[SOLVED] Develop Strategies to Allow Healthcare Institution’s Cost Structure to be More Flexible – Health Medical

Your hospital organization is experiencing several negative trends. First, procedures which were formerly performed exclusively at a hospital are now being performed at outpatient facilities. Also, insurance companies are reimbursing less for similar services than they did previously. Insurance companies are requiring patients to be held in observation status instead of admitting the patient to the hospital. The hospital incurs similar costs but receives approximately 1/3 the rate of reimbursement. The hospital cost structure was developed over years where reimbursements were very different. The hospital has a high-cost structure, which is hard to maintain in the new environment. You are to prepare a report to the board of directors developing strategies to bend the cost curve and make the cost structure more flexible.Length: 5-7 pages, not including title and reference pages (in lieu of a report you can prepare a 5-10 slide PowerPoint presentation)Resources: Include a minimum of 3-5 scholarly resources related to your issueMHA-5009 V1: Health Economics (3578369450) – MHA-5009 V1: Health Economics (3578369450)
2/12/21, 9:58 PM
MHA-5009 V1: Health Economics (357836945…
FB
Week 5
Economics of Healthcare Costs
The nature of cost has major implica!ons regarding services a healthcare
organiza!on will offer. There are three main types of costs:
Fixed Costs: Total fixed costs remain constant regardless of
volume but fluctuate on a per-unit basis. An example is a piece of
equipment. An MRI costs $1.5 million regardless of whether the
organiza!on performs 100 procedures or 1,000 procedures.
However, the cost per procedure varies, as the cost of the
procedure would be $1,500,000÷100 = $1,500 per procedure; or
if the volume is 1,000 procedures, then the cost per procedure
would be $1,500,000÷1,000 = $150. The $1.5 million does not
change, but the per-unit cost does as volume adjusts.
Variable Costs: These costs are the opposite of fixed. Per unit cost
remains the same regardless of volume, but total costs change
with volume. Examples are supplies and drugs. A drug may cost
$100 per unit, so 100 units the total cost is $10,000; and for 200
units, it’s $20,000.
Semi-Fixed/Variable: These costs, some!mes referred to as stepcosts, are both fixed and variable. These costs are mainly fixed but
need to adjust to reflect new volume at certain steps. Take the
MRI example. If there is one shi# for the MRI, staffing would
reflect that need. But if the organiza!on sees a need for a second
https://ncuone.ncu.edu/d2l/le/content/251482/printsyllabus/PrintSyllabus
Page 1 of 5
MHA-5009 V1: Health Economics (3578369450) – MHA-5009 V1: Health Economics (3578369450)
2/12/21, 9:58 PM
shi#, the new staff is required, thereby stepping the costs. This is
important, as the cost structure changes profitability at a certain
level of volume.
”
Launch in a separate window
Cost structures are important in determining the compe!!ve advantage
of an organiza!on. Organiza!ons want flexible cost structures so they
can react quickly to changing market condi!ons. Healthcare ins!tu!ons
historically have not been flexible. Cost structures are heavily fixed
compared to other industries. In !mes of increasing volume and revenue,
fixed-cost organiza!ons experience increasing profits; but in !mes of
decreasing volume and revenue, fixed-cost organiza!ons have difficulty
in adjus!ng their costs and experience financial difficul!es. Adjus!ng a
https://ncuone.ncu.edu/d2l/le/content/251482/printsyllabus/PrintSyllabus
Page 2 of 5
MHA-5009 V1: Health Economics (3578369450) – MHA-5009 V1: Health Economics (3578369450)
2/12/21, 9:58 PM
healthcare ins!tu!on’s costs is o#en compared to turning an aircra#
carrier around.
0 % 0 of 5 topics complete
Books and Resources for this Week
Goozner, M. (2017). Financial
engineering isn’t going to solve
healthcare’s cost woes. Modern
Healthcare, 47(49). 0026.
Link
Lee, R. H. (2015). Economics for
health care managers (3rd ed.).
Chicago, IL: Health
Administra!on Press.
Link
Jones, L. K., Pulk, R.,
Gionfriddo, M. R., Evans, M. A.,
& Parry, D. (2018). U!lizing big
data to provide be%er health at
lower cost. American…
Link
https://ncuone.ncu.edu/d2l/le/content/251482/printsyllabus/PrintSyllabus
Page 3 of 5
MHA-5009 V1: Health Economics (3578369450) – MHA-5009 V1: Health Economics (3578369450)
2/12/21, 9:58 PM
Maxi, M. C. (2016). What is the
future of healthcare in the
United States? The Journal of
the Louisiana State Medical
Society, 168(3), 74-75.
Link
Week 5 – Assignment: Develop Strategies to
Allow Healthcare Ins!tu!on’s Cost Structure
to be More Flexible
Assignment
Due February 14 at 11:59 PM
Your hospital organiza!on is experiencing several nega!ve trends. First,
procedures which were formerly performed exclusively at a hospital are
now being performed at outpa!ent facili!es. Also, insurance companies
are reimbursing less for similar services than they did previously.
Insurance companies are requiring pa!ents to be held in observa!on
status instead of admi&ng the pa!ent to the hospital. The hospital
incurs similar costs but receives approximately 1/3 the rate of
reimbursement. The hospital cost structure was developed over years
where reimbursements were very different. The hospital has a high-cost
structure, which is hard to maintain in the new environment. You are to
prepare a report to the board of directors developing strategies to bend
the cost curve and make the cost structure more flexible.
Length: 5-7 pages, not including !tle and reference pages (in lieu of a
report you can prepare a 5-10 slide PowerPoint presenta!on)
https://ncuone.ncu.edu/d2l/le/content/251482/printsyllabus/PrintSyllabus
Page 4 of 5
MHA-5009 V1: Health Economics (3578369450) – MHA-5009 V1: Health Economics (3578369450)
2/12/21, 9:58 PM
Resources: Include a minimum of 3-5 scholarly resources related to your
issue
Upload your document and click the Submit to Dropbox bu%on.
https://ncuone.ncu.edu/d2l/le/content/251482/printsyllabus/PrintSyllabus
Page 5 of 5
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
CHAPTER
UNDERSTANDING COSTS
5
Learning Objectives
After reading this chapter, students will be able to
•
•
•
•
•
calculate average and marginal costs,
articulate why efficiency is important,
identify opportunity costs,
forecast how changes in technology and prices will change costs, and
discuss the relationship between cost and quality.
Key Concepts
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Costs depend on perspective.
Costs can be hard to measure.
Good managers have an accurate understanding of costs.
Goods and services an organization produces are called outputs.
Goods and services an organization uses in production are called
inputs.
Incremental cost equals the change in cost resulting from a change in
output.
Average cost equals the total cost of a process divided by the total
output of a process.
Large firms have a cost advantage if there are economies of scale.
Multiproduct firms have a cost advantage if there are economies of scope.
Higher quality should mean higher costs. If not, the organization is
inefficient.
Higher input prices mean higher costs.
Costs depend on outputs, technology, input prices, and efficiency.
Opportunity cost is the value of a resource in its best alternative use.
Sunk costs, which are costs you cannot change, should be ignored.
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 73
Account: s1229530
73
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
74
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
5.1 Introduction
Efficient
Producing the
most valuable
output possible,
given the inputs
used (Viewed
differently,
an efficient
organization
uses the least
expensive inputs
possible, given
the quality and
quantity of output
it produces.)
Output
Goods and
services produced
by an organization
Input
Goods and
services used in
production
Opportunity cost
The value of a
resource in its
next best use (The
opportunity cost of
a product consists
of the other goods
and services
we cannot have
because we have
chosen to produce
the product in
question.)
Understanding and managing costs are core managerial tasks. Whatever the
mission of the organization, cost control must be a priority. As evidence
mounts that many healthcare firms are inefficient, cost control in the healthcare industry is becoming increasingly important. A firm is inefficient when
its costs are higher than the quality of its service warrants, when the quality
of a firm’s products is lower than the cost of its service warrants, or when the
quality of a firm’s products is lower and its costs are higher than the quality
and costs of comparable competitors.
An efficient producer of a good or service has a competitive advantage.
For example, a pharmacy that can accurately dispense a product more cheaply
than its competitors has an advantage. The efficient producer can win more
contracts, enjoy higher profit margins, or more easily weather a slump. In
healthcare, the bar has been raised as increased attention to the outcomes of
care challenges us to think about health, not just medical care. Healthcare
organizations are being challenged to work with customers to produce health
efficiently, not just to produce goods and services efficiently.
Nonetheless, the pressure to become more efficient has grown considerably. As Chapter 6 details, public and private insurers have taken steps to
steer patients to providers with lower costs. If your organization is a high-cost
producer, there may not be much time to become more efficient.
This chapter focuses on what is necessary to turn an organization into
an efficient producer. The starting point is to understand costs, which are
defined by a combination of two definitions. First, the goods or services an
organization uses in producing its outputs are called inputs. Second, opportunity cost equals the value of an input in its best alternative use. From this
production-oriented perspective, costs equal the opportunity cost per unit of
input multiplied by the volume of inputs the organization uses. Reducing the
cost per unit that the organization pays for inputs reduces total costs, but real
savings result from reducing the volume of inputs the organization uses. To
reduce input volume, managers must lead efficiency improvement efforts or
outsource the production of goods and services.
