HCM 6 - Financing the Health Care System PDF

CHAPTER 6 FINANCING THE HEALTH CARE SYSTEM LEARNING OBJECTIVES After completing this chapter, students will be able to: Describe how U.S. health care expenditure as a percentage of gross domestic product (GDP) has changed since 1960. Describe the differences between National Health Expendit...

CHAPTER 6 FINANCING THE HEALTH CARE SYSTEM LEARNING OBJECTIVES After completing this chapter, students will be able to: Describe how U.S. health care expenditure as a percentage of gross domestic product (GDP) has changed since 1960. Describe the differences between National Health Expenditures (NHE), health consumption expenditures (HCE), and personal health care expenditures (PHCE). Describe private health insurance and its contribution to paying the NHE and HCE. Define “out-of-pocket expenditures” and describe the patient’s contribution to paying the NHE and HCE. Discuss government spending on health care and how its percentage of the NHE has changed since 1960 for Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), and other government-provided health care programs. Explain the categories on which health care dollars are spent and what percent- age is spent on each. List and explain common modes of payment for health care services. Discuss the need for third-party payers and their role in the health care system. INTRODUCTION Health care is like no other sector of the economy. In his seminal 1963 article, “Uncertainty and the Welfare Economics of Medical Care,” Kenneth Arrow (1963) identified these differences as uncertainty, asymmetries of information, and nonmarketability of risks inherent in medicine and medical practice. Even after a millennium of observation and study, our knowledge about the human body, disease, and medicine is very much incomplete. In addition, whereas the physician nearly always has more medical knowledge, patients generally know more about their own history, so there is usually a significant informa- tion asymmetry between patient and provider. Economists refer to situations in which an individual’s behavior changes when they are able to shift the risks of decisions to others as moral hazard (Arrow, 1963). If an accident costs a person US$2,000 but insurance pays US$1,500, the 209 210 I: U.S. Health Care System: Present State insured person has less incentive to avoid the accident than if the insurance paid only US$500. Although some may argue that this does not apply to one’s health, clearly people who defer medical treatment until they end up in an ED and programs that reward peo- ple for preventive and wellness activities are instances of people making decisions that are worse, both financially and for their health, when others bear the risk. Financing health care is a tension among the ethics and values we place on human life, the asymmetries of information, and uncertainty about care wrapped in nonmar- ketable risks. The implication is that the health care market would collapse if entirely governed by market forces, even though the health care sector exists within a general market economy. At some level, health care competes for resources (e.g., workers, sup- porting goods and services) against the production of food, the construction of homes, the creation of movies, and the seemingly infinite number of other goods and services that a nation of 300+ million people and associated businesses consume. At some level, providing resources for an additional surgeon to perform cardiac surgeries means that fewer houses can be constructed or that the quality or quantity of food produced will be diminished. Within the health care sector itself, trade-offs are also made: Money spent on an MRI machine is money not spent on additional doctors; money spent on research is money not spent on providing care; and money spent researching one disease is money not spent on another. In response to this, financing health care in the United States is a complex matter of workarounds, redundancies, and contradictions. Furthermore, because the United States lacks a single national health care payment system, how the money is paid to the providers of health care has become very complicated (Igelhart, 1999a), a situation that health care reform policies have not reduced. This chapter describes the basics of health care financing in the United States today: how much money is spent on health care, what the money is spent on, how the money is paid to health care providers, and where the money comes from. Source of Information About Health Care Financing Since 1964, the U.S. Department of Health and Human Services (DHHS) has published data annually on total health expenditures for the United States, called the National Health Expenditure Accounts (NHEA). The NHEA are the official estimates of health care spend- ing in the United States. The goal for the NHEA is to measure spending on health care con- sumption and health care investment in the medical sector. The NHEA have the following benefits for understanding the health care sector spending: First, the NHEA are comprehensive because they contain all of the main com- ponents of the health care system within a unified mutually exclusive and exhaustive structure. Second, the NHEA are multidimensional, encompassing not only expenditures for medical goods and services, but also the payers that finance these expenditures. Third, the NHEA are consistent because they apply a common set of definitions that allow comparisons among categories and over time. (Centers for Medicare & Medicaid Services [CMS], 2018b, p. 3)  6: Financing the Health Care System 211 The following terms will be mentioned frequently in our discussion of health care financing: National Health Expenditures (NHE). The NHE includes all health care consumption and investment in medical structures and equipment and noncommercial health ser- vices and biomedical research. The NHE includes health consumption expenditures (HCE). The difference between NHE and HCE is the costs of investment in the med- ical sector. Health consumption expenditures. The HCE include all personal health care spending, government administration and net cost of private health insurance, and public health