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In the Nation's Interest

Whither Health Care Reform

After watching the efforts to reform U.S. health care over the past 5 years, I have concluded that health care reform will have to proceed from the bottom up and not from a top down approach like that of the recent bill, the Affordable Care Act. Reform is threatened by a Federal debt crisis that would throw health care into a survival mode with slash and burn cost cutting and no innovation. The quality of care would be at severe risk.

Health care in the U.S. now costs 18% of GDP. Eighteen percent of a $14 trillion economy is $2.5 trillion. That's a lot of dollars. A million seconds is about two weeks; a trillion seconds is about 30,000 years. In economic resources applied, health care in the U.S. is bigger than the entire economies of all but four other countries, Japan, Germany, India, and China. It is bigger than the entire economy of the UK or France. We're not devoting the level of competence and experience required to address the reform of such a large amount of economic activity.

Reform of the U.S. health care system requires solving three main problems:

  1. Our insurance and provision of care doesn’t cover fully or adequately 10-15% of our population.  Emergency room care of this population treats only acute problems, and not chronic conditions.  That’s not good care for this population and it’s an inefficient way to practice medicine.
  2. We have practically no limits on how much health care patients can ask for.  Our insurance is usually heavily subsidized by our employer and the Federal government.  Once we have paid our part of the premium, it doesn’t cost us to ask for more.  Moreover, the incentive system for doctors and hospitals, the fee for service system, results in more compensation from more activity.  The professional standards in medicine partially counterweight this incentive.  However, the standards are not perfect and are not the same in every part of the country.
  3. The provision of health care in many cases is inefficient and inconsistent, relative to the potential productivity.

In 2007, the Committee for Economic Development issued a report that addressed all three of these problems.  It remains today the only comprehensive proposal for health care reform in the U.S.  The Wyden- Bennett health care reform bill embodied many of the same proposals.  This bill attracted no interest from the political leadership in Washington.  The Democrats were interested primarily in coverage.  The Republicans were interested primarily in handing the President a defeat.

The Affordable Care Act passed by the slimmest possible margin.  In September, 2009, the seating of Al Franken from Minnesota meant that the Democrats had attained the ability to stop a Republican filibuster in the Senate.  However, the Senate wasn’t ready to vote on a health care reform bill until December.  By January, with the surprise election of the Republican Scott Brown in Massachusetts, the Democrats had again lost their ability to stop a Republican filibuster in the Senate.  So there was only a one month window in which the Affordable Care Bill could have passed the Senate.  The President and the House had to accept the Senate version of the bill because the Senate could not vote again.  Whatever the merits of the bill, this is no way to attempt to organize economic activity greater than the entire UK economy.

So we got coverage.  We will pay for coverage by raising fees and taxes, and cutting reimbursements, primarily to hospitals, which will charge private patients more.  We’ll cut back on Medicare Advantage.  Embedded in the bill also are a number of worthwhile insurance reforms.  The insurance industry is one of the least competitive industries.  Abuses of good practice have crept in; many will be corrected by the bill. 

How about the other two problems: unconstrained demand and below potential productivity?  We’re still asking for more and more health care.  The Congressional Budget Office was the truth teller in the debate about the bill.  It said that the President’s and Senate Finance Committee’s estimates of what the bill would cost were not right.  The CBO has been proved correct.  In the justification of the bill was the assumption that the sustainable growth rate for Medicare expense was going to be adhered to.  However every year when it comes to cutting reimbursements to doctors, the Congress has voted not to do that.  So the CBO said “we don’t think you’ll do it in the future either.” Sure enough, two months after the bill passed, the Administration proposed to the Congress that the sustainable growth rate be put aside again for doctors’ reimbursements.

The third problem of improving quality and efficiency through productivity improvement: we have an untested, theoretical regulatory approach to reform.  That doesn’t mean it won’t work, but there are serious reasons to be concerned about why it might not. 

Let’s take these issues one at a time.  On unconstrained demand, the new bill has a national board to evaluate evidence associated with procedures and treatments and to decide whether Medicare should reimburse for them.  This mechanism is not entirely new.  The UK has been doing it for a couple of years.  Actually Kaiser has been doing it in the U.S. for a long time.  Kaiser, for example, decided against paying for Vioxx.  Kaiser gets away with it because its customers are not locked into Kaiser’s services.  Kaiser’s customers have a choice.  For instance, they can choose another plan that would provide Vioxx, but at a higher premium.  Eighty percent of those with a choice between Kaiser and a fee for service insurance plan choose Kaiser.  Five years later surveys of these patients of Kaiser indicate 80% are satisfied with their choice.  They are satisfied because they have made the choice themselves.

