Part 2 – A Historic Perspective

Accountable care has come about over the past decade because there is near-universal agreement that the US healthcare delivery system is in a state of crisis. Quality isn’t high or consistent enough, and costs are too high.

Most healthcare experts agree that the rapidly escalating cost of healthcare services (a rate that grossly exceeds the consumer price index) has become unsustainable. Health insurance premiums have become unaffordable for many families and healthcare costs including insurance costs (mostly subsidized by employers) have become a barrier to global competitiveness.

The Commonwealth Fund has done a nice job in graphing out the current percentage of GDP dedicated to healthcare expenses, and a projection looking at the next 10 years showing the significant increase in the cost of healthcare over the past few decades.


In this second graph from the Commonwealth fund, you can see the dramatic increase in the cost of health insurance premiums compared to the rise in worker’s wages over the similar period. Healthcare premiums currently consume close to 25% of the average family’s paycheck, not accounting for non-covered medical expenses.



Many healthcare thinkers agree that there are number of reasons for the growth in the cost of healthcare.  The two primary drivers are:

The dramatic increase in the complexity of medical science and the rapid rate of medical innovation coupled with the enormously expensive infrastructure required to develop and test medical technologies.


A distorted consumer market for healthcare services where the usual consumer model of buyer/seller price/quality regulation doesn’t apply.

Lets discuss the second situation first, restricting the discussion to the primary mode of healthcare payment, which is fee-for-service (more details on this to follow).


In addition to the previously described contributors to cost – technological advancement and misalignment between the players – a major area of dysfunction revolves around the dominant model of US healthcare payment, traditionally called the fee-for-service model.

Fee-for-service [or FFS] has been the dominant payment model in the United States for decades.  Fee-for-service effectively means that every service delivered by physicians and providers such as hospitals and medical equipment companies is billed to the insurance company on a piecemeal basis.

In the United States, under fee-for-service, every widget of service that providers sell means additional revenue. The mathematics of running a business like this are quite simple:  profit is the difference between the revenue brought in from selling the widget, and the cost of providing the widget. Revenue is thus simply a question of the volume of service provided times the rate charged per unit volume.

Thus, in a fee-for-service environment, the mathematics look something like this:

Profit= (Volume x Rate per Unit) – Expenses

Healthcare companies have traditionally improved the bottom line by negotiating up the rates that they obtain from insurance companies (per unit of service) while ratcheting up the volume of service that they provide.  They do this by advertising, forming affiliation agreements with physicians, and doing things like building large, attractive hospital towers.

Providers have also had a strong incentive to provide certain specialty services such as neurosurgery, orthopedics, cardiology which have traditionally generated high revenues due to fact that these “procedural” specialties generate high units of billable service per unit of time/effort.

The fee-for-service model has been responsible for much of the hyper-inflation that we’ve seen in healthcare over the past 30 years.  It has given healthcare almost unlimited ability to grow.

Lets continue the discussion about the distorted healthcare environment by looking beyond the way healthcare is paid to the lack of alignment and unequal content knowledge among the three players in the healthcare environment

Misaligned Incentives, Knowledge Differentials and the Difference between Healthcare Purchases and Usual Consumer Purchases

Here is an illustration of the differences between the fee-for-service healthcare market and the normal consumer market:  Imagine going to a vacuum dealer:


257px-Dyson.cleaner.dc07.arpYou want the vacuum that’s in the window. The price of the vacuum is clear to all, and can be negotiated. The attributes of the vacuum, including any accessories are understood by all parties.  You have every incentive to buy the best vacuum for the least price. The dealer has every incentive to sell the least vacuum for the best price.  Somewhere between the two you shall meet. When the value of the deal makes sense to you (i.e. what you get/ what you pay) you get our a checkbook and sign the deal.