activities. “Government administration and the net cost of health insurance includes the administrative cost of running various government health care programs, and the difference between premiums earned by insurers and the claims or losses incurred for which insurers become liable (the net cost of PHI [private health insurance])” (CMS, 2018b, p. 6). The HCE includes PHCE. Personal health care (PHC). PHC includes all medical goods and services that are used to diagnose, treat, and prevent health problems in a specific person. “These include hospital care; professional services; other health, residential, and personal care; home health care; nursing care facilities and continuing care retirement communities; and the retail outlet sales of medical products” (CMS, 2018b, p. 8). HOW MUCH IS SPENT? Health care spending has increased in the United States every year since 1960 in absolute and per capita terms and as a percentage of GDP.1 In 2021, the NHE were approximately US$4,255 billion, 18.3% of GDP, and US$12,914 per capita. Spending reached this level after decades of increases. For example, per capita spending on health care—not adjusted for inflation—was US$146 in 1960, compared to US$12,914 in 2021. The Bureau of Labor Statistics (BLS) estimates the buying power of US$146 in 1960 equates to about US$1,207 when adjusted by the Consumer Price Index (CPI; U.S. Department of Labor, BLS, 2019; see Figure 6.1). For the typical household, direct and indirect spending on health care—were it to be allocated evenly across the population—would be larger than any other household expense. In 2022, per capita income was US$41,261, median household income was US$75,149, and median rent or owner costs for housing were US$15,216 and US$21,936, respectively. With per capita spending on health at US$12,914, health care expenditures would be nearly one- third of per capita income. With per-household health expenditures at around US$33,189 (based on 2.57 persons/household), health care expenditures would be about 44% of the median household income (U.S. Census Bureau, 2022). While health care consumption is not uniform across people nor throughout their lives, as will be discussed in the section “Where the Money Goes,” it is clear that the aggregate health care bill—that is, the NHE— is impractically large to allocate evenly across persons or their households. 1 Like all elements of the GDP, unpaid work is not counted. This is particularly significant in health care because most medical symptoms are self-diagnosed and treated (Dean, 1981). Additionally, it is very common for people to receive care from family and loved ones in the course of mild illness. When people stay home from work because of illness, the GDP is reduced. On the other hand, if those same people were taken care of by a paid caregiver, the GDP would increase. 212 I: U.S. Health Care System: Present State FIGURE 6.1 National Health Expenditures as a percentage of gross domestic product, 1960 to 2020. 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% National Health Expenditures as a percent of gross domestic product 2.0% 0.0% 1950 1960 1970 1980 1990 2000 2010 2020 SOURCE: Data from Centers for Medicare & Medicaid Services. (2021). National Health Expenditures by type of service and source of funds, CY 1960–2021. https://www.cms.gov/Research-Statistics-Data-and-Systems /Statistics-Trends-and-Reports/NationalHealthExpendData/NationalHealthAccountsHistorical Although health care spending has increased continually since 1960, the increases in spending have not been uniform from year to year. Between 1960 and 1990, the average annual percent changes were double-digit increases. Beginning in the 1990s, the annual rate of increase in health care spending began to decline into the single digits. From 2010 to 2021, the annual rate of increase each year was below 6%, except for a double-digit increase in 2020 during the COVID-19 pandemic. In 2021, spending grew only 3.2% from the previous year. The decline in the 1990s corresponds to the advent of managed care and its downward pres- sure on both physician and hospital usage, which put a brake on health care cost increases, at least for several years (see Table 6A.1 in the appendix at the end of this chapter). When trying to understand a sector of the economy that represents almost 20% of GDP, it will be helpful to remember the proceeding chapters describing key components of the health care system: health care facilities, workforce, medical supplies and equipment, and leadership and governance. While financing is a building block of the health care system in its own right (World Health Organization [WHO], 2023), it exists to fund the goods and services needed to provide health care. Additionally, the economist’s model of Cost = Price × Quantity can be helpful for analyz- ing the drivers of costs and their increases. The costs represented in the NHE are the sum of expenditures on billions of services and products consumed over the year at varying prices, but which can be grouped and analyzed across a limited number of categories. Within each category, it can be helpful to examine the quantity consumed, as well as the price paid for those goods or services. High or rising costs may be due to quantity, price, or, in some cases, both. Finally, the maxim, “you get what you pay for” should remain an implicit consider- ation in understanding how different health care entities are currently incentivized, as well as why there are efforts under way to change how these entities are paid. Paying for costs  6: Financing the Health Care System 213 tends to produce higher costs. Paying for services tends to produce more services. In reac- tion to this basic fact, and after years of direct pressure on price and quantity through man- aged care contracting and utilization management (with much effort and modest success), new approaches to paying for health care are being introduced to focus on value. This change of emphasis and policy has significant implications for how health care is financed and health care providers are paid. WHERE THE MONEY GOES Economists (and similarly, accountants with their own nomenclature) often separate expenses into current consumption and