In Medicare, enrollees don’t have the same freedom of choice.  They can get individual insurance supplements, but it’s quite expensive.  The risk for the new board is that the Medicare population will object to restrictions and will say “we want this stuff.” They will go to their Congressman and demand it.  Congress is very likely to cave and the determinations of the board will not hold.  Growth in costs will not be constrained.

With regard to quality and efficiency, the average cost in the U.S.  to care for a Medicare enrollee is 50% greater than best practice in the U.S.  These results are for large populations with no significant differences in health outcomes.  This situation can not occur elsewhere in our economy.  If you have a product in Virginia that is 50% better or costs 50% less than the equivalent product offered in Florida, the Virginia providers go to Florida and compete.  Best practice in the U.S. for cost per Medicare enrollee is in the upper Midwest and central Virginia.  But central Virginia and the upper Midwest don’t go to Florida and compete for the provision of health care.

I once asked a former, long-time CEO of Kaiser why he didn’t expand Kaiser to become the Walmart of health care and acquire a 40% market share nationally. (Kaiser enrolls about eight million people or 2% of the U.S. population.) He said the difficulty of expanding is a nightmare.  Incumbent physicians and state insurance regulators are in collusion and make it extremely difficult to establish new practices on a large scale.  Kaiser’s withdrawal from an attempt to enter the Research Triangle in North Carolina is the most widely known case.
How does the Affordable Care Act attempt to improve quality and efficiency?  It uses the carrot and stick.  There will be penalties of reduced Medicare reimbursements for less than what Medicare considers best practice standards of care. This approach will do some good.  However, it is difficult to see how this will bring about changes to make other states match the quality and efficiency of the upper Midwest and central Virginia.  Whatever measures Medicare ends up with, they will affect only a modest fraction of the total provision of health care.

We don’t have in the Affordable Care Act the generation of market forces that would make the transfer of best practices happen rapidly and on a large scale.  In health care a patient in Florida cannot choose Virginia medicine. Don Berwick, new head of the Center for Medicare Services, gave his maiden speech at the Brookings Institution last fall.  He gave a very clear diagnosis of the problems of the U.S.  health care system.  He never once used the word “market” in his discussion of solutions.  The phenomenon of best practice providers taking their quality and efficiency into new markets and forcing providers in those markets to improve or get out a way does not happen in medicine.  The result is we have to resort to regulatory control.

There is a reasonable chance that these efforts at regulatory control will collapse under the pressures of the complexity of the system and political difficulty of getting them accepted.  Regulating medicine is far more difficult than regulating the financial industry, and we all know how well the regulators did there.

The Affordable Care Act also relies on Accountable Care Organizations to improve quality and efficiency.  The focus of these organizations is on the integration of care.  This integration is crucial for best practice care of chronic diseases such as diabetes. 

In the mid 1990s, the McKinsey Global Institute compared the operational productivity of the health care systems of Germany, the UK, and the U.S. for the treatment of four diseases, gallstones, breast cancer, lung cancer, and diabetes.  U.S. had the highest productivity for the three acute diseases.  However for the one  chronic disease, diabetes, the UK had the highest productivity.  The reason was that the UK was better at reducing the rate of complications, which is where most of the cost of treating diabetes resides.  As with Kaiser, the UK had the incentive of reducing the total costs of treating a chronic disease.  That means that diabetics are monitored closely to detect early the onset of conditions that would lead to complications.  Such activity is not reimbursed under the U.S. fee for service system.  Accountable Care Organizations are meant to correct for this deficiency.

The proposed regulations for Accountable Care Organizations (ACOs) are out for comment, all 450 pages.  The regulations are complicated and have potential problems.  If ACOs have savings from integration, they get to keep part of the savings.  The problem is how do you calculate the savings.  What would the costs otherwise have been?  Any method is going to be contentious because there is no rigorous analytical way to calculate the savings.

And to get whatever savings are calculated, ACOs will have to meet 45 other conditions that have to do with policy standards related to best practices.  There are also elements of bundling care into program- like payments, including capitation.  Savings are to be shared between the government and the provider, but again, savings compared to what?

The last major element of the bill are exchanges.  They are the one market- like mechanism of the bill.  They were the heart of the Committee for Economic Development proposal and the Wyden-Bennett bill.  The exchanges are markets set up by the government on a level playing field basis but markets in which the government does not participate.

There were no advocates for the exchanges among the political leadership and among the major lobby groups.  You would have thought business would be in favor of them.  However, the Business Roundtable opposed the Wyden-Bennett bill and Wyden’s amendments to the Affordable Care Act.

The Roundtable cut a deal with the White House that the Roundtable would not oppose whatever reform legislation could pass as long as that legislation did not affect large businesses significantly. These businesses wanted to delay the intervention of government as long as possible and retain control of the health insurance provided their employees. That control has resulted in very little price competition between fee for service docs and salaried docs within a capitation system.

