Perspective

Reforming Provider Payment — The Price Side of the Equation

Paul B. Ginsburg, Ph.D.

N Engl J Med 2011; 365:1268-1270October 6, 2011

Comments open through October 12, 2011

Article

It's pretty basic economics: spending equals price times quantity. For some time, public health care payers, such as Medicare and Medicaid, have focused much of their cost-containment effort on constraining the prices they pay for health care services, which they set administratively. The Affordable Care Act includes additional constraints on Medicare prices as an important source of savings. But public payers recognize the limits of this strategy and hope to develop better methods of paying providers — such as bundled payment for episodes of care and payments to accountable care organizations (ACOs) and patient-centered medical homes — that will create incentives for treating patients using services more efficiently.

In contrast, private health care payers have traditionally focused more on the quantity part of the equation, using capitation in some health maintenance organizations (HMOs), cost sharing by patients, and more aggressive reviews of service utilization. But price is becoming a bigger headache for private payers as dominant health care providers, especially large hospital systems, have been using their market power to command increases in payment rates that exceed increases in unit costs. The ratio of private-payer rates to hospital costs increased from 116% in 2000 to 134% in 2009 (see graphAggregate Hospital Payment-to-Cost Ratios for Private Payers, Medicare, and Medicaid, 2000–2009.).1 Moreover, hospital leaders often cite inadequate Medicare and Medicaid payment rates as the reason they must demand higher rates from private insurers. There's no question that slowing the growth of Medicare and Medicaid spending is essential to long-term reduction of the federal deficit, but one result of further reductions in rates might be more cost shifting by those providers with leverage. Although many private payers share the enthusiasm for reforming provider payment, they realize that attempts to encourage hospitals, physicians, and other providers to integrate and align to improve care coordination are likely to lead to greater consolidation among providers, increased market power, and higher prices.

Although provider consolidation is often cited as a key factor permitting dominant providers to increase the prices they charge private payers, another important factor is the priority that consumers place on having a broad choice of providers. At the zenith of tightly managed care in the mid-1990s, insurers held the balance of power because they could credibly threaten to exclude high-priced providers from plan networks. But in response to the managed care backlash, health plans broadened their networks, typically incorporating most local hospitals and large physician practices. So-called must-have providers — those that were particularly valued by consumers either because of their reputation or as an important source for a particular specialty service or geographic area — amassed extensive leverage and the ability to obtain much higher prices than other providers. This mechanism is reflected in extensive price variation within and between markets.2,3

The disproportionate leverage secured by some providers can be countered by either market-based or regulatory approaches, or elements of each. The market approach involves adopting designs for insurance benefits that provide enrollees with incentives to choose lower-cost providers. Some designs, called tiered networks, sort network providers into tiers according to the insurer's assessment of costs and quality and then vary the deductible or other elements of patients' cost sharing by tier. This approach could potentially shift care to less costly providers and induce the more costly ones to become more efficient. Tiered designs were conceived some time ago but have not advanced much because of limited interest on the part of large employers in restricting employees' choices of providers and the ability of some hospitals to refuse to enter a contract unless the plan places them in the preferred tier. Massachusetts recently addressed the latter issue through 2010 legislation that prohibited such refusal to contract based on tier placement — an example of regulation supporting a market strategy.

Some small employers recently began shifting to insurance plans whose networks exclude the more expensive providers altogether, displaying a willingness to accept less provider choice in exchange for a lower premium.4 If the experience with the designs of prescription-drug benefits is any indication (tiered formularies, rather than closed formularies, became the norm), tiered networks may ultimately draw a larger following than limited-network designs. But the success of either approach is uncertain and will depend on the degree of consolidation in markets and consumers' willingness to embrace notions of market competition in health care. Should employers find that they have few opportunities to control prices through such market approaches, they could augment their current calls for more vigorous antitrust enforcement with demands for price regulation.

The United States has experience with regulation of hospital prices at the state level. During the 1970s, some states, mostly in the East, regulated what hospitals could charge private payers. But believing that other health system developments, such as Medicare inpatient prospective payment and managed care, would contain cost growth and entering an era that was more hostile to regulation, most of these states abandoned such all-payer rate setting in the 1980s or 1990s. Maryland and West Virginia still have all-payer rate setting, and in Maryland there is evidence that it has slowed cost growth. If dominant providers continue to use their market clout to extract higher-than-competitive rate increases from private payers, states with political cultures more inclined toward regulation may reconsider all-payer rate setting.

Much has changed in health care financing and delivery since the 1970s, and state rate setting would need to be different as well. For example, with Medicaid payment rates so much lower than either Medicare or private insurance rates today, it is probably not feasible to set the same rate ceilings for all payers. Existing differentials could be grandfathered or regulation could be limited to nongovernmental payers. Indeed, if other states decided to follow Maryland's model of having an independent commission set the rates, governors might be reluctant to cede power over Medicaid rates to such a body.