investment—those expenditures that create value in the future. These are represented in the NHE as investments. As can be seen in Table 6A.2 in the appendix at the end of this chapter, only a small portion of expenditures— ranging between 5% and 10% over the decades—go toward investments, a category com- prised of Research and Structures and Equipment. Further, investment amounts have declined steadily since 1960 when they were about 10% of the NHE. The vast majority of NHE are HCE,2 and most of these are for PHC, which includes hos- pitalization, physician services, prescription drugs, and other health care goods and ser- vices.3 It should be noted that the NHE does not include expenditures for a much broader definition of health care that might include nonmedically supervised dieting and weight loss, health and fitness clubs, sporting goods and related recreation, and healthy foods. Regarding types of expenditures within the NHE, Table 6A.2 in the appendix at the end of this chapter provides an overview and Figure 6.2 highlights the trends over time. Hospital care accounted for the largest share of NHE, at about 31% in 2021, a relatively sta- ble amount since 2000. Before that, the amount was about 35%. Professional services had the second highest share of the NHE, at 27%, and most of this amount was for physician services, whose share of the total has also remained relatively constant. Retail prescription drugs accounted for the third highest share and was also a relatively stable expenditure over the past 50-plus years. What has increased as a share of the NHE is: other health, residential, and personal care, particularly home health care, and also including such services as ambulance providers and care delivered in residential care facilities, as well as nontraditional settings such as community centers and schools; government administration; net cost of private health insurance (which includes administrative costs of running plans, dividends, and retained earnings from plan profits/losses); and government public health activities. 2 In comparison with discussion of research and development (R&D) for medical products in Chapter 4, Medicines, Devices, and Technology, please note footnote “6” in Table 6A.2 (located in the appendix at the end of this chapter), which highlights the exclusion of R&D for medical products from this category (paralleling a general approach to calculating GDP that only counts goods and services in their final use rather than calculating intermediate activities that would double-count overall production). 3 For those interested, expenditures for complementary and alternative medicine (CAM) are included under other professional services, and vitamin and mineral supplements are included under other medical products. 214 I: U.S. Health Care System: Present State FIGURE 6.2 Share of National Health Expenditure by type of expenditure for selected calendar years 1960 to 2020. 100% 80% 60% 40% 20% 0% 1960 1970 1980 1990 2000 2010 2020 Other health, residential, and personal care1 Hospital care Net cost of health insurance5 Retail prescription drugs Home health care2 Retail durable medical equipment Nursing care facilities and continuing Research6 care retirement communities2,3 Professional services Government public health activities Structures and equipment Government administration4 Retail nondurable medical products 1 Includes expenditures for residential care facilities (NAICS 623210 and 623220), ambulance providers (NAICS 621910), medical care delivered in nontraditional settings (such as community centers, senior citizens centers, schools, and military field stations), and expenditures for Home and Community Based Waiver programs under Medicaid. 2 Includes freestanding facilities only. Additional services of this type provided in hospital-based facilities are counted as hospital care. 3 Includes care provided in nursing care facilities (NAICS 6231), continuing care retirement communities (623311), state and local government nursing facilities, and nursing facilities operated by the Department of Veterans Affairs. 4 Includes all administrative costs (federal and state and local employees’ salaries, contracted employees including fiscal intermediaries, rent and building costs, computer systems and programs, other materials and supplies, and other miscellaneous expenses) associated with insuring individuals enrolled in the following health insurance programs: Medicare, Medicaid, Children’s Health Insurance Program, Department of Defense, Department of Veterans Affairs, Indian Health Service, workers’ compensation, maternal and child health, vocational rehabilitation, Substance Abuse and Mental Health Services Administration, and other federal programs. 5 Net cost of health insurance is calculated as the difference between CY incurred premiums earned and benefits paid for private health insurance. This includes administrative costs and, in some cases, additions to reserves, rate credits and dividends, premium taxes, and plan profits or losses. Also included in this category is the difference between premiums earned and benefits paid for the private health insurance companies that insure the enrollees of the following programs: Medicare, Medicaid, Children’s Health Insurance Program, and workers’ compensation (health portion only). 