots; Medicare or the insurance companies dictate what procedures they will authorize and how much they will pay for them. It's the healthcare providers' job is to provide the best care for their patients while staying within the boundaries set by the payers.

This has the effect of reducing and discouraging any innovations in the field because the provider may not be reimbursed for them. If a healthcare provider, medical device or pharmaceutical company has a better, more efficient or effective way of treating a patient this must be reviewed and approved by the payers before a healthcare provider can get paid. Although it is in the long term interest of the payers to reduce costs and improve quality, they are large bureaucracies and do not respond quickly to changes in the market. As a result such innovations as email and electronic medical record systems are not as easily implemented in healthcare as they are in virtually every other sector of the economy.

Goodman points out that those sectors of healthcare that are not reimbursable but rather paid for directly by the consumer, such as cosmetic or laser eye surgery, are both competitive and entrepreneurial. These sectors offer competitive and dropping prices, rapid gains in technology and constantly improving quality. In these sectors the coupling between payer and provider is looser; the consumer is simply interested in a smaller nose, better eyesight or fewer wrinkles and does not want to sweat the details of how much a syringe, anesthetic or some sub-task costs.

Some healthcare providers, such as the Mayo Clinic and Intermountain Healthcare, have bucked the system and have implemented efficient practices resulting in dramatically reduced healthcare costs. This requires not only vision, but a large investment of resources to implement. Most healthcare providers are too constrained by their current financial situation to take such a risk. Goodman suggests a way for Medicare to reward innovations that will lead lower costs in the long run. It may be a start, but the whole idea of a government agency managing innovation strikes me as equally perverse and ultimately futile.

Healthcare's Portion of GDP

The U.S. Centers for Medicare and Medicaid Services recently published their health expenditure data for 2005 indicating what we all expected; that healthcare costs continue to rise. But what is perhaps even more pertinent is the rise in the percentage of the GDP healthcare consumes; 16% in 2005 up from 15.9% in 2004 and 13.7% a decade ago. At 16%, the U.S. leads the world in the percentage of our GDP we spend on healthcare, second place Germany spends 10.5%. This means we either have the absolute best healthcare in the world or a pretty inefficient way of providing healthcare to our citizens. The Organization for Economic Cooperation and Development which monitors metrics in determining the health of a country, such as life expectancy and infant mortality, do not indicate the former.

The implication then is that the healthcare system is inefficient. This of course is the topic of many a debate in the government and healthcare industries but what is not under debate is the aging of the baby boomers, now reaching their 60's, and the ensuing increase in demand for healthcare services that they will require. With the healthcare system in its current state I see healthcare costs per capita continuing to rise at least for the next decade. Justin Lahart in his column Ahead of the Tape in the WSJ has suggested that Washington and state capitals will focus on the problem and thus bring the price down. How? The White House plan is to move toward the free market approach; allow the consumers to pick up a higher share of the costs of their healthcare which will in turn put pressure on providers to become more competitive. This entails the reduction in tax breaks on generous healthcare plans provided by some employers to their employees. Economists point out that this encourages these people to use excessive amounts of healthcare which drives up the overall costs.

Under the White House plan health benefits would be considered income and subject to income and payroll taxes. There would, however, be a deduction of $15,000 per family per year or $7,500 per individual. The same deduction would be available whether the coverage came from an employer or the individual.

Although many details still need to be worked out in this plan, making the consumer more responsive to healthcare costs is certainly the free market approach to controlling ever increasing healthcare costs. In a true free market of course, the consumer would negotiate the costs directly with the provider thus putting pressure on the provider to keep costs in check. But with the high costs of healthcare and its extremely variable distribution among the population, a third party payer system seemed like the most reasonable way to handle the situation. This system has short-circuited the free market checks and balances which has reduced competition among healthcare providers and thus reduced their need in seeking efficiencies in keeping costs down. The result is as expected: costs in healthcare have risen faster than the of costs in the economy as a whole without a commensurate rise in healthcare quality. Although providers may be assumed to have the best of intentions, only economic pressures will force them to make the hard choices required to reduce waste and improve efficiency.