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All-payer rate setting and health reform's underpants gnomes strategy

at 09:45 AM ET, 06/02/2011

One of the critiques of the Affordable Care Act is that the mechanisms that are intended to bend the cost curve leave too much room for uncertainty. Will accountable care organizations really work? How will the Independent Payment Advisory Board keep Medicare spending on a more sustainable track? Nobody knows. These are bold experiments and they're the best we have. And, though they may fail, we must try.

But suppose they work, as demonstrated by much lower growth in Medicare spending in, say, 2020. The next leap of faith is that the innovations that saved Medicare will transfer to the private sector, saving the entire health system. How? It's unclear. It's the underpants gnomes strategy embedded in current health policy (see phase 2).

The strategy is expressed by the Center for American Progress’s long-term budget plan:

[P]redicting the exact effect of the myriad test programs and reforms in the new health law is fraught with uncertainty. Thus we also include a failsafe mechanism that would ensure significant savings.
Our failsafe would be triggered if, starting in 2020, total economywide health care expenditures grow at a rate faster than the economy. Should that happen then we would empower the Independent Payment Advisory Board to extend successful reforms in Medicare and other public programs to insurance plans offered in the health care exchanges and then potentially to all health care plans, such that the target is met. This will ensure that costs are constrained across the health care sector, preventing cost-shifting and maintaining access for all.

The cost savings mechanism is crystal clear, right? Just transfer that Medicare magic to the private sector. Done.

But it is fair to ask, for example, why might ACOs and other incentives for quality and care coordination succeed in Medicare and not succeed for commercial market plans? The answer is very simple. Medicare is immune from provider market power, though not provider political power. Due to its size and with the federal government behind it, to a greater extent than private plans, Medicare can drive prices downward and institute payment reforms. In contrast, private plans can only accomplish what they can extract at the bargaining table. Here market power matters. The market does what the market is. (Blue Cross/Blue Shield of Massachusetts has launched an ACO-like program, the Alternative Quality Contract. But the guts of it are based on its negotiations with providers.)

Worse (from a private-side cost containment point of view), in anticipation of ACOs, providers are merging, integrating, and growing larger. They're amassing greater market power. This is natural because ACOs and other provisions of the law promote provider integration; they actively encourage it. How does that help in price reduction? It doesn’t.

Don't get me wrong. ACOs are not a bad idea. Paying for quality and transferring some of the risk of higher costs to providers is a sensible way to tame the health spending beast. It makes great sense for Medicare. But it does raise this private-side market power issue.

For a year, I've been asking every health economist and health policy expert I come across what can be done about this ACO market power issue. Those who don’t shrug their shoulders offer one of two suggestions: “all payer“ and single payer (which is a special case of all payer). An all payer rate setting system would allow associations of insurers to negotiate with each provider for a single price for each service it offers. In contrast, the way it works now is that each insurer (or third-party administrator of self-insured employers) negotiates with each provider separately. Thus, today, prices vary by insurer for the same service at a single hospital. Under an all payer system, insurers would pay one price, jointly negotiated.

By allowing insurers to, essentially, collude for the purposes of price negotiation, their individual degrees of market power are combined. It's a bit like collective bargaining in labor. Or think of it as bulk purchasing on steroids. In economics-speak, they have monopsony power. This should drive price lower. By allowing each provider to negotiate separately, some variation in prices across providers would remain. But those may be sensible and worth keeping, to the extent they reflect variations in quality or other amenities that are desired by consumers. So, this is a market-based all-payer system, somewhat like Germany's and in contrast to Maryland's administrative one.

Though under an all-payer system insurers would have monopsony power as purchasers of care, they would not necessarily have monopoly power as sellers of insurance. They are free to, and would be or should be required to, compete for consumers in the marketplace (e.g., via a competitive bidding model). That means that the lower prices they pay to providers would translate into lower premiums for consumers.

Is an all-payer system in our future? I don't know. However, as of now it is the only way I am aware of to maintain a private health insurance industry and  counter the growing market power of providers, which is encouraged by the ACO model. In short, it is the only way to make the entire system function a bit more like Medicare without extending Medicare to all. In other words, all payer may be the last stop before single payer.

Austin Frakt is a health economist and an Assistant Professor of Health Policy and Management at Boston University’s School of Public Health. He blogs at The Incidental Economist and tweets via @afrakt.

 
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