6 Research and development expenditures of drug companies and other manufacturers and providers of medical equipment and supplies are excluded from “research expenditures” but are included in the expenditure class in which the product falls. SOURCE: Centers for Medicare & Medicaid Services. (2018a). National Health Expenditures by type of service and source of funds, CY 1960–2017. https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and -Reports/NationalHealthExpendData/NationalHealthAccountsHistorical  6: Financing the Health Care System 215 While these remain a small share of the total NHE, these expenditures have grown sig- nificantly. The increase in spending on other health, residential, and personal care reflects a policy shift to lower costs by providing health care in facilities outside the hospital (see Chapter 2, The Settings for Health Care Delivery). The increase in net cost of private health insurance reflects an increasing use of private health insurance as a source of payment for health care consumption since 1960 (see Table 6A.2 in the appendix at the end of this chapter). Additionally, the increasing complexity and demands for sophistication and account- ability of plans administered by private health insurance have increased over the years (Miller & Luft, 1994). Also, the expenditures for administration—including both govern- ment and private insurance—are relatively high, at 7.2% of the NHE in 2021. Compared to our peer countries in the Organisation for Economic Co-operation and Development (OECD), this is high, as they range from about 6% to less than 2%. France had the next highest administrative costs—about 6% (OECD, 2023). How are the NHE allocated by health condition and characteristics of patients? Through its Medical Expenditure Panel Survey (MEPS) program, the Agency for Healthcare Research and Quality (AHRQ) maintains the most complete source of data on the cost and use of health care and health insurance coverage.4 Through large-scale surveys of families and individu- als, their medical providers (doctors, hospitals, pharmacies, etc.), and employers across the United States, MEPS collects data on the specific health services that Americans use, how frequently they use them, the cost of these services, and how they pay for them, as well as data on the cost, scope, and breadth of health insurance held by and available to U.S. workers. A key difference between the NHE and MEPS data is that the NHEA attempts to capture all health care expenditures in the United States, while the MEPS attempts to provide more granular estimates of the health care utilization and expenditures of noninstitutionalized civilians (Bernard et al., 2018). According to the Centers for Disease Control and Prevention (CDC, 2019a), “Chronic diseases are defined broadly as conditions that last 1 year or more and require ongoing medical attention or limit activities of daily living or both. Chronic diseases such as heart disease, cancer, and diabetes are the leading causes of death and disability in the United 4 The expenditures included in the MEPS survey are a subset of those included in the personal health care component of the NHE. Although the sample of U.S. civilian noninstitutionalized population surveyed in the household component of MEPS represents 98% of the U.S. population, the nature of the population excluded from the MEPS sample is such that they are likely to have very different health care expenditures. In addition, the NHE includes expenditures on nonpatient services (gift shops, cafeterias, etc.) as well as other expenditures not counted by MEPS (e.g., nonprescription non- durable goods, as well as CAM services). In 1996, the expenditures of MEPS household components made up about 60% of the personal health care component of NHEs, and in 2003, MEPS accounted for US$895.5 billion or slightly less than 62% of the estimated US$1,446 billion spent on personal health care. The authors strongly recommend that anyone planning to use either NHE or MEPS data for analysis or decision-making should supplement their understanding of the inclusions, exclu- sions, and limitations of such data with the article “Reconciling Medical Expenditure Estimates From the MEPS and the NHA,” by Selden and colleagues (2001). 216 I: U.S. Health Care System: Present State States” (CDC, 2019a, para. 1). Additionally, the CDC (2019b) notes that an estimated 90% of the NHE are for chronic and mental health diseases. Chronic conditions are also consid- ered some of the most preventable of all health conditions (CDC, 2016). It should be no surprise, then, that most of the top 10 medical conditions by total expen- ditures in 2015 were chronic diseases (unfortunately, more recent totals are not available due to the conversion to ICD-10 in 2015). Trauma-related disorders are the notable excep- tion and have the second-highest total expenditures of the conditions ranked. Also, the appearance of infectious diseases is notable as an expenditure, for these were barely in the top 20 as of 2012 (AHRQ, 2019; see Table 6.1 and Figure 6.3). TABLE 6.1 Total Expenditures ($) in Millions by Condition, United States, 2019 to 2021 Condition 2019 2020 2021 Diabetes mellitus $122,740 $ 123,806 $ 146,302 Cancer $140,709 $ 172,097 $ 145,950 Injury $98,500 $ 115,270 $ 125,835 Musculoskeletal pain and back problems $103,376 $ 115,343 $ 106,092 (including joint and back pain) Other disorders of the digestive system $58,166 $69,074 $71,083 Other care and screening $63,391 $57,763 $68,514 Other nervous system disorders $43,860 $45,400 $55,165 Other mental and substance use disorders $51,533 $49,173 $52,196 Other endocrine, nutritional, and metabolic disorders $28,352 $27,587 $50,689 Coronavirus disease (COVID-19) $33,249 $49,402 Other skin disorders $22,999 $26,533 $46,925 Anxiety $34,449 $38,463 $44,379 Other cardiovascular disease $39,633 $35,996 $44,309 Normal pregnancy/birth, and live born $46,489 $35,277 $42,871 Other conditions of the circulatory system $41,657 $43,385 $41,463 Depression $32,924 $41,795 $41,283 Infectious disease $40,582 $40,258 $41,101 Implant, device, or graft-related encounter $44,924 $19,690 $41,055 Hypertension (high blood pressure) $48,470 $43,472 $39,428 Other genitourinary conditions $29,220 $26,514 $38,556 SOURCE: Agency for Healthcare Research and Quality. (2022). Total expenditures ($) in millions by condition, United States, 1996 to 2021. Medical Expenditure Panel Survey. https://datatools.ahrq.gov/meps-hc?tab=medical -conditions&dash=17  A B D ia D be ia 0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 te be $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $140,000 $160,000 s te FIGURE 6.3 m s el m M lit us el lit us M us c ul us sko cu e Ca lo sk Ca (in leta nc er e nc O cl l p (in leta th u c lp er di ain ng a O l ud a er th i i n di jo nd In er ng a so in b ju di jo nd In rd t a ac ry so in b ju er nd k rd t a ac ry s p er nd k of ba ro s b p r th ck ble of e pa ms th ac ob k lem di in e pa s ge ) di in O st ge ) th ive O st er sy th ive O ca st er sy O th re em O ca th e r a O th re st em er ne nd th er a n m rv sc