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The Thing That Ate Healthcare

The health care industry is becoming a “retail” industry with individual customers shopping for individual products and services based on a price to value equation. Customers are beginning to purchase health insurance based on their own, and their family’s, needs, not on their employer’s needs. Customers are starting to buy physician services based on value in the moment, sometimes buying a nurse practitioner visit at CVS, other times going to the local urgent care, and other times going to a primary care physician. Customers are shopping for outpatient services, and there are even the beginnings of a value based market for inpatient services.

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Health care systems are ill prepared for this shift to powerful retail customers. Despite provider efforts to promote “patient centered care,” all of us know that consumers remain baffled by our industry’s processes, pricing models, and service standards. There are countless stories of, problems with access, service, quality, and cost.

This consumer discontent has not really mattered to health care bottom lines thus far. Because health care is not really a “consumer” industry, we have been insulated from “customers.” Employers provide insurance for a group of employees and then “patients” enter the health system. Individuals have not been thought of as “customers.” Instead, for insurance companies, the customer is the HR department of other companies. For doctors, the customer is the insurance company that pays the bills. For hospitals, the customers are the doctors who bring in the patients and the payer who pays.

The well-informed retail customer whose own money is on the line in every transaction is a frightening monster for an industry that has not really had to contend with it before. That customer shops with a constant, never-ending, relentless focus on price, and then expects value for that price. We are starting to see a shift in that customer’s behavior. He/she is shopping for individual insurance products, shopping for his or her needs at the deductible level, and finally, shopping even for acute care products. Far more than the weak ideas of “consumerism” that have been discussed in health care in the past, this is the rise of a retail market that affects every aspect of healthcare. It will transform the industry.

This transformation is the result of four forces:

  • A Laser-like Focus on Total Medical Expense

  • Pricing Transparency for Health Insurance Products and Each Offered Service

  • Wider Adoption of Plans with a Health Savings Account (HSA) and High Deductible Health Plans (HDHP)

  • Wide Adoption of Reference Pricing

As these forces come together, they will transform our pricing model, our care model, and how “customers” consume the health care product. Informed, price sensitive customers will drive the industry to greater efficiency, lower prices, improved customer service, and delivery of care.

Health Care is not Unique

Every industry has experienced transformational moments of sudden, unforeseen change. They sneak up, slowly take hold, and lead to unexpected and lasting business consequences. Convenience stores and supermarkets eliminated the milkman. Jiffy Lube and Midas Mufflers upended the service station. The carburetor industry was disrupted by the introduction of fuel injection. For travel agents, it was Expedia, Orbitz, and Travelocity. For photographic film, it was the digital camera. For books, it has been the Kindle, which in only a few years devastated publishing houses, book manufacturing, and book dealers. For Downtown Main Street, it was the mall and more recently, Wal-Mart.

In reality, the “sneaking up” was quite obvious, although much easier to recognize in hindsight then when it was happening. Most transformations are driven by the customer’s relentless demands for better quality, convenience, and service, along with a lower price.

Today, customers increasingly demand instant access to price comparisons. For example, they price compare everything associated with travel: airlines, hotels, and car rental. Customers have come to expect pricing transparency and instant access to the lowest price and a broad choice of quality goods and services.

The “sneaking up” of customer power will soon have a dramatic impact on health care delivery as well. Four phenomena are coalescing to radically change how consumers buy health care, how they make decisions about where to get their health care, and how much they are willing to pay for these services.

Phenomenon #1: A Laser-like Focus on Total Medical Expense

Since the dawn of employer-sponsored health care insurance in the 1950s, provider business strategy has been quite simple: keep the barriers to entry high, charge the high rates per unit of service, and sell as many units as possible.

High barriers to entry make the provider “indispensable” for the insurer. The insurer cannot sell a product to employers, unless that provider is in the network. Because health insurance has been a “benefit” of employment, employees want the best possible benefit that they can get. Without a sufficient network of providers, employees (seeking the biggest benefit) complain to the HR department.

For physicians, barriers to entry are significant. For example, specialists want to ensure they only perform the expensive and profitable cases, and all doctors want to make it difficult for nurse practitioners, physician assistants, and pharmacists to “upskill” into their business.

Until now, everyone – primary doctors, specialists, emergency room doctors, hospitals, home health agencies, etc. – has made more money by doing more units of service. There is a great incentive to require multiple visits and do as many tests and procedures as possible. Consumers are not on the hook for costs. They have no idea what the prices really are and no real ability to determine the quality of services rendered. Generally, they do not understand who they need to see for what service and they naturally tend to get inpatient services at the hospital nearest to them. In other words, despite the fact that they are the consumers of the service, they do not behave like traditional customers.

