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November 07, 2008

Reining In Healthcare Spending

Gary Frazier
Assistant Director, Healthcare and Pharmaceutical Management Program
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This is part of a series of posts on healthcare industry topics that will be discussed at the Columbia Business School Healthcare Conference on November 21. The “Payor/Provider Panel” will discuss new paradigms in medical cost and outcomes management and how these paradigms will be impacted by the election of Barack Obama.

Attempting to restrain healthcare spending in the U.S. is a bit like trying to extinguish a forest fire: while one of the smaller fires on the periphery may be easy to put out, the ones deep in the core of the forest are much more difficult to stop. Many of the propellants that have fueled national healthcare expenditures are deeply entrenched (“core”) aspects of either the healthcare system or our society’s values. As such, they have largely resisted many of the efforts made to control them.

According to the the Centers for Medicare and Medicaid Services, the share of U.S. GDP devoted to healthcare grew from 9.1% in 1980 to 16.0% in 2006. By 2016, healthcare expenditures are predicted to grow to $4.2 trillion dollars, or 20% of GDP. It is clear that it is necessary to control costs; however, the current recession will make doing so even more challenging.

Here is a cross-section of the social and logistical issues that cloud cost-cutting:

National Wealth

In spite of a potential global recession, the U.S. is likely to remain one of the wealthiest nations on earth. U.S. per capita spending on healthcare is 48% higher than that of the next highest-spending country (Norway) and 83% greater than Canada’s, according to the Organization for Economic Cooperation and Development. Princeton’s Uwe Reinhardt points out that the “ability to pay, as measured by GDP per capita, has repeatedly been shown to be one of the most important factors” driving a nation’s healthcare spending.

Administrative Costs

The U.S. healthcare financing system is very complex and entails significantly higher administrative costs than those of other countries. A study by Harvard Medical School and the Canadian Institute for Health Information estimated that approximately 31% of U.S. healthcare expenditures ($1,000 per person per year) are directed to administrative costs, about double what is spent in Canada.

System Inefficiencies

Poorly coordinated care, variations in provider practice patterns and misaligned financial incentives are just three of the inefficiencies of the U.S. healthcare system that drive up costs.

Cost of the Uninsured

A recession could force a greater number of people to live without insurance. The cost of paying for these patients when they show up at our nation’s emergency rooms is exorbitant and borne by the general public.

Cost of Technology/Resistance to Rationing

Most of the major medical technology/life science innovations over the past two decades have been priced at substantial premiums to previous technologies. In the absence of national pricing/reimbursement reform, this pricing structure will probably remain intact. The desire of Americans to always have the best doctors and the newest technologies drives up costs. Modestly intrusive practices that control the use of the most expensive treatment options, such as therapeutic substitution and step therapy, have gained some traction in the pharmaceuticals marketplace. More intrusive restrictions, such as rationing care or establishing annual cap amounts over which all care becomes out-of-pocket (a practice employed in some European countries), are much less likely to take hold. Outside of Oregon, America is probably not ready for measures as radical as rationing care.

Graying of America/Expense of End-of-Life Care

Healthcare expenses for persons over 65 are about three times those of the under-65 population, according to government data. When it comes to end-of-life care for relatives, most Americans want to keep family members alive as long as they have a “fighting chance.” Approximately 10-12% of the total national healthcare budget and 27% of the Medicare budget is spent on end-of-life care, according to the Center to Advance Palliative Care (CAPC). Like rationing, euthanasia is not likely to gain a foothold in the U.S. anytime soon, if ever. With the aging of our nation, this “core” issue will only grow in prominence. According to the U.S. Census Bureau, the percentage of the U.S. population over 65 will increase from 12% in 2006 to 20% by 2030.

What thoughts or questions do you have about healthcare spending? Please share your comments.