er ne d en ou re m rv sc ta s en en ou re la sy in ta s en nd st g la sy in em nd st g su bs di su e m O ta so O bs di Total expenditure by medical condition, 2021. th nc rd th ta so er e er s er nc rd en us e er s do e en u cr dis do se Co in or cr in d is m e, de or ro na e t n u rs Co m e, et nu de vi ab tr ol itio ro na a bo trit rs ru s i c n vi lic ion di al ru di se so , a s di al so , a Total Expenditure by Medical Condition, 2021 (in millions) as rd nd di rd nd er se e s er (C as e s O (C VI D O -1 VI 9) D -1 Prevalence of Top 10 Medical Conditions by Total Expenditures, 2021 (in thousands) 9) 6: Financing the Health Care System (continued) 217 218 I: U.S. Health Care System: Present State FIGURE 6.3 Total expenditure by medical condition, 2021. (continued) Mean Expenditures of Top 10 Medical Conditions by Total Expenditure, 2021 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 us er ry pa ms em g s rs rd nd 9) er in de -1 ju nc lit so , a ) s ck ble en st rd in er In D el or Ca sy di al so re VI m ba ro is c n di sc O ive p d ol itio s (C te nd k em e nd st t a ac ab tr us be ge u e a st in b i n as ia e sy di re jo nd nc m e, D se ca e in s ng a ta t di th ou e cr di in bs er s of do rv a th ru su cl l p ne s en O vi er (in leta nd na r rd er e u la ro th so e th sk ta Co O O di en lo er cu m th us er O M th C O SOURCE: Agency for Healthcare Research and Quality. (2022). Total expenditures ($) in millions by condition, United States, 2019 to 2021. Medical Expenditure Panel Survey. https://datatools.ahrq.gov/meps-hc/?tab=medical -conditions&dash=17 MEPS also provides insight into the concentration of health expenditures among non- institutionalized civilians. As Figures 6.4 and 6.5 show, the lowest 70% of utilizers of health care account for less than 10% of expenditures, while the top 5% account for about half of the spending. Most of the services utilized among the lowest 70% are ambulatory and dental services, with almost no inpatient hospital stays (Mitchell, 2019). This should not be surprising, as the cost of one hospital stay almost instantly puts a person in the top 50% of expenditures (see Figure 6.6). Finally, MEPS can be used to track persistence of health care utilization over time. For example, in 2013, about 14% of patients who were in the top 1% of utilization were also in the top 1% of utilization for 2012. About 54% of patients who were in the top 20% for 2012 were also in the top 20% for 2013, and just under 75% of patients who were in the top 50% or bottom 50% for 2012 were in the same category for 2013 (see Figure 6.7). The implication is that most people who do not have significant health care usage in 1 year do not have it in the next, while those who are high utilizers continue to be so. However, about 25% of the population does switch between the bottom 50% and top 50% of utilization from year to year. Additionally, while 14% of patients in the top 1% of health care users in 1 year will remain in the top 1% the next, the vast majority of the top users are patients who had much lower utilization the previous year (Cohen, 2015).  FIGURE 6.4 Concentration curve of health care expenditures, U.S. civilian noninstitutionalized population, 2016. 100% $1,600 90% $1,400 80% Cumulative percentage of expenditures 78.1 $1,200 Total expenditures (in billions) 70% 99% $1,000 60% 50% 50.0 $800 40% 34.0 95% $600 30% $400 20% 17.8 9.8 $200 10% 5.3 1.3 2.8 0.0 0.1 0.4 0% $0 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Cumulative percentage of population SOURCE: Mitchell, E. M. (2019). Concentration of health expenditures and selected characteristics of high spenders, U.S. civilian noninstitutionalized population, 2016 (AHRQ Statistical Brief #521). https://meps.ahrq.gov/data_files /publications/st521/stat521.pdf FIGURE 6.5 Mean total expenditure per person by percentile of spending, 2016. $120,000 $110,003 Average annual expenditure per person $100,000 $80,000 $60,000 $50,077 $40,000 $33,053 $20,000 $15,057 $9,735 $5,006 $276 $0 Overall Bottom Top Top Top Top Top 50% 50% 30% 10% 5% 1% Percentile of spending distribution SOURCE: Mitchell, E. M. (2019). Concentration of health expenditures and selected characteristics of high spenders, U.S. civilian noninstitutionalized population, 2016 (AHRQ Statistical Brief #521). https://meps.ahrq.gov/data_files /publications/st521/stat521.pdf 220 I: U.S. Health Care System: Present State FIGURE 6.6 Type of service distribution by percentile of spending, 2016. 3.4 2.2 100 8.2 7.6 7.6 8.5 90 5.4 5.6 30.2 80 25.7 26.4 36.1 40.3 70 Percentage 60 50 37.2 53.8 36.7 40 30.7 28.5 30 20 23.6 23.8 22.2 20.5 10 15.8 0 Overall Bottom Top Top Top 50%* 50% 10% 5% Dental and other Home health Inpatient stays Ambulatory events Prescribed medicines *Home health and inpatient stays comprise 0.1% of the bottom 50%. NOTE: An interesting difference between the expenditures tracked under the Medical Expenditure Panel Survey (MEPS) and the National Health Expenditures (NHE) is that prescribed medicines account for 23.6% of the former (Mitchell, 2019) and less than 10% of the latter. This may be due to measurement differences as well as a bias toward retail prescription usage among noninstitutionalized civilians. The population not sampled by MEPS (institutionalized persons) are unlikely to acquire their prescription drugs through a retail pharmacy. Then, while retail prescription drug costs may be only 10% of NHE, they may be a much larger proportion of the health expenditures of a typical household. SOURCE: Mitchell, E. M. (2019). Concentration of health expenditures and selected characteristics of high spenders, U.S. civilian noninstitutionalized population, 2016 (AHRQ Statistical Brief #521). https://meps.ahrq.gov/data_files /publications/st521/stat521.pdf Many of these outlier situations occur in the last year and even last 6 months of life, and while much attention has been given to better management of end-of-life care, Emanuel and Emanuel (1994) argue: Cost savings due to changes in practice at the end-of-life are not likely to be substantial. The amount that might be saved by reducing the use of aggressive life-sustaining interventions for dying patients is at most 3.3 percent of total national health care expenditures. (p. 543) They also assert that these savings “would not restrain the rate of growth in health care spending over time. Instead, this amount represents a fraction of the increase due to infla- tion in health care costs and less than (the amount) needed to cover the uninsured popula- tion” (p. 543). Accepting this, we cannot assume that less aggressive care at the end-of-life will solve the financial problems of the health care system.  