This document discusses Medicare spending and how it has grown significantly since its inception in 1965. It analyzes physician billing data from CMS using the framework of a "three-legged stool" of incentives, decision rights, and performance measurement. It finds disparities in billing amounts across specialties and locations that suggest physicians may respond to financial incentives, with some specialties showing much higher billing in high-cost versus low-cost areas of living. This could be due to unclear medical decisions or anchor institutions setting norms around revenue maximization in those specialties.
1. Health Care: Corporate Culture and the Three-Legged Stool
By Lillian Rosenthal & Nishant Saboo
Medicare Background:
“No longer will older Americans be denied the healing miracle of modern medicine. No
longer will illness crush and destroy the savings that they have so carefully put away over a
lifetime”. These were the words spoken by President Lyndon Johnson on July 30th 1965 at the
Medicare signing ceremony in Independence, Missouri1. In some respects President Johnson
accomplished the original aims of Medicare, but this achievement carried with it unanticipated
financial consequences which today are at the crux of America’s financial woes.
Medical expenses in this country have created enormous strain on the American economy,
“spending on doctors, hospitals, drugs, and the like now consumes more than one of every six
dollars we earn. The financial burden has damaged the global competitiveness of American
businesses and bankrupted millions of families, even those with insurance.”2
Not surprisingly, Medicare spending continues to grow every year. In 2002, already a dozen
years ago, Medicare spending accounted for 17% of all US health expenditures at the indulgent
cost of $260 billion per year. It also represented 2% of the GDP and one-eighth of the federal
budget3.
Medicare was intended to provide health insurance for individuals over the age of 65 who
might otherwise be deemed uninsurable or for whom the costs of attaining health insurance
were prohibitive4. However, the economic climate in which Medicare was passed into law was a
very different one than it is in 2014. One of the primary concerns in 1965 was that an elderly
uninsured individual would suffer enormous economic losses if they had to go to the hospital
1 Melichar,Lori."The Effect of Reimbursement on Medical Decision Making:Do Physicians Alter Treatment in
Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07.Web.
2 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June
2009.Web.
3 Melichar,Lori."The Effect of Reimbursement on Medical Decision Making:Do Physicians Alter Treatment in
Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07.Web.
4
Finklestein,Amy, and Robin McKnight. "What Did Medicare Do? The Initial Impactof Medicineon Mortality and
Out of Pocket Medical Spending." Journal of Public Economics (2008): 1644-668.Web.
2. suddenly and the stay incurred large costs. Expenditures on prescription drugs and medical
tests were at that time not a formidable concern5.
In 2014 advances in medicine and improved access to care, (partially attributable to
Medicare), has created a scenario wherein a larger proportion of the population is living well
beyond age 65. This “greying” of America means that individuals are staying in the Medicare
system much longer than was initially anticipated. Additionally, the costs of medical care have
continued to rise because of increasingly sophisticated, (and expensive), medical technology
and increased entitlement programs such as pharmaceutical coverage. Imaginations do not
have to be stretched far to see how this has created a financial burden on the system.
The Centers for Medicare & Medicare Services (CMS) is the government agency which is
responsible for managing the Medicare program. In April 2014 CMS, for the very first time,
published the amounts that they paid to individual physicians. The data released describes a
number of different features about each physician. This paper will focus on the following pieces
of data:
1) Physician location
2) Physician type
3) Total amount billed under Medicare
This paper will explore whether or not health care providers respond to financial incentives
and, if they do, what the outcome is. The newly released data will provide empirical evidence of
our analysis. One of the often repeated sentiments about health care providers in this country
is that “ethical obligations associated with providing healthcare make physicians less likely than
other service providers to respond to financial incentives by deviating from a practice pattern
that maximizes a patient health status”6. However, when medical provider behavior is analyzed
using the corporate 3-legged stool framework and Medicare data, the observations suggest a
contrary interpretation.
Billing in Medicare:
Customer costs in the health care world are unlike costs in any other consumer
segment. As a general principle, economists argue that there is no good in which demand for
that good is perfectly inelastic. For example, when the price of a car goes up, fewer consumers
5 Ibid.
6 Melichar,Lori."The Effect of Reimbursement on Medical Decision Making:Do Physicians Alter Treatment in
Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07.Web.
