Health Care: Corporate Culture and the Three-Legged Stool

By Lillian Rosenthal & Nishant Saboo

Medicare Background:

“No longer will older Americans be denied the healing miracle of modern medicine. No longer will illness crush and destroy the savings that they have so carefully put away over a lifetime”. These were the words spoken by President Lyndon Johnson on July 30th 1965 at the Medicare signing ceremony in Independence, Missouri1. In some respects President Johnson accomplished the original aims of Medicare, but this achievement carried with it unanticipated financial consequences which today are at the crux of America’s financial woes.

Medical expenses in this country have created enormous strain on the American economy, “spending on doctors, hospitals, drugs, and the like now consumes more than one of every six dollars we earn. The financial burden has damaged the global competitiveness of American businesses and bankrupted millions of families, even those with insurance.”2

Not surprisingly, Medicare spending continues to grow every year. In 2002, already a dozen years ago, Medicare spending accounted for 17% of all US health expenditures at the indulgent cost of $260 billion per year. It also represented 2% of the GDP and one-eighth of the federal budget3.

Medicare was intended to provide health insurance for individuals over the age of 65 who might otherwise be deemed uninsurable or for whom the costs of attaining health insurance were prohibitive4. However, the economic climate in which Medicare was passed into law was a very different one than it is in 2014. One of the primary concerns in 1965 was that an elderly uninsured individual would suffer enormous economic losses if they had to go to the hospital suddenly and the stay incurred large costs. Expenditures on prescription drugs and medical tests were at that time not a formidable concern5.

1 Melichar, Lori. "The Effect of Reimbursement on Medical Decision Making: Do Physicians Alter Treatment in Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07. Web.2 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June 2009. Web.3 Melichar, Lori. "The Effect of Reimbursement on Medical Decision Making: Do Physicians Alter Treatment in Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07. Web.4 Finklestein, Amy, and Robin McKnight. "What Did Medicare Do? The Initial Impact of Medicine on Mortality and Out of Pocket Medical Spending." Journal of Public Economics (2008): 1644-668. Web.5 Ibid.

In 2014 advances in medicine and improved access to care, (partially attributable to Medicare), has created a scenario wherein a larger proportion of the population is living well beyond age 65. This “greying” of America means that individuals are staying in the Medicare system much longer than was initially anticipated. Additionally, the costs of medical care have continued to rise because of increasingly sophisticated, (and expensive), medical technology and increased entitlement programs such as pharmaceutical coverage. Imaginations do not have to be stretched far to see how this has created a financial burden on the system.

The Centers for Medicare & Medicare Services (CMS) is the government agency which is responsible for managing the Medicare program. In April 2014 CMS, for the very first time, published the amounts that they paid to individual physicians. The data released describes a number of different features about each physician. This paper will focus on the following pieces of data:

1) Physician location2) Physician type3) Total amount billed under Medicare

This paper will explore whether or not health care providers respond to financial incentives and, if they do, what the outcome is. The newly released data will provide empirical evidence of our analysis. One of the often repeated sentiments about health care providers in this country is that “ethical obligations associated with providing healthcare make physicians less likely than other service providers to respond to financial incentives by deviating from a practice pattern that maximizes a patient health status”6. However, when medical provider behavior is analyzed using the corporate 3-legged stool framework and Medicare data, the observations suggest a contrary interpretation.

Billing in Medicare:

Customer costs in the health care world are unlike costs in any other consumer segment. As a general principle, economists argue that there is no good in which demand for that good is perfectly inelastic. For example, when the price of a car goes up, fewer consumers will buy the car. When the prices of houses in a specific market go down, more or less, the number of potential buyers will increase (for the purpose of this example, let’s ignore more complicated external factors such as crime rates in the area and quality of public education and the health of the overall economy).

6 Melichar, Lori. "The Effect of Reimbursement on Medical Decision Making: Do Physicians Alter Treatment in Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07. Web.