6: Financing the Health Care System 221 FIGURE 6.7 Persistence in the level of health care expenditures, U.S. civilian noninstitution- alized population, 2012 to 2013. 80 73.9 73.1 Percentage of population with same 63.2 53.8 percentile rank in 2013 60 42.7 40 33.7 14.0 20 0 Top Top Top Top Top Top Lower 1% 5% 10% 20% 30% 50% 50% Percentile rank by health care expenditures, 2012 SOURCE: Cohen, S. B. (2015). The concentration and persistence in the level of health expenditures over time: Estimates for the U.S. population, 2012–2013 (Statistical Brief No. 481). Agency for Healthcare Research and Quality. However, better palliative care has been shown to improve the quality of end-of-life care (and, ironically enough, the length of life) and, therefore, to be highly worthwhile even if it does not significantly reduce health care expenditures (Cruz-Oliver, 2017). INSURANCE, INTERMEDIARIES, AND OTHER THIRD PARTIES As noted earlier, whereas a significant number of people retain their health expenditure rank from year to year, a sizable number do not. While most people do not need very much health care in a given year, any significant health care incident is likely to be very expensive. Severe illness can easily cost tens of thousands of dollars, and heroic measures (e.g., trauma and organ transplants) can easily cost in the hundreds of thousands of dollars. Treatment of some rare conditions can even cost in the millions of dollars (Whyte, 2020; Zhang, 2006). A health care condition requiring US$500,000 in treatment would exceed the lifetime income of most people and would be financially devastating for all but a small percentage of the population. Therefore, most people want some sort of insurance to protect themselves against wild swings in health care costs. As Glied (2001) pointed out, people do not buy health insur- ance to insure their health, but rather to insure their ability to pay for (and obtain) health care in the event that their health status changes. Thus, health insurers are termed “third- party payers”—neither patients nor providers. Historically, health insurance was intended to cover major medical events (Dranove & Millenson, 2006). Matching Different Provider and Patient Payment Approaches Another motivation for having third-party payers is to bridge the gap between how peo- ple want to pay for health care and how providers want to be paid. Although there is little need for a third-party payer in a case where a person wants to pay a fixed monthly amount 222 I: U.S. Health Care System: Present State for health care to a provider who is paid on a capitation basis and offers the entire range of medical services, historically only a few providers (e.g., Kaiser Permanente) have offered this option. More often, people obtain their health care from a variety of providers that may be operating under different payments, and quite often an individual provider will offer ser- vices under multiple and differing charging models. A third-party payer adds value by converting a stream of monthly payments into a stream of service-driven or ailment-driven payments to providers. Maintaining a Network of Providers Third-party payers typically maintain a network of providers with which they have nego- tiated contracts. These contracts detail which payment models will be used and what rates will be used, as well as other details common to commercial contracts. Price and Provider Expertise Additionally, from their network of providers, payers inherently develop extensive data- bases of their patients’ experience with different providers over time. These databases are a wellspring of information for longitudinal studies and better understanding of treatment options. Third-party payers deal with an array of providers daily. They know the going rate for a wide variety of procedures and consultations across geographic regions and quality tiers. They can conduct quantitative quality studies more easily than any other organization. Therefore, it is third-party payers who have the best chance of predicting which providers will offer a good outcome. Many payers highlight their cost and quality experience with each of the providers in their network through some sort of star rating system, and these have become increasingly important for patients as they search for “in-network” providers. While patients historically followed the referrals to specialists and hospitals from the primary care provider or similar, payers’ large databases of claims and outcomes allow them to measure performance more objectively (as will be discussed in Chapter 7, Health Care System Performance). Provider Payment Approaches In general, there are six payment modes that people and organizations use to buy and sell services. These are: cost/cost-plus hourly or time and materials fee-for-service fixed price capitation value We discuss each in relationship to the provision of personal health care services. Cost/Cost-Plus “Reimbursement” is how hospitals describe payment received for services they have already provided. Under a cost payment method, the organization providing the services tracks all costs associated with each customer and then asks to be paid that amount. This is similar to how an employee might be reimbursed for expenses incurred during a business  6: Financing the Health Care System 223 trip. The employee would offer receipts for plane fare, hotel, food, and other allowable items and then expect to receive exactly that amount in return. An indemnity plan is one under which the covered party is reimbursed for all expenses they incur. An organization is often paid on a cost-plus basis (so-called because a contract specifies that the organization will be reimbursed for actual costs plus an additional percentage