3. will buy the car. When the prices of houses in a specific market go down, more or less, the
number of potential buyers will increase (for the purpose of this example, let’s ignore more
complicated external factors such as crime rates in the area and quality of public education and
the health of the overall economy).
Even basic necessities such as food are subject to the laws of economics. For example, if
overfishing has caused the price of swordfish to go up, consumers can avoid the price increase
by choosing to purchase a substitute good such as red snapper. Although food is a necessity of
life, the availability of substitute goods means that even food is not a perfectly inelastic good.
However, health care services are nearly perfectly inelastic goods due to three factors: the
consumers’ willingness to pay for their own survival, the difficulty of distinguishing between
vital and non-vital treatments and services and the fact that Medicare has removed most, (but
not all), of the financial disincentives. For example, let’s consider an example wherein two
treatments are available, (let’s call them treatments A and B), for a life threatening illness.
Treatment A is three times more expensive than treatment B, but B confers a smaller marginal
benefit. Although the benefit a consumer receives from his own survival is infinite, in reality
expensive treatments do not usually mean an absolute difference between life and death, but
rather an improved probability of recovery or survival. In some cases, the benefit may be
minimal or unproven, but the consumer is unlikely to forgo the expensive treatment as long as
there is a perceived benefit and the cost is experienced by someone else.
This translates into increased Medicare costs as consumer demand is met by willing
providers who see the possibility of financial gain at the expense of a remote and impersonal
entity (”the government”). It is also exacerbated by billing procedures under the Medicare
program which are complicated to execute, hard for the patient to follow and are onerous to
process for all parties, including the government.
Billing relies upon a series of codes. When an eligible Medicare patient sees a doctor for
a particular condition, the treatment and/or procedure that is provided will be assigned one or
more associated codes from a coding manual known as Current Procedural Terminology (CPT).
CPT codes are attached to a fee schedule, and although the system is national, the amount of
reimbursement is subject to some regional variation based upon the cost of living. Some
procedures and treatments will have higher levels of reimbursement attached to them than
others. All codes are submitted to the CMS for processing and the doctor will be subsequently
reimbursed by the government program. If there is a portion of the allowed payment which is
not covered by the government then the medical provider may attempt to recover the
remainder of the allowable amount from the patient directly. Note that this systemis almost
completely independent of the concept of “charge”. This unusual process has created
numerous problems that are unique to the health services industry.
4. Corporate Structures of a Traditional Business:
One of the many peculiarities of healthcare is that the yardsticks that are usually used to
measure business performance do not apply very comfortably in this industry. Analysis of the
recently released CMS data will enable us to observe an oddity of this system. If physician
practices are viewed as though they were companies, very high levels of payment would be
cause for rejoicing and investors would rush to buy stock. However, in reality, these high levels
are viewed with suspicion, and we think that is because there is no consensus on whose
performance should be optimized.
For the purposes of comparison we will consider the more traditional business model of
real estate. We have selected real estate as the point of comparison because like the health
care model this model is decentralized. In this example, like the health care model, there are
three entities:
1) Seller or Real estate company (principle)
2) Realtor (agent)
3) Prospective buyer (customer)
The interactions between these three entities are best explored through the lens of the three-
legged stool framework.
The three legs of the stool are:
1) Incentives
2) Decision Rights
3) Performance Measurement
Incentives: In this example the prospective buyer pays a given price for his home to the seller. A
percentage of this payment is awarded to the agent for their work on selling the house. In this
fairly common business model the more expensive the house that the agent sells to the buyer,
the more the realtor earns in commission. The realtor is, therefore, incentivized to sell the
house at the maximum price since his or her own rewards are directly tied to the sale of the
house. The incentives of the realtor are also aligned with the goals of the seller which would
also like the relator to sell the house at a maximum price.
Decision Rights: In the case of the realtor and the company for whom the realtor works, the
realtor is awarded decision rights as a byproduct of the relator’s specific knowledge. The
realtor has knowledge about the housing market in the area in which they are selling and so
they are given the power to negotiate the final selling price between the buyer’s agent and
their own client.
