American Journal of Law & Medicine

Clinical practice guidelines: the warped incentives in the U.S. healthcare system.

The healthcare system is sick. The players are incentivized to maximize their own benefit and externalize their costs onto the other parties. This paper examines the warped incentives that underlie the system. The tort system, lacking expertise and slow to adapt, is unable to overcome cognitive biases to adequately solve the problems. Clinical practice guidelines could pose a solution, but not as they are currently developed. Guidelines promulgated by healthcare associations are infected by a web of conflicts of interest with every player in the industry. Government agencies, and their revolving doors, are underfunded and also subject to the industry's web of conflicts. Even if adequate guidelines could consistently be produced, state legislatures and courts have been unwilling and unable to substantially incorporate guidelines into the legal landscape. Lastly, this article proposes a private regulation regime that could be a solution which would align all of the players' incentives to society's interests.


Washington is boiling over healthcare reform. The landmark reform-called the Patient Protection and Affordable Care Act (ACA)--was signed into law on March 23, 2010, and was dubbed just ACA. (1) It seems every day brings a new headline discussing the Republicans' latest attempts to reverse ACA, (2) and the Democrats' promise to fight them. (3) Lost in the political spat, however, is what reforms would actually be effective. Everyone agrees that patients should be able to find cheap, safe, and efficient care. Not only is there disagreement as to how to achieve those goals, but, at least in Washington, there is very little discussion of the underlying principles behind the reform. Any healthcare reform must deal with at least three categories of costs: medical errors, defensive medicine, and what I call offensive medicine.

Medical errors are caused by fatigue, poor judgment, over-confidence, lack of resources, lack of training, and lack of communication. The costs of medical errors include unnecessary hospitalization, injury, loss of income, and suffering. Patients, their insurers, and the hospital all bear the costs of these mistakes.

"Defensive medicine" is excessive care provided to avoid liability. For example, an overly cautious doctor may order a CT scan when only an X-ray is medically necessary, thus externalizing the extra cost to the patient and his health insurer. (4) A recent Wall Street Journal Op-Ed piece estimated that defensive medicine costs on average $200 billion per year, although other estimates are significantly lower. (5)

"Offensive medicine" is excessive care which doctors provide in an attempt to maximize reimbursements. These costs usually include minor procedures, but can also include more lucrative treatments such as heart surgery. (6) These costs grow because, among other reasons, patients are insured for their health costs. Doctors are essentially in an all-you-can-treat system, with the same incentives to save as in an all-you-can-eat restaurant. President Obama has described this as a system of "warped incentives." (7) Similar to costs associated with defensive medicine, these costs are borne by both patients and their insurance carriers. Academics have long documented this problem--which economists call "induced demand"--yet no one has estimated its overall impact. (8) It is suspected, though, that the costs of offensive medicine are higher than the other two types of costs combined.

Some of the more promising proposals in Washington offer doctors immunity from medical malpractice in return for following evidence-based clinical practice guidelines. (9) These proposals make sense because a major role of medical malpractice liability is to create incentives for doctors to behave optimally. (10) It follows naturally to give immunity to those who behave optimally by delivering evidence-based medicine. Thus, medical errors would be addressed by incentivizing doctors to follow guidelines, and defensive medicine would be addressed by granting doctors immunity. However, these proposals miss perhaps the most important point: the intrinsic problem with the actual production of the evidence-based medical guidelines. If medical guidelines are not produced under appropriate incentives, then the guidelines produced are not optimal, the doctors following them are not behaving optimally, and immunity for doctors from medical malpractice is not justified.

In this paper I describe the costs of the current legal regime in terms of medical errors, defensive medicine, and offensive medicine. I also describe the problems with existing tort law and how it treats medical guidelines. I conclude by sketching a new alternative regime I call private regulation that may solve many of the intrinsic problems the current regime faces.



Currently healthcare is expensive--very expensive. In fact, ours is the most expensive healthcare system in the world, but it does not deliver measurably better outcomes. (11) There are many reasons why the healthcare system is so expensive, but in this paper, as mentioned above, I will focus on only three of the leading causes: medical errors, defensive medicine, and offensive medicine.

The law has tried to tackle these three problems separately. Offensive medicine is supposed to be controlled by various anti-kickbacks laws, (12) anti-self-referral laws (Stark laws), (13) utilization review, and by subjecting doctors to medical malpractice liability for negligent care. Defensive medicine is supposed to be controlled by utilization review and by enacting tort reform geared towards reducing doctors' liability. Medical errors are supposed to be controlled by subjecting doctors to tort law, specifically medical malpractice law, for committing negligent errors.