of those costs). The cost-plus method provides an additional margin out of which the provid- ing organization can generate profit after any nonproject expenses are paid. In practice, no independent entity can be paid in a cost-only manner. Of course, a profit-generating organization will never survive under a pure cost-only reimbursement model, but even nonprofits need more than cost reimbursement to survive. Under any con- tract there are nonreimbursable expenses, and every significant organization has expenses that are not specific to one project. The margin allowed on the cost-plus project is what an organization draws from to pay these expenses. Some people like cost-plus contracts because they provide high levels of transparency and seem to limit profits. However, there are drawbacks. These bills are often so detailed that the payer can understand only the bottom line.5 In practice, what is reimbursable, as well as ceilings and thresholds on the amounts, must be set. Accounting for utilization of shares of resources can be complicated, and approaches must be agreed on. In addition, cost-plus contracting does not reward the organization, in this case the health care pro- vider, for either better quality or finding new ways to provide services more cheaply. In a true cost-plus system, the contract penalizes the providing organization for cutting costs. Time and Materials The hourly payment method, common in service industries, is often referred to as “time and materials.” In this case, a provider would be charged a fixed hourly rate covering all the costs except agreed-on materials, which would be billed as incurred. For example, a residential electrician might pass along all costs for fixtures and breakers and charge US$85 per hour for his time, which then must cover his vehicle, all his tools, any assistants he might employ, and so forth. The time and materials method tends to be the system of choice in cases where the scope of work is not clear to either party. Per diem (by the day) reimbursement remains a very common payment method for hospitals (Kaiser Family Foundation [KFF], 2002). Although such a system encourages the hospital to work hard to minimize overhead expenses, payers will always worry that the hospital is not looking for ways to increase efficiency. Fee-for-Service The fee-for-service method is common when the scope of work is clear to both sides. It is the oldest form of payment for health services and the predominant system of paying phy- sicians, dentists, and private providers in the “other professional services” category of the NHE. For example, a dentist will typically have a set price for a cleaning and checkup. If additional services are needed, those will be performed at essentially published prices. In such a system, the risk of inefficiency is borne by the provider and the risk of bad advice is borne by the customer. Whether a root canal requires 1 or 2 hours to perform and whether or not a root canal is the best use of the patient’s money, the dentist receives the same pay- ment. The local market and the dentist’s reputation drive the rates they can charge. 5 In health care, a cottage industry has formed around the interpretation of medical bills. For fees rang- ing between US$50 and US$250 per hour, “claims assistance” professionals or “health care advocates” will decipher bills, challenge errors, and negotiate discounts (Francis, 2006; Whitehouse, 2006). 224 I: U.S. Health Care System: Present State According to some observers (Jonas, 1978; Roemer, 1962), in the past, this piecework system was a major cause of many of the observed problems in the health care deliv- ery system. Although the patient’s risk that they overpay for a service is reduced, such systems do not reward the provider for better-quality service. Nor do they reward the provider for steering the patient toward more efficient services. A frequent complaint is that preventive medicine is completely ignored (Lown, 1998; Medical Reform Group of Ontario, 1980). Fixed Price A service is called “productized” when it can be marketed or sold as a commodity, which implies that a fixed price will buy a known quantity of that service. Critically, the known quantity is a customer-centric outcome (or in the case of health care, treatment of a disease or condition on a per-episode basis). This can be compared with the provider-centric fee- for-service system, which focuses on what the provider does, whereas a fixed-price, pro- ductized approach is nominally focused on the condition presented by the patient. As an example, Medicare (and many other payers) pay hospitals for their patients’ inpa- tient stays per-discharge based on the Diagnosis-Related Group (DRG) assigned to that discharge. Different payers may use a different methodology to assign a DRG (the most common methodologies being the Medicare Severity Diagnosis-Related Group [MS-DRG] used by CMS and the All Patient Refined Diagnosis-Related Groups [APR-DRGs] devel- oped by 3M) and set the prices associated with the DRG. CMS refers to this as a “prospec- tive payment system” (PPS), since while the rates are set to reimburse providers for their costs, they are established prospectively based on the expected utilization of resources for that DRG using an elaborate system of cost reports and historical claims data. The Acute Inpatient PPS was adopted for Medicare by the federal government in 1983 for Medicare Part A benefits (i.e., payments to hospitals) to control costs. It can be seen as forcing productization on the hospitals—at least with respect to the patients covered by Medicare. CMS’s DRG system originally covered only acute care and only the hospital or facility-related charges (Cacace & Schmid, 2009; Mayes, 2006). Hospital outpatient services were moved to a PPS-type system effective August 2000 (Wynn, 2005). Charges from providers received pre- and postdischarge, even if related to the episode of care, have been billed separately. Recently there has been a movement to bundle patient and episode-of-care payments for the most well-understood treatments, such as joint replace- ments. In such a system the provider is rewarded for how efficiently the patient is treated. Quality is emphasized