Case 5.1
Virginia Mason Medical Center
In 2001, Virginia Mason Medical Center was under
pressure to improve its financial performance.
Its processes of care were overrun with waste and rework, increasing
costs and putting patients at risk.
(continued)
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 74
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 5: Under standing C osts
75
Case 5.1
Virginia Mason used weeklong rapid process
improvement workshops to examine processes,
measure wasted resources, and identify activities
that did not add value for customers. Workshop participants included
leaders and frontline staff, supported by executive sponsors and performance improvement experts. After identifying areas for improvement, workshop participants discussed ways to standardize and optimize the work that would need to be done. Preliminary data collection
(including observations of how care was delivered) started weeks
before the workshops, and follow-up continued for months.
In 2005, an eight-person team (including a patient) participated
in a workshop focused on a 27-bed telemetry unit that was experiencing numerous problems. Nurses were assigned patients with no consideration of how sick the patients were or where they were located,
resulting in varied workloads and unnecessary travel between rooms.
Supplies and equipment were not kept where they were needed. The
work of nurses and technicians was poorly coordinated; some tasks
were done twice, and some were not done at all. Communication was
poor, patient status changes were missed too often, and nurses felt
pressured to skip breaks and lunches. Furthermore, the unit’s financial
performance was unsatisfactory because it was consistently staffing
over budget.
The workshop team made simple changes that dramatically
streamlined care. First, they changed staff assignments so that nurses
cared for patients in contiguous rooms, reducing travel by 85 percent. Second, they moved supplies to where they were needed and
simplified ordering, reducing the time spent retrieving supplies by 85
percent. Third, they standardized and streamlined morning rounds,
shortening them by 48 percent. As a result of these changes, costs and
overtime hours dropped, patient falls and pressure ulcers decreased,
patient satisfaction improved, and call light use fell (Nelson-Peterson
and Leppa 2007).
Nonetheless, nurses’ initial response to these changes was not positive. They wanted to focus on caring for patients rather than on improving
financial performance. In addition, they were not happy with the standardization of their work and resisted some of the proposed changes.
That resistance has largely faded. Now nurses spend almost 90 percent
of their time on direct patient care, a major change from the less than 40
percent when the process started (Virginia Mason Institute 2012).
(continued)
(continued)
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 75
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
76
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
Case 5.1
Today other organizations can study at the Virginia Mason Institute, Virginia Mason’s malpractice
premiums have dropped by more than 50 percent,
and Gary Kaplan, Virginia Mason’s CEO, believes that its costs are much
lower than those of comparable hospitals. Dr. Kaplan also argues that
“there is still a lot of opportunity to get better” (Sloane 2012).
(continued)
Discussion questions:
• Did standardizing care reduce quality? Did standardizing care
reduce costs? What evidence supports your conclusions?
• How would reducing travel time between rooms reduce costs?
• Does including a patient in the rapid process improvement
workshop make sense? Why?
• Was Virginia Mason efficient before it made these changes? Who is
responsible for ensuring that care is efficient?
• Why did the nurses resist the changes? Would you expect to
encounter resistance in other departments?
5.2 Cost Perspectives
Cost is a complex concept because it is difficult to measure and depends on
the perspective of the beholder. For example, consumers will characterize
the cost of a prescription in terms of their out-of-pocket spending and ancillary costs, such as the value of time spent filling a prescription. Pharmacists
will focus on the spending required to obtain, store, and dispense the drug.
Insurers will focus on their payments to the pharmacist for the prescription
and their spending on claim management. Each of these perspectives on costs
is valid. Exhibit 5.1 describes what costs look like from four perspectives.
A pharmacist acquires a prescription drug for $10 and incurs $5 in
processing, storing, and billing costs. The pharmacist should recognize that
reasonable returns on her time and on her investment in the pharmacy represent opportunity costs because both could be used in other ways.
The consumer is uninterested in the pharmacist’s costs. What matters
to him are his out-of-pocket costs and the $4 in travel expense he incurs
when he drives to the pharmacy. When the consumer does not have insurance, as shown in the left half of Exhibit 5.1, the consumer’s perspective on
costs mirrors society’s perspective. Both will say that the drug costs $20,
although the two calculations are different. The consumer will focus on the
price he pays and his travel costs. Society will ignore the price the consumer
pays and focus on the underlying resource use by the pharmacist and the
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 76
Account: s1229530
7/15/14 8:51 AM
77
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 5: Under standing C osts
EXHIBIT 5.1
Prescription Costs from Four Perspectives
Without Insurance
Pharmacy
Wholesale
price
Consumer
With Insurance
Society
Pharmacy
Consumer
Insurer
Society
$10
$0
$10
$10
$0
$0
$10
Travel
$0
$4
$4
$0
$4
$0
$4
Processing
$5
$0
$5
$5
$0
$9
$14
Return on
assets
$1
$0
$1
$1
$0
$1
$2
($16)
$16
$0
($16)
$5
$11
$0
$0
$20
$20
$0
$9
$21
$30
Retail price
Total
consumer. The payment is an accounting entry, not a real use of resources
(because it equals the amount the pharmacist receives).
The right side of Exhibit 5.1 lists cost perspectives when the prescription is covered by insurance. Three things change as a result of coverage.
First, the additional perspective of the insurer must be considered. Second,
the insurer incurs expense by processing the claim. Third, the consumer’s
perspective on costs differs from society’s perspective.
The insurer focuses on its share of the retail price and its cost of paying
the bill. Again, the insurer should factor in the opportunity cost of using its
investment to provide pharmacy insurance benefits but will probably express
this figure in terms of a required return on investment. From the perspective
of the insurer, covering the prescription adds $21 in costs. From the perspective of the consumer, insurance coverage reduces costs by $11. Note also
that society’s perspective on costs differs from the perspective of any of the
participants when insurance plays a role.
The concept of cost cannot be fully understood without stating a cost
perspective. The part of cost that matters depends on your point of view.
Your revenues are someone else’s costs, and your costs are someone else’s
revenues.
Most people want to focus on costs from the perspective of the organization in which they work, but shifting costs to customers or suppliers
seldom represents a good business strategy. Long-term business success rests
on selling products that offer your customers excellent value and offer your
suppliers adequate profits.
As stated earlier, the difficulty of measuring cost components also complicates the concept of costs. For example, opportunity costs are sometimes
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 77
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
78
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
hard to measure. Managers sometimes become confused when calculating
the opportunity cost of resources that have changed in value. For example,
land that your organization bought a few years ago may be more valuable if
rents in the area have risen or less valuable if rents have fallen. In most cases,
though, an input’s opportunity cost is simply its market price.
Linking the use of a resource to the organization’s output also poses
problems. A focus on incremental costs (i.e., the cost of the additional
resources you use when you increase output by a small amount) often simplifies this task. “How much more of a hospital’s information system does its
intensive care unit use when it cares for an additional patient?” is an example
of a way to reframe the relationship between resource use and output and
facilitate its measurement.
5.3 Vocabulary
Average cost
Total cost divided
by total output
Marginal or
incremental cost
The cost of
producing an
additional unit of
output
Fixed costs
Costs that do not
vary according to
output
Variable costs
Costs that change
as output changes
EXHIBIT 5.2
Total, Average,
and Incremental
Costs
To talk sensibly about costs, we need a clear vocabulary. At the core of that
vocabulary are the concepts of average cost and incremental cost. Average
cost equals the total cost of a process divided by the total output of a process.
In Exhibit 5.2, when total cost equals $10,500 and output equals 300, average cost equals $35. Incremental cost, also called marginal cost, equals the
change in a process’s total cost that is associated with a change in the process’s total output. In Exhibit 5.2, total cost rises from $8,000 to $10,500 as
output rises from 200 to 300, so incremental cost equals ($10,500 − $8,000)
÷ (300 − 200), or $25 per unit of output.
In Exhibit 5.2, average cost is significantly larger than incremental
cost. This difference is common because many processes require resources
(such as equipment or key personnel) that do not change as output varies.
For example, to open a pharmacy, a pharmacist has to rent a building and
commit her own time. If sales fall short of expectations, the rent will not
change. Rent is an example of a fixed cost, a component of total cost. In
contrast, some labor costs and the cost of restocking the pharmacy will vary
with sales. Average cost includes fixed and variable costs, but incremental
cost includes only variable costs. The fact that average cost often exceeds
Output
Total Cost
Average Cost
Incremental Cost
0
$3,000
100
$5,500
$55
$25
200
$8,000
$40
$25
300
$10,500
$10,500/300 = $35
$2,500/100 = $25
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 78
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 5: Under standing C osts
79
incremental cost is important because management decisions often hinge on
knowing how much increasing or decreasing production of a good or service
will cost. Your willingness to negotiate with an insurer that offers $300 per
service is likely to depend on whether you believe an additional service will
cost you $440 (the average cost) or $120 (the incremental cost).
Average and incremental cost are both important concepts, although
economists emphasize incremental values. Most management decisions concern incremental changes. Should we increase hours in the pediatric clinic?
Should we reduce evening pharmacy staff? Should we accept patients needing
skilled nursing care? These decisions demand data on incremental costs.
In addition to being the most relevant concept for managers, incremental cost is easier to calculate than average cost. Average cost calculations
always involve difficult questions (e.g., How much of the cost incurred by
the chief financial officer should we allocate to the pediatrics department?).