The wide payment-rate variation among providers would be another challenge. Regulation would seek to reduce the degree of variation in prices, but it would have to be done slowly, probably by accepting current rates as a starting point and allowing smaller increases for providers with higher rates.

Since rate setting addresses only the price side of the cost coin, not the quantity side, a key consideration is whether it would advance or hinder broader provider-payment reforms that address not only price but the quantity or mix of services. Rate setting entities need to readily approve innovative contracts between insurers and providers. It could advance reform if methods such as ACOs and episode bundles were pursued by both private and public payers, ideally using similar methods so that providers received consistent economic signals about providing high-quality care efficiently. On this front, a proposal from the governor of Massachusetts emphasizes coordinating a shift to global budgeting by Medicaid and private insurance plans subsidized by the state. Rate setting could allow providers to avoid situations in which some payers use ACO-like techniques while others continue to pay fee for service. But these days, provider-payment reform often involves physicians and other providers as well as hospitals, making rate setting far more challenging politically.

Nonetheless, the unchecked market power of some providers promises to become increasingly problematic for private payers. And if market approaches prove insufficient to solve a problem of this magnitude, regulatory intervention becomes more likely. But public and private payers alike should keep their focus on payment reforms that address both the price and the quantity of health care and avoid inadvertently working at cross purposes.

Disclosure forms provided by the author are available with the full text of this article at NEJM.org.

Source Information

From the Center for Studying Health System Change and the National Institute for Health Care Reform, Washington, DC.

References

References

1
Trendwatch chartbook 2011: trends affecting hospitals and health systems — supplementary data tables, trends in hospital financing, Table 4.4. Chicago: American Hospital Association, 2011. (http://www.aha.org/aha/trendwatch/chartbook/2011/table4-4.pdf.)

2
Examination of health care cost trends and cost drivers: report for annual public hearing. Boston: Office of Massachusetts Attorney General Martha Coakley, 2011. (http://www.mass.gov/Cago/docs/healthcare/2011_HCCTD.pdf.)

3
Ginsburg PB. Wide variation in hospital and physician payment rates evidence of provider market power. Research brief no. 16. Washington, DC: Center for Studying Health System Change, 2010. (http://www.hschange.org/CONTENT/1162.)

4
Felland LE, Grossman JM, Tu HT. Key findings from HSC's 2010 site visits: health care markets weather economic downturn, brace for health reform. Issue brief no. 135. Washington, DC: Center for Studying Health System Change, 2011. (http://www.hschange.org/CONTENT/1209.)

Comments (3)

3 Reader's Comments

Price Competition

Nice to hear the conversation include competitive pricing. This has worked in other industries and has recently been successful in durable medical equipment--slicing 28% off the Medicare expenses in that realm. The insurer (e.g. Medicare) could issue an RFP for their 10 most expensive or common procedures. Dear patient: If you want Medicare to pay for your total hip, here's where you must go. (P.S. If you pay for it yourself, you can go anywhere.) No, you can't regulate or fix prices. That has never worked. And Dear Provider: If you want to stay in business, find a way to provide the service at a price below your competitor. Estimates of procedural waste in healthcare vary from 20 to 50%, so there is ample room. The missing link has been the motivation to improve. We need to add price into the definition of quality in healthcare. It can be done.

DR JASON MCCUBBIN, MD | Physician | Disclosure: None

TAMPA FL

October 10, 2011

And Thus Limit a Physician's Independence

So will these "Third Party Payers" also factor in the cost of my education, or prorate me for the time that I sacrificed honing my professional abilities? I'm guessing that what you are saying is that my education, training and acquired skills can be standardized down to a pre-specified value established by your "Third Party Payer"! Furthermore, I as an independent physician have no right or say in the valuation of the quality of the care that I provide to my patients? Quite frankly, physicians who do their own billing, coding and collecting already understand the extensive amount of regulation that exists for professional reimbursements. This article should be directed at the large medical institutions and hospitals.

bob sigmond | Other | Disclosure: None

October 09, 2011

Doing Away with Pricing by Providers

Dr. Ginsburg's brilliant analysis convinces me that the time has come to reform provider payment by doing away with provider pricing. The simplest way is to have each provider organization select a single, competitive, third party payer to do all the payments to the contacting provider organization, based on a negotiated annual budget covering all of the provider's expenditures,without regard to specific services to individual patients.. The third party payer would take over the provider's billing and collection functions and will be much more effective than individual providers. To the extent that third party payers promote comprehensive benefits, expensive billing for specific provider services will gradually disappear. Until then, contracted third party payers can set the market prices for specific provider services, without provider involvement, thereby eliminating anti-social incentives associated with provider pricing. Why not do away with pricing by providers so they can concentrate on health improvement, with the guaranteed income in their annual budget?

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