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A Market Approach to Better Care at Lower Cost

Antos, Joseph MA, PhD

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doi: 10.1097/ACM.0000000000000925
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The problems of the U.S. health care system are well known: high and rising cost, too much unnecessary (and potentially harmful) care, too many people without insurance who lack access to necessary services, and a failure of information and coordination that prevents us from providing efficient and effective care. The Affordable Care Act (ACA) expanded health insurance coverage in the United States but did little to address the structural problems that plague our health system. The ACA required new federal spending for subsidies for individuals buying insurance on the exchanges and for expanded Medicaid eligibility, which was largely offset by reductions in Medicare payments to providers. Pilot projects such as accountable care organizations (ACOs), value-based purchasing programs, and bundled payments are taking aim at some of the structural issues within our system, but these remain in the test phase, and early results for ACOs have been disappointing.1

If we expect to make lasting reforms of our health care system, stronger actions based on market principles are needed. This means aligning the financial incentives of patients and providers to promote smarter spending. It also requires better information and more flexible regulation to promote well-functioning competitive markets that offer products and services that patients need and consumers want at prices they are willing to pay. New ways of organizing health care delivery will develop in response to the changing incentives and the opportunities presented by a more flexible system. This presents new challenges to academic medical centers (AMCs), who will need to find more efficient ways of operating to provide high-quality care at affordable prices.

Replace Open-Ended Subsidies

The major federal subsidies for health coverage have long been open-ended, with no upper limit on the amount of the subsidy. This approach encourages the use of services, including services of little or no value to patients, and drives up costs unnecessarily. Applying price controls and other regulations to dampen the cost growth triggered by these financial incentives has proven to be a losing battle. It makes more sense to change the way coverage is subsidized than to try to curb the inevitable market response to unlimited subsidies.


Medicare’s defined benefit ensures that beneficiaries receive all necessary services, with no limit on program spending. Combined with fee-for-service payment in traditional Medicare, this creates a powerful incentive to use more services and more complex services. Shifting from open-ended subsidies to fixed-dollar subsidies would reverse that incentive. Instead of profiting by increasing the volume and intensity of services, a fixed-dollar subsidy business model would reward cost-effective and efficient care.

Premium support proposals2—which have been advanced by fiscally concerned Republicans and Democrats ranging from Rep. Paul Ryan to Dr. Alice Rivlin—provide a fixed subsidy for each beneficiary’s purchase of insurance. Private plans would compete with traditional Medicare on equal terms. In most proposals, subsidies would be adjusted to account for income and health status, but beneficiaries choosing more expensive coverage would pay the full extra cost.


Medicaid is financed jointly by the federal and state governments through matching payments, with the federal government covering between 50% and about 73% of the cost of health benefits for persons enrolled in the program under rules set prior to the ACA and the states covering the rest. States that expanded Medicaid eligibility in response to the ACA receive 100% federal funding (tapering down to 90% by 2020) for benefits provided to the new enrollees. There is no limit on the dollar amount of federal matching payments that a state may receive for Medicaid.

Not surprisingly, this arrangement gives states an incentive to increase their billings to the federal government. One popular approach is to institute a state tax on health care providers, which raises the price of services provided to all patients (including those on Medicaid), ups Medicaid billings, and increases federal payment—and at the same time provides additional state revenue from the tax itself.3 Moreover, states have limited incentive to adopt cost-reducing reforms because they gain only a fraction of the savings that are generated when the federal government is footing most of the bill.

Converting Medicaid to a block grant or capping the amount of federal subsidy for each Medicaid beneficiary4 would correct those perverse incentives for keeping costs high.

Tax treatment of health insurance

The exclusion of premiums paid for employer-sponsored health insurance from income and payroll taxes saves workers about $250 billion annually,5 but it is unfair and inefficient. Because they are in higher tax brackets, higher-income workers benefit more from the exclusion than lower-paid workers do. In addition, the exclusion promotes the purchase of more generous insurance that offers lower cost-sharing, making consumers less sensitive to the price of health services.

