How the Federal Government Screwed up Health Care Costs

May 3, 2010 in Health Policy by RangelMD

Have you ever wondered how prices for various medical procedures as set by insurance company and government reimbursement are determined? Does it depend on supply and demand? Or the cost of the materials and the training required to perform it? Or is it plugged into a wacky equation that has never been validated as reflective of real world economics, combined with a significant hedge factor, and then buffered by political pressures and budget constraints? If you picked the first two choices then you are confusing the medical profession with every other business or industry that operates by logical economic principles. If you picked the last one then you must be a government or insurance industry bureaucrat or a cynical physician.

According to the Chief Operating Officer of Valley Baptist Medical Center in Texas, Edgardo Tenreiro, as of 2007, Medicare uses the following equation to determine reimbursement fees for physicians

Work RVU x Budget Neutrality Work Adjustor x Work (GPCI)+Practice Expense (PE) RVU x PE GPCI+Malpractice (PLI) RVU x PLI GPCI= Total RVUxCY 2007 Conversion Factor of $37.8975= Medicare Payment

The key value in this monster equation is the RVU which stands for Relative Value Unit and takes into account the work effort, skill, time, intensity and risk for every procedure. The overhead costs and liability risk and costs are factored in as well.

Where the hell did the RVU come from?

It turns out that in 1991 the Federal government hired the Harvard economist Dr. William Hsiao to develop a scientific way to rationalize the costs of various medical procedures. Before this time, medical costs were based on “traditional” fees or whatever doctors had historically charged their patients and what their patients were willing to pay. Before the 1970s, doctors billed their patients for services rendered in much the same way that plumbers bill for their services or say . . lawyers bill by the hour. It’s a rational economic system that bases costs on what value the professional believes they are worth versus what the customer is willing to pay based on need and perception of the value of the service.

After the introduction of Medicare and Medicaid in the late 1960s, the medical care economic model change from being one where professional fees were determined by the market to the dysfunctional insurance model that we have today. Somehow it was decided that medical care was too important for a free-market, out-of-pocket economic system to determine prices and so both doctors and patients were removed from their roles of determining fees and prices. From then on, and for the most part,  insurance company and government bureaucrats have been setting prices in much the same way that government central planning bureaucrats for the now defunct Soviet Union set prices for toilet paper.

But wait. It gets even better.

Without having to worry about upfront costs, doctors and patients started utilizing and spending on health care like a drunken Republican administration in a Tijuana whore house. Total health care spending went from about 6.5% of the GDP in 1969 to 13.5% by 1991.  The rise in health care costs was a direct result of the paradigm shift in the late 1960s that disconnected the consumer from a rational economic system for determining prices while the costs were simply shifted and reflected in higher insurance premiums and taxes.

The government believed that what was needed to control costs was another layer of bureaucracy. So Dr. Hsiao was hired to develop a bureaucratic way to determine the costs of professional services since basic supply and demand forces no longer applied. Yet, ironically, the RVU system as originally envisioned by Dr. Hsiao as a way to control health care cost increases has actually worsened the situation while giving primary care physicians the royal (Medicare) screw.

In a follow up study, Dr. Hsiao found that the RVU system as implemented by Congress and Medicare actually lead to higher reimbursement rates for specialists performing invasive procedures than what would have been calculated using Dr. Hsiao’s original work. The RVU system calculates reimbursement in part based on actual physician work and practice cost (overhead). Dr. Hsiao found that as implemented, the RVU system calculated practice costs based on “historical” data – what physicians traditionally charged – instead of any type of assessment of actual overhead costs.

The result was that the RVU system simply codified and cemented reimbursement inequities that went beyond the more accurate calculations of physicians work per procedure. Specialists who perform invasive procedures were over compensated and primary care docs where drastically under compensated based on actual practice costs.

To make matters even worse, the study found that overall, physicians were drastically under-compensated by established Medicare rates based on their level of training and work. AND THIS WAS IN 1993!!!! Even back then, Medicare rates were so bad that Hsaio calculated the net annual income of a family practitioner would be only $40,000 a year if all payers used the Medicare fee schedule.

Of course, physicians don’t make as little as this because they limit the number of Medicare patients in their practices (or they don’t take Medicare at all) and compensate for low reimbursement rates in other ways such as increasing the volume of patients seen per day and performing more invasive procedures and diagnostic testing. Of course, the end result of this system of government brilliance is that health care utilization and the resulting costs have increased. This is an end result that is still reflected today in significant regional variations in Medicare spending.

This institutionalized dysfunction has direct implications on every one’s health care costs.

Not only has the Federal government ensured that Medicare rates drastically under-compensate physicians (especially primary care providers), but by tipping the payment scales in favor of invasive procedures and advanced diagnostic testing (regardless of clinical utility) they  have ensured that health care costs will continue to increase without regard to outcomes or quality or utilization and the most recent “health care” reform law passed by Congress does not address this problem in the least. Think of the current RVU system and Medicare reimbursement schedule as a machine . . an engine that increases health care utilization and costs from the moment that it is turned on. Then think of all the hundreds of billions of dollars in additional funding established by the recent “health care” reform legislation as the fuel that will power this engine.

Except for those who will have their health care subsidized under the new law, the cost for health care for the rest of us is just going to get much worse.

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