American Journal of Law & Medicine

Follow the money: money matters in health care, just like in everything else. (Follow the Money: The Impact of Economic on the Delivery of Health Care)

    I suspect that our collective search for villains--for someone to    blame--has distracted us and our political leaders from addressing    the fundamental causes of our nation's health-care crisis. All of    the actors in health care--from doctors to insurers to    pharmaceutical companies--work in a heavily regulated, massively    subsidized industry full of structural distortions. They all want    to serve patients well. But they also all behave rationally in    response to the economic incentives those distortions create.    Accidentally, but relentlessly, America has built a health-care    system with incentives that inexorably generate terrible and    perverse results. Incentives that emphasize health care over any    other aspect of health and well-being. That emphasize treatment    over prevention. That disguise true costs. That favor complexity    and discourage transparent competition based on price or quality.    (1) 


In health care, as in everything else, money matters. Of course, money is not the only thing that matters--but it matters a lot--perhaps more than all the other factors combined. What we pay for and how we pay for it profoundly affects the care that is provided (and not provided), the settings in which care is provided (and not provided), and the lives and fortunes of those providing and receiving the care and those presented with the bill.

If all were well with the health care system, the observations in the prior paragraph would be of no particular significance. Thus, no one would be much interested in the observation that auto mechanics, plumbers, actors, bicycle messengers, and newspaper reporters also respond to economic incentives--and that misaligned incentives can have adverse consequences. Yet, to say the least, all is not well with American health care. Whether the subject is the quality of care that insured and uninsured Americans receive, the cost of coverage and of receiving care, Medicare's fiscal projections, the burdens Medicaid imposes on the states, the cost of pharmaceuticals, the availability of primary care physicians, the wide variation in cost and treatment patterns, the continued viability of employment-based health insurance, or the dysfunctions of the medical malpractice system, it is clear there is no shortage of problems with the U.S. health care system.

What all of these problems have in common is that some (and, more often than not, most) of the blame is properly attributable to misaligned economic incentives. Instead of trying to address that problem, past efforts have focused on a "collective search for villains," with the specific identities of the villains varying, depending on the political and philosophical commitments of the searchers. These efforts have been time-consuming, and have created steady work for lobbyists, lawyers, law professors, and policy wonks, but they have had about the same impact as the witch trials that swept Europe from 1400-1600 and Salem, Massachusetts from June-September, 1692: deeply satisfying for those who perceive they are doing "God's work," intensely unpleasant (and sometimes lethal) for the targets, but providing little actual improvement in the state of the world. Stated more positively, unless and until we alter the core incentives created by our existing payment system, we will get more of what we've already got--a dysfunctional non-system that delivers uncoordinated care of widely varying quality at a high cost. (2)

Part II provides a number of examples of how "money matters" in health care, and details the adverse consequences that have resulted from ignoring that basic insight. Part Ill details how the latest iteration of health reform has, in important ways, made things worse by "doubling down" on coverage without addressing these incentive problems. Part IV considers what we can learn from Massachusetts' 2006 health reform efforts. Part V concludes.


It is difficult to overstate the extent to which economic incentives explain the structure, performance, and pathologies of the American health care system. I focus on three examples, all of which present discrete variations on a common theme.


With limited exceptions, our health care system relies on an encounter-based, quality insensitive, fee-for-service system of compensation. In general, health care providers can lawfully bill for their efforts only when they physically interact with a patient or interpret a test that required direct physical interaction with the patient. Each such interaction generates a bill, with the amount billed varying greatly, depending on the nature of the service/interaction. However, payment does not vary based on the quality of the service or on its medical necessity. There are also almost no constraints on the volume of the services that may be provided as long as a licensed health care provider deems them necessary.

The consequences of this approach to compensation are quite predictable: we have a system that aggressively delivers massive quantities of health care services in a highly fragmented non-system, but pays little attention to whether the services in question actually contribute to health. Worse still, there is usually no "business case" for improving matters; delivering higher quality care and/or keeping one's patients healthier can actually make a provider financially worse off. (3)

Consider the experiences of three different providers, whose efforts to improve the quality and cost-effectiveness of the services they were providing ran head-first into the incentives created by an encounter-based, quality insensitive, fee-for-service payment system. In 1998, Duke University Medical Center implemented a disease management program focusing on congestive heart failure ("CHF"), a major source of morbidity and mortality in the elderly population. The Duke Heart Failure Program ("DHFP") emphasized a range of tactics (including aggressive use of medications and biweekly phone calls by nurse-practitioners) designed to keep patients with CHF healthy and out of the hospital. The DHFP was extremely successful; the rate of hospitalization plummeted as the health of patients with CHF improved. (4) Unfortunately, between the "extra" costs of the DHFP and the lost revenue from hospitalizations that no longer occurred, Duke was financially punished for making its patients healthier. Duke eventually discontinued the program.

Similarly, Virginia Mason Medical Center ("VM") sought to improve the quality of care it delivered for four common conditions (uncomplicated lower back pain; gastroesophageal reflux disease ("GERD"); migraine headaches; and cardiac arrhythmias). By reengineering its care processes, VM made considerable progress in improving the quality of care it was delivering and lowered the cost of treating individuals with those four conditions. Unfortunately, many of these changes predictably resulted in less revenue for VM. (5) As a set of external reviewers dryly noted, "all parties agreed that the project's sustainability requires solutions for VM's potential revenue losses...." (6)

A few years later, the same dynamic snared Intermountain Health Care in Utah:

    When Intermountain standardized lung care for premature    babies, it not only cut the number who went on a ventilator by    more than 75 percent; it also reduced costs by hundreds of    thousands of dollars a year. Perversely, Intermountain's revenues    were reduced by even more. Altogether, Intermountain lost    $329,000. Thanks to the fee-for-service system, the hospital had    been making money off substandard care. And by improving care--by    reducing the number of babies on ventilators--it lost    money. As James tartly said, "We got screwed pretty badly on    that." (7) 

There is no shortage of similar examples. Professor Alain Enthoven recently recounted a conversation with "the chancellor of a famous academic medical center [who complained]: 'we introduced innovations that saved thousands of dollars in patient care and the result was that we lost the dollars in revenue.'" (8)

Roughly 20% of Medicare beneficiaries that are discharged from the hospital will be readmitted within 30 days. (9) Hospitals have little incentive to prevent such readmissions, since Medicare routinely pays them for both admissions--and past attempts to address the problem without changing the underlying incentives have had no real impact. (10) Nosocomial infections present a similar dynamic; hospitals have an inadequate incentive to prevent such infections as long as they are paid the same (and sometimes more) if a hospitalized patient becomes infected. (11) Few health care providers use sophisticated IT to ensure the quality of care they deliver, but virtually all health care providers have computerized their billing operations--because only the latter translates into a direct positive impact on the bottom line. (12) Anesthesiologists knew that patient monitors detected misintubations but did not buy them because they were expensive. (13) Studies of numerous provider-sponsored quality improvement programs find that there is almost never a business case for quality. (14)

These problems are pervasive; as I summarized matters in an earlier piece:

    In health care, we get what we pay for--and what we pay for is    the provision of specific services--virtually irrespective of    whether they are provided efficiently, or even needed. Because    payment is conditioned on the laying of hands (or eyes) upon a    patient, time spent coordinating care doesn't create a billing    opportunity. When we don't pay for something, it generally    doesn't get done. Similarly, providing integrated care doesn't pay    better than fragmented care--and in some instances, it pays    worse. … 

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