In contrast, incremental cost calculations involve more straightforward questions and can be performed by most clinicians and frontline managers (e.g.,
What additional resources will we need to keep the pediatric clinic open
until 8 p.m. on Wednesdays, and what are the opportunity costs of those
resources?). To decide whether to start or stop a service, a manager needs
to compare average revenue and average cost. For example, a telemedicine
program that has average revenue of $84 and average cost of $98 is unprofitable. To decide whether to expand or contract a service, a manager needs
to compare how revenue and costs will change. To make this comparison,
information about incremental costs is essential. Usually confusion about
cost arises because one person is talking about average cost and another is
talking about incremental cost (or because one person is talking about costs
to society and the other is talking about costs to the organization).
5.4 Factors That Influence Costs
Producer costs depend on what is produced (the outputs), the prices of
inputs, how outputs are produced (the technology), and how efficiently
inputs are used. We will explore each of these factors.
5.4.1 Outputs
Differences in outputs can profoundly affect costs. Firms that produce large
volumes of a good or service may have lower costs than firms that produce
small volumes. Large firms that have a cost advantage have economies of
scale. Firms that produce several different kinds of goods or services may
have lower costs than firms that produce just one. Multiproduct firms that
have a cost advantage have economies of scope. Economies of scale and
scope result from sharing resources.
Economies of
scale
When larger
organizations have
lower average
costs
Economies of
scope
When multiproduct
organizations have
lower average
costs
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 79
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
80
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
An example of economies of scale might be a large pharmacy’s use of
automated dispensing equipment. In a larger pharmacy the fixed costs of the
equipment could be shared by a larger number of prescriptions, so the cost
per prescription could be lower. An example of economies of scope might
be a nursing home that expands to offer skilled care as well as intermediate
care. Fixed costs (such as the cost of the director of nursing) would be shared
by additional patients, so average costs for intermediate care could be lower.
Differences in the quality of outputs can affect costs as well. For an
efficient firm, higher-quality products cost more. For an inefficient firm,
higher-quality products may not.
What is higher quality? Economists define quality from the perspective of consumers, not from the clinical perspective common in healthcare.
In economics, a good or service is of higher quality when it is more valuable
to a well-informed customer than comparable goods or services. Consumers
usually find greater value in goods or services that produce better clinical
outcomes. Economists also define quality in terms of nonclinical factors.
Well-informed consumers may attribute higher quality to a product that is
easier to use, a service for which the wait is shorter, an insurance plan with
less confusing referral requirements, a provider who bills more accurately, or
a more cordial staff.
If higher quality does not cost more, failure to provide it demonstrates inefficiency. The many opportunities available to improve quality in
healthcare without increasing costs reflect how inefficient most healthcare
organizations are. Once an organization has become efficient, though, higher
quality (better service, improved reliability, greater accuracy, less pain, and
other enhancements) will cost more to produce.
Case 5.2
Improving Performance
Atul Gawande is an employee of an academic, nonprofit health system called Partners HealthCare, which owns a number
of hospitals and is associated with dozens of practices in Massachusetts. As Dr. Gawande sees it, in today’s environment Partners has very
clear incentives: “This year, my employer’s new contracts with Medicare,
BlueCross BlueShield, and others link financial reward to clinical performance. The more the hospital exceeds its cost-reduction and qualityimprovement targets, the more money it can keep” (Gawande 2012). In
short, Partners is taking part in multiple accountable care organizations.
(continued)
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 80
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 5: Under standing C osts
81
Case 5.2
When Dr. Gawande’s mother needed a knee
replacement, he steered her to a team at the
Brigham and Women’s Hospital, his own hospital.
He knew that this team (which included surgeons, anesthesiologists,
physical therapists, and nurses) had worked together for several years
to choose one best way of doing knee replacements. They looked at
the medical literature and at what the best orthopedic teams were
doing, and then made multiple changes in the whole knee replacement
process. They changed how anesthesia and postoperative care were
given, which reduced costs and got patients up and around faster.
They also settled on a few standard prostheses, which reduced inventory costs and reduced prosthesis costs (by choosing cost-effective
models and improving the hospital’s bargaining position).
In addition to reducing costs, this redesign has led to vastly better
outcomes. Patients leave the hospital sooner, with more mobility and
less pain.
(continued)
Discussion questions:
• Could limiting the number of prostheses improve the quality of
care?
• Why was a team needed to choose the best way of doing knee
replacements?
• Is standardization like this common? Should it be?
• Some of your staff object to standardizing care, calling it “cookbook
nursing.” How do you respond?
• What would happen to your organization if insurers started steering
patients to the most efficient providers and you were not one of
them?
• Was Brigham and Women’s Hospital efficient before it made the
changes described in this case?
5.4.2 Input Costs
Higher input prices mean higher costs. Shifting to a different combination
of inputs will only partially offset the effects of higher input prices. The only
times this rule does not hold are when a firm is inefficient or when a perfect,
lower-priced substitute for the higher-priced input is available. An inefficient
firm might be able to limit the effects of a cost increase by shifting to a more
efficient production process. For example, even if the wages of pharmacy
technicians increase, the cost of dispensing a prescription might not increase
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 81
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
82
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
if the pharmacy switches to the automated system it should have been using
before the wage increase. A firm also can avoid higher costs by switching
to a perfect substitute. For example, if an Internet access provider tried to
raise its monthly rates, firms could switch to rival Internet access providers
and costs would not go up. Unfortunately, firms are unlikely to find such a
replacement.
5.4.3 Technology
Advances in technology always reduce the cost of an activity. Adopting a
new technology would be pointless if it increased the costs of a process. For
example, installing an automated laboratory system would be absurd if it
increased cost per analysis. An automated laboratory system that reduces cost
per analysis, however, does not guarantee that laboratory costs will go down.
Lower costs per analysis may prompt physicians to request more analyses, and
the greater volume cancels the cost savings and might even drive up costs.
5.4.4 Efficiency
Increases in efficiency always reduce the cost of an activity. Production of
almost every healthcare good or service can be made more efficient. Few
production processes in healthcare have been examined carefully, and most
healthcare workers have little or no training in process improvement. Consequently, mistakes, delays, coordination failures, unwise input choices, and
excess capacity are routine. Techniques for improving production (total quality management, continuous quality improvement, and continuous process
improvement) are just beginning to be applied in healthcare.
Even though greater efficiency reduces costs, not everyone is in favor
of it. Greater efficiency often means that fewer workers will be needed.
Workers whose jobs are in jeopardy may not want to help improve efficiency.
(Commitment to a policy of no layoffs is usually one of the core terms of
efficiency improvements.) Others have limited incentive to participate in
efforts to improve efficiency. Physicians must help change clinical processes,
yet many physicians have little to gain from these efforts. The gains produced
by the changes will accrue to the healthcare organization, but the resulting
billing reductions will be problematic for physicians and other healthcare
workers not employed by the organization. A major challenge lies in devising incentives that will encourage workers and contractors to help improve
efficiency.
5.5 Variable and Fixed Costs
Managing costs requires an understanding of opportunity costs and triggers
that change costs. As stated earlier, opportunity costs usually are easy to
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 82
Account: s1229530
7/15/14 8:51 AM
83
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 5: Under standing C osts
assess. The opportunity cost of using $220 in supplies is $220. The opportunity cost of using an hour of legal time billed at $150 per hour is $150. Other
cases demand more study. For example, the opportunity cost of a vacant wing
of a hospital depends on its future use. If the wing will be reopened for acute
care in response to a rising hospital census, the opportunity cost of the wing
will depend on its value as an acute care unit. If the wing will be reopened
because the hospital needs a skilled nursing unit, the opportunity cost of the
wing will be determined by its value in that role.
Sunk costs should be ignored. A sunk cost is a cost you cannot
change. A computer’s purchase price is a sunk cost, as is money spent to train
employees to operate the computer. If your current needs do not require the
use of a computer, you should not fret about its initial cost. The opportunity
cost of the computer will depend on its value in some other use (including
its resale value).
In the long run, all costs are variable. Buildings and equipment can
be changed or built. The way work is done can be changed. Additional personnel can be hired. The entire organization could shut down, and its assets
could be sold.
In the short run, some costs are fixed. An existing lease may not be
negotiable, even if the building or equipment no longer suits your needs.
Ignore fixed costs in the short run. They are sunk costs.
When fixed costs are substantial, average costs typically fall as output
increases because the fixed costs are spread over a growing volume of output.
As long as average variable costs are stable, this drop in average fixed costs
will cause a reduction in average total costs. Average total costs equal average
fixed costs plus average variable costs. As Exhibit 5.3 illustrates, average fixed
cost drops from $30 to $15 as output rises from 100 to 200. If variable costs
rise quickly enough, average total costs may rise despite the fall in average
fixed costs. In Exhibit 5.3, variable costs rise by $10,000 as output increases
from 200 to 300. As a result, average total cost rises to $60 even though
average fixed cost continues to fall.
