Policies to Control Costs October 24, 2006

1. Policies to Control Costs October 24, 2006

2. Policies to Control Costs • Key policy question: How can a health care system that relies on third-party insurance control spending????

3. Keep in mind the 3 objectives associated with health care reform • keep costs down (expenditures) • provide access to care • provide quality of care • Expenditures = price x quantity (Some argue that controls lead to rationing. Be careful though since we have rationing in the U.S. It’s just not as obvious.)

4. Policy Options for Government Run Systems: • mandated fee schedules • global budgeting (spending caps) • resource rationing

5. Mandated Fee Schedules Keep in mind that fee schedules in and of themselves cannot keep expenditure low since: Expenditures = price x quantity

6. Price Controls • To the extent that the controls lead docs to lower their expenses, waste can be reduced. • But in the longer run these gains are exhausted.

7. Price controls might not reduce expenditure: Expenditures = price x quantity • see more patients • treat them more intensively • Un bundle services

8. Unbundling • Instead of billing for the service, the provider bills for each part of the treatment. • The practice defies logic because the sum of the parts is greater than the whole. • e.g. Standard care for treating a broken bone, when broken into its component parts with a separate bill for each, will cost more than the complete item. (The amount that can be billed for an office visit, two x-rays and a follow-up visit is often greater than the bill for the total package including the cast and its removal.)

9. Mandated Fee Schedules Expenditures = price x quantity • Usually controlled prices don’t last. • fee schedule is usually adjusted downward • negotiated fee schedules eventually become one of regulated fee schedules (Note: Providers often find that they can get around controls by seeing more patients and treating them more intensively.)

10. Global Budgeting – Spending Caps • Canada and Germany: set global budgets for hospitals (set amount of money to be used to provide services to all patients) • What happens when budgets are exhausted: • delay treatment • close hospital wards • operating rooms unused • personnel take unpaid vacations • elective surgery is delayed (wait lists) • treat only life threatening conditions

11. Resource Rationing • improve access to primary and preventative care by encouraging more physicians into primary and preventative care As system evolves: • primary care physicians are cast in the role of “gatekeeper” • access to high tech equipment and procedures is restricted (Bottom line: rationing limits access to the high-cost hospital and specialty sector.)

12. Summary • Price controls in medical care benefit patients at the expense of providers in the short run. • After the initial cost efficiencies are realized, the lower prices lead to fixed budgets and eventually limits on services. • Targets become mandates and eventually limits on services. • Controls are likely to lead to increased costs because the distortions created by controls may stifle innovative activities that would lower costs. • Moral of the story: The root cause of increased spending, limited cost-conscious behavior on the part of buyers and sellers is not addressed.

13. Cost Containment Strategies in the U.S. • Since the U.S. government pays around ½ of the cost of medical care, cost containment policies have centered on Medicare and Medicaid.

14. Diagnosis Related Groups • Prior to 1983 Medicare reimbursed hospitals on a cost-plus basis. • What incentives were given to hospitals to control costs?

15. Prospective payments to hospitals: These are flat-rate reimbursement rates for hospitals. • What incentives were given to hospitals to control costs? • Note that the hospitals received a fixed amount of $ for a given condition.

16. Diagnosis Related Groups (DRGs): Charges to hospitals are determined in advance on a per-case basis. • Payments are based on • a point system, AND • on a reimbursement rate that is set for each case weighted point • (Relative weights are set nationally and adjusted for rural or urban location, the number of residents and interns per bed for teaching facilities, and the number of low income patients treated by hospitals.)

17. Example: In the 2000, the unadjusted reimbursement rate for hospitals in large urban areas was $3,951.03 per weighted unit.

19. (Currently about 500 DRGs) • Example of the calculation: A female presenting herself for normal delivery of a baby • Normal delivery without complications (DRG # 373 has a resource use weighting of 0.3973. • Cesarean delivery, DRG 370, has a resource weighting of 0.9067 – implying a doubling of resource use. • Using the monetary conversion rate of $3,950 per weighting unit: • DRG 370 (cesarean delivery): total bill is $3,581 (.9067 x $3,950)

20. Hospital reimbursement determined at the point of diagnosis. • If the cost of treatment is less than the DRG payment, the hospital keeps the surplus. • If the cost of treatment is greater than the DRG payment, the hospital absorbs the loss. • Impact of DRGs --admissions fell --average length of stay fell

21. Setting Physicians’ Fees: Resource-Based Relative Value Scale (RBRVS) • Late 1980s: budgetary constraints in light of deficit awareness highlighted two main concerns about reimbursing Docs by Medicare. Two facts were brought out: 1. Spending is not necessarily cost effective 2. Previous pay schedules had inequitable rates between procedural services (i.e. surgery and invasive testing) and evaluation and management (E/M) services (i.e., office visits and consultations).

22. Under Medicare, the payments were limited to the minimum of “customary, prevailing, and reasonable” charges for a particular physician practicing in a particular geographic area. • Customary charge: is the median charge of the physician’s charges during the previous year. • If the actual charge was lower than the “customary, prevailing and reasonable” charge, then the price was allowed by Medicare.

23. This had a built in inflationary bias since it was based on actual prices charged. • Physicians had no incentives to compete on price. • If the physician’s actual charges were less than the customary charge the doc received the actual charge. • But why charge less than customary? • That is, it had problems and was distorting behavior of physicians.

24. Resource-based relative value schedule (RBRVS) • an index of relative values of resource use when physicians produce services or procedures • indices reflect the time, skill, and overhead cost of providing a particular service • Can combined with a monetary conversion factor to obtain a fee schedule • unit value of RBRVS was $36.20 in 2002.

25. Today, Medicare physician payment is based on the principle that differences in pay should reflect differences in work effort. • Three kinds of costs: -- work effort measured by their own time energy and skill level -- the overhead cost of their practice -- professional liability insurance premiums (the relative value unit for each service is based on these costs)

26. In 2002, the monetary conversion factor was $36.20. Thus, a medical service with a weighting of 5 units would be reimbursed $36.20 x 5, or $181. • Note that to control costs the rate was dropped from $38.26 in 2001 to $36.20 in 2002.

27. Results of the RBRVS system: • Physicians with a strong patient base in the private sector (i.e. non aged) will begin to refuse new Medicare patients. • In 2001, almost 30% of U.S. docs were not accepting new Medicare patients • prediction: Emergency rooms will become the best alternative source of care for a greater number of Medicare patients. • prediction: Shortages of health care services will begin to develop as resources are shifted into the unregulated, private sector.

28. Managed care as opposed to fee for service: • Capitation: providers receive a fixed payment in advance • care is provided to a well-defined patient population • some risk is shifted to providers • gives incentives to be efficient