America spent 17.3% of its gross domestic product on health care
in 2009 (1). If you break that down on an individual level, we spend
$7,129 per person each year on health care…more than any other country
in the world (2). With 17 cents of every dollar Americans spent keeping
our country healthy, it’s no wonder the government is determined to
reform the system. Despite the overwhelming attention health care is
getting in the media, we know very little about where that money comes
from or how it makes its way into the system (and rightfully so…the
way we pay for health care is insanely complex, to say the least). This
convoluted system is the unfortunate result of a series of programs that
attempt to control spending layered on top of one another. What follows
is a systematic attempt to peel away those layers, helping you become
an informed health care consumer and an incontrovertible debater when
discussing “Health Care Reform.”

Who’s paying the bill?

The
“bill payers” fall into three distinct buckets: individuals paying
out-of-pocket, private insurance companies, and the government. We can
look at these payors in two different ways: 1) How much do they pay and
2) How many people do they pay for?

The majority of individuals in
America are insured by private insurance companies via their employers,
followed second by the government. These two sources of payment
combined account for close to 80% of the funding for health care. The
“Out-of-Pocket” payers fall into the uninsured as they have chosen to
carry the risk of medical expense independently. When we look at the
amount of money each of these groups spends on health care annually, the
pie shifts dramatically.

The government currently pays for 46% of
national health care expenditures. How is that possible? This will make
much more sense when we examine each of the payors individually.

Understanding the Payors

Out-of-Pocket

A
select portion of the population chooses to carry the risk of medical
expenses themselves rather than buying into an insurance plan. This
group tends to be younger and healthier than insured patients and, as
such, accesses medical care much less frequently. Because this group has
to pay for all incurred costs, they also tend to be much more
discriminating in how they access the system. The result is that
patients (now more appropriately termed “consumers”) comparison shop for
tests and elective procedures and wait longer before seeking medical
attention. The payment method for this group is simple: the doctors and
hospitals charge set fees for their services and the patient pays that
amount directly to the doctor/hospital.

Private Insurance

This
is where the whole system gets a lot more complicated. Private
insurance is purchased either individually or is provided by employers
(most people get it through their employer as we mentioned). When it
comes to private insurance, there are two main types: Fee-for-Service
insurers and Managed Care insurers. These two groups approach paying for
care very differently.

Fee-for-Service:

This
group makes it relatively simple (believe it or not). The employer or
individual buys a health plan from a private insurance company with a
defined set of benefits. This benefit package will also have what is
called a deductible (an amount the
patient/individual must pay for their health care services before their
insurance pays anything). Once the deductible amount is met, the health
plan pays the fees for services provided throughout the health care
system. Often, they will pay a maximum fee for a service (say $100 for
an x-ray). The plan will require the individual to pay a copayment
(a sharing of the cost between the health plan and the individual). A
typical industry standard is an 80/20 split of the payment, so in the
case of the $100 x-ray, the health plan would pay $80 and the patient
would pay $20…remember those annoying medical bills stating your
insurance did not cover all the charges? This is where they come from.
Another downside of this model is that health care providers are both
financially incentivized and legally bound to perform more tests and
procedures as they are paid additional fees for each of these or are
held legally accountable for not ordering the tests when things go wrong
(called “CYA or “Cover You’re A**” medicine). If ordering more tests
provided you with more legal protection and more compensation, wouldn’t
you order anything justifiable? Can we say misalignment of incentives?

Managed Care:

Now
it gets crazy. Managed care insurers pay for care while also “managing”
the care they pay for (very clever name, right). Managed care is
defined as “a set of techniques used by or on behalf of purchasers of
health care benefits to manage health care costs by influencing patient
care decision making through case-by-case assessments of the
appropriateness of care prior to its provision” (2). Yep, insurers make
medical decisions on your behalf (sound as scary to you as it does to
us?). The original idea was driven by a desire by employers, insurance
companies, and the public to control soaring health care costs. Doesn’t
seem to be working quite yet. Managed care groups either provide medical
care directly or contract with a select group of health care providers.
These insurers are further subdivided based on their own personal
management styles. You may be familiar with many of these sub-types as
you’ve had to choose between then when selecting your insurance.

• Preferred Provider Organization (PPO) / Exclusive Provider Organization (EPO):This
  is the closet managed care gets to the Fee-for-Service model with many
  of the same characteristics as a Fee-for-Service plan like deductibles
  and copayments. PPO’s & EPO’s contract with a set list of providers
  (we’re all familiar with these lists) with whom they have negotiated set
  (read discounted) fees for care. Yes, individual doctors have to charge
  less for their services if they want to see patients with these
  insurance plans. An EPO has a smaller and more strictly regulated list
  of physicians than a PPO but are otherwise the same. PPO’s control costs
  by requiring preauthorization for many services and second opinions for
  major procedures. All of this aside, many consumers feel that they have
  the greatest amount of autonomy and flexibility with PPO’s.
  