To resolve these problems, we could replace the exclusion with a fixed-dollar subsidy available to everyone purchasing private insurance (with higher amounts to families or older persons with greater health needs). Both capping the tax exclusion and the ACA’s “Cadillac tax”—a 40% excise tax on high-cost insurance—reduce the incentive to buy expensive employer-sponsored insurance, but they continue to limit the worker to coverage offered by the employer and do not address the disadvantages of the current system for low-income individuals.

Modernize Medicare

Converting Medicare to premium support is only part of the necessary reform. Other changes are needed to give beneficiaries more comprehensive coverage, reduce unnecessary spending, and improve the quality and effectiveness of medical care. Because it is the largest purchaser of health services, Medicare reforms that promote efficiency and quality can shape the professional and financial climate for the health system as a whole.

The traditional fee-for-service payment model is in many ways an artifact of 1965, with a complex and fragmented benefit structure that needs to be streamlined and simplified. Consolidating the baffling array of cost-sharing requirements, which include multiple deductibles and complex copayment and coinsurance rules that vary depending on the service, would help beneficiaries better understand what they are expected to pay out of pocket. Currently, many patients rely on Medigap and other supplemental coverage to fill in many of the holes in Medicare’s coverage, which (along with fee-for-service incentives) results in greater utilization but often no better results for the patient.

Payment reforms are critical to improving the performance of the health system. The recent enactment of the Medicare “doc fix” legislation replaces the sustainable growth rate, which called for double-digit reductions in physician payment, with a more stable system that rewards physicians who participate in an alternative payment model rather than remaining in traditional fee-for-service.6 Physicians who have at least 25% of their Medicare revenue tied to models such as ACOs or bundled payments would be eligible for substantial bonuses. Payments to other physicians would be based on performance in the new merit-based incentive payment system.

Whether such changes can reduce spending and maintain or improve quality of care remains to be seen. The Pioneer ACO program has had a rocky start, with a meager 1.2% savings on average1 and 13 of the original 32 Pioneer program participants dropping out because they faced nearly certain losses.7 Performance-based payment depends crucially on accurate and relevant performance measures, but such measures have yet to be identified.8 Few details of a new physician payment system have been developed, but the difficulties of trying to hold providers financially accountable for meeting cost and quality targets in the current fee-for-service administered price system are already emerging.

Traditional Medicare should continue to explore alternatives to fee-for-service pricing, but there are no guarantees of success. Fortunately, the makings of a feasible alternative are already in place. Medicare Advantage (MA) plans are paid on a capitated basis and pay providers rates that are consistent with the broader market rather than the formula-driven payment methods used by traditional Medicare. MA plans are not burdened with the complex benefit design of traditional Medicare, and they have an incentive to tailor their benefits to meet the demands of enrollees. To promote competition, reforms should be made in the MA bidding process so that payments to private plans are not tied to the cost of the traditional program.

As part of these reforms, AMCs will find it necessary to adopt new business models and forge new relationships with community hospitals, health plans, and other provider organizations. It has long been recognized that AMCs are vulnerable to financial threats.9 In a more fully competitive system, those threats will be a reality.

A recent study by Pricewaterhouse Coopers offered several strategies to help AMCs succeed in a much tougher post-ACA market.10 Successful AMCs will cut operating costs while maintaining quality standards, making them attractive partners for lower-cost community hospitals and new delivery models. Left unanswered are fundamental questions about the teaching and research roles that AMCs have played. Teaching and research both require upfront investment that pays off over subsequent years. Competitive reforms will have to balance the attention to the financial bottom line with the longer-term perspective necessary to ensure that our health care system continues to meet the needs of future generations of patients.

Reduce Unneeded Regulation

Regulatory reforms are needed to promote innovation in health care delivery and to provide better options for consumers. The ACA added a new layer of federal insurance regulation, but simply reverting to state regulation is not the answer. We need smarter regulation to protect consumers without imposing greater inefficiency on the health care market.