Healthcare transactions are different. First, there are three parties in a typical healthcare transaction, rather than the usual two in a consumer purchase:  the patient, the healthcare provider and the health insurance company.  Each of these parties has a different incentive and is privy to different information regarding the deal.

In a nutshell, here are the how the three parties likely perceive the healthcare transaction:

The patient has a strong interest in receiving high quality, timely healthcare.  Her primary interest to staying well and receiving the best quality medical care when sick.  She has a strong interest in paying the smallest amount of money possible to the insurance company while receiving the most and best medical services. She is also very interested in maintaining unlimited choice and access of the newest medical technologies.  But, given the complexity of medicine, the consumer doesn’t approach the healthcare negotiation with the knowledge of the science of medicine, and is often unaware of what she is getting, or why– or what the alternatives might be.  Thus, transparency is a problem. The patient relies on the healthcare provider as his/her agent to interpret and guide the healthcare decision.

The health insurance company has a strong interest in keeping premiums low in order to compete in the insurance marketplace. To stay profitable, they need to maintain a margin between premium revenue and the cost of medical services paid.  They understand the healthcare business, but their interests are not necessarily aligned with those of the patient.  Instead, they have an interest and minimizing unnecessary healthcare services, and reducing the cost and volume of care.

The provider, in the healthcare transaction is often quite torn. Providers, under the fee-for-service system, have an incentive to order and “do” since that’s how revenue is generated. There is no financial incentive to coordinate care, or to seek efficiencies by ordering fewer tests–such as reducing unnecessary scans for example.  They also have no financial incentive to encourage wellness, or to provide preventive care (although clearly most caregivers takes seriously their oath to care for the patients and I don’t want to minimize this fiduciary obligation).

A problem is the fact that healthcare costs are opaque from the prescriber’s perspective, and most physicians will tell you they can’t even begin to anticipate the costs of the prescribed therapy, nor can they tell you where to find a deal.

To summarize, each of the three main players in the traditional fee-for-service healthcare negotiation approaches the discussion with varying levels of understanding of cost, healthcare knowledge, and goals.

Patient Provider Insurance
Transparency of Costs Low Low High
Healthcare Knowledge


High Medium
Goal re. Cost per Unit Care Basically Neutral Increase Reduce
Goal re. Volume of Care Neutral or Increase Increase Reduce
Goal re. Access to New Therapies Increase Increase Depends on downstream effect+ length of relationship w patient
Goal re. Providing Preventive Care Increase Conflicted- Fiduciary but  no Financial Responsibility Depends on downstream effect+ length of relationship w patient

Chart Showing Relative Incentives for Patients, Providers and Insurance Companies in the FFS System

The provider, in the healthcare transaction is often quite torn. Most providers under the fee-for-service system have an incentive to order, since more tests, or procedures, and more visits generates more revenue. There is no financial incentive to coordinate care, or to seek efficiencies by ordering fewer tests (reducing unnecessary scans for example).  They have no financial incentive to encourage wellness, or to provide preventive care, although clearly most caregivers takes seriously their oath to care for the patients (and I don’t want to minimize how seriously many providers take this fiduciary obligation).  A primary problem on the provider side of the relationship is the fact that most healthcare costs are completely opaque from the prescriber’s perspective. Most physicians who tell you they can’t even begin to anticipate the costs of the prescribed therapy, nor can they tell you where to find a deal.


The issue with the system is that its inherent tensions have led to a situation where provider influence and patient demand has overwhelmed the insurance company’s abilities to control healthcare utilization and cost.

There are, after all, only two main “brakes” in the system: the insurance company’s willingness and ability to say “no” to increasing rates, and the consumer’s unwillingness to pay the health insurance premiums generated.

The second “brake” is problematic because the true cost of the health insurance premiums are rarely fully transferred to the consumer, but are generally subsidized by employers and federal payers.  Most employers have been quite willing to buffer their employees from increasing health premium costs as an employee benefit.



On to Part 3- The Rise of Accountable Care

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s