Even basic necessities such as food are subject to the laws of economics. For example, if overfishing has caused the price of swordfish to go up, consumers can avoid the price increase by choosing to purchase a substitute good such as red snapper. Although food is a necessity of life, the availability of substitute goods means that even food is not a perfectly inelastic good. However, health care services are nearly perfectly inelastic goods due to three factors: the consumers’ willingness to pay for their own survival, the difficulty of distinguishing between vital and non-vital treatments and services and the fact that Medicare has removed most, (but not all), of the financial disincentives. For example, let’s consider an example wherein two treatments are available, (let’s call them treatments A and B), for a life threatening illness. Treatment A is three times more expensive than treatment B, but B confers a smaller marginal benefit. Although the benefit a consumer receives from his own survival is infinite, in reality expensive treatments do not usually mean an absolute difference between life and death, but rather an improved probability of recovery or survival. In some cases, the benefit may be minimal or unproven, but the consumer is unlikely to forgo the expensive treatment as long as there is a perceived benefit and the cost is experienced by someone else.

This translates into increased Medicare costs as consumer demand is met by willing providers who see the possibility of financial gain at the expense of a remote and impersonal entity (”the government”). It is also exacerbated by billing procedures under the Medicare program which are complicated to execute, hard for the patient to follow and are onerous to process for all parties, including the government.

Billing relies upon a series of codes. When an eligible Medicare patient sees a doctor for a particular condition, the treatment and/or procedure that is provided will be assigned one or more associated codes from a coding manual known as Current Procedural Terminology (CPT). CPT codes are attached to a fee schedule, and although the system is national, the amount of reimbursement is subject to some regional variation based upon the cost of living. Some procedures and treatments will have higher levels of reimbursement attached to them than others. All codes are submitted to the CMS for processing and the doctor will be subsequently reimbursed by the government program. If there is a portion of the allowed payment which is not covered by the government then the medical provider may attempt to recover the remainder of the allowable amount from the patient directly. Note that this system is almost completely independent of the concept of “charge”. This unusual process has created numerous problems that are unique to the health services industry.

Corporate Structures of a Traditional Business:

One of the many peculiarities of healthcare is that the yardsticks that are usually used to measure business performance do not apply very comfortably in this industry. Analysis of the recently released CMS data will enable us to observe an oddity of this system. If physician

practices are viewed as though they were companies, very high levels of payment would be cause for rejoicing and investors would rush to buy stock. However, in reality, these high levels are viewed with suspicion, and we think that is because there is no consensus on whose performance should be optimized.

For the purposes of comparison we will consider the more traditional business model of real estate. We have selected real estate as the point of comparison because like the health care model this model is decentralized. In this example, like the health care model, there are three entities:

1) Seller or Real estate company (principle)2) Realtor (agent)3) Prospective buyer (customer)

The interactions between these three entities are best explored through the lens of the three-legged stool framework.

The three legs of the stool are:

1) Incentives2) Decision Rights3) Performance Measurement

Incentives: In this example the prospective buyer pays a given price for his home to the seller. A percentage of this payment is awarded to the agent for their work on selling the house. In this fairly common business model the more expensive the house that the agent sells to the buyer, the more the realtor earns in commission. The realtor is, therefore, incentivized to sell the house at the maximum price since his or her own rewards are directly tied to the sale of the house. The incentives of the realtor are also aligned with the goals of the seller which would also like the relator to sell the house at a maximum price.

Decision Rights: In the case of the realtor and the company for whom the realtor works, the realtor is awarded decision rights as a byproduct of the relator’s specific knowledge. The realtor has knowledge about the housing market in the area in which they are selling and so they are given the power to negotiate the final selling price between the buyer’s agent and their own client.

Performance Measurement: Top performers in this model can be readily identified based on several statistics. One can perceive who the top earner is which will provide insights as to who makes the most money for the company. Another way to identify and measure performance

would be to track the number of houses a realtor sold (the top earner and the top closer in this model may or may not be the same individual).