Increasing the number of people with insurance is an important step in improving population health, but offering coverage that consumers want at a price they are willing to pay works better than mandating that they buy only what satisfies government requirements. Avalere Health reports that 76% of those eligible for the highest subsidies—those with incomes between 100% and 150% of the poverty level—enrolled in exchange plans, but enrollment dropped off sharply as subsidies declined.11 Insurers need greater flexibility to offer a wider array of benefit packages.

Counterproductive regulations, including restrictions that discourage the use of proven patient management methods, should be eliminated. Government controls on insurance pricing attempt to make coverage more affordable for some groups but drive up the average premium to allow for this redistribution. For example, states have typically limited age-rated premiums to a 5:1 ratio, indicating that an older individual will pay no more than five times the premium costs a younger person would pay. Starting in 2014 the ACA limited the ratio to 3:1, which drives up premiums for young people with the lowest typical health costs and discourages them from enrolling in insurance. If we want to help those who most need financial assistance, we should provide that help directly rather than distort market prices. Reforming the open-ended subsidies already available would provide an opportunity to better focus aid on the least fortunate.

Medicare and Medicaid need greater flexibility to meet the needs of beneficiaries without dictating how health care must be provided. Although traditional Medicare is thought of as a uniform national program, it operates in local markets that have varying needs and resources. Restructuring the program would give it greater ability to promote local delivery system innovations, to price services to reflect local conditions, and to become more competitive in a premium support setting.

States also need more autonomy in running their Medicaid programs. State innovation waivers under ACA section 1332 allow states to change how they implement ACA requirements, beginning in 2017. However, that authority is limited, and states that wish to make adjustments to Medicaid must apply to the Centers for Medicare and Medicaid Services (CMS) for additional waivers.12 CMS has granted waivers to several states that expanded Medicaid eligibility, but the agency has not allowed states full control over how they run their own programs.13

Give Consumers an Effective Voice

If we hope to create a health care system that produces better results in terms of both cost and quality, the individual must become an active consumer rather than a passive patient. Markets respond to changes in demand, and the growing importance of consumer-driven health care—high-deductible plans and health savings accounts—means that our health system is, in fact, becoming driven by consumer decisions.

The consumer role extends well beyond selecting a health plan and following a physician’s advice. The consumer’s own lifestyle and behavior are the first lines of defense against disease. This places a high demand on education and information: education about healthy living, and information about the choices consumers have for financing health care and treating disease.

We are at the early stages of developing a health information infrastructure that provides the right information at the right time to the consumer, the doctor, and the health plan. Despite the ongoing problems with the ACA’s health insurance exchanges, systems ranging from the Federal Employees Health Benefits Program to the Medicare Part D prescription drug program demonstrate that consumers can successfully choose from a variety of health plans.

Consumers need reliable indicators of provider capability and performance, they need information about treatment alternatives, and they need to know what their treatment will cost. The financial incentives to carefully choose one’s provider and course of treatment will drive development of decision support tools that include performance and pricing information.

Information also fuels health care delivery. Electronic health records are the leading edge of the “big data” revolution, which may someday allow us to systematically narrow the range of diagnostic and therapeutic alternatives and enable physicians to tailor health care to the actual patient rather than to a “typical” one.14


In the United States we will spend more than $3.2 trillion on health care this year, but few people recognize how much they are paying personally. The cost of health care is hidden in lower wages for workers who get their coverage on the job and in higher taxes for everyone to cover the rising cost of government health programs and subsidies for health insurance.

Much of that money should be better spent. The incentives of fee-for-service payment combined with generous insurance benefits promote greater use of services, though not necessarily better care for patients. Regulations further reinforce the status quo, reducing opportunities for upstart competitors to bring innovative approaches to market. Consumers do not know what they are paying, do not know what they are getting, and cannot know what they are missing.

All that is about to change. We are entering a new era of creativity and competition in the health care market. AMCs have an opportunity and responsibility to offer medical training suited to the more dynamic era that we have entered. Smarter regulation combined with smarter insurance and a more capable and efficient health care system will bring consumers better value, greater convenience, and more certainty that they will get the care they need when they need it.


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© 2015 by the Association of American Medical Colleges