Sunk costs
Costs that have
been incurred
and cannot be
recouped
EXHIBIT 5.3
Fixed and Variable Costs
Total
Cost
Fixed
Cost
0
$3,000
$3,000
100
$5,500
200
300
Output
Average Total Cost
Average
Fixed Cost
Average
Variable Cost
$3,000
$55
$30
$25
$8,000
$3,000
$40
$15
$25
$18,000
$3,000
$18,000/300 = $60
$3,000/300 = $10
$15,000/300 = $50
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 83
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
84
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
Fixed and variable costs are important concepts for day-to-day management of healthcare organizations. For example, an advantage of growth is
that fixed costs can be spread over a larger volume of output. The idea is that
lower average fixed costs result in lower average total costs, so profit margins
can be larger. As Exhibit 5.3 illustrates, growth should not result in increases
in average variable costs large enough to offset any reduction in average fixed
costs. Otherwise, growth will be unprofitable.
Misclassification of costs can result in odd incentives. For example,
fixed overhead costs are often allocated on the basis of some measure of
output, which can make growth appear less profitable than it is because the
overhead costs allocated to a unit increase as it grows. So that unit managers
are not discouraged from expanding, allocated fixed costs should not vary
with output.
Case 5.3
The Costs of Nonurgent Care in the
Emergency Department
“Obviously,” said Kelly, director of patient accounts, “it costs more to
see a patient in the emergency department than in a physician’s office.
We’ve got to channel these folks back to their primary care physicians.
Plus, I’m sure they are money losers for us.”
Cameron, director of emergency services, replied, “Actually, it’s
more complicated than that. Most patients seen in our emergency
department have insurance, and it is not clear whether we are making money on them. There have been a couple of careful studies of
costs in emergency departments, but they reach different conclusions.
A study by Williams in 1996 concluded that the incremental cost of a
patient visit for routine ambulatory care was not high and that these
patients were quite profitable for hospitals. A subsequent study, by
Bamezai and Melnick in 2006, found much higher costs. Emergency
departments produce such a range of services, and there is so much
overhead to allocate, that figuring out how much it costs to care for a
child with an earache at 2 a.m. is a nightmare. We’d be happy to do a
detailed cost analysis of the emergency department, but we have had
other priorities up to now.”
At that point, Morgan, chief executive, chimed in, “Let’s think
strategically here. First, I’ll bet a month’s pay that we could reduce
costs in the emergency department and improve the experience of our
patients, critically ill or not. Doing so will increase profits, whatever
(continued)
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 84
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 5: Under standing C osts
85
Case 5.3
our costs are. Second, our emergency department
is overcrowded. We need to develop the capacity
to see patients who are not critically ill more efficiently. Most of these patients do not need the sort of sophisticated
care that our emergency department provides, and our emergency
department was on diversion for eight days last month. That is not
acceptable. In addition, we have made a commitment to have all of
our primary care practices be recognized as patient-centered medical
homes. To make that happen we need to create expanded after-hours
options for patients. Cameron, I want you and Kelly to develop a menu
of options for our next meeting.”
(continued)
Discussion questions:
• Why do patients who are not critically ill go to emergency
departments?
• Why do the variety of services emergency departments produce and
the amount of overhead to be allocated make cost finding difficult?
• Why was Morgan confident that costs could be reduced while
quality could be improved? Is this conclusion supported in the
literature?
• Thinking as a consumer, what would constitute higher quality in the
emergency department?
• What options should the hospital consider? Why would you be
confident that these options would incur lower costs than an
emergency department? Do you think quality would be higher?
• If the hospital creates one or more urgent care clinics and adds
evening and weekend hours to its primary care clinics, what will
happen to emergency department volumes? What effect will that
have on emergency department costs?
5.6 Conclusion
Cost management has become vital in healthcare. A more efficient producer
always has an advantage. The increasingly competitive environment is forcing healthcare organizations to reduce costs and reassess product lines. More
and more, healthcare organizations are seeking the cheapest production
techniques and identifying core goods and services. This pressure has intensified as purchasers of goods and services have realized that high costs do not
guarantee high quality and that high quality does not necessarily equate to
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 85
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
86
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
high cost. Healthcare organizations are beginning to adopt cost-reducing
technology, substitute low-cost production techniques for high-cost ones,
purchase goods and services more conservatively, and rethink what they produce. Healthcare providers are also being challenged to improve the health of
target populations in ways that are cost-effective—a task that is more difficult
than the efficient production of healthcare products.
Exercises
5.1 Why is it important to distinguish between fixed and variable costs?
5.2 Explain how a decrease in input prices or an increase in efficiency
would affect costs.
5.3 You spent $500,000 on staff training last year. Why should this
cost be treated as a sunk cost? Why should this cost be ignored in
making a decision whether to switch coding software?
5.4 Your president bought two acres of land for $200,000 ten years ago.
Although it is zoned for commercial use, it currently holds eight
small, single-family houses. A property management firm that wants
to continue leasing the eight houses has offered you $400,000
for the property. A developer wants to build a 12-story apartment
building on the site and has offered $600,000. What value should
you assign to the property?
5.5 A community health center has assembled the following data
on cost and volume. Calculate its average and marginal costs for
volumes ranging from 25 to 40. What patterns do you see?
Visits
Total Cost
20
$2,200
25
$2,250
30
$2,300
35
$2,350
40
$2,400
5.6 Sweetwater Nursing Home has 150 beds. Its cost and volume data
are as follows. Calculate its average and marginal costs for volumes
ranging from 100 to 140. What patterns do you see?
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 86
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 5: Under standing C osts
Residents
Costs
80
$10,000
100
$11,000
120
$12,000
140
$13,200
87
5.7 It takes a phlebotomist 15 minutes to complete a blood draw. The
supplies for each draw cost $4, and the phlebotomist earns $20
per hour. The phlebotomy lab is designed to accommodate 20,000
draws per year. Its rent is $80,000 per year. What are the average
and incremental costs of a blood draw when the volume is 20,000?
10,000? What principle does your calculation illustrate?
5.8 How would the average and marginal costs change if the
phlebotomist’s wage rose to $24 per hour? What principle does your
calculation illustrate?
5.9 A new computer lets a phlebotomist complete a blood draw
in 10 minutes. The supplies for each draw cost $4, and the
phlebotomist earns $20 per hour. The phlebotomy lab is designed
to accommodate 20,000 draws per year. Its rent is $80,000 per year.
What is the marginal cost of a blood draw? What principle does your
calculation illustrate?
5.10 Use the data in Exercise 5.7. How would the average and marginal
costs change if the rent rose to $100,000? What principle does your
calculation illustrate?
5.11 A patient visits a clinic. She incurs $10 in travel costs and has a
copayment of $20. The clinic’s total charge is $60. The clinic
spends $9 to bill the insurance company for the visit and uses
resources worth $51 to produce the visit. The insurance company
pays the clinic $40 and spends $11 to process the claim. Describe
the cost of the visit from the perspective of the patient, the clinic,
the insurer, and society.
5.12 A practice uses $40 worth of a dentist’s time, $30 worth of a
hygienist’s time, $10 worth of supplies, and $15 worth of a billing
clerk’s time to produce a visit. The practice charges a patient $25
and charges her insurer $70. The insurer spends an additional $4 to
process the claim. The patient incurs travel costs of $20. What are
the costs of the visit from the perspective of society, the patient, the
practice, and the insurer?
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 87
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
88
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
5.13 Kim and Pat underwrite insurance. Each underwrites 50 accounts
per month. Each account takes four hours to underwrite. The value
of their time is $40 per hour. Monthly costs for each are $1,500
for an office, $2,000 for a receptionist, and $2,400 for a secretary.
Calculate the average and incremental cost per case for Kim and
Pat.
5.14 If Kim and Pat merge their operations, they would need only one
receptionist, and their rent for the joint office would be $2,800 per
month. All other values stay the same. Calculate the average and
incremental cost per case for the merged office. Are there economies
of scale at 100 accounts per month? Should Kim and Pat merge
their offices?
References
Bamezai, A., and G. Melnick. 2006. “Marginal Cost of Emergency Department
Outpatient Visits: An Update Using California Data.” Medical Care 44 (9):
835–41.
Gawande, A. 2012. “Big Med.” The New Yorker. Published August 13. www.newyorker.
com/reporting/2012/08/13/120813fa_fact_gawande.
Nelson-Peterson, D. L., and C. J. Leppa. 2007. “Creating an Environment for Caring Using Lean Principles of the Virginia Mason Production System.” Journal
of Nursing Administration 37 (6): 287–94.
Sloane, T. 2012. “The Learning Lab for Health Care Transformation.” Partners
September/October: 22–29.
Virginia Mason Institute. 2012. “Case Study: Adding Valuable Nursing Time at the
Bedside.” Accessed July 2, 2014. www.virginiamasoninstitute.org/workfiles/
Virginia-Mason-Institute-Case-Study-Adding-Valuable-Nursing-Time-atBedside.pdf.
Williams, R. M. 1996. “The Costs of Visits to Emergency Departments.” New England Journal of Medicine 334 (10): 642–46.
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:17 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 88
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
CHAPTER
BENDING THE COST CURVE
6
Learning Objectives
After reading this chapter, students will be able to
•
•
•
•
explain what the Triple Aim is,
discuss several strategies for realizing the Triple Aim,
describe several strategies for reducing services per patient, and
identify several ways to reduce cost per service.
Key Concepts
• The Triple Aim includes improving the experience of care for patients,
improving population health, and reducing healthcare costs per person.
• The Affordable Care Act (ACA) has changed incentives for insurers
and providers in a number of ways.
• The ACA has already increased hospitals’ incentives to reduce
readmissions.
• Medicare Advantage HMOs are growing.
