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An understanding of the organization of the health-care system enables the clinician to better navigate the system on behalf of the patient. It provides important insights that improve the ability of health-care professionals to continue to operate in their chosen profession, increasing the likelihood of succeeding and surviving financially. The US health-care system is frequently described as “broken.” To understand how it can be improved, it is useful to have an appreciation of how it presently is configured and how it evolved. The purpose of this chapter is to provide an overview of fundamental principles of financing health care and insurance. The most relevant programs for the elderly, Medicare and Medicaid, are addressed. There are multiple complex and interacting segments that comprise the health-care delivery and financing system. Where the money comes from, where it goes, and why so much is spent will be examined. Possible responses to a system under stress that is facing the challenges of changing demographics and relentless cost trends are presented.
The health-care “system”
It is useful to remember that the care of the elderly patient occurs in a system that is complex and provides and finances care for well children, disabled adults, the uninsured, that is, the entire population. The many elements of the financing and delivery system are interdependent. Cross-subsidization occurs. This results in all elements being relevant to the elderly patient. It is Medicare, however, that has come to symbolize the health-care system for the geriatric patient. Medicare is far more complex than a governmental insurance company paying claims for persons older than 65 years of age. Medicare also pays for care provided to the disabled and those on dialysis; it contracts with private health plans and drug plans to provide required and supplemental benefits to beneficiaries. It has a major role in financing medical education, researching the impact of system change through demonstration projects, and shaping the delivery system. Private insurance often mimics Medicare payment and benefits policies. Medicare is a financing system, not the delivery system. Health care is delivered by providers such as doctors and hospitals. There are suppliers such as drug and device manufacturers who not only provide important tools for improving health and preventing disease, but also significantly impact the cost and politics of health care. The system includes private and governmental payers other than Medicare. These payers ostensibly act on behalf of and respond to demands of employers and the voting populace and finance a greater dollar volume of health care than does Medicare. Their impact on the system is substantial. Private insurance is important for the elderly too, as most have some form of coverage beyond traditional Medicare, whether it is employee or retiree coverage, a Medicare Advantage plan, or “gap” coverage. Medicaid is critical for low-income seniors and those in long-term care institutions. The Veterans Administration plays an important role in funding and delivery of care. The most important parts of the health-care system are the patients and their families. The elderly, although just a population subset, are patients of great diversity in employment status, cultural, behavioral, financial, educational, health, and functional attributes.
There is general popular agreement that our system is seriously flawed. It is often stated that aligning incentives will improve the likelihood that the system will better serve the needs of society. A common goal of achieving a healthy population is agreed on (assuming providers of goods and services believe they will still be needed), but the uniformity of viewpoints stops there. Complex systems also have great inertia because any change in one part of the system tends to affect another. The ripple from any change may be predictable, based on study of the past, such as service volume increasing in response to price reduction, or dauntingly unknown, such as the use of services by a baby boom cohort that may be of improved health status, yet accustomed to aggressive consumption of new technologies. The health-care system also exists within a social milieu in which health care consumes resources that might otherwise be used for education or housing and income equality, housing and education may have greater effects on health than medical care. Health-care professionals may not naturally operate on an assumption that the growth rate of the economy is as relevant to health-care organization and financing, and therefore their practice of medicine, as is the latest treatment innovation for a condition of interest. Furthermore, the financing and delivery system often seems to be no system at all with conflicting interests, as hospitals compete with doctors for fee updates and payers seek to avoid any updates in the face of increased utilization of services. Yet clinicians impact the system one patient at a time and have a unique potential to lead system change: a potential that comes with the experience of operating daily at the interfaces of finance, delivery, and caring for our patients.
International perspectives
This chapter focuses on the US system. Much can be learned from other countries. The United States spends more per capita and a greater portion of its GDP than other nations, yet is generally considered to have lower health status than our peer nations.[1, 2] Social factors, universal coverage, the balance of regulation and entrepreneurial liberty, per capita wealth, age of the population, diversity and homogeneity, national budget policy, delivery system, payment amounts, and benefits/coverage policy are all factors in this equation. For many of these factors there are significant differences between the United States and our fellow developed nations. However, there are also many consistent issues such as human behavior and economic principles and the need for political will to change.