Photo credit: Ben Hulley


by Kimberly Kinchen | November 07, 2008 at 5:30 PM

While not everything is preventable, many common serious medical conditions are. Can you comment on how preventative efforts fit in here? Do we have a broad sense that for every $x spent (be it on preventative medical practices or efforts on the part of individuals, employers and, for young people, schools) on prevention, $y is saved? Or any sense that its more cost effective to concentrate on one approach to prevention versus another, or even whether investment in prevention is a significant part of a solution?

by David Beim | November 08, 2008 at 11:50 AM

The central dilemma in healthcare is that we want three things: accessibility, affordability and quality. Unfortunately, it is not possible to have all three - at best we can only have two. I see no escape from this. We can have affordability and quality if we are willing to limit access. Oregon's plan was a highly intelligent approach to rationing (do all procedures with a sufficiently high ratio of benefit to cost) and this would be my preferred solution. Or we can have affordability and access by sacrificing quality - limiting payments to providers and living with the consequences. Does anyone really want this? Or we can have access and quality if we are willing to pay unlimited amounts of GDP for all the reasons stated in Mr. Frazier's posting. But I fear this would bankrupt our already over-stretched public finances. I personally see no attractive alternative to rationing, and I think we can only make progress by facing this.

by Adam Hutton | November 11, 2008 at 9:02 AM

The above article assumes that the cost of providing health care is artificially high because of complex cost structures and poor business efficiency, therefore, the price passed on to consumers by health care providers is, as a result, artificially high. Therefore the government must step in to set price controls (either indirectly or directly) or to, by some means, improve the efficiency by which health care providers can run their businesses. It seems illogical that by adding government intervention, businesses will significantly reduce their cost of providing services - as opposed to market mechanisms and competition. Its difficult to think of any situation that government intervention has ever streamlined a private industry's business processes or reduced its cost of doing business. Subsidies would simply save the businesses from incurring the cost of inefficiencies to the taxpayers - removing the incentives for the business to reduce its own cost structure. By simply imposing price controls ('medicare will pay this, will not pay that'), drugs will still be extremely difficult to develop and bring to market, doctors and researchers will still be in high demand, and health care technologies will still be expensive. Because drugs and health care can rarely be substituted, wouldn't the best attack at reducing the costs come from increasing the supply of trained health care professionals, doctors, researchers, chemists and bioinformatics professionals? In this reader's opinion, $100bln could put a lot of advanced degrees in our citizens hands and have a much more significant contribution to reducing health care costs in the long-run than any subsidy or price-control mechanism the federal government could propose.

by Gary Frazier | November 11, 2008 at 3:34 PM

I appreciate your perspectives. There are indeed many articles that deal with the downside of government price controls in healthcare. My intent in stating "In the absence of national pricing/reimbursement reform, this pricing structure will probably remain intact" was not to make a value judgment on government price controls or on the pricing of medical technology/products. I wanted to merely point out that in the presence of our society's strong demand for the best medical technologies and given the significant price tag for new technologies, and in the absence of something major re: price controls/reimbursement reform or something that dramatically alters the competitive and/or technology assessment landscape, the cost of medical technology will remain a major cost driver in the U.S. healthcare system. Due to space limitations, the cost/benefit or "value" equation was also not addressed in this blog. In other words, some technologies/drugs are well worth their pricetag in lives saved or lives dramatically improved. Others are not. We will perhaps save that topic for a future blog.

by Gary Frazier | November 18, 2008 at 12:06 PM

Kimberly: Thanks for sharing your thoughts about prevention. It's a very important sub-topic within the cost-quality equation. Most preventative efforts--whether in the form of corporate wellness programs, government guidelines, or recommendations from specialists in Preventative Medicine--target the leading causes of preventable death and illness, such as: smoking, obesity, alcohol consumption, STDs, infections, and illicit drug use just to name a few. Corporate wellness programs focus on prevention, education, disease management, and risk appraisals. On www.chiphealth.com, the corporate wellness programs of Dupont, Motorola, Pepsico, and Citibank are cited as returning between $3.00 and $5.00 for every dollar invested.

by Ying Liu | November 20, 2008 at 1:43 PM

One point I would like to make is all the players in the healthcare industry, such as drug makers, insurers, government and others, need to pitch in and be prepared to be part of the savings. They all need to contribute and it has been shown that every sector can become more efficient in terms of competitiveness. The drug industry is open to working on reforms than it has been possibly any time in the past. With the new leadership on the Capitol Hill, new healthcare policies are bound to come.

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