• Multiple trials of Medicare accountable care organizations (contracts
with potential gains for providers if cost and quality goals are met) are
underway.
• Private insurers are also testing accountable care organizations and
simpler variants called narrow networks.
• The prices that private insurers pay for similar products vary a great
deal.
• Private insurers are testing ways of steering patients to less expensive
providers.
• Multiple trials of bundled payments (fixed payments for an episode of
care) are underway.
• Multiple trials of medical homes are underway.
• A number of states are shifting Medicaid beneficiaries to HMOs.
• Some states have expanded Medicaid; some have not.
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 89
Account: s1229530
89
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
90
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
• Some evidence indicates that the ACA’s initiatives have had positive
effects.
• The full effects of the ACA’s initiatives will not be known for years.
6.1 The Triple Aim
Berwick, Nolan, and Whittington (2008) argued that the United States
should try to reach three aims simultaneously:
• improving the experience of care,
• improving population health, and
• reducing healthcare costs per person.
This chapter explores strategies for reducing costs while improving
population health and customer satisfaction. Berwick, Nolan, and Whittington (2008, 768) noted that “the remaining barriers to integrated care are not
technical; they are political.”
In making this argument, Berwick, Nolan, and Whittington (2008)
offered the example of congestive heart failure. Congestive heart failure is the
most common reason that Medicare patients are hospitalized, and more than
25 percent are readmitted within 30 days of discharge (Ryan et al. 2013).
Many of these readmissions can be prevented, and a number of interventions have succeeded in doing so (Takeda et al. 2012). These interventions
typically involved enhancing the instruction about managing heart failure
provided to patients and families during the hospitalization, scheduling a
follow-up visit before discharge, and calling recently discharged patients to
check on their health. An ongoing barrier to these steps was that hospitals
had limited incentives to try to reduce readmission. Preventing readmissions
took resources and reduced hospital profits.
The Affordable Care Act (ACA) changed hospitals’ incentives. It
reduced Medicare payments to hospitals with higher-than-expected 30-day
readmission rates. Hospitals could avoid significant revenue losses by increasing their cost per heart failure admission only a little (and possibly generating
additional profits from follow-up visits). In contrast, from a payer perspective, reducing readmissions has always been a clear win. Reducing readmissions improves population health and can save significant amounts of money.
Medicare savings of $8.2 billion by 2020 are anticipated as a result of reductions in readmissions (Laderman, Loehrer, and McCarthy 2013).
As we will see in this chapter, the ACA has changed incentives for
insurers and providers. Although focused on expanding health insurance
coverage, the ACA has helped spark innovation in the federal, state, local, and
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 90
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 6 : Bending the C ost C ur ve
91
private sectors. We will also examine the major uncertainties that exist in the
varied political, regulatory, and market environments that define American
healthcare about how to realize the Triple Aim. The barriers are not only
political.
6.2 Reducing Costs
Cost per person depends on services per person and the price of each of those
services, so there are two ways of reducing costs. One is to reduce service use.
The other way is to reduce the price per service. Both ways require changes
in behavior, and these changes in behavior require changes in incentives. As
we will see in this chapter, new insurance models are being tested publicly
and privately.
The Medicare Physician Group Practice Demonstration
In this demonstration, which compared outcomes for millions of
Medicare beneficiaries, physician groups shared in any savings that
they realized if they met quality targets (Colla et al. 2012). This demonstration was, in short, a test of the effects of an accountable care
organization (ACO), which is one of the initiatives funded by the ACA.
An ACO gives providers incentives to improve quality and reduce cost
per patient, making the arrangement more like an HMO than a fee-forservice (FFS) organization.
About 15 percent of the demonstration’s patients were eligible for
both Medicare and Medicaid. Because these patients are poor and
elderly or disabled, their spending was much higher than average.
Per capita savings in the demonstration group averaged just $114,
but this figure may understate the potential of ACOs. First, savings
among patients who were eligible for both Medicare and Medicaid
averaged $532, hinting that improving the care of these patients might
have a substantial payoff. Second, savings varied considerably among
the group practices. Two large, well-established clinics began with
lower-than-average costs and also realized greater-than-average savings. Both clinics had offered HMOs for many years, suggesting that
experience in controlling costs might be important.
Savings were not linked with lower quality of care. Quality was
generally better in the demonstration group, which had higher quality
scores and lower readmission and emergency department use rates.
Accountable care
organization
A provider
organization that
contracts to be
paid based on the
cost and quality
metrics of a
patient population
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 91
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
92
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
Risk adjustment
Payments
(or insurance
premiums)
that vary to
reflect patient
characteristics,
especially
age, sex, other
demographic
characteristics,
and health status
Overuse of care
When the harms
of services exceed
the benefits
Favorable risk
selection
When an insurance
plan attracts
customers who
use fewer services
than average and
therefore has
lower costs
The traditional strategy for changing incentives has long focused
on HMOs. In these integrated delivery models, the health plan is paid a
fixed amount per member per month (perhaps with risk adjustment) and
physicians are usually salaried. As a result, neither the organization nor the
physician gains from higher use of services. In addition, HMOs increasingly
exclude high-cost providers from their networks, which can result in significant savings. For example, the Massachusetts health insurer Harvard Pilgrim
launched a new health plan that costs about 10 percent less than its standard
plan, largely because its smaller network excludes some providers with high
prices (Weisman 2012).
HMOs have elicited three main concerns. One is that HMOs will stint
on needed care. A second is that HMOs will have lower costs because they
can enroll low-risk customers, not because they deliver care more efficiently.
A third is that Americans do not want to accept any limits on their choices
and will simply reject HMOs.
HMO advocates point out that the available evidence points to overuse of care in FFS settings more than to underuse in HMO settings. Robust
(but limited) evidence indicates that Americans in FFS settings get care that
provides little value to them (Korenstein et al. 2012). For example, in a large
sample of Medicare patients, 24 percent of those with normal colonoscopy
results had early repeat exams with no evidence that the colonoscopy was
anything but routine (Goodwin et al. 2011). Why the early colonoscopies
were done is not known, but the authors of the study suspected that high
colonoscopy profit margins play a role. Although FFS physicians are constrained by professional ethics, they have significant financial incentives to
provide lots of care.
HMO physicians face different incentives. Most are salaried and have
weak incentives to skimp on care. These weak incentives may be offset by
professional ethics. The HMO itself has incentives to limit care, although this
fact may be balanced by the need to keep and attract customers.
HMO patients clearly use less care than comparable FFS patients.
Landon and colleagues (2012) found that utilization rates were generally
lower in Medicare Advantage HMOs than in traditional Medicare. Although
outpatient visit rates were virtually equal, emergency department use was a
third lower in HMOs, ambulatory surgeries were 7 percent lower, hospital
days were 8 percent lower, and knee replacements were also 8 percent lower.
Another study (Ayanian et al. 2013) found that Medicare HMOs generally did a better job of providing recommended preventive services, such as
appropriate cholesterol testing or flu vaccinations. Given ongoing concerns
about overuse of emergency departments and underuse of preventive services, these differences could be viewed as evidence of better care in HMOs.
Favorable risk selection is a major concern related to HMOs. For
a number of reasons, HMOs tend to attract patients who are much better
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 92
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 6 : Bending the C ost C ur ve
93
risks than FFS plans do. (One reason is that healthy patients are less likely
to have to end a relationship with a physician when they join an HMO.)
An example of favorable risk selection is that Medicare Advantage plans
have generally been able to enroll healthier beneficiaries, meaning that their
costs would be lower whether or not they delivered care more efficiently. To
address this imbalance, Medicare improved its risk adjustment formula and
reduced options to switch plans. Newhouse and colleagues (2012) concluded
that by 2008 these changes had markedly reduced differences in predicted
spending and mortality. Because the ACA’s insurance exchanges use similar
approaches, problems with risk selection should be smaller.
The easiest of these concerns to address is acceptability. Enrollment
in Medicare Advantage HMOs, which is completely voluntary, rose from
5.6 million in 2007 to 9.3 million in 2013 (Gold et al. 2013). At least some
Americans are willing to choose HMOs. The “rejection” of HMOs around
the turn of the twenty-first century largely came from employees who had
no choice other than an HMO. As of 2013, more than 70 million Americans
were enrolled in HMOs (Kaiser Family Foundation 2013), with significant
growth taking place among Medicaid and Medicare enrollees. Even though
the remainder of this chapter emphasizes new approaches to realizing the
Triple Aim, HMOs remain a relevant strategy.
Transforming Primary Care: Geisinger’s Medical
Home
Geisinger Health System is an integrated, physician-led system that
serves more than 2.6 million residents of Pennsylvania. In 2006 Geisinger launched a new program called ProvenCare. It stresses evidencebased medicine, bundled prices for some procedures (such as openheart surgery), and enhanced patient engagement. ProvenHealth
Navigator, Geisinger’s version of a medical home, was launched at the
same time. ProvenCare and ProvenHealth Navigator are integral parts
of Geisinger’s Medicare Advantage HMO (Steele 2010).
Geisinger’s Medicare Advantage HMO is different from many
Medicare Advantage HMOs because it is integrated with the health
system and because Geisinger has years of experience in running an
HMO. Begun in 1972 as a pilot program for Geisinger Medical Center
employees and residents of five nearby counties, Geisinger Health
Plan received state approval to operate an HMO in 1985 and approval
to offer Medicare Advantage plans in 1994 (Geisinger Gold 2014).