During the late 1990’s first managed care boom, insurers put into place narrow, low-cost networks, with physicians as gatekeepers; however, they found it tough to sell those networks to their best customers – the large employers. These networks were shelved and returned to traditional open access products. Employers needed to please many employees who frequently lived across a sizable geography, and so the tendency was to buy the largest network and hear the fewest “my doctor is not in the network” complaints.

This has already begun to change.

The focus of the industry, from Medicare through commercial insurance, from health systems to doctors, from insurers to general health care consumers, will increasingly be: “How much does it cost to care for a person for a year?” The spotlight is on reducing the “Total Medical Expense” or TME for a given population. For example, the Medicare ACO experiment is an attempt to reduce the TME for Medicare patients.

Intel, Wal-Mart, Lowes and other self-insured employers have redesigned health care coverage for their workers in a way that will reduce TME. For the first time, the industry is focusing on the cost of an individual’s health care, not on the rates charged by providers, or the price of health insurance.

While the federal and state health exchanges have hit quite a few speed bumps, they have still enrolled over 8 million people into individual insurance plans in the first year. Private exchanges are also experiencing rapid growth. In the private exchange model, the employer still provides a health care benefit – but it is in a fixed dollar amount. The employee is given a broad set of insurance options, some of which can be paid in full with the fixed dollar amount, and the rest require that the employee “top up” out of his or her own pocket.

For the first time, the employee benefits are beginning to look more like a consumer good, and employees are acting like customers: thinking through the value of things like access, location, and reputed quality. The 2013 AON survey says that 33% of companies will put their employees into private health insurance exchanges in the next few years. These are generally narrow network plans. For example, all of the WellPoint products on the public insurance exchanges are narrow network products. The projection is that there will be 30+ million enrolled in the public exchanges by 2018 and another 40 million in private exchanges. There are 10 million right now. So 20% of the market may be price shopping.

Phenomenon #2: HSA Plans Make Patients Sensitive to Price

Over the last 10 years, employers have kept their own health care costs down by shifting their cost increases to their employees with larger and larger copays and deductibles. Half of all employees are now enrolled in plans with a deductible of more than $1,000, but that deductible did not drive a new pricing model.

This has already begun to change. Recently employers have been adopting the High Deductible Health Plan, in combination with the Healthcare Savings Account.[1] For example, an employee’s plan might have a deductible of $5,000, and the employer contributes $3,800 in the employee’s health care spending account. Every health expenditure can be paid from this account and the employee can “bank” unused money and watch it grow over the current year and into future years. Employees have a real sense that they are spending their own money with every doctor visit, test, and procedure. There is a real incentive to save. All evidence shows that when individuals are enrolled in these types of health plans, they behave more like retail customers: They reduce their spending and become interested in prices. The man with a sore thumb is more willing to “wait and see” if it goes away and less willing to pay for an MRI right away. The woman with rheumatoid arthritis, who has had pretty good results with methotrexate, chooses to forego paying the additional $600 per month for a modest improvement she might get from Enbrel.

Phenomenon #3: Prices are Becoming more Transparent

An early experiment in pricing transparency occurred in the automobile industry with the 1958 federal mandate of the “Monroney Sticker.” Prior to 1958, there was no consistency to the pricing of an automobile from one place to another. The dealer would simply make up a “List Price” that had no connection to reality. Consumers had no way of knowing that each dealer had a different “list price” and that they would be paying 25% less for their car if they bought it down the road.

The Monroney Sticker is the sticker attached to the window of every new car that is for sale, and shows the manufacturer’s suggested retail price (MSRP), engine and transmission specifications, standard equipment and warranty details, and optional equipment and pricing. For the first time, consumers had pricing information available, made informed choices, and it drastically reduced many dealer’s profits. (For decades, automobile dealers referred to the sticker as the “morony” sticker.)

In health care, we are currently in a world with less pricing transparency than even in the automobile industry in the 1950s. Health system CFOs cannot tell you the price of services at their own hospitals. No one cares about “list price” because everyone negotiates over rates. A primary doctor wants high rates for his office services. A surgeon wants high rates for his procedures. A hospital wants high rates for their beds, ORs, and emergency room. The insurer does not really care so much about rates, as it does about the cost per member per year. If everyone has high rates, but the members don’t use health care services, that is fine. If everyone has low rates, but the members all go to the doctor and hospital every week, that is a problem. As to the members, customers, or patients: they never see a price or a rate. All they see is a co-pay or a deductible.

This has already begun to change.