• 
  Health Management Organization (HMO): HMO’s
  combine insurance with health care delivery. This model will not have
  deductibles but will have copayments. In an HMO, the organization hires
  doctors to provide care and either builds its own hospital or contracts
  for the services of a hospital within the community. In this model the
  doctor works for the insurance provider directly (aka a Staff Model
  HMO). Kaiser Permanente is an example of a very large HMO that we’ve
  heard mentioned frequently during the recent debates. Since the company
  paying the bill is also providing the care, HMO’s heavily emphasize
  preventive medicine and primary care (enter the Kaiser “Thrive”
  campaign). The healthier you are, the more money the HMO saves. The
  HMO’s emphasis on keeping patients healthy is commendable as this is the
  only model to do so, however, with complex, lifelong, or advanced
  diseases, they are incentivized to provide the minimum amount of care
  necessary to reduce costs. It is with these conditions that we hear the
  horror stories of insufficient care. This being said, physicians in HMO
  settings continue to practice medicine as they feel is needed to best
  care for their patients despite the incentives to reduce costs inherent
  in the system (recall that physicians are often salaried in HMO’s and
  have no incentive to order more or less tests).

The Government

The
U.S. Government pays for health care in a variety of ways depending on
whom they are paying for. The government, through a number of different
programs, provides insurance to individuals over 65 years of age, people
of any age with permanent kidney failure, certain disabled people under
65, the military, military veterans, federal employees, children of
low-income families, and, most interestingly, prisoners. It also has the
same characteristics as a Fee-for-Service plan, with deductibles and
copayments. As you would imagine, the majority of these populations are
very expensive to cover medically. While the government only insures 28%
of the American population, they are paying for 46% of all care
provided. The populations covered by the government are amongst the
sickest and most medically needy in America resulting in this
discrepancy between number of individuals insured and cost of care.

The largest and most well-known government programs are Medicare and Medicaid. Let’s take a look at these individually:

Medicare:

The
Medicare program currently covers 42.5 million Americans. To qualify
for Medicare you must meet one of the following criteria:

• Over 65 years of age
  
• 
  Permanent kidney failure
  
• 
  Meet certain disability requirements

So you meet the criteria…what do you get? Medicare
comes in 4 parts (Part A-D), some of which are free and some of which
you have to pay for. You’ve probably heard of the various parts over the
years thanks to CNN (remember the commotion about the Part D drug
benefits during the Bush administration?) but we’ll give you a quick
refresher just in case.

• Part A (Hospital Insurance):
  This part of Medicare is free and covers any inpatient and outpatient
  hospital care the patient may need (only for a set number of days,
  however, with the added bonus of copayments and deductibles…apparently
  there really is no such thing as a free lunch).
  
• 
  Part B (Medical Insurance): This part, which you must purchase, covers
  physicians’ services, and selected other health care services and
  supplies that are not covered by Part A. What does it cost? The Part B
  premium for 2009 ranged from $96.40 to $308.30 per month depending on
  your household income.
  
• 
  Part C (Managed Care): This part, called Medicare Advantage, is a
  private insurance plan that provides all of the coverage provided in
  Parts A and B and must cover medically necessary services. Part C
  replaces Parts A & B. All private insurers that want to provide Part
  C coverage must meet certain criteria set forth by the government. Your
  care will also be managed much like the HMO plans previously discussed.
  
• 
  Part D (Prescription Drug Plans): Part D covers prescription drugs and costs $20 to $40 per month for those who chose to enroll.

Ok,
now how does Medicare pay for everything? Hospitals are paid
predetermined amounts of money per admission or per outpatient procedure
for services provided to Medicare patients. These predetermined amounts
are based upon over 470 diagnosis-related groups (DRGs) or Ambulatory
Payment Classifications (APC’s) rather than the actual cost of the care
rendered (interesting way to peg hospital reimbursement…especially
when the Harvard economist who developed the DRG system openly disagrees
with its use for this purpose). The cherry on top of the irrational
reimbursement system is that the amount of money assigned to each DRG is
not the same for each hospital. Totally logical (can you sense our
sarcasm?). The figure is based on a formula that takes into account the
type of service, the type of hospital, and the location of the hospital.
This may sound logical but often times this system fails.

Medicaid:

Medicaid
is a jointly funded (funded by both federal and state governments)
health insurance program for low-income families. Eligibility rules vary
from state to state and factors in age, pregnancy, disability, income
and resources. Poverty alone does not qualify an individual for Medicaid
(there is currently no government-provided insurance for the American
poor…despite the fact that almost all first world countries have such a
system…enter the current health care debate) but is a significant
factor in Medicaid eligibility. Each state operates its own Medicaid
program but must adhere to certain federal guidelines to receive
matching federal funds (you may be familiar with California’s MediCal,
Massachusetts’ MassHealth and Oregon’s Oregon Health Plan due to their
recent media coverage). Medicaid payments currently assist nearly 60
percent of all nursing home residents and about 37 percent of all
childbirths in the United States.

