Wednesday, September 23, 2009

Why is Medicare bankrupting us? Why are the costs out of control?

We’ve heard many times that healthcare costs are spiraling out of control, but a lot of things are described that way, so how can we put this into context? The two best figures to compare are the US Gross Domestic Product (GDP), which grows at 2-3%/year in normal times, and the US Consumer Price Index (CPI), which has been 0-4%/year since 1990s. Medical cost trend has grown around 6-10%/year since the turn of the century. Quick sidenote - for employees, it feels even higher since they are being asked to pay for a greater share of their healthcare costs. It's no wonder that healthcare is taking on a greater share of the economy and the consumer's wallet.

Medicare officially keeps a relatively low cost trend for the program – roughly 5-8%/year. However, Medicare’s hidden trick is that it pays providers a predetermined rate that providers can not negotiate. If a hospital doesn’t like its Medicare rate, the only thing it can do is not accept Medicare. Considering the volume of business that Medicare commands, that’s an impossible option. Said another way, because of the high fixed cost nature of hospital, hospitals without Medicare volume would not survive, but hospitals with only Medicare rates across all their volume would not survive either. This means that Medicare is actually underpaying providers by paying above variable cost but below average cost. Hospitals cope in 2 ways: 1) They increase the number of billable services they perform on Medicare patients (we'll revisit this below) and 2) They charge the commercial insurers more than they normally would. [See this Milliman report for more information on cost shifting to the commercial insurers]

What this really means is that the true cost of Medicare does not show up in its official Medicare medical cost trend. That’s because some of the costs that Medicare should be paying for is paid for by the commercial insurance population. In fact, even the true administrative cost of Medicare is higher than what is claimed. For example, while only the Center for Medicare and Medicaid Services is counted towards the 2-3% administrative costs, the cost of enrollment is actually housed under the social security administration.

So what makes Medicare’s true cost trend so high? The answer is in the utilization of services. Breaking Medicare’s cost trend into two parts: it’s roughly 20% rate increases and 80% volume (utilization) increases. Roughly the opposite is true in the commercial managed care environment with 20% utilization and 80% price inflation. Remember how Medicare is an unmanaged fee-for-service program? That means Medicare reimburses whatever a physician charges to Medicare – no questions asked. I’ll give a few examples of extreme cases to illustrate the point. First example, if someone walks into a hospital with some knee pain there are a few things that could happen ranging from least to most expensive: a) an external examination and some aspirin, b) an x-ray, or c) an MRI. All of these practices are equally acceptable to Medicare. There are parts of the country where the care is delivered in a cost appropriate manner (ie. giving x-rays where appropriate and MRIs where appropriate), but there are certain parts of the country where an immediate MRI is standard operating procedure. [Expect a future post on geographic disparities.] Second example, if a senior needed an oxygen ventilator to help them breathe, Medicare pays the same monthly rental of that equipment whether it is new, used, or outdated. There were ventilators that had been passed through multiple patients and racked up $11,541 in rental charges to Medicare while having an original price tag of $745! There are cases where a single patient would rack up enough charges to pay for 12 ventilators. This is equipment that has “minimal servicing and maintenance” required. There is a clear reason that almost no commercial plans pay for oxygen equipment rental – they just buy them and administer it themselves. Today, there have been a lot of limitations imposed and cuts to the rates of these oxygen providers, but they still continue to make some pretty enviable margins. Honestly, how hard could that be? Third example, the plain vanilla hospitals (called inpatient acute care hospitals) are paid based on the diagnosis that someone has. That means they get paid the same amount whether someone stays for 5 days or 55 days because of a mild or nasty case of XYZ. Ideally, that encourages hospitals to be efficient and get patients better more quickly. There’s a special type of hospital called long-term acute care hospitals. These guys treat some of the sickest patients that require more attention (think a step below the intensive care unit). One day the inpatient hospitals decided that this was actually a pretty good business to be in, so they started their own long-term acute care hospitals, except they would put it on another floor of their own hospitals. So the egregious part of it is what they did with the patient to maximize the revenue they get from each patient. Remember, they should be getting a flat rate for the whole thing. First, they would admit a patient into their inpatient hospital (bill Medicare once), discharge the patient and roll him upstairs to admit him to their long-term acute care hospital (bill Medicare a 2nd time), discharge the patient after the allowable amount of time, and then READMIT him into the inpatient hospital (bill Medicare a 3rd time)! I’ll emphasize a few things. The latter two are just examples of old, ridiculous loopholes in the Medicare reimbursement system there have been caught and addressed (although I wouldn’t say closed), but trust me many more examples of these abuses exist.

