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05 MARCH 2018
The shock wave felt across the health care business

by Rita Gunther Mcgrath: Associate professor at Columbia Business School.

Would you bet against Jeff Bezos, Warren Buffett and Jamie Dimon?

As it happens, I was at Magellan Healthcare’s MOVE conference when the news hit that these three movers and shakers have agreed to form a new company to do something about burgeoning costs and other problems in the healthcare business. While the details are still unclear, the agreement has a lot of people in the healthcare system wondering what it might mean for them.

The hungry tapeworm of ballooning healthcare costs

Warren Buffett is ever brilliant at a turn of phrase, and this one is no different. Not only are healthcare costs in the United States higher than they are in the rest of the world, they’ve also been rising faster than elsewhere. According to Consumer Reports, if you sliced out healthcare spending in the United States and made a country out of it, it would be the world’s fifth largest economy.

The negative consequences of one sector sucking up so much of the economy are, indeed, dire. Funds going into healthcare aren’t available for other things – things like raises for workers, for instance, contributing to flat wages and limited earning power for many. The Bezos-Buffett-Dimon agreement clearly signals that the frustration with seemingly intractable momentum in rising costs has reached some kind of tipping point.

Completely broken market mechanisms

According to Capitalism 101, prices for things are set by market mechanisms. Buyers try to get the lowest prices they can get, and sellers try to get the highest, and depending on the laws of supply and demand they eventually negotiate a deal. Not so with healthcare. Indeed, the former CEO of Kaiser Permanente, a massive health maintenance organisation based in California, George Halvorson, observed, “Prices are made up depending on who the payer is.”

Further, because the delivery of healthcare is fragmented across all kinds of providers, system-wide savings do not necessarily benefit any given player. For instance, investing in preventive care (which costs something up front) may save the cost of looking after severe, untreated conditions down the road (which is generally more expensive). But the cost is borne by a different party than reaps the benefit of the savings, so the incentives are mis-aligned. We’re beginning to see the consequences of this with the broad adoption of high deductible health plans (HDHP’s) in which consumers are responsible for more of their own costs.

While the logic behind HDHP’s was that they would incent consumers to shop more intelligently for their care, this hasn’t necessarily happened. Patients are skipping medications and treatments to save cost. In a recent tragic case, Heather Holland, a second-grade teacher, died of the flu after deciding to skip a medication (costing $116) that might have saved her life. The Kaiser Family Foundation said this isn’t unusual, reporting that 43% of insured patients skipped a recommended test or treatment due to high costs. Healthcare providers are feeling the strain as well – hospitals are reporting sharp increases in unpaid collectibles from patients who are unable to afford the larger portion of the cost of their care with these plans.

Miracle cures – but at a price

On the pharmaceutical side of the business, the industry continues to produce cures that for the people affected are miraculous. Sovaldi actually cures Hepatitis C, in many cases preventing the need for liver transplants that can cost up to $500,000. The price of the drug? A course can run $84,000 to $150,000. Remicade, a treatment for diseases as varied as arthritis and Crohn’s is pricey as well, although finding an exact number is a challenge. Sources report costs of anywhere from $3,000 to $13,000 per treatment for a drug that is administered every six weeks.

Another cost-inflating practice became a major scandal, when drug company executives realised that they could acquire older drugs (that they made no investment to develop) and use favourable market positions to jack the prices up astronomically. Essentially, absent a market mechanism, the justification for this on the part of these executives was “because I can”. Four companies were considered to be so egregious in their practices that the Senate Aging Committee investigated them - Turing Pharmaceuticals, Retrophin Inc., Valeant Pharmaceuticals International and Rodelis Therapeutics. Among their findings:

  • The price increases had nothing to do with creating new treatments and everything to do with rewarding investors and executives at the companies;
  • The companies deliberately withheld supplies of the drugs from competitors so that the competition couldn’t prove it could make the same thing;
  • Programmes to help patients with co-pays basically ended up sticking insurance companies with vastly larger bills than they previously had, raising costs for everyone in the system.

It’s hardly surprising that legislators and policymakers are starting to consider taking action against these practices.

Perverse incentives and the shift to paying for value?

Further, the piecemeal delivery of most healthcare services in the U.S. creates incentives to do more, not less, even if the service is not, strictly speaking, necessary. Unlike other industries, in which increased efficiency makes an organisation more competitive, efficiency in healthcare delivery means less revenue. Innovating to require one CT scan rather than three, for instance, means a provider only gets paid once, not three times.

To better align incentives with rewards, many players in the ecosystem have concluded that a payment system based on value – on patient outcomes, for instance – rather than activities makes more sense. If a group made less money, not more, by operating inefficiently, the incentive to do so would diminish. The unintended consequence of course, is that with the incentives now heading in the opposite direction, there may well be a reward for withholding necessary or expensive care from patients. Or of rationing care, which is already common practice in countries with single-payer systems. Indeed, the United States differs from most other countries where effectiveness calculations are used to determine who has access to care. The result in many places is indeed, rationing. The sad reality, of course is that the US is no different than any other place in the sense that only so much can be spent on healthcare, and so some form of rationing is inevitable.

So what innovations might the new healthcare company pursue?

Let’s call this new entity HealthCo. What might it do to try to rein in healthcare costs? To make an impact, HealthCo is going to have to try to tame the fragmentation in the current delivery system so that savings in one part of the system benefit the whole. One likely effort is to cut out the middlemen involved in the distribution of pharmaceuticals and other medical supplies. Companies such as Amerisource, Cardinal Health and McKesson could see themselves disintermediated in a big way.

A second group that could find themselves in HealthCo’s sights are Pharmacy Benefit Managers (PBM’s) such as Express Scripts Holding, OptumRx (a unit of insurer UnitedHealth Group), and CVS Health. These few companies “process about 70 percent of the nation’s prescriptions, according to Pembroke Consulting”. The experience of companies like Caterpillar who have cut out the PBM’s by hiring its own doctors and pharmacists is an illustrative tale of how effective an alternative model can be. According to a recent analysis, $15 of every $100 spent on brand-name pharmaceuticals goes to middlemen, as opposed to about $4 of that $100 that is spent in other countries. In a clear indication that standard PBM practices are not necessarily in their customers’ interests, the industry has strongly resisted being held to a fiduciary standard (in which they would have to bear the best interests of their customers in mind as they make recommendations), and smaller, more transparent PBM’s than the large ones show savings of 15% or more as compared to the large incumbents.

Given the size of HealthCo’s potential covered base of employees, it could negotiate directly with pharmaceutical firms or even force them to bid on the right to supply certain types of solutions. As one of the participants in the Magellan MOVE conference observed, one outcome could have the effect of single payer pricing, as prices offered to HealthCo would set a standard for prices offered to everybody else.

The big problem with paying for healthcare, unlike other forms of insurance, is that there is no uncertainty about people’s need to use it. We are all born, suffer from maladies, and die. In other words, we know there will be spending involved on the part of whoever is paying for care. That is a context in which the U.S. system of for-profit players, itself a historical accident, makes less and less sense.

Useful resources:

Rita Gunther McGrath
Rita McGrath works extensively with leadership teams in Global 1000 companies who wish to develop their capability to drive growth. Visit our InfoCentre or website.

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