Using one policy tool, say tort law, to combat all these problems is problematic. Attempting to solve one problem immediately exacerbates another. For example, tort reform that reduces providers' liability does dilute incentives to perform defensive medicine, but at the same time has two adverse effects. First, it dilutes providers' incentives to take optimal care, thus potentially increasing costs from medical errors. Second, decreasing liability increases providers' incentives to perform offensive medicine. For example, providing an excessive bypass surgery is less risky when malpractice liability is capped. (14)

Indeed, tort law's primary mission is not to cure all three problems, but instead it focuses largely on medical errors. Tort law, in fact, is the primary way the legal system deals with medical errors by regulating providers' behavior. Unfortunately it does not do a satisfying job on that frontier. There are two necessary conditions for tort law to optimally regulate behavior under a regime of negligence. First, all negligence cases, not just the large ones, must be brought. If not all negligent cases are brought, then victims remain uncompensated for the harm they have incurred, and the signal from the legal system that is supposed to incentivize optimal behavior is distorted. Second, for cases that are brought, the court must find liability only when defendants were actually negligent (and caused harm thereby, to be technically correct). (15)

Even unbiased, random judicial error will cause defendants to be too careful or to engage in too little activity. (16) If courts are biased--for example if false negatives (erroneously finding doctors not to be negligent) are more common than false positives (erroneously finding doctors negligent)--or if courts' random errors are relatively large, the problem worsens. (17) The major reasons courts make biased decisions are the "identifiable other effect" and "hindsight bias." The major reason courts can make relatively large random errors is that they lack expertise in dealing with complex medical issues. Lastly, the nature of the common law limits courts' ability to incentivize (or at least not to impede) medical progress. What follows is a discussion of these barriers to the legal system, court biases, errors and limitations.

1. Barriers to the Legal System

Although it is commonly perceived that Americans sue too often, evidence indicates that the opposite is true. Several important studies have analyzed the number of malpractice claims filed relative to actual cases of negligence. The most cited study is the Harvard Medical Practice Study (HMPS), which focused on hospitalizations in fifty-one hospitals in New York during 1984. (18) The researchers matched cases of negligent injury with actual claim filings, and determined that only two percent of those who were negligently injured sued. (19) A similar 1992 study focusing on hospitalizations in Colorado and Utah found similar numbers; only 2.5% of those who were negligently injured filed a claim. (20) Lastly, these findings were consistent with a late 1990s Florida study that found that of 19,885 incidents of medical negligence self-reported by hospitals, only 3,177 patients filed claims. (21)

There are a number of barriers that prevent malpractice victims from pursuing claims, but I will discuss only two. First, many patients may not even realize that they have a valid claim. Even for those forms of negligence that cause great harm, patients may lack the ability to connect the dots. (22) For example, a wrongly-interpreted test result may cause the unnecessary progression of a harmful disease that does not begin debilitating the patient until the test itself is a distant memory. The problem may be amplified by the fact that the doctor who committed the error holds much of the information on whether an error occurred. (23)

Second, many aggrieved patients can be deterred from pursuing claims by the disproportionate cost, time, and stress of litigation in comparison to the amount of damages likely to be recovered. (24) The high cost to benefit ratio is often caused by high discovery costs, expensive expert witnesses, state-exacted tort reform which limits the recovery, and the typical defendant litigation strategy of fighting even meritorious claims. (25) Due to these high costs, most patients must find contingency fee attorneys. These lawyers have an incentive to take only the most lucrative cases, leaving many victims of malpractice without recourse. These "orphan" victims often come from states that enact tort reform, such as caps on damages.

2. The Identifiable Other Effect

There is some evidence suggesting that courts seem to compensate the injured when their harm is large, even in the absence of negligence. (26) Indeed, the urge to compensate victims is so strong that courts in the United States have developed various doctrines that appear at times to award plaintiffs as much compensation as possible. For example, the doctrine of lost chance (a doctrine which is primarily applied to medical malpractice) allows partial recovery even when the patient was already likely to die prior to her interaction with the doctors The reason for courts' bias toward the compensation goals could well be rooted in the identifiable other effect. As first noted by Thomas Schelling, identifiable victims stimulate more powerful emotional reactions than do statistical victims. (28) For example, over $700,000 was donated to rescue 18-month-old Jessica McClure ("Baby Jessica") when she was trapped in a well in Texas. The same $700,000 could have potentially saved many more lives if spent on preventative health care for children. (29) For various reasons, people seem to care more about identifiable victims than statistical victims. (30)