Insurance basics
Health insurance serves two fundamental goals: prepay predictable expenses and provide financial protection against the cost of infrequent but very costly events. It is well established that the uninsured and underinsured do not receive recommended and necessary services. Traditionally, health insurance allowed the individual to obtain treatment for an acute illness that could otherwise not be purchased due to limitations of personal financial resources. The reason to prepay predictable expenses is a newer insurance phenomenon related to payment for prevention. It is intended to encourage appropriate use of services that will prevent disease, disability, and future medical expenses. It is also a mechanism to provide services at a contracted amount as compared with charges and to fund care for persons with essentially no resources, such as those with poverty-level incomes. A growing share of insurance finances go to health care for chronic illness. Insurance also finances the delivery system infrastructure.
Insurance is foremost a pooling or spreading of risk across a large population. It works by everyone paying a little into a pool that few will use. Those few who use it will exhaust the pool, less administrative costs and some reserves for unexpected variation. The reserves, besides being a cushion, produce investment income, lowering the amount needed to be collected from each person, known as the premium. In this manner, health insurance is no different than automobile, homeowners, or professional liability insurance. According to the Kaiser Family Foundation, in 2010, 10% of all Medicare beneficiaries accounted for approximately 60% of Medicare spending, but 12% incurred no Medicare expenses at all.[5] In younger populations where the prevalence of chronic illness is lower, the contrast between the few who spend a great deal and those who use little to no services is more stark. The high-use population is composed of different types of people. Some have one time high-cost events, such as those who survive major trauma without disability or those who die after an expensive course of care. Others have chronic illness punctuated with rare high-cost events such as coronary artery disease with bypass surgery or chronic illness with recurrent costly events such as congestive heart failure and recurrent inpatient care. According to the CMS Chronic Conditions Chartbook 2012, in 2010, the 14% of Medicare beneficiaries with six or more chronic conditions accounted for roughly half of the program expenditures.[3] Those with multiple chronic conditions and functional limitations are the most costly.[4]
The effect of spreading risk works best when it is spread over the largest possible population. Any segmentation creates the potential for the effects of what is known as “adverse selection” or “cherry picking.” The United States does not have a system in which the entire population is enrolled in one insurance program. Although most payments are a form of fee for service, many provider groups receive payment that is at least partially based on some form of prepayment per person or “capitation,” and therefore the provider assumes some insurance function or risk. This is expected to grow as Medicare seeks to move away from fee-for-service payment methods. Therefore, adverse selection is very relevant. Consider two health plans: plan A has 5% of its members with a serious chronic illness; plan B has 6% of its members with the same condition. The difference at first appears trivial; however, because the 5% account for 50% of all expenses in plan A, that means that each 1% change in the sick population will result in a 10% difference in total expenses. If plan B is to make ends meet, it will raise its premiums to cover its greater costs. This may lead people who do not use services and thus see less value in health insurance to leave to a lower premium plan, which then only decreases the pool of healthier people over which to spread the risk. Plan B spirals into insolvency. Risk or case mix–adjusted premiums might work, but the high-risk people may not be able to afford the higher premium. Adjusting premiums to risk also defeats the principle of pooling risk, unless the risk level is under the control of the insured, for example by using tobacco or not, or the premiums are paid from a pool, such as premium support programs in a federal health exchange under the Affordable Care Act. It also is the case that the risk adjustors account for a relatively limited amount of the per person variance because there remains a significant degree of unpredictability in expenses. Most insurance today has some form of risk adjustment. Large employer groups may be rated (have their premiums priced) by historical use experience. Small groups may be rated by age or sex adjustments. Medicare risk adjusts payments to Medicare Advantage plans based on factors such as age, diagnoses (high-cost conditions), and whether the person is institutionalized. One of the largest challenges in a voluntary health insurance system is setting premiums for well young adults at a level at which they will purchase coverage. They are indeed low risk and often see little value in insurance that they perceive as inadequately risk adjusted, thus incentives or mandates are used to create the largest pool.