(continued)
Medical home
A primary care
model, often called
a patient-centered
medical home, that
emphasizes being
patient centered,
comprehensive,
team based,
coordinated,
accessible, and
committed to
quality and safety
(A medical home
devotes resources
to coordinating
care, improving
communication,
and making care
available after
office hours.)
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 93
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
94
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
(continued)
Bundled payment
A single payment,
also called a
bundled episode
payment, that
covers all services
delivered during
a given episode
of care (Examples
of an episode
of care include
hip replacement,
a year of
diabetes care, or
pregnancy.)
Narrow network
A limited group
of providers who
have contracted
with an insurance
company (Patients
will usually pay
more if they
get care from
a provider not
in the network.
The network is
usually restricted
to providers with
good quality who
will accept low
payments.)
Reference pricing
A system in which
an insurer’s
allowed fee has
an upper limit (A
customer who
chooses a provider
with a price above
the limit will pay
the difference
between the limit
and the price.)
A team of researchers used the gradual rollout of ProvenHealth
Navigator to examine whether it reduced costs (Maeng, Graham, et
al. 2012). It did. Costs were 4.3 percent lower for patients in ProvenHealth Navigator clinics. Even better, for patients receiving care from
ProvenHealth Navigator clinics for more than two years, costs were 6.7
percent lower. Given that patients in ProvenHealth Navigator clinics
also reported higher patient satisfaction and better clinical outcomes
(Maeng, Graf, et al. 2012), these data suggest that Geisinger is close to
realizing the Triple Aim.
Will medical homes work better or worse in other settings? Can
medical homes be effective as independent clinics, or do they need to
be part of an HMO or ACO? Stay tuned.
6.3 Innovations to Reduce the Cost of Care
How the ACA will affect the cost of care is not easy to understand. The
ACA supports a broad array of initiatives, and it is not clear how well they
will work. Will bundled payments, ACOs, medical homes, expanded insurance coverage, incentives to reduce readmissions, or reduced Medicare payments have an impact on costs? Will the ACA’s changes in insurance markets
have indirect effects on costs? Will state expansions of Medicaid managed
care reduce costs? Will private-sector efforts to rein in costs, which include
bundled payments, high-deductible plans, ACOs, narrow networks, medical homes, and reference pricing, be effective? Will healthcare organizations
that offer better quality and lower costs continue to capture market share?
The questions are many, and the evidence is varied and preliminary.
The sheer number and variety of efforts to bend the cost curve are
hard to grasp. In addition, because of the diversity and novelty of these
efforts, interpreting successes and failures is difficult. Might a minor design
change turn a seeming failure into a success? Can a successful pilot be
repeated elsewhere, or were the unique attributes of the patients and the
providers involved responsible for the results? To offer a sense of the many
cost control efforts and settings that are in play, this section looks at public
and private efforts in three states: New Jersey, Missouri, and California.
6.3.1 Innovations to Reduce the Cost of Care: New Jersey
New Jersey is a high-cost state, so the fact that multiple efforts are underway
is not surprising. Average spending per capita is $7,583, which is 11 percent
above the national average, and the uninsured comprise 16 percent of the
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 94
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 6 : Bending the C ost C ur ve
population, very close to the national average (Kaiser Family Foundation
2013). Twenty-two percent of the population is enrolled in an HMO, which
is near the national average. As of 2013, control of the state government was
split. The governor was a Republican, but both houses of the legislature had
comfortable Democratic majorities (StateScape 2014).
In 2009, a handful of New Jersey hospitals joined a New Jersey Hospital Association gainsharing pilot program, made possible by the Medicare
Modernization Act of 2003. Gainsharing means that physicians can earn
bonuses if they work with a hospital to reduce the cost of caring for Medicare patients. (Examples include bonuses for physicians who agree to use the
same hip prosthesis, who agree to a common time for rounds, or who adopt
a standard protocol.) An earlier attempt ended before it really got started, but
the 2009 program was widely believed to be successful. Participating hospitals reduced their costs of treating Medicare patients, primarily by reducing
length of stay. The best evidence of the gainsharing pilot’s perceived success
is that it grew to 33 hospitals statewide in 2013 (Davis 2013).
Termed a form of bundled payment by Medicare, this expanded
demonstration continues to emphasize gainsharing. The hospital gets a discounted payment for its services and benefits financially if it can deliver these
services for less than the discounted payment. Gainsharing continues to be
allowed, but Medicare will pay physicians separately.
Twenty-four New Jersey healthcare organizations will be taking part
in three other bundled payment demonstrations. Twelve hospitals are testing
a bundle that combines physicians’ services, acute inpatient services, and all
related post-acute services. (Post-acute services include care in skilled nursing facilities, inpatient rehabilitation facilities, long-term care hospitals, and
home health agencies. They also include readmissions and some outpatient
services.) Ten organizations (a mix of home health and skilled nursing companies) are testing a bundle that covers post-acute services, and two hospitals
are testing a single prospective payment for all services during a hospitalization episode (Centers for Medicare & Medicaid Services 2014a). Only three
of these New Jersey organizations are proceeding without support from a
company such as Remedy Partners, which is essentially a bundled payment
consulting firm (Centers for Medicare & Medicaid Services 2014b).
In addition, multiple changes are taking place in New Jersey Medicaid.
New Jersey is participating in Medicaid expansion under the ACA, meaning that an additional 265,000 people will have coverage. All of those who
enroll will be in managed care plans, including those eligible for Medicare
and Medicaid, those receiving behavioral health services, those with developmental disabilities, and those eligible for long-term care services (National
Senior Citizens Law Center 2013). In addition, New Jersey Medicaid will
begin testing ACOs, will limit benefits for those newly eligible, and will
change how it pays many providers. One of those changes is a requirement
95
Gainsharing
A strategy for
rewarding those
who contribute to
an organization’s
success
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 95
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
96
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
that all Medicaid managed care plans include patient-centered medical homes
in their networks. (This chapter uses the more generic term medical home.)
A number of New Jersey Federally Qualified Health Centers are
participating in the Advanced Primary Care Practice demonstration. This
demonstration is designed to test if the medical home model can help realize the Triple Aim in these centers. In addition, the Comprehensive Primary
Care Initiative, a medical home demonstration, covers the entire state of New
Jersey. The demonstration allocates risk-adjusted care coordination funds to
physician practices (NJBIZ 2013). An otherwise typical project of the Centers for Medicare & Medicaid Services, the Comprehensive Primary Care
Initiative differs in that five major private insurers are participating. Because
more insurers are participating, more practices can participate at lower cost.
Improved care, better clinical outcomes, and lower costs have been shown
in a number of trials (though not all), so these trials would seem to indicate
projects with potential (Arend et al. 2012).
In New Jersey, as in most states, multiple ACOs have been launched
in recent years. Many existing ACOs focus on the Medicare population, but
private insurers are increasingly creating these arrangements (McCann 2013).
The Centers for Medicare & Medicaid Services has already announced that
beneficiaries in its Pioneer ACO program had better care, lower costs, and
higher satisfaction than beneficiaries in its FFS programs (Centers for Medicare & Medicaid Services 2013).
Insurers are also moving aggressively toward narrow networks that
exclude providers with high prices. For example, Aetna offered only narrownetwork products on the exchanges in New Jersey (McQueen 2013). The
assumption is that customers who buy insurance on an exchange will be price
sensitive, so lower prices will be essential.
In addition, eight hospitals and health centers are taking part in the
Strong Start for Mothers and Newborns initiative. Funded by the ACA, this
initiative seeks to reduce the number of elective preterm deliveries as one of
its goals.
In short, many innovations are being tried in New Jersey. These
innovations are supported by the federal government, the state government,
private insurers, provider organizations, and healthcare organizations.
6.3.2 Innovations to Reduce the Cost of Care: Missouri
Missouri is not a high-cost state, but multiple efforts are underway nonetheless. Average spending per capita is $6,967, which is 2 percent above the
national average, and the uninsured comprise 14 percent of the population,
slightly less than the national average (Kaiser Family Foundation 2013).
Thirteen percent of the population is enrolled in an HMO, which is well
below the national average.
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 96
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 6 : Bending the C ost C ur ve
97
As of 2013, control of the state government was split. The governor
was a Democrat, but both houses of the legislature had large Republican
majorities (StateScape 2014). The governor urged that Missouri take part
in Medicaid expansion, but the legislature rejected the expansion, declined
to set up a state health insurance exchange, restricted the activity of helping
with ACA enrollment, and decided not to enforce the new ACA insurance
regulations (Somashekhar 2013).
Given the political resistance to the ACA in Missouri, one might not
anticipate that the state is home to a number of ACOs, but it is. Mercy
Hospital Springfield and Mercy Clinic Springfield (Mercy Clinic was a participant in the Medicare Physician Group Practice Demonstration) have been
recognized by the Centers for Medicare & Medicaid Services as an ACO.