5. Performance Measurement: Top performers in this model can be readily identified based on
several statistics. One can perceive who the top earner is which will provide insights as to who
makes the most money for the company. Another way to identify and measure performance
would be to track the number of houses a realtor sold (the top earner and the top closer in this
model may or may not be the same individual).
In the case of the real estate model incentives, decision rights and performance
measures all work in tandem with one another. Each helps to bolster the impact of the other
two legs of the stool. However, next we will examine how and why this framework breaks down
when applied to the health services industry.
Corporate Structure of the Medicare Program:
“Rich towns get the new school buildings, fire trucks and roads, not to mention the better
teachers and policy officers and civil engineers. Poor towns don’t. But that rule doesn’t hold for
health care.”7
When analyzed from the perspective of the three-legged stool one can observe just how
deeply flawed the Medicare structure is. Before the analysis of this economic framework can
be undertaken it is important to first establish an understanding of how the health services
industry is set up under the Medicare program.
A professional services corporation is akin to the seller or realty company. They are both
the principles and have the right to hire and can fire its employees. However, the similarity
between the two structures immediately begins to breakdown. For instance, physicians may
practice medicine individually, or in groups but a corporation cannot practice medicine.
Payments are made to individual physicians, even if they are part of a group. The payment
amounts can result from a fee schedule, (as in the case of Medicare), or negotiated, (as oft
happens with private insurance companies). In the case of a group of physicians, revenues can
be pooled and paid out to individuals as salary, or simply paid to the individual who was
responsible for the bill. As was the case in the real estate model, the health care model can be
viewed as though the payer is the employer and the fees paid are the incentives. In the case of
the real estate model the fees paid were the commissions received. The commissions received
by the realtors are a percentage of the overall price of the house bought or sold. Similarly, for a
physician the reimbursement fees received result from billings to Medicare, other payers, or
sometimes directly to patients. The fees that the physician receives from the Medicare program
7 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June
2009.Web.
6. are dependent upon the type of procedure or treatment which the physician has undertaken as
identified by the CPT code(s).
Within the realtor model the agent is likely to make more money in areas where the
average income and cost of living of a region is high. The higher the average income and cost of
living of a given region the nicer and more expensive the houses will probably be. This is not the
case with the health services industry (see Exhibit 1). To explore this statement in greater detail
4 cities were selected to be analyzed from the CMS data. We looked at the cost of home values
as a proxy for the cost of living. If the median is below 170 it is low and above 200 it is high. We
looked at the costs of health care across various types of services comparing areas of low and
high median home values. These cities are listed below along with a brief description of the
locations (according to Zillow.com the median home value in the United States is $170,200)8:
1) McAllen Texas:
Zillow Home Value Index: 2014 the median home value in McAllen is $113,500
2) South bend Indiana:
Zillow Home Value Index: 2014 the median home value in South Bend is $66,200
3) Boston Massachusetts:
Zillow Home Value Index: 2014 the median home value in Boston is $425,200
4) Miami Florida:
Zillow Home Value Index: 2014 The median home value in Miami is $271,20
8 "Zillow:Real Estate, Apartments, Mortgage & Home Values in the US." Zillow. Yahoo!-ZillowReal Estate Network.
Web. 27 May 2014.
7. The graph below was culled together by identifying the maximum Medicare
reimbursement (per patient) in the four cities in a particular specialty and subtracting the
minimum cost in the same specialty. The difference between the highest reimbursement and
the lowest is what is pictorially displayed below. The top 5 areas of practice with the largest
differences between maximum and minimum billings are Radiation Oncology ($14,347 per
patient), Interventional Pain Management ($7,189 per patient), Preventive Medicine ($6,992
per patient), Hematology/Oncology ($5,104 per patient) and Cardiac Surgery ($3,142 per
patient). Compare this with the average differences between top and lowest billings across all
specialties ($1,139) and one can see that the graph below suggests that there are a small
number of specialties which account for a large percentage of the difference between high cost
and low cost areas of living.
