The Economics of Healthcare Systems: 6 Trends Entrepreneurs Should Know
“Health is the greatest of human blessings” — Hippocrates
The US spent $3.5 trillion — nearly 18% of GDP — on healthcare in 2017. Healthcare spending has outpaced GDP growth for the last five decades. For entrepreneurs passionate about impact and scale, healthcare would seem to be fertile ground.
But understanding the incentives and structure of the healthcare industry can be daunting. Even President Trump said it: healthcare is “an unbelievably complex subject.”
Thankfully, there is a wealth of economics and policy research to guide the way. This post covers healthcare systems — the organizations that deliver care. Borrowing from academic research, I outline six trends shaping their economic future. I give a brief introduction to each topic and share resources for learning more.
1. Payment Reform is Slowly Shifting Incentives from Volume to Value
Economists often say healthcare is unique. In contrast to most transactions — with a seller and a buyer— healthcare services involve three parties: the patient, the provider, and the payer. Payers reimburse services providers deliver to patients. Payment models, the rules for how and when services are covered, are central to understanding the economic incentives healthcare providers face.
The bulk of care today is covered under a “fee for service” (FFS) model. Under FFS, the payers (healthcare insurance companies) pay healthcare providers for each individual service a patient receives — a lab test, a procedure, or an office visit, for example. The big concern with FFS is that it incentivizes providers to deliver higher volumes of care with less attention to quality or cost.
Certain services are more profitable than others in FFS. See this article in Health Affairs for an overview and this blog post by the late economist Uwe Reinhardt for guidance on hospital incentives specifically. For the truly numbers-oriented, read the annual reports of major healthcare systems — they often include financial statements — or request Medicare Cost Reports for a full financial overview of one system.
FFS is one payment model along a spectrum of alternatives. The other end of the spectrum is “capitation.” In lieu of reimbursing providers for each service they provide, capitation bundles all services together. Healthcare providers receive an annual risk-adjusted payment to cover any service that may be necessary for a patient. At the end of the year, providers keep whatever money remains.
Capitation and other “value-based care” models offer some hope of reducing costs by incentivizing value over volume. Capitation increases cost sensitivity, but it also runs the risk of incentivizing reductions in valuable care.
There is a hearty alphabet soup of payment models out there. The Healthcare Payment Learning and Action Network (LAN), a public-private partnership focused on alternative payment models, categorizes them into four groups, with pure FFS on the left, and pure capitation on the right.
For the last two years, LAN has tracked the percentage of spending that falls in each category. The measurement is part of a broader movement — led by the government and large employers alike — to reduce the costs of healthcare by shifting payment models.
Through the Centers for Medicare and Medicaid Services, the government is leading the way in experimenting with alternative payment models. LAN’s goal is to accelerate that shift with the help of measurement. Between 2015 and 2016, the percentage of healthcare spending covered by FFS payments with no link to quality dropped from 62% to 43%.
Still, the majority of spending is tied to the FFS model, and adoption of pure capitation models remains limited.
This is not the first attempt to remedy FFS, and we are still learning whether alternative payment models will deliver more efficient care. A big focus is on “Accountable Care Organizations” (ACOs). ACOs are provider organizations that cover all services for a patient over a long period of time in exchange for a single payment. They are “risk-bearing” because patients may need more or fewer services than anticipated by the payment. Economists have studied how effective ACOs are at reducing spending. The results seem to depend on the type of ACO.
ACOs in the early part of the Medicare Shared Savings Program (MSSP) have shown limited evidence of savings. In one 2016 NEJM study, the authors conclude:
“…our findings extend evidence of small but meaningful reductions in spending, with unchanged or improved quality of care, early in the Medicare ACO programs and suggest that progress toward net savings to Medicare or society may be slow.”
Other ACO models have shown reductions around 8%. The success of the ACO model hinges on the ability to change frontline provider workflows and decision making; some organizations are better placed to take advantage of that than others. To learn about why savings may vary by the type of ACO — for example an outpatient medical group vs. an integrated health system — see “Explaining Sluggish Savings under Accountable Care.”
While ACOs may not have achieved overwhelming cost reductions yet, there are strong political and economic forces favoring their adoption. Stay tuned for more payment model shifts.
2. Consolidation Continues, Further Weakening Competition
Over the last three decades, there has been a major shift in the ownership structure of provider organizations. Group practices and independent hospitals have consolidated into large healthcare systems, which employ doctors, own multiple hospitals, and increasingly offer healthcare insurance.
David Cutler and Fiona Scott Morton provide a nice overview of this trend in a JAMA article, Hospitals, Market Share, and Consolidation. For example, from 2007 to 2012 there were 432 hospital merger and acquisition deals.
One measure of current consolidation is market share, the percent of hospital days within a region that one system receives. Cutler and Morton show that on average, two hospital systems cover more than 60% of the market:
Consolidation brings tradeoffs. The upside is the potential for greater efficiency and coordination at scale. In theory, larger healthcare systems can spread fixed costs over more patients and coordinate care across all providers a patient may need to see.
The downside of consolidation is reduced competition, which is a driver of increased prices and fewer incentives for innovation. With less competition, providers can raise prices rather than improve efficiency when facing economic pressure.
Reduced competition is especially problematic in an industry with few existing incentives to compete based on quality. Entrepreneurs bringing innovative products to market should understand this point clearly. Solutions that increase the quality of care may not be immediately embraced by healthcare systems with large market share and limited incentives to compete on quality. Leemore Dafny and Thomas Lee make this point well in an HBR article.
3. The ACA Expanded Coverage, but Premiums are Still Rising
The Affordable Care Act (ACA), also known as “Obamacare,” introduced the most drastic changes to healthcare since the creation of Medicare in 1965.