The bellwether story demonstrating a new era of pricing transparency in health is similar to the Monroney Sticker in that the government is driving transparency. It is the result of the “Romneycare” health reform in Massachusetts. As of January 2014, both insurers and providers are required by Massachusetts state law to provide prices for all health care services for consumers. While obtaining the pricing information initially requires a complex process of filling out forms and knowing exactly what you are asking the price for, over time, it is expected that entrepreneurs will make the information easily accessible, in the same way that LexisNexis initially made legal documents accessible, and Travelocity and Orbitz made flight and hotel prices available.

Never before have consumers been able to look at the prices for an MRI or a knee replacement and determine which facility they choose based partially on price. Just as consumers “showroom” while they shop at Best Buy and make their purchase on their phones, patients may be told they need a test or a procedure. They can quickly “showroom” the cost on their phone, then decide to go down the street to a cheaper facility.

As we witnessed a shift to generic drugs when the patient became sensitive to price and the rise of the “doc in a box” and “nurse in a box” platforms that offer price and convenience, we will soon see a transformation in hospital pricing.

Already the Commonwealth of Massachusetts has legislated pricing transparency. While that is going to take time to be effective, there are new companies springing up that offer employers and insurers tools that give consumers direct access to pricing information. It’s just a matter of time before this information is mainstream.

One example is Castlight, founded in 2008, and now offering instant access to pricing (via an app on a smartphone) to employees of Disney, Wal-Mart, Microsoft, CVS, Caremark, and others.

This is especially problematic for hospital based health systems. Traditionally, hospitals have charged significantly higher prices for many outpatient services. As one executive said, “With these tools, and their deductible, patients are not going to pay $1,200 for an MRI that they can get across the street for $400.”

Phenomenon: Number #4: Insurers Adopt Reference Pricing Type Models

Phenomena 1-3 begin to change the pricing model. There is pressure to reduce the total medical expense, consumers are on the hook for up to the first $5,000 of their annual medical expenses, and they can shop based on price. While high dollar deductibles create more incentive to reduce utilization and price shop than simple co-pays, it does not do much for care costs over the deductible. Even with a $5,000 deductible, if the patient needs a knee replacement, they will use up their $5,000 deductible and get a $30,000 service. That is a great deal! Once they have “blown through” their deductible, patients do not care about how much an expensive procedure costs. They do not care how much the physician or hospital charges for these items that cost tens of thousands of dollars, because now they are getting a steep discount, and only paying the copay or co-insurance up to their out-of-pocket maximum.

This has already begun to change.

Insurers, and self funded employers, are seeking to develop plan designs that will push patients to behave more like customers even with high priced items. While still in its infancy, we will no doubt see more experimentation in this area.

There is already one significant example, engaged in by CalPERs, the organization that manages pension and health benefits for 1.6 million people in California. In 2010, in order to confront the problem of a high deductible providing the wrong incentive, CalPERs set a “reference price” for some procedures. Employees could choose where to have an expensive procedure, but if the hospital they chose charged more than CalPERs “reference price” then the employee would have to pay the difference. For example, hip and knee replacements were each reference priced at $30,000. CalPERs had a list of 48 hospitals in the state that would do the procedures for less than that price. Members who chose to have their procedure at one of those hospitals, paid nothing, but members who chose to go to a hospital that charged more than $30,000 paid the full difference.

CalPERs health plan costs for those procedures dropped almost 20% from $35,408 to $28,695, per surgical-related admission.[1] More importantly, patients swarmed to the low priced hospitals, and avoided the high priced hospitals (as you can see in the graphic above).

Fascinatingly, Anthem patients, who were not in a reference pricing pilot, also started to change where they got care, most likely from the word of mouth received from the new, larger set of patients who were going there. For the low priced hospitals, reference pricing was a virtuous circle; they attracted more patients based on price, and that increased the number of patients, meaning more satisfied customers recommending their care.

For the high priced hospitals, the story is grim. A rapid loss of inpatient business from CalPERs enrollees exacerbated by a loss in patients in other health plans. Ultimately, the vast majority of the high priced hospitals dropped their prices in response to this new consumer behavior and market pressure.

Reference pricing is only one tool for driving customer behavior in patients who need high priced services. The idea is, that we are entering a new world where there is a desire to give patients an incentive to shop for providers.

What it all Means

Individually, each of these forces has had some impact, but put together, they make for a powerful equation:

Focus on Cost Per Person Per Year + Pricing Transparency for Health Insurance and Each Provider Service + HSAs + Reference Pricing = Retail Customer Market Power

As these forces spread and coalesce, they will transform our pricing model and how our “customers” consume our product. They will likely drive the industry to improve the customer experience, create greater efficiency and quality, and lower prices.