One argument which could be made to help to explain the striking differences shown
above is related to differences in decision-making. According to research done by Atul Gawande
in situations “where the right thing to do was well established—for example, whether to
recommend a mammogram for a fifty-year-old woman (the answer is yes) – physicians in high-
and-low-cost cities made the same decisions. But, in cases in which the science was unclear,
some physicians pursued the maximum possible amount of testing and procedures; some
pursued the minimum. And which kind of doctor they were depended on where they came
from9”. A similar ideology could be applied with respect to areas of service. It is possible that
some areas of practice are more susceptible to decisions wherein the right and wrong answers
are not clear. In addition to similar patterns of decision-making it is also possible that this graph
depicts the effects of the anchor-tenant theory of economic development. This theory states
9 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June
2009.Web.
0
2000
4000
6000
8000
10000
12000
14000
16000
RadiationOncology
CardiacSurgery
PhysicalTherapist
ColorectalSurgery…
Occupational…
PhysicalMedicine…
FamilyPractice
Pathology
Otolaryngology
NursePractitioner
Psychiatry
PediatricMedicine
Obstetrics/Gynecolo…
VascularSurgery
CriticalCare…
GeriatricPsychiatry
Hematology
Unknown…
Discrepancy between Highest & Lowest Billings
by Region
Discrepancy between Highest &
Lowest Billings by Region
8. that “as an anchor store will define the character of a mall, anchor tenants in biotechnology,
whether it’s a company like Genentech, in South San Francisco, or a University like M.I.T., in
Cambridge, define the character of an economic community. They set the norms. The anchor
tenants that set norms encouraging the free flow of ideas and collaboration, even with
competitors, produced enduringly successful communities, while those that mainly sought to
dominate did not.10” One possible interpretation of the graph and ensuing application of the
anchor-tenant theory is that the medical leaders in the top billing categories have set a
precedence of behavior which has defined the corporate cultures within the category
specialties. In other words the leaders of Radiation Oncology in this country may have enabled
a culture of revenue maximization and gaming of the billing under Medicare.
What else accounts for such an unusual distributions of payments? To gain a greater
understanding of this issue we will apply the 3-legged stool framework to the Medicare system.
Medicare and the Three Legged Stool:
Decision Rights: What decisions can be made by the physicians?
Extensive decision rights are accorded to physicians. Several decisions which are
pertinent to the discussion of atypical payment distribution are:
1) During consultation with the prospective patient, a physician can prescribe the type of
procedure and/or treatment to be performed.
2) If the patient accepts the suggested treatment from the physician, the physician may
also choose to perform the procedure himself or refer it to someone else.
3) The details of the treatment or procedure to be performed are also up to the discretion
of the physician. This can increase or decrease the cost to the physician of offering the
treatment.
4) How a physician chooses to classify the procedure or treatment to the payer, (in the
case of Medicare this would be the government), is also up to the physician. For
example, a doctor may choose to present “deviated septum” as a reason for a nose job
rather than “cosmetic”. This can increase or decrease the probability that Medicare will
pay.
5) The physician also must decide whether or not to offer night and/or emergency
services. This can also increase or decrease the cost to the physician of offering the
treatment.
The physician has specialized knowledge of the medical field in which they work in and are
given decision rights accordingly. Given the highly specialized nature of the medical field it
makes sense to afford some decision rights to the physician. However, there are several issues
that arise as a result of the expansive decision rights given.
10 Ibid.
9. Physician Incentives:
One major problem from an economic standpoint is born out of the asymmetry of
information. The medical world is so specialized that the consumer, unlike the consumer for a
house, is reliant upon the agent to be both a provider of services as well as a consultant.
Imagine this scenario in the context of the real estate market. What would happen if a
consumer did not have a foundation of information on how to asses a house, and did not have
access to a home inspector, but was obliged to rely solely on the advice of the realtor? Bear in
mind our earlier discussion about realtor incentives. In the case of the medical world,
“asymmetric information between physicians, patients and insurance companies about
appropriate medical treatment provides [sic] physicians with the opportunity to boost their
incomes by providing a higher or lower level of care than a fully informed or financially liable
patient would have accepted11”.
In the real estate world, the agent is acting on behalf of the seller who pays his fees. The
more he gets for the house, the higher his fee and the happier his employer, (the principle), is
likely to be. However, in the Medicare scenario, the government is both the seller of services
(through its physician “agents”) and the buyer. In McAllen “Medicare paid for five times as
many home nurse visits12” than a neighboring town with higher costs of living and “the primary
cause of McAllen’s extreme costs was, very simply, the across-the-board overuse of
medicine13”. As a result of the misaligned incentives, patients are getting “more of the stuff that
cost more, but not more of what they needed14”. In addition to issues with misalignment of
incentives, item 4 listed under decision rights above provides an opportunity for profit-
maximizing savvy physicians to game the system.