So reading this stuff may make you wonder why there is zero management to reduce some of the fraud, waste, and abuse of the Medicare system. The reason there is no management of services is that culturally and/or politically speaking, many citizens in the US believe that the government should not get between the physician and his patient to determine the type of care the patient needs. I think this is a very well-intentioned principle that has inadvertently lead to some ill consequences – namely uncontrollable costs. To be clear, I’m not commenting here that I think the government or private sector should be involved in the physician/patient decision; I am merely underscoring one of the major effects of having Uncle Sam’s blank check available.

We’ll next explore another well-intentioned principle that has had some boneheaded ripple effects.

Sources: Bureau of Labor Statistics, Barclays Capital, Office of the Inspector General

Next Post: Why does healthcare come from our employers anyway? How did that get started?


  1. Another one of the problems of Medicare is that the system inappropriately rewards procedural work instead of evidence-based medicine. For instance, a patient with generic chest pain that isn't life-threatening to him would be given conservative management (basically, aspirin, good history-taking skills, and watching the patient for a bit longer), but in some hospitals (especially a top-ranked one in Houston that will not be named) the work-up will include stress test, echo, MRI, and heart cath study. These procedures aren't necessary and actually may do more harm, but are reimbursable by both insurance and Medicare at a higher rate, so billing for these procedures is encouraged. This is one of the reasons causing many of the problems in medicine, such as physician shortages, increased spending, and the US having such low ratings in several global health care rankings.

  2. Very informative. Keep up the good work Andy!

  3. can you give any information on why it is that the U.S. government finds it so much more plausible to provide healthcare for its prison inmates than for the general population?

  4. Albert, that's ~exactly~ the type of problem that Medicare has. There's nothing stopping that if there's no check or balance. Of course, who wants Big Brother saying what type of healthcare we receive? Tough call to make.

    Peng, that's a tough question. The only principle I can throw out there is that inmates are still treated as human beings and are at the responsibility of the state. As such, they are 'entitled' to some basic necessities such as food, a measure of safety, and proper healthcare. Of course, they also get cable TV, so I can see the annoyance that criminals get better treatment than law-abiding citizens! Clearly, they are giving up their freedom, so I wouldn't exactly be jealous, but that's my opinion.

  5. The reason why prison inmates are getting better health care than the general population is that when you're a prison inmate, you become a ward of the state (in this case, to sequester criminals from the general public). Like any other governmental branch in the US (armed forces, civilian workers, politicians, etc.), they take care of their own. The general population, though, is basically given the option to pursue whatever private insurance (or none) they want.

    As for the medicare issue, one of the easiest ways to fix this problem is to decrease reimbursements for procedures and increase reimbursements for basic primary care and smarter management. Many med students want to do the procedural specialties, partly because they like it, but also because it pays very well. Internists, pediatricians, family physicians, and psychiatrists work just as hard and are just as smart as surgeons, interventional radiologists, and anesthesiologists, but are paid less and have more BS to deal with, as well as dealing with crap from everyone. I could go on and on about this, but a comprehensive solution is always a political quagmire. The moment we try to do things like promote end-of-life issues, managing rather than trying for an absolute cure, and figure out more efficient and better ways of helping patients, an entire chorus of people shout and scream.