“Benefits” are what insurance covers or pays for. Benefit design is a critical element in understanding health-care financing, as it defines what is being financed through insurance. If hospital care is covered by insurance, then the price and volume of hospital services must be calculated and spread over the population paying premiums. If long-term nursing home care is not covered, then its cost and volume is irrelevant. Because insurance is a legal contract between the insurer and the insured, careful definition is critical. Certain services may be essential to the health of the patient, but that fact does not make them covered. Until Medicare created a prescription drug plan, there was no coverage for medications, yet medications were more important than many covered services to the health of most Medicare patients. Medicare does not cover long-term care in a nursing facility yet it is necessary for many. Benefit design may create or minimize adverse selection risk. Presume our example plan B had a different mix of member complexity from plan A not by random chance but because plan B had slightly different benefits that made it much more attractive to people with chronic illness. Perhaps coverage for a certain drug important to a person with the illness was slightly better. By providing better benefits plan B created its problem. Provider network may also create selection risk for a health plan. This same type of issue can affect physicians or physicians groups who accept some of the risk by becoming paid by capitation. Group A has no geriatricians and has a typical complexity patient panel mix. Group B has geriatricians who attract complex patients. If the two groups are paid the same amount per patient, group B will have to do a far superior management job to make ends meet. There is a great deal of unexplained variation or waste in health-care services utilization, but the disease burden of the patient, not the management skill of the clinicians, will dictate most of the cost of caring for the patient. It is unlikely that group B will succeed financially.
Long-term care provides a good example for two other important points: calculating cost offsets or “savings” and behavior change. Insurance coverage of a service will make it more accessible. This will expand its use and create a market for providers who will seek to expand it further. If home care is paid fully out of pocket, some will utilize it. If it is insured, the use will grow. Behavior changes with coverage. It is almost certain that some nursing home residents can be cared for more cost-effectively at home with home care services supporting other caregivers. If $50 per day on home care would prevent $150 per day of nursing home care, it would seem a good buy. It is a gross miscalculation, however, to base savings on the experience expected for one person. Insurance covers populations. In structuring the home-care benefit to cover that nursing home patient who could be cared for at home, it might be that five people at home who need home care, but are presently paying out of pocket, now become eligible for insurance to pay. The $150 per day “saved” results in $300 per day of home care for six patients, not $50 per day for one. Perhaps five caregivers missed less work, saving their employer costs and boosting productivity and society was better off. The health-care insurance costs were not reduced, however.
This brings us to the point of total costs, insurance costs, cost shifting, and returns on investment. Whether the insurance is provided by a for-profit company or the government, there is a budget of sorts. One way to control the budget is to shift costs to the patient by limiting the benefit. Medicare Part D drug coverage has beneficiary cost sharing so that it could be affordable to society (at least to the degree that Congress determined). States and the federal government have different programs that have unique budgets, but a single patient may be a beneficiary of both programs. Ideally, such shifting and fragmentation does not create unintended or harmful gaps or increase total costs, but too frequently it does. Multiple programs also create multiple administrative processes and added expense. More significantly, one payer may take actions to save a little for itself, even if it results in higher total costs and higher cost to the other payer and patient. Costs may also be shifted over time periods by making an investment. A diabetes program that delays diabetic morbidity may save an employer-sponsored private insurance company money if an upfront investment in the member’s care can be amortized over years of membership premiums and the most costly episodes are prevented or deferred to an age of Medicare eligibility and thus shifted to the Medicare program. The insurance company will see a return on the investment assuming the member remains with them long enough. One of the ironic consequences of Medicare programs helping a person survive to another year is that there will be another year of Medicare expenses. Medicare is not funded primarily by annual beneficiary premiums; therefore, if Medicare is to have a return on investment, it must reduce lifetime expenditures, which is very difficult to accomplish. For Medicare, a smaller population is less costly. Private insurance has a per member premium. Reducing membership reduces income and is not financially desirable.
An insurance company can control costs in limited ways. It can reduce the price of a service or it can reduce the frequency of a service: pay less or buy less. One way to reduce the price is to shift some cost to the member or to not cover the service at all. Price reductions may stimulate providers to increase volume to make up for lost income. Price reductions may make a service unavailable due to provider drop out. If the reduction is achieved by shifting the cost to the member, the member may forego the service. If the service was particularly cost-effective, this would be deleterious. The price change could result in substitution with a more costly service or result in disease progression to more costly stages due to lack of the service. If the service was not cost-effective, the frequency reduction achieved is positive. Attempting to reduce frequency by means other than price can have the same risk/benefit calculus. Administrative costs may be incurred implementing programs designed to reduce volume of services. Seemingly simple actions can have complex unanticipated results.
