• Making it up on volume

    I haven’t read David Goldhill’s book, but it is on my list. As such, I’ve more-or-less deliberately avoided reviews, analysis, and interviews. I want to read it myself and draw my own conclusions. But I did read his recent WaPo op-ed, the gist of which is:

    [Medicare's] low prices are a mirage. As any businessperson knows, with enough market power — not to mention political power — you can always make it up in volume.

    This is the supplier induced demand hypothesis and there’s something to it. Now, want to make it more interesting? Try to reconcile it with the cost shifting hypothesis. If providers can shift costs, that would take the pressure off inducing demand, wouldn’t it? Of course, they mostly can’t shift costs. Why not?

    Well, the classic reason is that they’re profit-maximizing (yes, even not-for-profits do it). A firm that has already used all its market power to maximize profit can’t profitably raise prices. Therefore, it can’t cost shift. But what else would a profit-maximizing firm do?

    One thing it wouldn’t do is raise volume in a sector with lower prices. It’d volume shift to the sector where the prices are higher. That is, what one expects from profit maximization theory is that when Medicare prices are lower, volume is shifted away from Medicare and toward private payers (insurers) that offer higher prices. It’s all in the charts right here.

    It’s actually a bit difficult to articulate an economic theory of health care providers that accounts for all the observations — demand inducement, degree of cost shifting or lack thereof, cost cutting, etc. — or at least for what we think we observe. It should be noted, however, that casual observation of bivariate relationships can be deceiving. Without a proper research design that accounts for confounding factors, we could be deceiving ourselves as to what is really going on.

    My guess is that volume increases are not isolated in one sector, that there is a general trend toward more intense utilization, not just in Medicare but overall. The economist in me says that the more important driving factor of more intense utilization is not lower Medicare prices but higher private ones. We do think higher prices induce greater supply, don’t we? This is America, right? If so, then that’s what one should expect from the commercial market.

    Perhaps what we see in Medicare is a spillover effect. Once the MRI machine is warmed up, it’s hard not to use it on everyone.

    @afrakt

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    • What’s driving integration in the industry is higher reimbursement rates – higher rates negotiated by large group practices, by hospitals with greater leverage (due to size) that employ or affiliate with physicians, by academic medical centers that employ or affiliate with private physicians. Perversely, integration will lead to an increase in overall health care costs, at least in the short-run as physicians respond to incentives for more diagnostics and in-patient admissions (where reimbursement rates are higher as compared to rates for outpatient services). Frakt is correct. While I may encourage my clients to integrate for a variety of reasons (efficiency, branding, bundling, etc.), what pushes them across is the lure of higher reimbursement rates, and that’s the case even though I warn them that the higher rates are most likely a temporary phenomenon.

    • Let’s flash back to Econ 101: supply curves are upward sloping. That means that if you pay more for a product, producers of that product will produce more of it, and if you pay less producers will produce less. That rule of thumb applies to medical care in the same way it applies to just about everything else. The notion that Medicare is driving up quantity by driving down prices is fantasy. To me, the real puzzle is why this make-it-up-on-volume fantasy is repeated so regularly. It may be that medical providers (and their proxies) don’t like Medicare price cuts, and are grasping for arguments against them.

    • An environmental metaphor. An insured patient is an almost limitless repository of RVUs. Once he’s paid his premium (entered the commons) he puts up no natural defenses to the extraction of those RVUs. The provider can “harvest” those RVUs sustainably (with great discipline and an eye to the total environment) or they can engage in the medical equivalent of mountain top removal coal mining, damn the externalities. As physicians attempt to profit maximize, they ramp up volume in all sectors and generate a tremendous amount of ancillary cost (therapy, DME, imaging) even in instances where they do not capture the ancillary revenue. Think bacteria growing in a petri dish, growing exponentially until they consume all the nutrient media available and then crash.

    • Nicely stated.

    • “One thing it wouldn’t do is raise volume in a sector with lower prices. It’d volume shift to the sector where the prices are higher.”

      Volume is a peculiar entity in healthcare.

