Thursday, June 23, 2011

Excelling at Average Results

Fee-for-service (FFS) is the method by which you pay your lawyer, your barber, your waiter, your cleaning lady, your airline, your plumber,  your dry-cleaner, and your mechanic, to just name a few. If you expand services to include tangible products, then you pay fee-for-product (FFP) at your grocery store, bookstore, hardware store, car dealer, farmer market and any other purveyor of goods. Sometimes, you don’t pay FFS or FFP. When you purchase a subscription service like cable TV or New York Times online news, or a membership for a gym or a professional society, you pay a capitated rate for a predefined package of services that you have unlimited access to for a certain period of time, usually a year or more. A third way of paying for services is through extended warranty contracts. Here you pay a fixed fee, in advance, and the seller is committing to keep your product in functioning order, or replace it, no matter how much labor goes into this task. Warranties usually have exclusions, in very small print, spelling out exactly what repairs will not be made and usually if you are negligent in your care for the covered product, they won’t fix it under the warranty contract. You’ll have to pay extra if you want it fixed. It is easy to buy warranties for shiny new products and almost impossible to obtain coverage for older items that are more likely to break and may not be worth much anyway.

When you go to a doctor or a hospital, and you have no insurance, you will pay on a FFS basis for each encounter. You will receive an itemized bill for all services and materials used in your treatment, with the obligatory shock inducing grand total at the bottom. This is very similar to taking your car to a mechanic, except that nobody will give you an estimate before doing the work. Many times you will get separate bills from several physicians involved in your care, if they are not employed by the same facility, which is very confusing. If you have insurance, which is similar to having purchased an extended warranty on your persona, they will still send you the same bills “for your records”. If all services fall under the contractual terms of your warranty, your insurer will pay the bills, and worst case scenario, you will have to pay a small percentage of the total, which is much lower than the original asking price. If you happen to be insured by an HMO, your doctor won’t get payment for the particular bill. Instead your HMO has a fixed price contract with your doctor, which in effect means that your HMO is purchasing a third party warranty from your doctor to cover the warranty they sold you in the form of insurance. For services that are outside the warranty terms, you will have to pay full price.  If you visit a subscription based concierge practice, it’s pretty much like going to the gym. You won’t have to pay anything unless you order one of those high energy smoothies at the bar.

The current common wisdom is that the FFS model in medical care is not working as well as it does in every other part of the economy mainly because most consumers are covered by those pesky warranties and therefore completely desensitized to price of services. People that buy those extended warranties at the electronics store, somehow don’t exhibit the same levels of gluttony for repair services and those warranties prove to be very good business for the seller as evident in the incessant and sometimes downright aggressive efforts to make you buy one before you leave the store. So why is it that folks don’t regularly throw their iPhones down the toilet, and don’t send their notebooks back to Dell on a weekly basis, but seem to constantly be seeking more “free” medical services? The most common explanation is that those doctors, who are not selling third party warranties to insurers and are therefore paid under the FFS model, are using their professional status to encourage the superfluous usage of their medical services for the sole purpose of personal financial gain. On the other hand, those physicians who do provide warranties on their patients under an HMO model have been often accused of withholding necessary services with the exact same purpose in mind.

The proposed solution to this quandary is to require physicians and the entities they work for to sell third party warranties augmented by Service Level Agreements (SLA) to ensure adequate quality of service. Since, if you run a small shop, it is rather hard, and very risky, to sell comprehensive warranties for something as complex as a person, most care providers are consolidating to create large shops and networks capable of providing soup to nuts services in-house. SLAs are not a new concept. In the computer industry, for example, maintenance and support agreements usually include specified uptimes, first response times and resolution times based on problem severity. They also include financial penalties for all of the above. If humans could be kept on locked racks in temperature controlled rooms, connected to adequate energy supplies and be equipped with diagnostic monitoring devices (like in the Matrix), we could easily apply very good SLAs to capitation contracts. Since this is not yet the case, and since we are talking about many millions of units, the best we can do is formulate medical care SLAs mostly in terms of percentages of evidence-based processes leading to good enough outcomes at a reasonable cost per head. So for example, if 80% of diabetics can be controlled at a cost not to exceed an average of, say $10,000 per diabetic per year, the care provider will be considered to provide good value for the dollar and therefore rewarded with some sort of performance bonus. If you can maintain 99% of diabetics controlled at an average cost of $15,000 per diabetic per year, you’re out of luck, and the same goes for achieving only 50% control regardless of the price. This is called Value Based Purchasing (VBP) and this is how insurers will be contracting with increasingly larger provider organizations to supply medical care to increasingly larger populations.

This model of paying for services is not necessarily bad, since we probably have a long way to go before most providers are able to meet the currently proposed SLAs. We can also keep pushing the SLAs up incrementally, and by tightening controls on both consumers and providers, we should be able to reduce variability of processes and standardize enough to achieve Six Sigma on measures shown to best contain overall costs of care. Of course, in this zero sum system, there is no room for outliers. Just like spending all day trying to fix one stubborn server can derail maintenance on a farm of thousands of machines, and may even get you fired, providing heroic and very expensive medical care to one individual is directly detrimental to assigned population needs and may cause serious financial loss to the provider. Every rookie computer engineer knows that in large enough server farms, it is best to ditch a malfunctioning server. You won’t even feel it. That’s the whole point of having server farms. Now if you work for a small business and all you have is one lonely rack of servers, and they all have names (the Oracle box, the NAS, the web server, etc.), you’ll work all day and all night to keep each and single one alive. You’ll get fired if you don’t.


  1. Margalit: a home run piece! Thoughtful and dumbed down to where I can connect dots in VBP.

    As I read copy this thought popped in my mind since while late to the party, I am just reading Michael Lewis' 'The Big Short'.

    So, the connection made is: actuaries are to risk bearing medical groups or IDN's, as the ratings agencies where to subprime mortgage debt underwriters/issuers and the credit default swap hedges they enabled.

    I still say cap the $2.5 trillion pipeline and re-engineer the care delivery and underlying finance paradigms. Given the complexity associated with being human and the flawed nature of the 'data science' (actuarial models) we have to assume/warrant/price optimal care/outcomes, i'd say at best it's a crap shoot. Yet, the production mindset left to its unbridled ways, will only continue its rapacious consumption of increasing levels of GDP.


  2. Thanks, Gregg.

    Your analogy to the financial markets is priceless.
    All we need now is someone to step in and create appropriate CDOs, while purchasing the opposing CDSs by the truckload. The IDNs would have to get significantly bigger though.
    Can't figure out if the original bet should be on people staying healthy or dropping dead quickly.
    I thought I saw something a while ago about derivatives for life insurance policies, so I guess the sky is the limit when it comes to financial instruments innovation... :-)