The exchanges would give individuals choices among different health care plans.  There would be competition between fee for service plans and capitation plans, including HMOs.  The California State Personnel System has successfully implemented such a plan.  The potential cost savings to enrollees are 20- 30%.

The difficulty is that the final version of the bill delegated the establishment of exchanges to the individual states.  This is complex stuff.  It’s analogous to delegating to each individual state the establishment and management of its own individual currency.  California might be able to it because of its experience and size, but not many other states can.  The Wyden-Bennett bill proposed 4-5 regional exchanges.  It is unlikely that individual state exchanges will go anywhere.

So where then do we go from here?  Reform will likely progress from the bottom up rather than from the top down.  The current top down approach has too much confusion and uncertainty.  One thing is certain.  Costs will be under never ending pressure.  For operating health care providers, the one safe harbor strategy in these circumstances is to make sure you meet all best practice quality standards with  costs lower than those of your competitors.  Problems will then occur for them first and you will have time to watch and react without going into a crisis mode.

Hospitals will take the lead.  They are the natural integrators of care.  They see acute episodes, where chronic problems usually first show up.  Physicians’ practices are specialized and fragmented.  This is already starting to happen.

The Community Hospital of the Monterey Peninsula in California self- insures the health care of its employees.  That hospital’s health plan group started two years ago to integrate the care hospital employees receive from various physicians groups and the hospital itself.  Care managers (case managers) coordinate the care for employees with chronic diseases.  The hospital is already seeing substantial cost savings.  The program is so successful that the hospital’s health plan group is offering the same service to large employers in the Monterey Bay area.  The hospital is practicing medicine the way it thinks it should be practiced.  Reimbursements will be what they are, but the care of the hospital’s patients will be better and its costs will be lower than for its competitors.

It’s hard to know where this model will lead.  All doctors could effectively become employees of the hospital.  The idea is to practice medicine with the right incentives as far as possible.

The expansion of this sort of best practice will not occur by doctors moving to new locations and hospitals acquiring other hospitals.  This is simply too difficult in the current health care environment.  However doctors and hospitals will learn from each other.  This will mean that the lessons of implementation will have to be learned over and over again.  This is inefficient.  Walmart opens a new store by moving experienced people to a new location, not by sending untrained people to observe an existing store and then have them start up a new store.  However, that’s the way it’s going to have to be in health care.  Still, best practice models could spread fairly rapidly because the people involved are smart, the insistence on quality is intense, and the pressure on costs is severe.  So in 25 years, the majority of health care provision in the U.S. could be integrated.  That is if we have 25 years to do it.

The serious threat to health care reform is the growing Federal debt.  Of course much of the growing Federal debt is coming from the increased cost of Medicare.  We’re borrowing from China to pay Medicare bills and that can’t go on.  If we had entered this period of baby boomer retirement with low debt, we could borrow to get over the demographic hump.  We could buy time to fix the system.  But now the Federal debt is 62% of GDP, when 60% is the limit of prudence.  And we really haven’t started to fix the health care system yet.  No matter what, you don’t fix a part of the economy bigger than the entire economy of the UK overnight.

So U.S. citizens and foreign governments will become reluctant to lend to the U.S. government for fear of not being paid back.  To continue lending to the U.S., investors need confidence that we are fixing the health care system.  That’s the biggest failure of the Affordable Care Act.  It does not instill confidence in the financial markets around the world that the U.S. is fixing its health care problem.  It didn’t convince Standard & Poor’s and Moody’s and it’s not going to convince a lot of other people.

The U.S. may have a financial crisis the way Russia did in 1998 or Greece, Ireland, and Portugal are having today.  The U.S. hasn’t seen anything like this since the 1930s.  The recession of the past three years is nothing in comparison.  In a real financial crisis, you have to cut to the bone.  You have to fix the budget when the economy and the resulting Federal tax revenues are declining significantly.  So what’s the quick fix for Medicare?  You get a sustainable growth rate that’s negative.

In these circumstances there’s no alternative but fewer people and less compensation.  You can imagine the difficulties of delivering adequate care.  It would be impossible to make structural reforms and to continue to innovate. 

So is the U.S. in a Catch 22 situation for health care?  Does it no longer have the time needed to reform health care in the only way the country seems capable of?  Time will tell.  But it’s tragic to be caught in this situation because so much more was possible.

William Lewis is Director Emeritus of the McKinsey Global Institute and a Trustee of the Committee for Economic Development. This paper is based on remarks delivered to the Lynchburg Virginia Academy of Medicine on May 12, 2011. The views in this article are solely the author's.