In May of this year, California Hospital Association published a “guidebook” for hospitals entitled Modern Pricing: Clarifying Hospital Charges for Consumers. They describe it as a voluntary effort hospitals can undertake to adjust their charges to create a user friendly billing process and achieve regulatory compliance, while sustaining revenue integrity. This initiative is critical to ensuring that hospital charges are explainable, understandable, and reflect the unique cost structure of each hospital’s mission and patient population.”

This is a laudable effort, but the real drive for price change will not be “voluntary.”

Real consumers behaving like real customers for the first time in our market, or The Thing That Ate Health Care, will not be seeking an explanation of why prices are high. They will just gravitate toward the lowest available price that provides the value they seek.

How do Health Systems Manage through the Turbulence?

Giving advice to health systems as a whole across the nation is a fool’s errand. Health care is not a national market. In large part, health care providers battle for market share on a zip-code-by-zip-code basis. While we may see full risk vertically integrated systems capturing the entire premium dollar in some markets, in others insurers will continue to take the first dollar, and partner with health systems in risk arrangements. In other markets, the insurers will capture first dollar, and we may see a collapse of risk sharing, a collapse of “care management” and a drive toward “value per encounter” that adds up to a lower cost insurer product.

Each system will need to do its own market evaluation, develop its own population health and referral strategy, and determine its own approach to risk sharing. These are high risk, large bets, and no system should take a “wait and see” approach to this. Careful fact based analysis, deep understanding of what is happening in different markets of the country, and the ability to bring in fresh thinking are key to getting this right.

With that caveat, the implications of a “retail market” in our industry means that there are some important questions that health system executives should consider:

  • Purchase of the insurance product by the patient walking out of the doctor’s office. Too often in health care our “patient centered care” is top down. We decide what the patient wants and needs (and a way to deliver it that isn’t too inconvenient or upsetting to us). We then try to foist it on them. In a world of transparency, and patients controlling their own spending, this has to end. We need to really focus on the customer experience and deliver what the customer wants. As the old saying goes, “The worm has to be tasty to the fish, not the fisherman.”

  • Is your physician network equipped to respond to the new consumer market? If your executive team meetings are still having the “how much money are we losing on our physicians” conversation, this needs to change immediately. Don’t be left behind. Leading organizations already have self-governing physician organizations made up of both employed and private practice physicians with goals and measures that relate to both quality and cost. Health systems have moved from just employing physicians to creating self-governing medical groups with sensible employment agreements and a bonus structure that enables the transition from productivity based RVUs to care based salaries.

  • Is your organization ready to think and act like a health plan? Ask anyone: “Would you like to take on more risk?” and except for Hollywood stuntmen you are likely to get a resounding “No!” Instead ask: “Would you like control of 100% of this customer’s dollar, or just 80 cents of it?” Most will say: “The whole dollar.” Yes, there is risk in that and there will be two critical “buying decision points.” First, when the consumer is looking at the options for buying a health plan. Second, when the consumer is looking for a provider product. If a health system is at the right scale, has a high performance physician network, and has experience with managing Medicare Advantage and its own employees’ “risk”, then it is time to evaluate being in charge of the entire product.

  • Are you prepared for new pricing models? Consumers think: “How much will it cost for my hip replacement in total?” We need to have answers to these questions. We need to know what our costs are and what their price is.

  • Are you adopting the approach of pure play competitors as fast as possible? In the carburetor industry, people were saying: “But if we try to compete with the fuel injectors, we are going to lose money.” Today many health system executives argue that they cannot lower prices on outpatient services and imaging to the prices that are available from direct pure play competitors. With pricing transparency, and a stake in the price (either through their HSA or reference pricing), consumers will not care about those pure plays, they will just go for the lower price.

This is an outstanding moment for health care in the United States. While the retail customer can be a powerful and frightening monster in every other industry from airlines to dining, it has greatly improved value. While health systems will need new, well-researched, and well-considered strategies to deal with this retail market, in the end, it will create a higher standard of health care delivery for our communities.


[1] According to the 2013 AON survey, only 2% of employers in 2013 provide employees with a fixed-dollar subsidy to purchase health coverage; however, 28% of employers expect to move to a defined contribution approach in the next 3-5 years. In addition, the fastest growing area of employer coverage is high-deductibles in the $3,000-5,000 range.

[2] Robinson, James C., and Brown, Timothy T., “Increases in Consumer Cost Sharing Redirect Patient Volumes and Reduce Hospital Prices for Orthopedic Surgery,” Health Affairs, Vol. 32, No. 8 (August 2013)


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