to the extent that it affects the efficiency of the treatments for the initial diagnosis. The negative side of this type of system is that it intrinsically rewards pro- viders who exaggerate the reported severity of the diagnosis, because disease classification determines the amount of payment that will be received. Since patients are classified by the same organizations that treat them, there can be what is called “up-coding.” Also, providers are rewarded for attracting or seeking healthier patients (who otherwise tend to heal faster than sicker ones) and preventive medicine tends to remain a low priority. Finally, it should be noted that a true fixed price or productized solution would have a set price based solely on achieving the desired outcome, as compared to a fee-for-service system in which the prices for services are set though the services required varies (based on the decisions of medical professions in most cases). The current DRG systems are there- fore in between, for while the rate is fixed based on the DRG regardless of the services used in providing care during the inpatient stay, there are different DRGs for different  6: Financing the Health Care System 225 treatments and procedural options, and the DRG is not finalized until the discharge is fully coded. As an example, both the MS-DRG and APR-DRG have different DRGs for vaginal and cesarean delivery (CMS, 2019; New York State Department of Health [NYS- DOH], 2018). The authors wonder if the U.S. C-section rate, which is roughly twice the rate that WHO considers justifiable (Gibbons et al., 2010; National Center for Health Statistics [NCHS], 2023) and which some consider epidemic (Lancet, 2018), would trend lower if hospitals received the same rate regardless of the type of delivery. Capitation Capitation is a fixed prepayment per person to the health care provider for an agreed-on array of services. The payment is the same no matter how many services or what type of services each patient actually gets. In theory, such a system encourages the selection of the least expensive treatments as well as promotes services likely to result in the lowest overall cost during the contract period. However, such a system has no reinforcement for promoting the long-term health of the patient. With capitation, providers are likely to be rewarded for enrolling patients least likely to consume many health services, that is, the healthy. One can also see “global budgeting” (a payment method common to government-run facilities) as a simplified form of capitation—one with only one payer. The provider receives a global budget, which must cover all costs of treatment needed by the eligible population. This is the common way of paying for Veterans Administration (VA) hospitals, state men- tal hospitals, and local health department clinics. In practice, a global-budget model tends to resemble the cost model, as the budgets are often negotiated starting with the previous year’s cost, and those in operational control are not usually rewarded for coming in under budget. In bureaucracies, coming in under budget is taken as a sign that the budget was set too high. Value “Value-based compensation” is the payment model in which the performing organization is rewarded for the value delivered. Value-based systems are most often used when the value is easy to measure and indisputable. For example, personal injury lawyers often offer their services purely for a contingency fee because the value of the lawsuit proceeds is easy to measure. When first referenced in the sixth edition of this book, tying payments to value in health care was almost unheard of. It was only in 2006 that Michael Porter and Elizabeth Teisberg had brought the idea to the forefront in their book, Redefining Health Care (Porter & Teisberg, 2006). Nonetheless, initiatives such as MACRA, passed by Congress in 2015 (Shryock, 2019), and the New York State Delivery System Reform Incentive Program (DSRIP), finalized in 2014 after several years of negotiations between the State of New York and CMS, placed strong emphasis on shifting the delivery system to focus on and ultimately reward value (NYS-DOH, n.d.). However, in September 2019, it was noted in the mainstream press that “Value-based care has created a conundrum: pretty much everyone in healthcare likes the idea of paying for outcomes, but no one is sure how to fairly implement it” (Shryock, 2019, p. 8). While states like New York are continuing on their journey to a delivery system more focused on value after investing billions of dollars in system transformation, a review of their last roadmap suggests it is not simple and much work remains to be done (NYS-DOH, 2016). 226 I: U.S. Health Care System: Present State Risk Transfer and Good Intentions The different payment models can be arranged along a continuum representing the finan- cial risk borne by the buyer and the risk borne by the provider. If the payment model with which the patient pays is different from the payment model under which the provider operates (as is possible in a system with third-party payers such as the current U.S. health system), then the possible combinations can be represented as a matrix (see Figure 6.8). With each combination, any risk not borne by the provider or patient is borne by the third-party payer. One could expect a third-party payer to react to this risk by excluding people or conditions, rejecting charges, capping fees, or otherwise capping coverage and raising premiums. On the other hand, even when the payment methods match (e.g., the patient and the provider operate under a fee-for-service contract), either side may wish to use an inter- mediary. The introduction of health savings accounts (HSAs) created an opening for a different type of institution in health care that starts to resemble something like American Express as opposed to United Health. Initially banks—experts in low-risk, high-volume transactions such as managing payments for product purchases—entered the health care market. However, the regulatory requirements of managing HSAs was sufficiently differ- ent than traditional financial services that many traditional financial services firms exited the business over the past few yea