Economic Principles of Payment Reform Council of State Governments Eastern Regional Conference 4 August 2009

1. Economic Principles of Payment ReformCouncil of State GovernmentsEastern Regional Conference4 August 2009 Doug Emery, MS Operations Manager, Prometheus / Bridges To Excellence

2. About PROMETHEUS Payment Not for profit with independent BOD made up of employers, plans, providers, health care services experts Funded in 2006 by CMWF to develop and model Evidence-informed Case Rates Funded in 2007 by RWJF to develop implementation plan Funded in 2008 by RWJF to support pilot implementations

3. President Obama on Payment Reform to the AMA …starts with reforming the way we compensate our doctors and hospitals. We need to bundle payments so you aren’t paid for every single treatment you offer a patient with a chronic condition like diabetes, but instead are paid for how you treat the overall disease. We need to create incentives for physicians to team up – because we know that when that happens, it results in a healthier patient. We need to give doctors bonuses for good health outcomes – so that we are not promoting just more treatment, but better care.

4. HMO < 5% Discount FFS Little Employer Pressure Solo/IPAs Independent Hospitals Specialists Rule Profit 6-10% Original Picture (circa 1985-1995)Orthodox, Closed-System Ideology of Managed Care Stage 1 Stage 2 Stage 3 Stage 4 Stage 5 • HMO 5-15% • Deep Discounts • Capitation Starts • Some Coalitions • IPAs/CWOW • Hospitals Form/Join Systems • PHOs • Profit 2-3% • PCP Nets • HMO 15-25% • Capitation Grows • Increasing Employer Pressure • MSOs / Practice Acquisitions • Hospital Mergers • HMO 25-40% • Capitation • Coalitions • Large Medical Groups • Linked Physician Groups • 2-3 Dominant Regional Networks • HMO>40% • Capitation • Value-based purchasing Equity/Staff Models • Provider-Sponsored HMOs/PSO • 2-3 Dominant Integrated Health Networks Managed Care Penetration • Vertically Integrated HMO/IDS Triumph • Near Universal Capitation • Ecstatic Consumers

5. Errant Prophesy: Just How Wrong Were They? “By 2005, every major metropolitan area in the country will be dominated by a few integrated provider networks holding direct capitated contracts with individuals, corporations and government.” Source: Hamilton/KSA Health Care Consultants

6. Managed Care Orthodoxy The economic philosophy that health insurance can be integrated with health care; once integrated, organizations can compete on the basis of price and quality

7. Paul Ellwood (Interview with Managed Care magazine, November, 1997): “We coined the term HMO for the Nixon Administration as a way of describing an organization that would compete on the basis of price and quality that would combine insurance and health care in a single organization. That happened in 1970.”

8. Single Market Myth:When we purchase health insurance, we purchase health care • Ex Ante Market for Health Insurance • Ex Post Market for Health Services Delivery But There actually two markets:

9. Economic Distortions of Orthodox Risk Theory • 1) “risk” is unidimensional; therefore • 2) “risk” can be shifted or integrated (i.e., health insurance can be efficiently alloyed with health care); therefore; • 3) “integrated risk” can be efficiently sold in one marketplace (i.e., HMOs competing on the basis of price and quality, or capitated providers competing for HMO business)

10. #1 Probability Risk Probability risk is defined as the risk associated with pricing future, unresolved states of medical demand Other names: insurance risk, actuarial risk, population risk and risk of occurrence Probability risk is sold in the ex ante market or health insurance market

11. #2 Technical Risk • Technical risk is defined as the risk associated with globally pricing integrated episodes of care. • An episode of care is defined as: “The complete, self-contained sequence of medical interactions between a patient and provider(s) of healthcare services in pursuit of a defined clinical objective over a specified period of time.” Source: Global Fees for Episodes of Care: New Approaches to Healthcare Financing Douglas W. Emery, McGraw-Hill 1999 • Hornbrook et al., 1985: “A health episode is a higher-order concept that deals with all the reasons for contact with the healthcare system.” Source: “Health Care Episodes: Definition, Measurement and Use”Medical Care Review Fall 1985”

12. Global Fees or Case Rates • Global fees (case rates) are the economic means of allocating technical risk along the production function of care and pricing discrete healthcare products • Two kinds of global fees and case rates: 1) Integrated 2) Virtual

13. Orthodox Compression Wedge Source: Global Fees for Episodes of Care: New Approaches to Healthcare Financing Douglas W. Emery, McGraw-Hill 1999 Insured lives Premium base Master policy Market Ex Ante (Employers, self-employed, government, etc.) Total set of insurable lives Risk Conflation Patience choice Physician choice Ex Post Market Total set of available providers (Doctors, nurses, therapists, extenders, etc.)

14. Four Cardinal “Pressure Points” of the Health Care Public Square 1) Patient Choice/Access Compression (selective contracting, gatekeeping,etc.) 2) Physician Choice Compression (preauthorizations, utilization review, protocols, etc.) 3) Price Compression (through such leveraging methods as discounts, the RBRVS and capitation) 4) Fiduciary Role Compression (the fiduciary role of insurance conflated with the fiduciary role of Hippocratic Oath; specialists’ roles compressed into generalists’ roles)

15. Evidence of Market Coercion 1) patient discontent 2) physician discontent 3) orthodox managed care failures 4) state and court intervention

16. Risk bifurcation in the PROMETHEUS model Global Cap Total Cost of Care “Coarse” Episodes Reliable Care Costs of all Diabetes Episodes Costs of all Typical Episodes Costs of all Potentially Avoidable Complications Evidence-informed Case Rate Costs of all Base Services Costs of all Severity Adjusters Insurer – Probability risk Provider – Technical risk Consumer – Probability risk

17. The High Cost of FFS Care • All diabetes-related inpatient stays • All professional services during stays • All claims with “PAC” diagnosis codes • All claims with “PAC” procedure codes • Drugs used to treat PACs Potentially Avoidable Complications: $813 million Diabetes Relevant Services $1.32 billion Medical $488 Million Pharmacy $325 Million Typical claims and services: $515 million • Claims that do not have a “PAC” code • Pharmacy • $732 Million • Pharmacy • $407 Million Medical $108 Million

18. Results of Diabetes Model

19. Regional Variation: Typical and PAC costs

21. Questions