BJC HealthCare of Saint Louis, Mosaic Life Care of Saint Joseph, and the
Kansas City Metropolitan Physicians Association have also been recognized
(Centers for Medicare & Medicaid Services 2014b). In addition, several
insurers have launched narrow-network plans, which resemble an ACO in
several important ways. The insurer chooses a small number of hospitals and
physicians who have demonstrated high quality (usually based on adherence
to standards of care) with low costs and then markets the plan as an inexpensive alternative. For example, a series of plans from Coventry essentially limits
patients to hospitals and physicians who are part of the Mercy Health System
in the Saint Louis area (Doyle 2013). Insurers and healthcare organizations
increasingly see ACOs and narrow networks as potentially advantageous business models (Pfannenstiel 2013a).
Narrow networks are likely to be especially attractive in Missouri
because prices that insurers and patients pay vary so widely. For example, in
2011 in Kansas City the average private price for an inpatient stay was about
double the Medicare price, but some hospitals were paid 50 percent more
(White, Bond, and Reschovsky 2013). Hospital outpatient prices were even
higher. In Kansas City and Saint Louis the average hospital outpatient price
was nearly triple the Medicare price, and some hospitals were able to negotiate much higher prices. As a result, a number of insurers are experimenting
with offering narrow networks on exchanges and to employers.
In 2007 the Missouri legislature passed the Missouri Health Improvement Act, which required that Missouri Medicaid provide all beneficiaries
with a healthcare home (which was not defined by the law) (National Academy for State Health Policy 2014). In 2011 the Centers for Medicare &
Medicaid Services approved two separate medical home programs for Missouri. One was for patients served by community mental health centers, and
the other focused on patients served by Federally Qualified Health Centers,
Rural Health Clinics, and hospital-based primary care clinics. As a result,
more than 50 organizations (which sponsor more than 100 clinics) across the
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 97
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
98
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
state are taking part in Medicaid-supported medical home demonstrations
(Centers for Medicare & Medicaid Services 2014b).
In addition, medical home projects have been launched for patients
with other insurance plans. For example, in 2009 Blue Cross and Blue Shield
of Kansas City began a test of paying practices to become medical homes. Finding that hospital admissions and readmissions dropped for patients in medical
homes, the insurer sharply expanded the program (Pfannenstiel 2013b). From
this insurer’s perspective, paying a primary care practice to coordinate and
manage care is a good investment. The scientific evidence regarding medical
homes shows a mix of favorable, unfavorable, and inconclusive results (Peikes
et al. 2012), so the value of medical homes remains uncertain.
Eight Missouri hospitals are taking part in Medicare’s bundled payment demonstration. Most are taking part in the trial that pays the hospital
for all inpatient and post-acute care, but three are participating in the version in which the hospital is paid prospectively for all of the services provided (including physicians’ services) during a hospital episode (Centers
for Medicare & Medicaid Services 2014b). A small-scale precursor to the
demonstration found that participating hospitals generally reduced costs and
improved quality, primarily by standardizing how they provided some cardiac
and orthopedic services (Herman 2012). Because of these results, private
employers and insurers are also experimenting with bundled payments. In
Missouri, Anthem Blue Cross and Blue Shield is conducting a trial of bundled
payments for orthopedic services, and Wal-Mart Stores offers its employees
and their families free heart and spine surgeries, while paying Mercy Hospital
Springfield using a bundled payment system (Herman 2013).
Two other ACA programs are underway in Missouri. The Kansas
City Quality Improvement Consortium, which operates in five Kansas and
Missouri counties in the metropolitan area, is taking part in the CommunityBased Care Transitions Program. This program seeks to improve transitions
between settings, to improve quality of care, to reduce readmissions for highrisk beneficiaries, and to reduce Medicare spending. Two other organizations
are participating in the Strong Start for Mothers and Newborns initiative,
which was described in Section 6.3.1.
Even though significant political opposition to the ACA is present
in Missouri, multiple innovations that are designed to bend the cost curve
are being tested there. These changes are supported by the federal government, the state government, private insurers, and healthcare organizations.
Although ACA innovations command the most attention, private insurers
are actively exploring bundled payments, medical homes, ACOs, narrow
networks, clinical feedback to providers, enhanced price transparency for consumers, and value-based insurance (Johnson 2013). Private insurers started
some of these innovations before the passage of the ACA, but the pace of
change certainly seems to have speeded up.
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 98
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 6 : Bending the C ost C ur ve
99
6.3.3 Innovations to Reduce the Cost of Care: California
California is a low-cost state, but multiple efforts are underway nonetheless. Average spending per capita is $6,238, which is 9 percent below the
national average, and the uninsured comprise 26 percent of the population,
well above the national average (Kaiser Family Foundation 2013). Forty-two
percent of the population is enrolled in an HMO, which is well above the
national average. As of 2013 control of the state government was solidly
Democratic. The governor was a Democrat, and both houses of the legislature had comfortable Democratic majorities (StateScape 2014).
In California the ACA is likely to mean that more than 3 million
residents will gain health insurance (Long and Gruber 2011). The state has
agreed to expand Medicaid, which is expected to increase eligibility by 1.4
million. In addition, about 2.5 million Californians are already eligible for
Medicaid but not enrolled. To increase coverage, California has already taken
steps to simplify Medicaid eligibility determinations and enrollment. These
steps include using a standardized application, using electronic federal and
state data sources, and allowing applications in person, by mail, online, or by
phone. Beginning in January 2014, Covered California (the California health
benefit exchange) further simplified and expanded enrollment (Lucia et al.
2013). Bending the cost curve is a high priority in California, and expanding coverage is seen as an essential part of that effort. California’s Medicaid
program is also in the process of shifting most enrollees (including children,
rural residents, and those also eligible for Medicare) to managed care.
Both the federal government and commercial insurers are funding
medical home projects in California. Seventy Federally Qualified Health Centers are participating in the Advanced Primary Care Practice demonstration
in California. In addition, Blue Shield of California has developed a narrow
network that includes a medical home for patients with chronic conditions
(such as cancer, heart failure, or diabetes). This combination is one tier of a
product called Blue Groove being offered to large employers in Sacramento
and Modesto (Burns 2012). Healthcare organizations in California are setting up medical homes as well. Just in the Bay Area, John Muir Health,
Stanford HealthCare Alliance, and Sutter Health launched programs in 2012
(Kleffman 2012).
California has eleven ACOs in place. Six of these were part of the
Medicare Pioneer ACO demonstration (although two withdrew in July
2013) (Gamble and Punke 2013). Most of the organizations have both
Medicare and commercial ACO contracts. Most of the organizations sponsoring ACOs have participated in California’s many HMOs, so profitably
providing care to ACO members should not seem new.
Twenty-eight California hospitals are taking part in Medicare’s
bundled payment demonstration. Eight hospitals (covering 118 types of
episodes) are taking part in the trial that pays the hospital for all inpatient
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 99
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
100
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
and post-acute care. A provider of post-acute services is participating in the
version of the trial that just covers post-acute services. Eighteen hospitals
(covering 136 episodes of care) are testing prospective payment for all of the
services provided (including physicians’ services) during a hospital episode
(Centers for Medicare & Medicaid Services 2014b). Participation in the prospective payment trial is different than in other states. California hospitals are
testing many more episodes of care than New Jersey or Missouri hospitals,
only one hospital is relying on an external consultant, and Tenet Healthcare
Corporation (a large for-profit system) is sponsoring six hospitals.
A number of private bundled payment trials are also underway. Hoag
Orthopedic Institute of Irvine has contracts with Kroger that cover orthopedic and spine surgery and contracts with Aetna, Cigna, and Blue Shield of
California that cover orthopedics (Herman 2013). Alta Bates Summit Medical Center (a Sutter Health affiliate) has contracts with Aetna and Blue Shield
for total hip and knee replacements (Stansbury and Lally 2013). A challenge
is that bundled payment is an alternative to capitation, and many California
providers are already capitated.
California is engaged in two other major initiatives. Nearly 400 California hospitals are taking part in the Partnership for Patients program. Its
goal is to reduce hospital-acquired conditions and readmissions. In addition,
the American Association of Birth Centers is testing birth centers in four
locations. This trial is a part of the Strong Start for Mothers and Newborns
initiative discussed previously.
In California just about everything is being tried to bend the cost
curve. Not surprisingly, given insurers’ and providers’ extensive experience
with managed care, more is being done in California than elsewhere.
Steering Patients to Less Expensive Providers
Medicare and Medicaid payments are set administratively and vary
only modestly within markets. With commercial insurance, in contrast,
prices may be very different for seemingly comparable services. Health
systems that have large market shares or excellent reputations may be
able to negotiate much higher prices than competitors. In Los Angeles, for example, commercial insurers paid some hospitals less than
Medicare did, while other hospitals received more than 400 percent
of the Medicare payment (Ginsburg 2010). Commercial insurers have
difficulty selling plans that exclude high-priced hospitals, and these
“must-have” hospitals often insist on contracts that include all of their
(continued)
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 100
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 6 : Bending the C ost C ur ve
101
(continued)
services in the insurer’s network. This requirement limits insurers’ cost
reduction strategies.
Plan sponsors, in contrast, need have no such ambivalence, and
some have begun to try to steer patients to less expensive providers.
One strategy, known as reference pricing, caps the amount the employer
will pay for a service and requires patients to pay the difference between
the reference price and the allowed charge (the price negotiated with a
provider). For example, suppose an employer sets the reference price
for hip replacement at $30,000. An employee who goes to a hospital
with an allowed charge of $32,000 will pay $2,000 out of pocket, but an
employee who goes to a hospital with an allowed charge of $42,000 will
pay $12,000 out of pocket. The goal is to encourage employees to use
the lower-priced provider and, just possibly, to encourage the higherpriced provider to negotiate a better deal with the plan.
