How can the federal government encourage low-cost, high-quality medical care?

There are basically two approaches: a bottom-up, market-based approach and a top-down command-and-control approach:

The former is based on competition, markets and economic incentives; the latter is based on rules, regulations, fines and penalties.

The former gets the economic incentives right for all of the individuals in the system, but does not try to dictate or even predict the final outcome; the latter decides in advance what the end result should look like and tries to free people to achieve it, even if it is not in their self interest to do so.

The former pleads ignorance about how medicine should be practiced — letting that be determined by competition in the marketplace; the latter decides in advance how medicine should be practiced and tries to impose it from above.

The former depends for its success on the intelligence, creativity and innovative ability of thousands of doctors, nurses and hospital personnel; the latter depends for its success on a small group of experts having all the right answers.

In the bottom-up world, 778,000 doctors, 2.6 million registered nurses and thousands of hospital and facilities personnel get up every morning and ask themselves, “How can I make costs lower and quality higher today?” In the top-down world, all of those people get up every morning and ask, “How can I squeeze even another dollar out of the third-party reimbursement formulas?”

Of these two approaches, which do you think the Obama administration is following? I’ll give you a minute to decide, then check your answer below the fold…tick,…tick,…tick, …tick,…

Ah, just as I thought. You didn’t need a minute. After all, if the words “competition,” “entrepreneurship” and “innovation” are not even in your vocabulary, you are unlikely to stumble upon a bottom-up approach, even if you are picking policies randomly.

Bottom-Up Health Economics. What does this concept mean? At a minimum it means that everyone on the provider side is encouraged to repackage and reprice his services in cost-reducing, quality-increasing ways.

Almost all third-party payment is based on impersonal formulas. To the providers, these formulas appear immutable and unchanging. Economic self interest encourages them to find ways to manipulate the formulas and maximize net revenue against them. A bottom-up approach, by contrast, encourages every doctor, hospital, facility, etc. to propose new formulas — different ways of being paid. The parameters are: (1) the total cost to the third-party payer cannot go up; (2) the quality of care cannot go down; and (3) there must be some reasonable way of determining whether restrictions (1) and (2) have been satisfied.

[Note: The third requirement will become hopelessly complicated and insidiously undermining if the green eyeshades at the Office of Management and Budget (OMB) are the arbiters. These folks have no incentive whatsoever to take risks or approve new ideas. The decision-making process, therefore, must be business-like, not OMB-like.]

Case Study: Hospital Readmissions. About one in every five hospitalized Medicare patients is readmitted for a problem related to the cause of the initial surgery. These readmissions are not only costly, they are also life-threatening.

Now consider Geisinger Health System in central Pennsylvania. Not only has this organization made a valiant effort to reduce readmissions, it has a 90-day warranty on heart surgery, similar to the type of warranties found in consumer product markets. If the patient returns with complications during that period, Geisinger promises to provide treatment without sending the patient or the insurer another bill. Unfortunately, Geisinger incurs financial losses under this practice, even as it saves money for Medicare. This is because health care organizations like Geisinger are paid more when patients have complications that lead to more visits, more tests and more readmissions. (Most hospitals make money on their mistakes!) As a result, no other hospital has a financial incentive to follow in Geisinger’s footsteps.

Now, if the federal government was following a bottom-up approach to health reform it would turn these financial incentives around. It would offer to pay Geisinger more for the initial surgery in return for the warranty. (Say it offers 50 cents for every $1 it judges that the warranty saves Medicare.) Then it would communicate what it had done to every other hospital in the country. The message: Medicare is willing to pay you in a different way if you can reduce Medicare’s overall costs and raise quality at the same time.

Hospitals could copy what Geisinger does. Or they could try other approaches. In no time, hospitals would be competing with each other in an effort to make money by lowering Medicare’s costs.

Top-Down Health Economics. Barack Obama has repeatedly told us his vision of health reform. It’s almost word-for-word the same as his vision of education reform. To wit: Let’s find out what works and then go implement it. Never mind that we have been unsuccessfully trying that approach in education for a quarter of a century. If you don’t believe in markets or competition or entrepreneurship, there really is nothing left to do. [Although to be fair, this was also the health care approach of the Bush administration.]

Instead of encouraging thousands of Geisinger-like experiments all over the country, Medicare bureaucrats in Washington have decided on their own how medicine should be practiced. For example, the federal government has identified 10 readmission conditions that it won’t pay for, including catheter-associated urinary tract infection and stage III-IV pressure ulcers. How much has Medicare saved with this tactic? Less than $19 million in 2009. That’s less than 1/300 of 1 percent of all Medicare spending that year.

Why We Don’t Need More Pilot Programs. The Affordable Care Act is making millions of dollars available for pilot programs and demonstration projects. Every single one of these is the product of the top-down mentality. They are all based on the search for “what works.” But this is both pointless and unnecessary. We already know what works. Examples of high-quality, low-cost medicine have been studied over and over. What we don’t know (and what no pilot program is trying to find out) is how to replicate what works. Moreover, we may never find out how to replicate excellence. That may be unknowable.

Studies by researchers at the Dartmouth Institute for Health Policy and Clinical Practice imply that if everyone in America went to the Mayo Clinic for health care, the nation could reduce its annual health care bill by one-fourth. If everyone went to Intermountain Healthcare in Salt Lake City, the nation could reduce its health care spending by one-third. Studies by Dartmouth and the National Center for Policy Analysis imply that if every region of the country practiced medicine the way the most “efficient” or low-cost regions do, we could meet Medicare spending by one-third to one-fourth of its current level.

But of course, every patient can’t go to the Mayo Clinic. And no one knows how to replicate Mayo everywhere else. Nor is there any reason to think we should try. A study of 10 high-rated hospital regions by researchers associated with the Brookings Institution could find no objective characteristics that could be reliably copied by others. Some employed doctors on staff. Some paid fee-for-service. Some had electronic medical records. Some did not.

Going Forward. How difficult could it be for Medicare to start rewarding excellence? Suppose we shave 1 percent off of every Medicare hospital payment in the country and use the savings to reward hospitals that provide superior outcomes. One recent study found that the best hospitals have about one-third fewer deaths and one-fifth lower costs for trauma patients. Why not pay these hospitals 10 percent more than Medicare’s normal rate just to get the ball rolling? This invites all the other hospitals to propose ways of changing their payment formulas.

Note: We should not tell the hospitals what we will and won’t pay for [top-down]. We should invite the hospitals to make more money by telling us how they can reduce costs and increase quality [bottom-up], understanding that every single one of them may do something different.