In the case of the real estate model incentives, decision rights and performance measures all work in tandem with one another. Each helps to bolster the impact of the other two legs of the stool. However, next we will examine how and why this framework breaks down when applied to the health services industry.

Corporate Structure of the Medicare Program:

“Rich towns get the new school buildings, fire trucks and roads, not to mention the better teachers and policy officers and civil engineers. Poor towns don’t. But that rule doesn’t hold for health care.”7

When analyzed from the perspective of the three-legged stool one can observe just how deeply flawed the Medicare structure is. Before the analysis of this economic framework can be undertaken it is important to first establish an understanding of how the health services industry is set up under the Medicare program.

A professional services corporation is akin to the seller or realty company. They are both the principles and have the right to hire and can fire its employees. However, the similarity between the two structures immediately begins to breakdown. For instance, physicians may practice medicine individually, or in groups but a corporation cannot practice medicine. Payments are made to individual physicians, even if they are part of a group. The payment amounts can result from a fee schedule, (as in the case of Medicare), or negotiated, (as oft happens with private insurance companies). In the case of a group of physicians, revenues can be pooled and paid out to individuals as salary, or simply paid to the individual who was responsible for the bill. As was the case in the real estate model, the health care model can be viewed as though the payer is the employer and the fees paid are the incentives. In the case of the real estate model the fees paid were the commissions received. The commissions received by the realtors are a percentage of the overall price of the house bought or sold. Similarly, for a physician the reimbursement fees received result from billings to Medicare, other payers, or sometimes directly to patients. The fees that the physician receives from the Medicare program are dependent upon the type of procedure or treatment which the physician has undertaken as identified by the CPT code(s).

7 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June 2009. Web.

Within the realtor model the agent is likely to make more money in areas where the average income and cost of living of a region is high. The higher the average income and cost of living of a given region the nicer and more expensive the houses will probably be. This is not the case with the health services industry (see Exhibit 1). To explore this statement in greater detail 4 cities were selected to be analyzed from the CMS data. We looked at the cost of home values as a proxy for the cost of living. If the median is below 170 it is low and above 200 it is high. We looked at the costs of health care across various types of services comparing areas of low and high median home values. These cities are listed below along with a brief description of the locations (according to Zillow.com the median home value in the United States is $170,200)8:

1) McAllen Texas: Zillow Home Value Index: 2014 the median home value in McAllen is $113,500

2) South bend Indiana: Zillow Home Value Index: 2014 the median home value in South Bend is $66,200

3) Boston Massachusetts: Zillow Home Value Index: 2014 the median home value in Boston is $425,200

4) Miami Florida: Zillow Home Value Index: 2014 The median home value in Miami is $271,20

8 "Zillow: Real Estate, Apartments, Mortgage & Home Values in the US." Zillow. Yahoo!-Zillow Real Estate Network. Web. 27 May 2014.

The graph below was culled together by identifying the maximum Medicare reimbursement (per patient) in the four cities in a particular specialty and subtracting the minimum cost in the same specialty. The difference between the highest reimbursement and the lowest is what is pictorially displayed below. The top 5 areas of practice with the largest differences between maximum and minimum billings are Radiation Oncology ($14,347 per patient), Interventional Pain Management ($7,189 per patient), Preventive Medicine ($6,992 per patient), Hematology/Oncology ($5,104 per patient) and Cardiac Surgery ($3,142 per patient). Compare this with the average differences between top and lowest billings across all specialties ($1,139) and one can see that the graph below suggests that there are a small number of specialties which account for a large percentage of the difference between high cost and low cost areas of living.