A major goal of the ACA was to reduce the number of uninsured Americans. On that metric, the reform was successful. As former President Obama noted in a JAMA article, there was a 43% reduction from 2010 to 2015 in the uninsured rate (from 16% to 9.1%). Data from the US Census Bureau show that the reduction was particularly concentrated among young people in their 20s:
President Trump has attacked the ACA, undermining the changes in coverage Obama sought. For example, Trump has focused on reducing subsidies that help low-income Americans obtain health insurance.
The ACA also sought to reduce the total cost of care. In that, it has been less successful. In the same JAMA issue, two economists, Jonathan Skinner and Amitabh Chandra, conclude that “the ACA has, to this point, not accomplished its goal of making healthcare more affordable.” The Kaiser Family Foundation annual survey of employers shows continued growth in healthcare insurance premiums:
Affordability remains a dominant concern in healthcare reform and will spur further changes. Chandra and Skinner offer their own take on what additional reform could look like:
….some combination of price regulation for highly monopolized health care organizations, and bundled payments that encourage new health care entrants to disrupt traditional hospital monopolies, may offer a way forward
Given rising healthcare costs and tight government budgets, reform of this sort is likely to continue.
4. Patients are Becoming More Cost Sensitive with Higher Deductibles
One idea to reduce healthcare costs is to give patients more responsibility for spending. High-deductible health plans (HDHPs) do just that. With HDHPs, consumers must pay a large chunk of their healthcare expenditures (typically a few thousand dollars) out of pocket before insurance covers any amount.
HDPS are on the rise. The 2017 Kaiser Family Foundation survey of employers showed a 24 percentage point increase from 2006 (4%) to 2017 (28%) in coverage via an HDHP.
Exposing consumers to more “first-dollar” cost of care creates a variety of new incentives. Consumers must make sharper tradeoffs between cost, convenience, and quality. The market is shifting accordingly. For example, urgent care centers —which limit costly emergency department visits and add convenience — have become very popular.
HDHPs seem to reduce the total amount of care patients seek. A 2017 study in the Quarterly Journal of Economics evaluated spending among patients whose employer switched to offering HDHPs only. The authors found a ~13% decrease in total spending after the switch. Contrary to expectations, the reductions were not due to price shopping or investment in higher value services:
“We clearly documented that spending reductions were due almost entirely to consumer quantity reductions across a broad range of services, including some that were likely of high value in terms of health and potential to avoid future costs. Consumers did not shift to cheaper providers, in either of the two years we observe post-switch.”
Employees were especially sensitive to cost while spending remained under the deductible — even among those employees who could expect to exceed the deductible in the same year. That is, though insurance would eventually kick in to cover most of their costs, employees focused primarily on the “spot” price of care. With higher deductibles, patients are becoming more cost-sensitive.
5. Spending is High and Growing for Outpatient Care and Chronic Conditions
Costly emergency department visits and pharmaceutical drugs often receive the spotlight in discussions of healthcare spending. A 2016 JAMA study estimated spending for those areas at $102B and $288B respectively in 2013. The majority of spending, however, comes from outpatient visits ($706B) and inpatient hospital stays ($697B). Over time, the share of outpatient spending relative to inpatient stays has increased.
In addition to changes in care settings, there has been a large increase in spending on chronic disease, with conditions such as diabetes and hypertension showing the most growth over the last decade. Diabetes leads the way, increasing by $64.4 billion from 1996–2013 ($37 billion to $101.4 billion).
All of these numbers come from the same 2016 JAMA study, US Spending on Personal Health Care and Public Health, 1996–2013. The authors provide a nice breakdown of both care settings and conditions:
For an interactive version of the graph allowing you to drill down by age, gender, and disease, see this site.
Shifts in utilization and payment gradually alter the economic prospects of a variety of healthcare actors, including providers. McKinsey produced a 2018 report showing how earnings for each industry group may be impacted by shifts in the market. Outpatient and post-acute care settings are expected to see the most growth relative to hospitals.
6. Electronic Medical Records are Pervasive but Problematic
Adoption of electronic medical records (EMRs) has soared in the last 10 years. The 2009 Health Information Technology for Economic and Clinical Health (HITECH) Act accelerated adoption through subsidies under a program known as Meaningful Use (now called Promoting Interoperability). According to the Office of the National Coordinator for Health Information Technology, adoption of basic EHRs increased from 9.4% in 2008 to 83.8% in 2015:
Around the passage of the Act, there was great hope for the benefits digitization might bring to healthcare. A 2005 RAND study estimated a potential $81 billion in annual healthcare savings from the widespread adoption of EMRs.
Few studies have credibly evaluated how these systems have actually impacted the efficiency of care. The hope is that pervasive IT systems can benefit healthcare just as they have other industries. There are many ideas for how to do that.
In reality, one thing is clear: most doctors do not like their EMRs. The HITECH Act accelerated the adoption of EMRs on the market at the time — which many healthcare providers had previously not found worth purchasing. Clunky EMRs have contributed to increasing physician burnout and physicians now spend roughly the same amount of time in front of a computer as they do seeing patients.
Conclusion
Behind the data, graphs, and studies in this article is an industry that matters. Economics and policy research may not be the most inspiring part of healthcare — resilient patients and dedicated providers certainly top the list — but for entrepreneurs trying to make a scalable difference for healthcare systems, economic incentives are a useful place to start. Hopefully this list has been helpful as an overview and launching point for more in-depth understanding.
Health economics and healthcare are broad. Payers, pharmaceutical companies, and patients themselves each play a large role. Economists study those too. Questions range from how to improve healthy behaviors using behavioral economics to the role of patents in pharmaceutical innovation. Healthcare is not only an important industry, it is one in which opportunities for continual learning abound.
