A L ESSON IN H EALTH E CONOMICS C HAPTER 13 Code Blue Health Science Edition 4

Lack of proper incentives for cost control In a free enterprise market economy, the market provides incentives for cost control. In a free enterprise market economy, the market provides incentives for cost control. There is no “market mechanism” in healthcare. There is no “market mechanism” in healthcare.

Lack of Proper Incentives When people shop on the basis of price... When people shop on the basis of price... This creates cost competition... This creates cost competition... Which provides an incentive for businesses to keep costs low. Which provides an incentive for businesses to keep costs low. There is no such incentive in the healthcare industry. There is no such incentive in the healthcare industry.

Lack of Price Competition When is the last time you heard someone say: When is the last time you heard someone say: “Where can I get a cut-rate price on a brain operation?” or “Where can I get a cut-rate price on a brain operation?” or “Who is the cheapest doctor in town?” “Who is the cheapest doctor in town?”

In addition... Most products in a market economy have prices that can be determined before they are purchased. Most products in a market economy have prices that can be determined before they are purchased.

In addition... This is not true of healthcare. This is not true of healthcare. Doctors and hospitals don’t post their charges, and... Doctors and hospitals don’t post their charges, and... Most patients don’t know the cost of the products they purchase until they receive a bill. Most patients don’t know the cost of the products they purchase until they receive a bill.

Are there other reasons doctors didn’t have a real incentive to control costs? Yes, one of these had to do with the way doctors and hospitals were paid. Yes, one of these had to do with the way doctors and hospitals were paid. Hospitals traditionally were paid cost plus a small margin for profit. Hospitals traditionally were paid cost plus a small margin for profit. This was called cost reimbursement. This was called cost reimbursement. Cost reimbursement provided few incentives for cost control. Cost reimbursement provided few incentives for cost control.

Cost Control If you were the administrator of a hospital that received full cost as your payment for services, plus a 3% profit, what is one easy way you could increase profits? If you were the administrator of a hospital that received full cost as your payment for services, plus a 3% profit, what is one easy way you could increase profits? Increase costs—or at least do little to control them. Increase costs—or at least do little to control them.

Hospital Reimbursement The government tried to correct this problem in the early 1980s by establishing a fixed price for all products and services. The government tried to correct this problem in the early 1980s by establishing a fixed price for all products and services. This was known as fixed price payment or fixed price reimbursement. This was known as fixed price payment or fixed price reimbursement.

Hospital Reimbursement With fixed price reimbursement, hospitals and doctors would absorb the cost of inefficiency. With fixed price reimbursement, hospitals and doctors would absorb the cost of inefficiency. If costs were higher than the fixed payment they were to receive, they would lose money. If costs were higher than the fixed payment they were to receive, they would lose money. Hence, there now became an incentive to control costs. Hence, there now became an incentive to control costs.

Hospital Reimbursement Fixed price payment is also called prospective payment or prospective reimbursement. Fixed price payment is also called prospective payment or prospective reimbursement.

Hospital Reimbursement One type of prospective reimbursement is Diagnostic Related Group (DRG) reimbursement. One type of prospective reimbursement is Diagnostic Related Group (DRG) reimbursement. Medicare classified all illnesses into approximately 400 categories. Medicare classified all illnesses into approximately 400 categories. A fixed price was set for each product. A fixed price was set for each product.

Hospital Reimbursement If the hospital’s actual costs to treat the patient were less than the fixed payment, they made an additional profit. If the hospital’s actual costs to treat the patient were less than the fixed payment, they made an additional profit. If the costs were higher, the hospital had to absorb the loss. If the costs were higher, the hospital had to absorb the loss.

Hospital Reimbursement DRG reimbursement provided an incentive to keep costs down. DRG reimbursement provided an incentive to keep costs down. All of this happened in about All of this happened in about Obamacare, or the Patient Protection and Affordable Care Act, will use prospective reimbursement as one of its tools to control costs. Obamacare, or the Patient Protection and Affordable Care Act, will use prospective reimbursement as one of its tools to control costs.

Other Incentives Another way that the government and the insurance industry has tried to provide incentives for cost control is through managed care. Another way that the government and the insurance industry has tried to provide incentives for cost control is through managed care.

Managed care tries to keep costs down by: Negotiating lower prices with doctors and hospitals Negotiating lower prices with doctors and hospitals Mandating that patients go to specific doctors and hospitals Mandating that patients go to specific doctors and hospitals Making patients get a second opinion before getting an expensive procedure or operation Making patients get a second opinion before getting an expensive procedure or operation Encouraging patients to use generic drugs Encouraging patients to use generic drugs

Managed Care Not everyone likes managed care. Not everyone likes managed care. Doctors feel that insurance companies are telling them how to practice medicine. Doctors feel that insurance companies are telling them how to practice medicine. Patients don’t like being told where to go for treatment. Patients don’t like being told where to go for treatment. The issue is cost versus choice. The issue is cost versus choice.

If you don’t like the system... If you don’t like the system... Then you and those of your generation will have to fix it. Then you and those of your generation will have to fix it. The students in your class who go on to become healthcare professionals, will face problems far more severe than any previous generation of healthcare professionals. The students in your class who go on to become healthcare professionals, will face problems far more severe than any previous generation of healthcare professionals.

Redesign of System If the healthcare delivery system of tomorrow is to meet the needs of the American population, physicians, nurses and other health professionals will have to take the system back from the businessmen, accountants and actuaries. If the healthcare delivery system of tomorrow is to meet the needs of the American population, physicians, nurses and other health professionals will have to take the system back from the businessmen, accountants and actuaries. Both groups are needed, of course, but more input is needed from doctors and nurses. Both groups are needed, of course, but more input is needed from doctors and nurses.

Redesign of System In a sense, you will play the role of Wes Douglas, except you’ll be trying to save the American healthcare delivery system, instead of just one hospital. In a sense, you will play the role of Wes Douglas, except you’ll be trying to save the American healthcare delivery system, instead of just one hospital. To fix the system, you will need to understand how it works. To fix the system, you will need to understand how it works.

The End Children’s Hospital—Buffalo, New York