The cost of bargaining and billing leads private players, usually much smaller, to use Medicare's model, write Jeffrey Clemens and Joshua Gottlie

Clemens, Jeffrey

Gottlieb, Joshua

LSE Research Online

4/18/2017Medicare’s payments system affects the whole UShealthcare sectorblogs.lse.ac.uk /businessreview/2017/04/18/medicares-payments-system-affects-the-whole-us-healthcare-sector/The United States health care system is known for the private sector’s uniquely large role. Of the $3.2 trillion that theU.S. spent on health care in 2015, private individuals and private insurance directly financed at least 44 per cent, or$1.4 trillion. In a recent paper, we ask whether this system is as different as it might seem from one dominated bythe public sector.Why might the public sector continue to have a key role in this mixed system? Despite the private sector’sprominence, the largest single insurer in the U.S. is Medicare, the federal insurer of the elderly and disabled.Medicare spent $646 billion in 2015, and $144 billion on the type of care we focus on: physician and professionalservices. This care cost $635 billion in total, so Medicare alone bought 23 percent of this sector’s output. In additionto being the single largest buyer of medical care, Medicare enjoys the federal government’s backing. Its heft andreputation may give it outsized influence on the industry. We study the extent of this influence and the channelsthrough which it works.How important are payment systems?Payment systems are the structures through which the government or market rewards health-care providers. Ifhospitals, physicians and pharmaceutical companies respond to the incentives these systems create, then theirdesign can influence the costs and efficiency of the entire health sector.Recent studies show that physicians do respond to the incentives provided by state Medicaid programs, privateinsurance arrangements and Medicare. Among numerous other examples, pediatricians spent less time withpatients following expansions in low-paying public coverage, and capitation-based managed care induces moreconservative treatment of heart attacks than fee-for-service arrangements. We found previously that physiciansexpand total service supply when Medicare’s fees rise across the board, in particular for elective services.1/3Medicare’s Influence on Private Payment SystemsIndustry participants describe a simple institutional mechanism by which Medicare can influence the private sector’spayment system: Medicare’s fee schedule creates a platform around which insurers and physicians often negotiate.As we show in related work, insurers bargain with doctors’ practices over a fixed markup relative to Medicare’spayment menu. A midsize practice might be offered 110 per cent of Medicare’s rates, while a larger group with amonopoly in its region might be offered 140 per cent.This structure implies a strong link between the relative prices of, for example, angioplasty and office visits in thepublic and private sectors. Once the parties have agreed on a markup relative to Medicare’s rates, this relationshipbecomes mechanical. If Medicare increases payments for primary care relative to more intensive services, privaterates would automatically follow suit.To investigate Medicare’s importance, we studied the private sector’s response to a large legislative change inMedicare’s fee schedule. In 1998, Medicare reduced its payments for surgical procedures by 17 per cent relative toits payments for other medical services. Using a database of more than 144 million private-sector insurance claims,we found that private prices closely tracked Medicare’s changes. On average, a $1 decrease in Medicare’s paymentfor a surgical service relative to other services led to a $1.20 change in the relevant private payments. This price-following coefficient of 1.2 is close to the average ratio between Medicare and private payment rates, suggesting thata mechanical relationship between private rates and the Medicare fee schedule may indeed prevail.Why copy Medicare?Because of well-known inefficiencies built into Medicare’s fee schedule, private markets’ choice to copy it may be acause for concern. Medicare’s relative payments are based primarily on estimates of input costs. Congress prohibitsMedicare from adjusting its payments to reflect value added or cost effectiveness of different types of care.Consequently, one might hope that physicians and insurers would innovate beyond Medicare’s menu to increase thevalue of insurance arrangements. Greater payment system innovation would be a more-than-welcome product ofcompetition among private insurers.At the same time, bargaining over and implementing alternative payment systems can be complicated and costly.Medicare and private insurers recognize more than 10,000 distinct billing codes. Code-specific negotiations couldcarry on interminably. Health care billing administration consumes substantial resources, and those costs couldescalate further if each insurer and physician group established a unique payment structure.This explanation for Medicare’s influence has testable implications: larger physician groups will be less likely tofollow Medicare’s lead. When insurers bargain with small physician groups, the cost of haggling over service-specificprices is unlikely to be worthwhile, since fine-tuning the incentives facing a single physician adds relatively littlevalue. But when insurers negotiate with large physician groups, more value is at stake. Large groups’ billingdepartments may also be better equipped to manage variation in payment models.We tested these implications by examining the strength of the public-private price linkage across markets. Inmarkets dominated by small physician groups, we found that Medicare’s price transmission is particularly strong.Markets with large physician groups exhibit more independence from Medicare’s prices. These results support thetransaction-cost theory.Our results show that, in most markets, Medicare’s pricing menu exerts significant influence over private paymentsfor physicians’ services. When Medicare pays generously for a low value service, incentives in private markets echothat mistake. The evidence suggests that a public good problem may limit the development of value-orientedpayment systems. Because private players are small, they have insufficient incentives to innovate beyondMedicare’s menu. The expense of bargaining and subsequent billing may lead market participants to use Medicareas a reference around which they can coordinate. The benefit of getting Medicare’s payments right, or at least2/3improving them around the margins, is thus likely to extend well beyond Medicare itself.Policy ImplicationsThe literature is building a powerful case that payment systems matter, with Medicare’s perhaps the most influentialof all. Medicare’s incentive structures influence treatment decisions, investments in medical technologies, and thelong-run development of these technologies themselves. Private insurers’ adoption of Medicare’s payment methodsmagnifies these effects. So reducing inefficiencies in Medicare payments should be a major health-policy priority.♣♣♣Notes:This blog post is based on the authors’ paper In the Shadow of a Giant: Medicare’s Influence on PrivatePhysician Payments, in the Journal of Political Economy, 125, no. 1 (February 2017): 1-39.The post gives the views of its author, not the position of LSE Business Review or the London School ofEconomics.Featured image credit: Photo by NEC Corporation of America , under a CC-BY-2.0 licence. Before commenting, please read our Comment Policy.Jeffrey Clemens is an Assistant Professor in the Department of Economics at the University ofCalifornia at San Diego. His research interests are: the intersections between health economicsand public finance; the economics of redistribution and social insurance; and the state and localgovernment finances. He received a PhD in Economics from Harvard University in 2011. Joshua Gottlieb is an assistant professor in the Vancouver School of Economics at the Universityof British Columbia, and Faculty Research Fellow in the National Bureau of Economic Research. He conducts research in applied microeconomics, specifically in public finance, health care, andlabour economics. Dr. Gottlieb completed his Ph.D. in economics at Harvard University in 2012.His research has been recognised with the 2015 Kenneth Arrow Award for best paper in healtheconomics and the 2012 National Tax Association Dissertation Award.   He is a Visiting Scholar atthe Federal Reserve Bank of San Francisco and was a Visiting Assistant Professor at StanfordUniversity in 2015-16. The Social Sciences and Humanities Research Council of Canada and theNational Institute on Aging fund Dr. Gottlieb’s work.. Copyright © 2015 London School of Economics3/3

Medicare’s payments system affects the whole US healthcare sector

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