Log In

Market-Based Theory for HMOs

Douglas W. Emery, MS

May 30, 2000
Managed Care Theory

The U.S. health care system is a complex economy. The global theory of managed care advocates taking stock of the most primal, elementary forces shaping the economics of health care and harnessing them. That means all activities involving health care and its payment must be sorted and puzzled together according to the multidimensional nature of risk. The entire universe of medical treatments must be organized into a robust taxonomy of clinically homogenous episode product lines.
A market-oriented solution to the social inefficiencies inherent in traditional managed care would be driven by three values: risk bifurcation, polycentrism, and consumer sovereignty. These three values can be contrasted with the three values that dominate traditional managed care: risk conflation, monopolism, and paternalism.

Risk Bifurcation

The overarching problem that traditional managed care faces involves pricing two unrelated bodies of risk: probability risk and technical risk. A genuine market approach would recognize that one category of institutions should manage probability risk and another should manage technical risk. Though managed care— and particularly capitation—has the potential to achieve cost efficiencies unheard of in a traditional indemnity, fee-for-service context, those gains are inherently limited, and at some point, turn back on themselves. The current savings from capitated managed care flow primarily from price compression, reduced hospital admissions, shorter lengths of stay, and some efficiencies in managing patients.

Even greater savings and leaps in optimal health care technology will occur when, as happens in other markets, providers managing technical risk compete on the basis of global fees for acute care or maintenance fees for chronic care. The only way to accomplish such point-of-service price competition in health care is to organize the delivery of care by episode. The episode of care is the natural unit of analysis identifying and categorizing all relevant types of human behavior and resource consumption in the delivery of care. Furthermore, it is the only way to measure quality and outcomes in the delivery process of care meaningfully.

Globally priced episodes of care act as a lens to focus clinical decisions regarding appropriate levels of resource utilization. Commenting on participating in Medicare's experiment with globally priced cardiology episodes, Richard Shemin, MD, chief of cardiothoracic surgery at Boston University Medical Center, said the challenge was to alter protocols to fit within the global payment system without compromising the care physicians provide. The cardiologists canceled all standing orders for bypass patients, which forced them to think twice before ordering any procedure, he said. Shemin found global payments to be vastly superior to several alternatives and much less onerous than such options as capitation.

Shemin's team has been saving almost $100,000 annually just by substituting less expensive but equally effective anesthetics and other pharmaceuticals. The team also cut back on the use of ventilators in postoperative recovery, which speeds the patient's convalescence and cuts costs. Left alone to manage technical risk, surgeons were freed from the additional burden of having to manage the probability risk of capitation. Note also Shemin's observation that the challenge was to adjust the factor inputs just to the point that patient care was not jeopardized. The reason a globally priced episode of care is attractive is that it is the only incentive-oriented payment modality that actually centers on the patient. By comparison, capitation centers on an abstract aggregation of total population resource utilization adjusted to the needs of payers and providers. By organizing health care delivery around episodes of care, health systems would encourage price competition.

By organizing the delivery of care around episodes of care and paying for them with global fees, health systems create two markets: one for insurance and one for health care itself. Price competition is encouraged to operate in both markets.

Polycentrism

Polycentrism is defined as a diversity of competing episode providers and competing payer systems all vying for market share under robust price competition. In a polycentric system, health care insurers would sell premiums and health care providers would sell episodes of care. Under the current system, however, provider entities that integrate and manage episodes of care have the awesome task of delivering care and ensuring that premiums are sold at rates sufficient to cover the actual and foreseeable costs of care.

In a polycentric world, these provider systems could be physician-hospital organizations, management service organizations, IPAs, or small boutique operations that specialize in one area of delivery expertise, such as carpal tunnel release, for example. Each provider system would offer its discrete globally priced products of episodic care to consumers.

But because they cannot specialize under the current market, as every other healthy market can, provider systems today are frustrated by the task of attempting to be all things to all people. This is one of the reasons that integrated delivery systems are doing so poorly.

In a polycentric world, integrated episodes would put physicians back in control of the delivery system by giving them a sovereign voice in management to design optimal care processes, making them financially and clinically accountable for the performance of the integrated organizations to which they belong and by providing all health care providers with the incentive to collaborate. Under the current system, physicians and other clinical professionals have had socially perverse incentives to resist collaboration in a team-oriented, collegially cooperative manner.

Polycentrism means that consumers shop premiums from discrete, competing health care insurers who help them protect their assets from future catastrophic medical expenses by ensuring robust global fee competition for acute episodes and maintenance fees for chronic episodes. It also means structuring real-time, user-friendly information when patients need it, and making easily accessible care available that is designed to help prevent illness. Once a risky event or medical consumption becomes a certainty, then consumers enter the market to purchase care from discrete, laterally integrated provider groups. In a polycentrist market, a patient needing surgery would have the opportunity to shop for his or her care from a menu of competing, discrete provider groups with minimal regard to his or her insurer.

Consumer Sovereignty

The truth about traditional managed care is that, because consumers do not have true choice, the real consumer is the HMO, and, therefore, the HMO is sovereign. Since consumers have largely been forced to surrender their ability to respond individually to market information, the HMO is forced to develop paternalistic strategies toward patients and providers. Therefore, the HMO compels patients to consume according to its preferences for risk. This fact may be one of the unstated reasons managed care supporters oppose medical savings accounts and, at times, global fees. To the extent that the patient's preferences are sovereign in the choice of care delivery, HMOs and other managed care payers lose their base of power.
It is important to stress that as consumers are empowered to make decisions regarding allocation of their own resources, the more likely it is that they will be prudent. Consumer sovereignty means that, at some level, there must be consumer risk. Uwe Reinhardt, a noted economist and health care expert at Princeton University, has been quoted as saying, “I’d remind patients that they make economic trade-offs in their own lives. They take a chance in buying a car to save some money; why shouldn't they take a similar chance to save some money in health care?”

Such trade-offs bring reason to any competitive market. People must be able to compare trade-offs by balancing what they would spend against what value they would receive in return. Since health care is a service produced by many organizations working together, patients must become managing partners both with their insurers and their providers, eschewing risky behavior and complying with physician advice. HMOs do little to motivate patients to invest in their own health. Therefore, health care cost control must come from the bottom up: from patients to doctors to payers to government, not the other way around. If such cost control cannot be accomplished, excess health care inflation will never be tamed.

There are, however, strategies for getting consumers to become partners in ensuring their own good health. Health systems need to define episodes of care and assign them global fees, and then eliminate care that appears to be free (or nearly free) at the point of care. At no time should consumption of medical care at the point of service be free, unless the managers of probability risk are trying to entice patients to consume, as with preventive care. It should be clear that $5 copayments for office visits and $3 copayments for prescriptions are about as close to free care as one can get. When cost at the point of service is made meaningful (as opposed to onerous), consumer choice will become the sovereign power in the market.

When health care systems are organized around these three values—risk bifurcation, polycentrism, and consumer sovereignty—the result will be a decentralized structure in which consumers shop in one competitive market for health care insurance, and once insured, shop in another competitive market for health care. This structure does not preclude traditional managed care. A robust market in health care should encourage a rich system of competing organizations. In fact, if a truly vibrant market were to develop, it would probably strengthen the vertically integrated systems by generating the information they need to price their products more effectively—if they're still around.