Performance Measures
Misalignment of incentives isn’t necessarily the only reason that Medicare costs are
ballooning, but it certainly proves to be a critical factor. Decentralized decision rights support a
culture of empowerment and an entrepreneurial spirit, which is in keeping with basic
organizational strategy frameworks. The final leg of the stool, performance measurement, is so
poorly developed that it is almost altogether missing.
Medicare ranks hospitals on 25 metrics of care. Nearly all of the measurements which
are used to asses a doctor’s performance are process-oriented and do not relate directly to the
11
Melichar,Lori."The Effect of Reimbursement on Medical Decision Making:Do PhysiciansAlter Treatment in
Response to a Managed Care Incentive?" Journal of Health Economics 28.4 (2009): 902-07.Web.
12 Gawande, Atul. "The Cost Conundrum (what a Texas Town Can Teach Us about Health Care)." New Yorker 1 June
2009.Web.
13 Ibid
14 Ibid
10. quality of care provided to the patient. In fact it isn’t even clear what “quality” as it relates to a
physician truly means. Below is a sample of the broader categories which are used to asses a
physician’s performance (they are a mixture of input and output-based performance
measures):
1) General Information (includes operational items such as ability to track clinical results
between patient visits)
2) Survey of Patients’ Experiences (includes items such as level of communication with
doctors, how well did the doctor communicate with the patient)
3) Timely and Effective Care (includes measurements such as timing of antibiotics – did the
outpatients having surgery receive the proper antibiotics at the right moments)
4) Medicare Volume (number of Medicare patients treated for selected procedures)
As one can see from this cross section of metrics, there is no objective yardstick of the
appropriate “amount” of care delivered. In fact the existence of so many metrics of care (and
only some of them relate to the physician, many are measurements of hospital performance)
dilutes the importance of the metric system as a whole.
Implications of Fractured Corporate Cultures and an Unbalanced Stool
The health services industry is incredibly complicated. It is unarguable that Medicare
expenses are enormous, continuing to rise and represent a fiscal threat to the United States.
There is no direct link between expenditures and the quality of care given to the patient. It is
not a surprise that costs of Medicare continue to rise when one examines the corporate culture
created under the Medicare program as well as the interplay of the three legs of the stool.
As preciously depicted, the differences in billing per patient vary greatly across
specialties. Using the anchor-tenant theory of economics, it can be argued that the
decentralized nature of the medicinal world enabled distinctive corporate cultures to arise
across different specialties. The categorical corporate cultures could either set a tone of
business driven by ethical obligation or business practices driven by revenue generation. A
culture of revenue generation most likely originated as a result of the imbalanced nature of the
legs of the economic framework stool.
In the incentive leg the principle (the government) has designed an incentive system
which it hopes the agents (the physicians) do not take advantage of. The government would
rather not pay out fees under the Medicare program and it would certainly rather avoid paying
out fees for tests and procedures that are unnecessary. However, it offers financial incentives,
for doctors to over prescribe and over utilize health services as a means to maximize their own
revenue. The actions resulting from these incentives are costly, and may not be in the best
interest of the consumers (patients). However, due to asymmetry of information the consumers
have no way of making informed choices based on the recommendation provided to them by
the physicians. Ultimately, nobody is accountable in part because the leg of the stool which
11. measures performance is essentially missing. This has created a scenario whereby the cost of
care is not linked to the quality of care.
It seems that at least in some cases, the doctors’ sense of ethical duty is no match for
the financial incentives. The following is an apt description of the situation in which we find
ourselves as a result of the poorly balanced stool, “somewhere in the United States at this
moment, a patient with chest pain, or a tumor, or a cough is seeing a doctor. And the damning
question we have to ask is whether the doctor is set up to meet the needs of the patient, first
and foremost, or to maximize revenue. There is no insurance system that will make the two
aims match perfectly. But having a system that does so much to misalign them has proved
disastrous”15.
15 Ibid