    • Just to make clear, I’m not arguing that the private prices are truly higher — but rather because of the unique way health care is bought, they appear so. I really meant that low prices are a “mirage:” because of the insurance function, they’re not real in the sense we’re used to in other industries (and an interesting point in Brill’s piece is that the only people who ever face health care prices are the uninsured — a kind of reverse price discrimination). Providers adjust their business models, rate card, volume of necessary service to reflect the real customer — insurers or CMS. Since most health care services have relatively little true marginal cost, providers have much greater flexibility in how they price and structure service. Also worth remembering is that much of Medicare’s reimbursement process is contracted out to private insurers, who seemingly spend far more on processing claims for their own accounts than for Medicare’s (the opposite of what we see in most contracted services businesses). Again, would make sense if these are customers with very different needs as to what they in turn justify to their very different underlying customers — corporations for private insurers and politicians/the public for CMS.

      • Do I presume correctly that this and more is covered in your book? If so, I think it’d be best if I read it before commenting further. I know an op-ed can’t get into important details.

        • yes, although the book is directed more to a general audience than to economists. I do argue that prices are not allowed to serve their proper function in health care, that they are often merely symbolic when transmitted to a patient through the insurance function. For Medicare (and even more so in Medicaid), I suspect the political obsession with paying low prices (while at the same time maintaining lax oversight of volumes to make certain that no senior is deprived of any “benefits”) has a meaningful impact on volume of medicine performed. More importantly, I suspect that, unlike most other goods and services, more health care is likely to be truly bad for the customer (and so therefore not merely waste). Further, since maintaining a low-reimbursement regime hurts those who sell time more than those who sell procedures, Medicare policy has essentially driven geriatricians and other generalists out of business. This not only magnifies the supply-driven care problem stemming from too many specialists serving primary roles, but also changes the very nature of care itself.
          If you have the time to read my book, would enjoy discussing with you.

      • Thank you for so clearly describing some of the peculiarities that we have to face.

        I wonder if you could expand a bit on what you said: “Also worth remembering is that much of Medicare’s reimbursement process is contracted out to private insurers, who seemingly spend far more on processing claims for their own accounts than for Medicare’s (the opposite of what we see in most contracted services businesses).”

        Medicare’s administrative expenditures vs private insurers is sometimes a hotly debated subject so I think it would be of interest to know why this little portion of total administration costs differ.

        I am adding your book to my library.

    • Speaking to your post, yes on confounding and more than just bivariate relationships.

      When a CFO or provider has mulitple payers and multiple contracts, thinking though volume, cost shift, profit maxmization, etc., seems beside the point.

      Barring capitated arrangments, the impimatur driving the train: order as much as you can for the most you can.

      Brad

      • Tell me, then, is it a Medicare-driven problem? That’s the conjecture. I’m not seeing anything like evidence or even a logical argument that it must be.

        • Who orders the tests? Not economists and not CFOs.

          Concierge and specialty practices aside, the revolving door of patients seen on an hour to hour basis–or in my case laid up in hospital beds–does not permit profit calculations at the margins. While you could make a case of behavior based on payer, thinking along those lines becomes difficult.

          So yes, I agree.

          In this conversation, perhaps defining who profit maximizes, drives volume, or costs shifts–at what level I mean–would be helpful. Administration or office personnel negotiating with payers and overseeing utilization, or providers.?practicing?

          • “Concierge and specialty practices aside, the revolving door of patients seen on an hour to hour basis–or in my case laid up in hospital beds–does not permit profit calculations at the margins.”

            Not being an MD, I was hesitant to make this claim/point, but it strikes me as being exactly right. There really isn’t time or energy to make microeconomic considerations when you are looking at a patient.

            So I find It very hard to believe that there are significant savings to be had from reducing “unnecessary” testing and treatment. If all testing and treatment were reimbursed at Medicare rates, there’d be a lot of money left over to fix that 800-pound gorilla over there in the corner.

            That is, my best guess (having lost my father in almost exactly the same way Goldhill lost his, namely horrific malpractice), is that there’s a lot more money to be saved by reducing the incidence of medical malpractice than there is by micromanaging hospital microeconomics.