Is Fee-for-Service What Ails America's Health Care System?

Though there is precious little consensus on fixing the nation's health care system, most knowledgeable citizens agree that the current system's skyrocketing costs are unsustainable. The facts are daunting: The U.S. spends 16% of its GDP on health care, 60% more than Germany and other Northern European "socialized medicine" states, and double what Japan devotes to health care.The U.S. lays out almost $7,300 per citizen; oil-rich Norway is a distant second at $4,760 per citizen. And research has found that despite spending twice as much per person on health care as England, Americans are less healthy than their British counterparts.

%%DynaPub-Enhancement class="enhancement contentType-HTML Content fragmentId-1 payloadId-61603 alignment-right size-small"%% According to medical professionals who have examined the 2,000-plus page health care reform bill working its way through Congress, it attempts to solve the problem of lowering costs by essentially throwing a bunch of solutions at the wall and seeing which ones stick.

While this "let a thousand innovations bloom" strategy has some appeal to well-meaning reformers, it assumes the problem of skyrocketing costs has a managerial solution: Under that theory, all we need to do is collect more data, sort out the most effective, lowest-cost health care services, and then issue a raft of new administrative rules, guidelines and mandates.

But this approach fails to question the root cause of our health care cost crisis: Perhaps the real cause is the "fee-for-service" model which is the foundation of all private insurance and public entitlement programs in the U.S.

How Fee-For-Service Turns One Little Toe Into One Big Bill

Here's an example of the type of incentive built into a fee-for-service system. On her doctor's advice, my mother recently elected to have a minor procedure performed on a toe which had been bothering her. She's in good health for an 80-year-old, with no serious chronic diseases; the procedure took about an hour, and required only local anesthetic.

The bill paid by Medicare was over $13,000, including a $2,000 recovery room fee, which surprised her, as her time in a "recovery room" consisted of sitting in a chair for a few minutes before I picked her up. My physician contacts inform me that recovery rooms are intended for patients coming out of general anesthesia, not for patients who had only local anesthetic.

The point here isn't whether this particular fee met Medicare guidelines; the point is that the fee-for-service model provides powerful incentives to pad bills or even commit fraud. Indeed, poor medical practices net providers more money. According to a recent report, only 3% of the millions of charges submitted to Medicare are reviewed, and over 10% of Medicare's $453 billion in annual expenditures are outright fraud.

Not only does the fee-for-service model offer perverse incentives to providers, it also offers no incentives for patients to skip unnecessary procedures, or to seek lower-cost service. In effect, fee-for-service is open-ended: It's like going to an auto mechanic and agreeing to pay for whatever services he deems necessary, at whatever price he chooses, with no penalties to the provider if the service is poor.

Putting Prices Back on the Health Care Menu

There was a time in the U.S. when the fees for medical services were entirely transparent. My sister recently gave me a copy of a hospital fee sheet for having a baby in 1952. The obstetrical fee was $30, with an additional $30 for Caesarian section. A semi-private room was $16, a private room was $19 a day, a deluxe private room was $23. The fee for caring for the baby while the mother was in the hospital was $6 a day.

According to the Bureau of Labor Statistics inflation calculator, $1 in 1952 is equal to $8.12 in 2009 dollars. So the cost for having a baby in today's dollars was about $245, and the daily rate for a deluxe private room was $187. Typically in that era, patients paid their hospital bills in cash.

Today, the cost of childbirth without complications runs between $5,000 and $10,000, roughly 10 times the equivalent cost in the 1950s.

The usual reason offered for skyrocketing health care costs is improved technology. But few commentators mention the negative incentives built into the current model. Many observers also blame "defensive medicine": To avoid malpractice lawsuits, they say, doctors over-order tests and procedures. While defensive medicine is undoubtedly a factor, this explanation too ignores the primary incentive for providers to over-test, over-operate and over-prescribe medications: The more services they provide, the more money they are paid.

By contrast, the medical procedures offered in Thailand, India and elsewhere in the booming "medical tourism" industry are transparently priced and easily compared to equivalent services offered elsewhere.

Cost Control -- and the Lack Thereof

So who is controlling costs in our health care system? Federal agencies constantly attempt to rein in runaway costs, with mixed results. Medicare and Medicaid costs continue rising at about 7% per year, decade after decade, regardless of the many reforms implemented.

In private insurance, cost control is left to insurers. Their efforts also offer mixed results, as consumer dissatisfaction is high and the costs of private insurance continue to skyrocket.

The fact that neither the private sector nor federal agencies have had any success in curtailing costs suggests the problem lies not with the management of the system, but with the entire model. If anyone thinks this model of care is sustainable, consider the chart below, which I prepared based on data from the government agencies (sources listed at the bottom of the article). The chart shows historical and projected costs of Medicare and Medicaid (the red and pink lines) and the total federal budget (the blue line).

The largest single factor in rising costs in the decade ahead is looming entrance of the Baby Boomers into the Medicare system starting in 2011. Those 78 million people born from 1946 to 1964 are sometimes called "the pig in the python." The projected effect of their enrollment in Medicare is a rise from 45 million beneficiaries now to over 67 million by 2020.

That alone will boost costs by 50%, even if the costs per beneficiary remain static. Unfortunately, decades of data suggest costs per beneficiary will continue rising by about 7% per year. Based on a reasonably conservative extrapolation of current economic trends, we get a scenario in which Medicare/Medicaid costs will consume fully half the federal budget by 2020.

The federal budget train is heading for a cliff, and modest adjustments won't prevent the train wreck. What's needed is a complete reversal of the current, perverse incentives.

Ironically, there is one vast government agency which provides health care without a fee-for-service model: the Veterans Administration, which provides health care to millions of U.S. veterans for about $47.2 billion in 2009. (The total VA budget was about $93.7 billion.)

No agency is perfect, public or private, but the VA provides care to millions of vets, many disabled, for less than a tenth of the cost of Medicare's system.

Maybe we should learn from this successful, large-scale health care program, in our own backyard, and reconsider the entire fee-for-service model before passing a 2,000-page expansion of the status quo.

Data for this article was drawn from the following sources:

* Center for Budget and Policy Priorities
* Congressional Budget Office
* U.S. Department of Health & Human Services (responsible for Medicare/Medicaid)
* Henry J. Kaiser Family Foundation
* Tax Policy Center
* Bureau of Labor Statistics
* St. Louis Federal Reserve
* for historical data on the Federal Budget.
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