How are the bills paid?

We
now understand who is paying the bill but we have yet to cover how
those bills are paid. There are two broad divisions of arrangements for
paying for and delivering health care: fee-for-service care and prepaid
care.

Fee-for-Service

As we
mentioned briefly while discussing PPO’s, in a fee-for-service
structure, consumers select a provider, receive care (a.k.a. “service”)
from the provider, and incur expenses (a.k.a. “a fee”) for the care.
Deductibles and copayments are also required as previously discussed.
Pretty simple. The physician is then reimbursed for their services in
part by the insurer (i.e. a private insurance company or the government)
and in part by the patient, who is responsible for the balance unpaid
by the insurer (the return of the unanticipated medical bill despite
your overpriced insurance). Again, the major downfall of the
fee-for-service approach is that medical professionals are incentivized
to provide services (and by this we mean any and all services they can
legally request or must request to be protected legally), some of which
may be nonessential, to increase their revenue and/or “C.Y.A.” (revenue
that has steadily decreased as insurance companies continue to lower the
amount they pay medical professionals for their services).

Fee Schedule

A
fee schedule operates in the same way that Fee-for-Service does with
one exception: instead of using the “usual, customary, and reasonable”
amount to reimburse medical professionals, states set fees to be paid
for specific procedures and services. The reimbursement is very low
($.10-.15 on the dollar) and barely covers the actual direct cost of
providing the care. Physicians may chose to opt into the plan or not
(starting to see why a doctor might not be so excited about this plan?).
Would you sign up to be paid 10 cents for every dollar you charged for
your work? Try the insurance reimbursement approach next time you go out
to eat. We’ll come bail you out of the Big House if things go awry.
What happens when the insurance system does this? You get the Wal-Mart
approach to medicine (high volume, low quality). Not the kind of heath
care we recommend.

Pre-Paid

Pre-paid
health care? Like a phone card? Not exactly–but close. The pre-paid
system evolved out of the insurance company’s desire to share its risk (
a.k.a “pooled risk”) with health care providers. Essentially, they
wanted the doctors to have some skin in the game. In the pre-paid
system, insurers make arrangements with health care providers to provide
agreed-upon covered health care services to a given population of
consumers for a (usually discounted) set price-the per-person premium
fee-over a particular time period. What does that mean? It means that
Dr. Bob gets paid, say, $30 per month to take care of Joe the Plumber
including his blood work and x-rays. If Dr. Bob spends less than that
caring for Joe, he makes money. If Joe is sick every month and needs
lots of tests and follow-up visits, Dr. Bob could lose money caring for
Joe. The set monthly fee paid to the doctor for taking care of a patient
is set up on a per-member, per-month (PMPM) rate called a “capitated fee.”
The provider receives the capitated fee per enrollee regardless of
whether the enrollee uses health care services and regardless of the
quality of services provided (not a good thing in our book).
Theoretically, providers should become more prudent and subsequently
provide services in a more cost effective manner because they are
bearing some of the risk. Often times, however, less care is provided
than is needed in hopes of saving money and increasing profits. In
addition, physicians are incentivized to cherry pick the youngest and
healthiest patients because these patients typically require less care
(i.e. they are cheaper to keep healthy). We like that doctors are
encouraged to keep patients healthy but we have to worry about the ways
in which they are being encouraged to reduce costs (as little care as
possible?). Again, the incentive system falls short and encourages
providers to act unethically.

The Take Home Message:

Health
Care in the United States today is complex and messy at best. The
layers on top of layers of failed attempts to correct the system
continue to encourage the wrong behavior in both patients (out of fear
of medical bills) and providers (out of fear of bankruptcy). We have yet
to provide every American citizen with medical care (something that
goes without saying in most 1st World countries…even Cuba has it!). We
spend more money on caring for our citizens than any country in the
world yet we continue to lag behind in terms of national health
outcomes. We think it’s safe to say that we’re not getting the best bang
for our buck. The ultimate solution? We wish we knew. Only time will
tell where the system goes from here. Our goal: to help you better
understand the system as it stands today in hopes of developing a more
effective, efficient, and comprehensive system for the future. Are you
with us?

References

1. Levey N. Soaring cost of healthcare sets a record. Los Angeles Times. Feb 4 2010.

2. McKenzie J, Pinger R, Kotecki J. An Introduction to Community Health, 6th Ed. Jones and Bartlett Publishers. 2008.

3. Bodenheimer TS, Grumbach K. Understanding Health Policy. 5th Ed. Lange Medical Books/McGraw-Hill. 2002.

4.
Kaiser Family Foundation. “EXPLAINING HEALTH CARE REFORM: How Do Health
Care Costs Vary By Region?” Brief #8030. December 2009.