Radiati

on Onco

logy

Medica

l Onco

logy

Internal

Medicin

e

Licen

sed Clin

ical S

ocial W

orker

Physical

Med

icine a

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on

Genera

l Surge

ry

Nephro

logy

Allergy

/Immunology

Psychiat

ry

Oral Su

rgery

(dentists

only)

Audiologist (b

illing i

ndepen

dently

)

Regist

ered Dieti

cian/N

utrition Pro

fessio

nal

Geriatr

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Osteopath

ic Man

ipulative

Med

icine

0

4000

8000

12000

16000

Discrepancy between Highest & Lowest Billings by Region

Discrepancy between Highest & Lowest Billings by Region

One argument which could be made to help to explain the striking differences shown above is related to differences in decision-making. According to research done by Atul Gawande in situations “where the right thing to do was well established—for example, whether to recommend a mammogram for a fifty-year-old woman (the answer is yes) – physicians in high-and-low-cost cities made the same decisions. But, in cases in which the science was unclear, some physicians pursued the maximum possible amount of testing and procedures; some pursued the minimum. And which kind of doctor they were depended on where they came from9”. A similar ideology could be applied with respect to areas of service. It is possible that some areas of practice are more susceptible to decisions wherein the right and wrong answers are not clear. In addition to similar patterns of decision-making it is also possible that this graph depicts the effects of the anchor-tenant theory of economic development. This theory states that “as an anchor store will define the character of a mall, anchor tenants in biotechnology, 9 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June 2009. Web.

whether it’s a company like Genentech, in South San Francisco, or a University like M.I.T., in Cambridge, define the character of an economic community. They set the norms. The anchor tenants that set norms encouraging the free flow of ideas and collaboration, even with competitors, produced enduringly successful communities, while those that mainly sought to dominate did not.10” One possible interpretation of the graph and ensuing application of the anchor-tenant theory is that the medical leaders in the top billing categories have set a precedence of behavior which has defined the corporate cultures within the category specialties. In other words the leaders of Radiation Oncology in this country may have enabled a culture of revenue maximization and gaming of the billing under Medicare.

What else accounts for such an unusual distributions of payments? To gain a greater understanding of this issue we will apply the 3-legged stool framework to the Medicare system.

Medicare and the Three Legged Stool:

Decision Rights: What decisions can be made by the physicians?

Extensive decision rights are accorded to physicians. Several decisions which are pertinent to the discussion of atypical payment distribution are:

1) During consultation with the prospective patient, a physician can prescribe the type of procedure and/or treatment to be performed.

2) If the patient accepts the suggested treatment from the physician, the physician may also choose to perform the procedure himself or refer it to someone else.

3) The details of the treatment or procedure to be performed are also up to the discretion of the physician. This can increase or decrease the cost to the physician of offering the treatment.

4) How a physician chooses to classify the procedure or treatment to the payer, (in the case of Medicare this would be the government), is also up to the physician. For example, a doctor may choose to present “deviated septum” as a reason for a nose job rather than “cosmetic”. This can increase or decrease the probability that Medicare will pay.

5) The physician also must decide whether or not to offer night and/or emergency services. This can also increase or decrease the cost to the physician of offering the treatment.

The physician has specialized knowledge of the medical field in which they work in and are given decision rights accordingly. Given the highly specialized nature of the medical field it makes sense to afford some decision rights to the physician. However, there are several issues that arise as a result of the expansive decision rights given.

10 Ibid.

Physician Incentives:

One major problem from an economic standpoint is born out of the asymmetry of information. The medical world is so specialized that the consumer, unlike the consumer for a house, is reliant upon the agent to be both a provider of services as well as a consultant. Imagine this scenario in the context of the real estate market. What would happen if a consumer did not have a foundation of information on how to asses a house, and did not have access to a home inspector, but was obliged to rely solely on the advice of the realtor? Bear in mind our earlier discussion about realtor incentives. In the case of the medical world, “asymmetric information between physicians, patients and insurance companies about appropriate medical treatment provides [sic] physicians with the opportunity to boost their incomes by providing a higher or lower level of care than a fully informed or financially liable patient would have accepted11”.