Recently, commentators have claimed that the identifiable victim effect is just an example of a more general tendency to react more strongly to identifiable others, whether they are victims or perpetrators. (31) If correct, the "identifiable other effect" suggests that courts react more strongly towards both the identified defendant-doctor and the identified plaintiff-victim, treating the identified doctor more harshly and the identified victim more sympathetically. This can lead to many more (presumably erroneous) findings of negligence compared to adjudication based on the efficiency of guidelines per se, a task that involves dealing with statistical victims and statistical doctors. (32)

3. The Hindsight Bias

Another well-known problem that courts suffer from is the hindsight bias, which emerges because courts engage in ex post analysis. Because of hindsight bias, "people consistently exaggerate what could have been anticipated in foresight." (33) Thus, under the current medical malpractice negligence regime, doctors may be found liable when their patients are injured even though the doctors behaved reasonably. Anticipating courts' hindsight bias and the impossibility of eliminating or even moderating it, doctors may be rational in practicing defensive medicine. (34) This problem has been noticed by courts, which use various techniques that potentially moderate the hindsight bias. (35) But the actual success of these techniques is an open question. Consider the way courts treat compliance with medical custom (but not with custom in other industries). In most jurisdictions such compliance is virtually a complete defense. (36) This should eliminate hindsight bias and reach the efficient outcome, but only if the custom evolved is indeed efficient. But there are reasons to doubt that an efficient custom will evolve in medicine, due to the heterogeneity of patients' medical conditions, patients' ignorance of the appropriate care they should receive, patients' unequal financial conditions which ultimately determine the level of health care they receive, and the myriad agency problems between doctors, hospitals and payers. (37)

4. The Lack of Expertise

In addition to bias problems, courts suffer from a lack of expertise and information. Courts deal with the few who were injured by a given treatment rather than the many who benefited from that same treatment. This selective perspective is problematic because medical treatment is often probabilistic, not deterministic. The most appropriate course of action may involve a treatment that likely leads to a patient's recovery but also involves a small chance of exacerbating the patient's condition. But courts often lack the relevant evidence on the comparative benefits of the treatment, especially with new treatments. This problem might cause courts to find negligence even when the practice under review was cost-beneficial.

Moreover, even if the information on the relative value of various treatments exists, courts are unlikely to get it right. Many of the cases litigated deal with complex medical issues, and the likelihood that fact-finders (whether bench or jury) with little expertise will get things right is not promising. Expert witnesses do not solve the problem either, as these experts often are ex-doctors who make their living by providing expert testimony. These ex-doctors are usually no longer involved in active doctoring and potentially testify for the highest bidder. Judge Posner described expert witnesses as "paid liars." (38) Cross-examination of experts does not improve the jury's understanding of the problem, as cross-examination often deteriorates into haggling over credentials. (39)

A possible, yet only partial, solution to this problem would be to establish a health court system of administrative compensation for medical injuries, similar to the way injuries at work are handled. In February, 2011, the Obama administration announced its plan to do exactly that. Two of the potential advantages of such a system include the cultivation of a culture of transparency regarding medical errors and the creation of mechanisms for gathering and analyzing data on medical injuries. Indeed, several foreign countries--New Zealand, Sweden and Denmark--have already implemented such a system. (40) As attractive as this solution is, it is controversial and politically difficult. Moreover, health courts by themselves do not require a specific standard to judge doctors' behavior, and are susceptible to the other problems highlighted in this section.

5. Common Law and Medical Progress

Another limitation of the common law is that it fails to encourage systematic knowledge-production as well as continuously updated behavior-regulation mechanisms. Unfortunately, the current system is inadequate with respect to both investigation and adoption of new medical procedures. The investigation of procedures such as surgical techniques is often left to the creativity and improvisation of any willing physician, which is of course problematic. (41) In most cases, a new procedure does not require the approval of any governmental agency. But still, physicians interested in developing new techniques face numerous informational barriers, as well as additional tort liability risk. Often an individual physician will see too few patients needing a particular procedure to confirm that an innovative procedure is a significant improvement. This is problematic since adopting new procedures can be costly (in terms of training, infrastructure, and the risk of being perceived as having adopted a poor procedure).

Even for those procedures already proven superior, significant barriers to adoption by physicians exist. …

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