In January 2011 the California Public Employees’ Retirement System implemented reference pricing for hip and knee replacement
surgery (Robinson and Brown 2013). Before reference pricing, 52
percent of the system’s procedures were in higher-priced hospitals.
Within a year this share fell to 37 percent. In addition, the average
price decreased by 26 percent, primarily because higher-priced facilities negotiated lower prices. This pilot study has occasioned interest
within the healthcare industry.
Reference pricing could be applied more broadly. For example,
the average price of a colonoscopy in the United States is $1,185, but
according to the International Federation of Health Plans (2013) a
quarter of providers charge $536 or less. What would happen in this
market with a reference price of $500?
Some have suggested taking this idea a step further. Although a
good way to detect colon cancer, colonoscopies are expensive and not
very pleasant. An annual fecal immunochemical test (with a colonoscopy if abnormal results are found) can be as effective as a colonoscopy for population colon cancer screening but costs less than $25
(Flitcroft et al. 2012). What would happen in the market for colonoscopies with a reference price of $25?
6.4 Conclusion
The ACA appears to have changed the political and economic landscape.
For the most part, it has done so by speeding up trials of ideas that existed
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 101
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
102
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
before its passage. Bundled payments, medical homes, ACOs, and HMOs are
not new ideas, but by supporting pilot studies of these ideas, the ACA has
encouraged an explosion of these prototypes.
The innovations that seem new—narrow networks and reference
pricing—have largely come out of the private sector. Both reflect old ideas,
though, because insurers and plan sponsors have noted that they pay different amounts for products that seem similar. What is new is that insurers
are increasingly willing to take steps to avoid high-cost providers, and some
providers are willing and able to use this opportunity to capture market share.
Nonetheless, the ACA appears to have had an effect on the private sector as
well. By creating large markets of cost-conscious consumers, the ACA seems
to have altered the strategies of insurers and some providers.
The effects of expanding insurance coverage on costs will take years
to understand, but another feature of the ACA already seems to have shown
positive results. The ACA incorporated incentives for hospitals to reduce
readmissions (which went into effect on October 1, 2012), and readmissions
for 2012 decreased (Gerhardt et al. 2013). Cost per beneficiary rose by just
0.3 percent in the first year of Medicare’s Pioneer ACO, and costs for similar
beneficiaries in traditional Medicare grew by only 0.8 percent (Centers for
Medicare & Medicaid Services 2013). For all of these beneficiaries, reductions in hospital admissions and readmissions helped keep costs rising more
slowly than general inflation.
Even more striking, Cigna, Aetna, and other insurers have publicly
announced that they plan to start hundreds more ACOs during the next
several years (Hastings 2013). And this statement says nothing about the
hundreds of other innovations likely to be launched.
These innovations are a long way from becoming established tools for
federal, state, and private policymakers. Some will work. Some will not. Early
results suggest that ACOs are realizing some savings and that reductions in
spending for targeted groups also reduce costs for other patients served by
the same providers (McWilliams, Landon, and Chernew 2013). All of these
indications seem likely to mean that healthcare managers will live in interesting times.
Exercises
6.1 An insurance market consists of high-risk patients, who average
$40,000 in spending per year, and low-risk patients, who average
$1,000 per year. Overall, low-risk patients represent 90 percent of
the population. What would average spending be for a population
like this?
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 102
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
C hap ter 6 : Bending the C ost C ur ve
103
6.2 Refer to Exercise 6.1. What would average spending be if low-risk
patients were 92 percent of the population?
6.3 Refer to Exercise 6.1. If an insurer sold 100,000 policies at $6,000,
what would revenue be? What would medical costs be if the insurer
paid for everything and low-risk patients were 90 percent of the
population? How would that change if low-risk patients were 92
percent of the population?
6.4 Why did hospitals have limited incentives to reduce readmissions
prior to the ACA?
6.5 Refer to the box titled “Steering Patients to Less Expensive
Providers” in this chapter. What would happen in the market for
colonoscopies with a reference price of $500? What would happen
in the market for colonoscopies with a reference price of $25?
6.6 Go to the CMS Innovation Center website (http://innovation.cms.
gov) and see what ideas are being tested in a state of your choice.
6.7 Why would a system like John Muir Health launch a medical home
that is intended to reduce its revenues?
6.8 How are a narrow network and an ACO different?
6.9 What recent evidence about the performance of ACOs can you find?
Are they growing? Are they saving money? Do enrollees seem to like
the care they get? Is the quality of care good?
6.10 What recent evidence about the performance of medical homes can
you find? Are they growing? Are they saving money? Do enrollees
seem to like the care they get? Is the quality of care good?
6.11 What recent evidence about bundled payment programs can you
find? Are they growing? Are they saving money? Do enrollees seem
to like the care they get? Is the quality of care good?
6.12 What recent evidence about Medicare Advantage HMOs can you
find? Are they growing? Are they saving money? Do enrollees seem
to like the care they get? Is the quality of care good?
6.13 How much did cost per Medicare beneficiary go up last year?
(The Kaiser Family Foundation publishes these data on its website
[http://kff.org/state-category/medicare/]).
6.14 Why would a health system want to participate in a trial of bundled
payments?
6.15 What risk does a health system bear when it agrees to a bundled
payment?
6.16 What risk does a health system bear when it agrees to accept
capitation?
EBSCO Publishing : eBook Collection (EBSCOhost) – printed on 2/12/2021 10:18 PM via NORTHCENTRAL UNIV
AN: 1663949 ; Robert Lee.; Economics for Healthcare Managers, Third Edition
00_Lee (2266).indb 103
Account: s1229530
7/15/14 8:51 AM
Copyright © 2015. Health Administration Press. All rights reserved. May not be reproduced in any form without permission from the publisher, except fair uses permitted
under U.S. or applicable copyright law.
104
Ec o n o m ic s f o r H e a l th c a re M a n a g e r s
References
Arend, J., J. Tsang-Quinn, C. Levine, and D. Thomas. 2012. “The Patient-Centered
Medical Home: History, Components, and Review of the Evidence.” Mount
Sinai Journal of Medicine 79 (4): 433–50.
Ayanian, J. Z., B. E. Landon, A. M. Zaslavsky, R. C. Saunders, L. G. Pawlson, and J.
P. Newhouse. 2013. “Medicare Beneficiaries More Likely to Receive Appropriate Ambulatory Services in HMOs Than in Traditional Medicare.” Health
Affairs 32 (7): 1228–35.
Berwick, D. M., T. W. Nolan, and J. Whittington. 2008. “The Triple Aim: Care,
Health, and Cost.” Health Affairs 27 (3): 759–69.
Burns, J. 2012. “Narrow Networks Found to Yield Substantial Savings.” Managed
Care. Published February. www.managedcaremag.com/archives/1202/1202.
narrow_networks.html.
Centers for Medicare & Medicaid Services. 2014a. “Bundled Payments for Care
Improvement (BPCI) Initiative: General Information.” Accessed April 23.
http://innovation.cms.gov/initiatives/bundled-payments/.
———. 2014b. “Where Innovation Is Happening.” Accessed April 7. http://
innovation.cms.gov/initiatives/map/index.html#state=MO&
model=federally-qualified-health-center-fqhc-advanced-primary-care-practicedemonstration.
———. 2013. “Pioneer Accountable Care Organizations Succeed in Improving Care,
Lowering Costs.” Accessed July 2, 2014. www.cms.gov/Newsroom/Media
ReleaseDatabase/Press-Releases/2013-Press-Releases-Items/2013-07-16.
html.
Colla, C. H., D. E. Wennberg, E. Meara, J. S. Skinner, D. Gottlieb, V. A. Lewis, C.
M. Snyder, and E. S. Fisher. 2012. “Spending Differences Associated with the
Medicare Physician Group Practice Demonstration.” Journal of the American
Medical Association 308 (10): 1015–23.
Davis, M. 2013. “New Program Has Mercer County Hospitals Sharing Fees with
Doctors to Contain Costs.” NJ.com. Published February 7. www.nj.com/
mercer/index.ssf/2013/02/new_program_has_mercer_county.html.
Doyle, J. 2013. “Health Insurers Face an Uncertain Future.” St. Louis PostDispatch. Published November 17. www.stltoday.com/business/local/healthinsurers-face-an-uncertain-future/article_38508…
Purchase answer to see full
attachment

Why Choose Us

• 100% non-plagiarized Papers
• 24/7 /365 Service Available
• Affordable Prices
• Any Paper, Urgency, and Subject
• Will complete your papers in 6 hours
• On-time Delivery
• Money-back and Privacy guarantees
• Unlimited Amendments upon request
• Satisfaction guarantee

How it Works

• Click on the “Place Order” tab at the top menu or “Order Now” icon at the bottom and a new page will appear with an order form to be filled.
• Fill in your paper’s requirements in the "PAPER DETAILS" section.
• Fill in your paper’s academic level, deadline, and the required number of pages from the drop-down menus.
• Click “CREATE ACCOUNT & SIGN IN” to enter your registration details and get an account with us for record-keeping and then, click on “PROCEED TO CHECKOUT” at the bottom of the page.
• From there, the payment sections will show, follow the guided payment process and your order will be available for our writing team to work on it.