Financial principles
In a system in which there are issues such as cost shifting and adverse selection, it may appear that standard business principles do not apply; however, the delivery system is a business and fundamentals generally do apply. The financing system may contribute to confusion over fundamentals. For example, payments may be based on historical charges and not based on current true costs or competitive pricing. That said, every business has income and expenses. It has a product that it provides and makes money per some unit of product. It can have loss leaders or provide charitable services, but it cannot lose money on every service and survive. Inappropriate payment can affect service availability, by over stimulating growth of a highly profitable service and causing undervalued services to wither.
A solo practitioner running his or her office must have a good sense of these realities. There is the rent, the utilities, the employees and their benefits, professional liability insurance, and supplies. Then there is income that is typically fee for service. Each patient is a little different, but overall there is a predictable gross income per unit of patient service. Income must exceed expenses. There are also variable and fixed costs to consider. One more patient on the schedule will not change the rent or staffing, which are the fixed costs. That patient may use another paper gown as a variable cost, but mostly the patient is pure net income. At some number of additional patients, more staff will need to be added or another doctor asked to join the practice. At that point there might need to be a subsidy of the new doctor’s salary. The practice founder will assess the value of the investment in the new doctor by estimating the cost today as compared with what a similar investment would generate over time and decide whether to bring on the associate or to purchase mutual fund shares for a better return on investment. Of course, there are also estimates of intangibles such as reduced on-call schedule, ability to better manage unexpected surges in patient demand, and other nonfinancial calculations that will occur.
The same principles apply for health-care systems. A hospital-employed geriatrician may directly produce income that exceeds his expenses and salary plus benefits. In such a case, that single unit is profitable. The geriatrician might be using only variable costs, if the clinic space and staffing is fixed anyway, but it is likely that fixed costs would be proportionally allocated to all users of facility and staff. The geriatrician may be a feeder of patients to the specialists and hospital. Hospitals have huge fixed costs. A few extra admissions incur few variable costs and are usually highly desirable. If the hospital believes that the geriatrician’s patients would not have been at the hospital were it not for his employment, this might be recognized as his contribution to another cost or profit center. The geriatrician’s patients may also give generously to the hospital capital campaigns. A geriatrics service acute and post-acute care may reduce hospital readmissions and complications and be of increasing importance in the emerging value-based payment world. On the other hand, if the hospital concludes that the geriatrician’s patients always incur costs of care exceeding the reimbursement the hospital receives, the hospital may wish to no longer employ the doctor even if he earns his salary based on the office/clinic income. A geriatrician may work for a nursing facility–based special needs health plan that employs physicians and receives Medicare capitation payments. The plan may determine that a skilled geriatrician results in markedly fewer transfers to the hospital, better drug and laboratory usage, more appropriate specialty care, and lower costs. The number of patients seen per day is only relevant to the extent that it results in better, more cost-effective care; payment generated per nursing home visit is not relevant. The bottom line is that regardless of the setting, there is a calculation of productivity or income by some measure. There is a calculation of costs or resources used. There is either profit and sustainability, or loss and eventual demise. These calculations may be complex and involve assumptions that are controversial or flawed. If profit margins of a larger organization are good, the effect of a small unit may not be calculated or be worth the attention, but ultimately real income and real expense exist in any endeavor and are likely to be a factor.
Other basics warrant mention. The most salient is that in the financing and delivery dyad, costs to one party is income to another. Any cost reductions for payers result in income loss for the providers in the aggregate, although not necessarily for an individual provider. The tension is obvious.
Efficient provider units lower health-care costs without losing profitability of the unit. They can maintain the same profit margin by reducing expenses even while lowering the price of their services. This is the typical economic paradigm in competitive markets; however, health-care markets are distorted by many factors. A cost-effective provider is not the same as an efficient provider as described previously. Cost-effective providers could reduce their income because fewer of their services are used or increase their incomes because they shared in the cost savings, or because the more cost-effective services were the more profitable services for them.
Another important point concerns growth rates and compounding. In a mortgage, a lower principal will save great sums when interest is applied over time, but the interest rate can be more significant. Baseline expenditures and the growth trend are principal and interest in another setting. An extremely high trend in a service that accounts for a minute portion of total expenditures has an insignificant effect compared with modest growth in services that are responsible of a high proportion of total costs. Sustained high growth rate can, however, make a service that was once an inconsequential expense become very significant. An example of this in health care is the projected costs of high-cost “specialty” drugs such as the biological agents.
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