THE ECONOMIC EVOLUTION OF AMERICAN HEALTH CARE THE ECONOMIC EVOLUTION OF AMERICAN HEALTH CARE FROM MARCUS WELBY TO MANAGED CA RE David Dranove PRINCETON UNIVERSITY PRESS PRINCETON AND OXFORD Copyright © 2000 by Princeton University Press Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, 3 Market Place, Woodstock, Oxfordshire OX20 1SY All Rights Reserved Library of Congress Cataloging-in-Publication Data Dranove, David. The economic evolution of American health care : from Marcus Welby to managed care / David Dranove. p.cm. Includes bibliographical references and index. eISBN 978-1-40082-468-7 1. Managed care plans (Medical care)—Economic aspects—United States. 2. Medical care—Economic aspects—United States. 3. Public health—Economic aspects—United States. I. Title. RA413.D73 2000 338.4¢73621¢0973—dc2100-039975 CIP This book has been composed in Bauer Bodoni The paper used in this publication meets the minimum requirements of ANSI/NISO Z39.48-1992 (R 1997) (Permanence of Paper) www.pup.princeton.edu Printed in the United States of America 1 3 5 7 9 10 8 6 4 2 Contents Acknowledgments Introduction PART ONE: THE RISE OF MANAGED CARE Chapter 1. Marcus Welby Medicine Chapter 2. The Origins of Managed Care Chapter 3.The Government Steps In Chapter 4.Managed Care Takes Over PART TWO: THE MODERN HEALTH ECONOMY Chapter 5. The Business of Health Care Chapter 6. Merger Mania Chapter 7. Quality Chapter 8. Fulfilling the Promise of Managed Care Notes Bibliography Acknowledgments I WOULD like to thank Paul Biondi and Madeleine Shalowitz for conducting extensive background research. I am especially grateful to my wife for letting me bounce ideas off of her, no matter how serious or silly. Lastly, I owe a deep debt of gratitude to Alain Enthoven, who twenty years ago encouraged me to use the lens of economics to bring some clarity to the way we think about health care. I hope this book fits the bill. THE ECONOMIC EVOLUTION OF AMERICAN HEALTH CARE Introduction FOR THE PAST two decades, I have researched the role of market forces in health care. As a graduate student, I was privileged to study under Alain Enthoven, one of the leading architects of the managed care revolution. Since then, I have been on the faculty of two outstanding business schools. I have always been a big believer in the benefits of competition. In this book I use an economic lens to examine the historical development of managed care. The starting point for this analysis is the "shopping problem." Economists have long recognized that it is very difficult for patients to shop for medical care. Patients have poor information about what care is needed and where to buy it and also have muted incentives to shop for the best price. The result is that patients are unlikely to be cost- effective medical decision makers. The evolution of the health economy, from the traditional system centered on autonomous physicians, through government planning efforts to today's managed care organizations, represents an ongoing effort to help patients solve the shopping problem. When I started to write this book, I fully expected it to be a sweeping endorsement of managed care. Indeed, I find a lot of evidence that managed care is working. By one credible estimate, managed care is saving patients over $300 billion annually. At the same time, there is no systematic evidence that managed care has harmed quality. Finally, managed care has clearly won the market test, with the vast majority of privately insured patients enrolled in some type of managed care plan. But managed care has utterly failed to win the trust of American patients and is a favorite target of politicians on both sides of the political spectrum. Piece by piece, politicians may legislate managed care out of existence. Patients do not trust managed care because they see it as an unnecessary intrusion into the traditional physician-patient relationship. One of my goals in writing this book has been to detail the strengths and weaknesses of the traditional relationship. Another is to refocus the public debate about managed care. The current, simplistic view is that managed care is a cost containment mechanism run amok. The simplistic solution is regulation. I believe that the market forces unleashed by managed care offer opportunities to vastly improve upon the traditional health economy by simultaneously improving quality and containing cost. In the eighteen months since I began this book, my optimistic view of managed care's potential has wavered. I accept the possibility that managed care will never fulfill its promise. But the problems with managed care come mainly from the outside. I have no doubt that market forces can enable patients to obtain the highest quality care at low prices, while encouraging providers to be efficient and innovative. But I see several hurdles, largely beyond the control of managed care organizations, that must be overcome before we reach this state of health care nirvana: •Markets have to remain competitive, free of the power struggles emerging between large buyers and providers. This will require vigorous enforcement of antitrust laws. • There will need to be substantial improvements in health care data.We need better outcomes measures and must be able to link patient- level medical records across providers. This may necessitate government intervention, both to coordinate the collection of data and to establish a confidential patient "identifier." • Providers must accept that quality varies and must actively engage in quality measurement. Quality measurement is imperfect and unfair to many providers, but providers should rally behind the quality movement because patients stand to benefit. • Patients must become consumers, willing to shop around for the best managed care plans and the best providers. Patients have much to gain by doing so, perhaps their very lives. It seems to me that these are all necessary conditions for managed care to be successful. If even one hurdle remains standing, patients will fail to realize the full potential of a truly competitive health economy. While this seems like a lot to overcome, I remain cautiously optimistic. Despite ongoing merger activity on both the provider and the buyer sides of the market, most urban health care markets remain competitive, and antitrust agencies continue to fight against blatantly anticompetitive combinations. There are massive public and private sector efforts to create sophisticated health care data systems. Providers are gradually getting used to quality evaluation, and patients are increasingly using quality data. We can expect to see more and better data in the future. My optimism is tempered by the knowledge that improving data and changing attitudes will not happen overnight. In the meantime, patients are growing impatient with organizations that seem to do a better job of managing costs than managing care. Seeking to appeal to angry voters, legislators will enact laws that undo the potential of managed care. Part One THE RISE OF MANAGED CARE