In the real estate world, the agent is acting on behalf of the seller who pays his fees. The more he gets for the house, the higher his fee and the happier his employer, (the principle), is likely to be. However, in the Medicare scenario, the government is both the seller of services (through its physician “agents”) and the buyer. In McAllen “Medicare paid for five times as many home nurse visits12” than a neighboring town with higher costs of living and “the primary cause of McAllen’s extreme costs was, very simply, the across-the-board overuse of medicine13”. As a result of the misaligned incentives, patients are getting “more of the stuff that cost more, but not more of what they needed14”. In addition to issues with misalignment of incentives, item 4 listed under decision rights above provides an opportunity for profit-maximizing savvy physicians to game the system.

Performance Measures

Misalignment of incentives isn’t necessarily the only reason that Medicare costs are ballooning, but it certainly proves to be a critical factor. Decentralized decision rights support a culture of empowerment and an entrepreneurial spirit, which is in keeping with basic organizational strategy frameworks. The final leg of the stool, performance measurement, is so poorly developed that it is almost altogether missing.

Medicare ranks hospitals on 25 metrics of care. Nearly all of the measurements which are used to asses a doctor’s performance are process-oriented and do not relate directly to the

11 Melichar, Lori. "The Effect of Reimbursement on Medical Decision Making: Do Physicians Alter Treatment in Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07. Web.12 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June 2009. Web.13 Ibid14 Ibid

quality of care provided to the patient. In fact it isn’t even clear what “quality” as it relates to a physician truly means. Below is a sample of the broader categories which are used to asses a physician’s performance (they are a mixture of input and output-based performance measures):

1) General Information (includes operational items such as ability to track clinical results between patient visits)

2) Survey of Patients’ Experiences (includes items such as level of communication with doctors, how well did the doctor communicate with the patient)

3) Timely and Effective Care (includes measurements such as timing of antibiotics – did the outpatients having surgery receive the proper antibiotics at the right moments)

4) Medicare Volume (number of Medicare patients treated for selected procedures)

As one can see from this cross section of metrics, there is no objective yardstick of the appropriate “amount” of care delivered. In fact the existence of so many metrics of care (and only some of them relate to the physician, many are measurements of hospital performance) dilutes the importance of the metric system as a whole.

Implications of Fractured Corporate Cultures and an Unbalanced Stool

The health services industry is incredibly complicated. It is unarguable that Medicare expenses are enormous, continuing to rise and represent a fiscal threat to the United States. There is no direct link between expenditures and the quality of care given to the patient. It is not a surprise that costs of Medicare continue to rise when one examines the corporate culture created under the Medicare program as well as the interplay of the three legs of the stool.

As preciously depicted, the differences in billing per patient vary greatly across specialties. Using the anchor-tenant theory of economics, it can be argued that the decentralized nature of the medicinal world enabled distinctive corporate cultures to arise across different specialties. The categorical corporate cultures could either set a tone of business driven by ethical obligation or business practices driven by revenue generation. A culture of revenue generation most likely originated as a result of the imbalanced nature of the legs of the economic framework stool.

In the incentive leg the principle (the government) has designed an incentive system which it hopes the agents (the physicians) do not take advantage of. The government would rather not pay out fees under the Medicare program and it would certainly rather avoid paying out fees for tests and procedures that are unnecessary. However, it offers financial incentives, for doctors to over prescribe and over utilize health services as a means to maximize their own revenue. The actions resulting from these incentives are costly, and may not be in the best interest of the consumers (patients). However, due to asymmetry of information the consumers have no way of making informed choices based on the recommendation provided to them by the physicians. Ultimately, nobody is accountable in part because the leg of the stool which

measures performance is essentially missing. This has created a scenario whereby the cost of care is not linked to the quality of care.

It seems that at least in some cases, the doctors’ sense of ethical duty is no match for the financial incentives. The following is an apt description of the situation in which we find ourselves as a result of the poorly balanced stool, “somewhere in the United States at this moment, a patient with chest pain, or a tumor, or a cough is seeing a doctor. And the damning question we have to ask is whether the doctor is set up to meet the needs of the patient, first and foremost, or to maximize revenue. There is no insurance system that will make the two aims match perfectly. But having a system that does so much to misalign them has proved disastrous”15.

15 Ibid