Thursday, January 3, 2013

After the Affordable Care Act? After Obamacare? Part Four: Scale and integration vs. a fragmentation model

Reviewing parts one, two and three of this series, John Cochrane professor of finance at the University of Chicago Booth School of Business wrote a recent essay entitled After ACA: Freeing the market for health care. The essay is very interesting as it makes the case of the need for decoupling health care from health insurance when discussing the demand and supply for health care and insurance merely being a mechanism to address catastrophic losses. Others have also pointed out the need to decouple the two concepts, however Cochrane does so in such a way that points out that the supposed market failure in health care is directly related to government failure in the realm of health care due to government lead market distortions on both the demand and supply side of health care.

Scale and integration vs. a fragmentation model

Although many health-care systems seem large and large in such a way to capture the positive aspects of scale, these health-care systems are in fact fragmented and do not come close to producing scale. Cochrane points to Harvard law professor Einer Elhauge’s paper The Fragmentation of US. HealthCare and makes this observation:

'Einer Elhauge9 examines “fragmentation” of medical care in detail, the fact that even in hospital settings care is bought essentially from different doctors and specialists rather than in an integrated manner, as, say airline travel is, where you do not separately purchase pilot, flight attendant, fuel and baggage services. My examples suggest a consolidation, integration, and corporatization of overall health service provision, as restaurant chains displace individual stores. What stops this defragmentation? He surveys research concluding that nothing in the nature of health care seems to require this structure, as hospitals in other countries have salaried doctors, and concludes instead (p.11):
“The dominant cause of fragmentation instead appears to be the law, which dictates many of the fragmented features described above and thus precludes alterative organizational structures.”
He lists a long string of legal impediments, including Medicare reimbursement rules, laws against corporate medicine and tort doctrines. Referring to private insurance (p.12):

“…State laws generally make it illegal for physicians to split their fees with anyone other than physicians with which a physician is in a partnership. More important, alternative payment systems, such as paying a hospital (or other firm) to produce some health outcome or set of treatments, would make sense only if it has some control over the physicians and other contributors to that outcome and treatments. And other laws preclude such control, as detailed in the chapters by Professors Blumstein, Greaney, Hyman, Madison, Cebul, Rebitzer, Taylor, and Votruba. The corporate practice of medicine doctrine provides that firms—whether hospitals or HMOs—cannot direct how physicians practice medicine because the firms do not have medical licenses, only the physicians do. Although some states allow hospitals to hire physicians as employees, that change in formal status does not help much if the employer cannot tell the employee what to do. Even if the law did not prohibit such interference, tort law generally penalizes firm decisions to interfere with the medical judgments of individual physicians, making it unprofitable to try, as Professor Blumstein observes. Further, hospital bylaws usually require leaving the medical staff in charge of medical decisions, and those bylaws are in turn required by hospital accreditation standards and often by licensing laws. By dictating autonomy for the various providers involved in jointly producing health outcomes, these rules largely dictate separate payments to each autonomous provider.

Private insurer efforts to directly manage care have likewise been curbed by the ban on corporate practices of medicine and the threat of tort liability. In addition, states have adopted laws requiring insurers to pay for any care (within covered categories) that a physician deemed medically necessary, banning insurers from selectively contracting with particular providers, and restricting the financial incentives that insurers can offer providers.” ‘ (1) (2)

Hence scale can’t be achieved and fragmentation is the rule due to, once again, politicos through the mechanism of government writing legislation spawning regulation resulting in government failure. Therefore rather than promoting scale and integration as a price reducer we end with a scheme of fragmentation as a cost inducer.

It gets better, these seemingly large hospitals and health care systems that would seem to produce scale but actually are highly fragmented are based on non-profit models:

“My cost-cutting examples are all for-profit companies. About 70% of hospitals and 85% of health care employment is in non-profits, whose legal and regulatory treatment protects muchinefficiency from competition.

If United didn’t have to pay taxes, Southwest’s job would have been that much harder.

Maybe for-profit companies pay too much attention to stock prices. But non-profits can go on inefficiently forever, with no stockholders to complain. The whole point of a non-profit is to pursue goals other than economic efficiency.

More importantly, if a for profit company is inefficiently run, another company or a private equity firm can buy up the stock cheaply, replace management, and force reorganization. Non-profits (and their management especially) are protected from this “market for corporate control.” (3) (4) (5)

The price nitwitery is astounding! You have a promoted model of fragmentation delivered through a non-profit model protecting inefficiency. However, the non-profit aspect is being eliminated to some extent by hospital mergers where for-profit merge with non-profits or non-profits change to for-profit. But even this aspect become impeded by government failure. Cochrane writes:

“Recognizing some of these pathologies, there is a wave of mergers, and transfers between for-profit and not for-profit status. But there is lots of gum in the works. When a nonprofit is sold or converts to for profit, the state attorney general and courts can weigh in on the sale; legally to ensure that the proceeds benefit a charitable cause related to the non-profit’s original mission. This is a great opportunity for competitors to block the change.

The FTC is ramping up antitrust action against hospital mergers. Hospitals need economiesof scale for expensive, specialized modern medicine and to comply with the avalanche of regulatory and insurance regulation. The FTC worries about local monopolies able to raise prices, especially given the inelastic demand by insurers and government reimbursement. So here we have the government forcing small size in order to boost competition with one hand, stopping entry to protect hospitals from competition with another, trying to force larger “networks” through “Affordable Care Organizations” to obtain the needed economies of scale with the third, but laws preserving doctor independence with the fourth.” (6) (7) (8)

A major price driver in health care is none other than government. More succinctly, politicos through the mechanism of government have created legislation spawning regulation that drives up health care prices. Hence one is looking straight into the eye of government failure. Further the Affordable Act is based upon a price fixing scheme. Think of that aspect of price fixing. Its absurd as politcos have passed legislation to price fix the very prices they themselves have driven astronomically upward.

Maybe health care needs a waiver from government.


(1) After the ACA: Freeing the market for health care, John H. Cochrane, October 18, 2012.

(2) The Fragmentation of U.S. Health Care, Einer Elhauge.

(3) After the ACA: Freeing the market for health care, John H. Cochrane, October 18, 2012.

(4) “Non-Profit Production and Industry Performance”, Journal of Public Economics, Lakdawalla, D., and T. Philipson.

(5) “Agency Problems and Residual Claims” Journal of Law and Economics, Fama and Jensen.

(6) After the ACA: Freeing the market for health care, John H. Cochrane, October 18, 2012.

(7) Horwitz, Jill R. 2012, “State Oversight of Hospital Conversions: Preserving Trust or Protecting Health?” The Hauser Center for Nonprofit Organizations, The Kennedy School of Government.

(8) “Regulators Seek to Cool Hospital-Deal Fever” Wall Street Journal, 03/18/2012.

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