A payer model that will curb costs of care

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Jul 26, 2016

Curbing Healthcare Costs Resized

One of my good friends, Bob, runs a small manufacturing company in Massachusetts. Bob’s company has just over 100 employees and is profitable. Last year, the company generated over $10 million in revenues with $1 million income. While the business is growing, Bob is concerned— his company’s annual healthcare cost keeps rising, and he doesn’t know how to control it. His company’s insurance premium was more than $1 million last year, and  it is slated to increase by 5% this year – equivalent to costs of one employee. What frustrates Bob the most is that his employees have been consuming less healthcare services than in past years. Though the employees see doctors less, his company keeps paying more.

Bob’s story is a familiar problem for many companies and individuals today. For companies who are too small to be self-insured, healthcare costs continue to rise even if their employees remain healthy. Rather than paying for the amount of care his employees consume, Bob thinks that his company is tasked with unfairly subsidizing the costs of care for a larger, less healthy population. Certainly, this cost subsidy engine drives every insurance model, but if the financial burden on these small businesses becomes too severe, they could face significant pressure which could lead to workforce reduction and declining productivity.

In The Innovator’s Prescription, Clayton Christensen proposes that the integrated fixed fee (IFF) provider model offers one possible solution to this thorny problem. An IFF provider has its own insurance provider under its corporate umbrella, and charges every member a fixed fee (either monthly or annually) for all the care that they need. Kaiser Permanente of California and Intermountain Health Systems in Utah are two well-known IFF providers in the U.S. Unlike the traditional health system model where the hospital or health network profits by increasing the patient volume, IFF providers profit when their members remain healthy and stay out of the hospital. Therefore, even if hospitals see declining revenues and profits, the integrated network as a whole sees growth in revenues and profits. The model grows from member retention, so focus on care quality and patient satisfaction are core values.

On the surface, the IFF model seems to be a no-brainer. But, the current U.S. healthcare system is still dominated by the traditional fee-for-service (FFS) model. Only a handful of IFF provider networks, including Kaiser Permanente and Intermountain Health, are operating at the moment. If the potential benefits are well documented, why is there a strong resistance? Two key issues stand in the way: many physicians and hospitals worry that capped fees would results negatively impact their income, and many confuse the IFF model with capitation models that failed decades ago.

Most healthcare systems are built on payment contracts between hospitals, physicians, and payers. Under a fee-for-service (FFS) model, physicians work as independent contractors who are paid by insurance companies for each care service they provide. Hospitals are separately reimbursed by insurance companies based on type of patient-physician interaction. For example, hospitals earn far more for a surgery than a simple consultation with one of their specialists. Unfortunately, these episode-based rates are oftentimes hotly negotiated, causing tension and bad relations between parties. Because insurance companies are left out of patient-physician interactions, they have little leverage to push back, enabling hospitals and physicians to usually win out.  While the FFS model is clearly flawed, many physicians and hospitals have generally resisted transitioning to fixed fee models, because capped fees in the FFS independent-contract model would negatively impact their income.

The other roadblock to change stems from people confusing the IFF model with negative outcomes from past capitation models. Under the 1980s-1990s health maintenance organization model (HMO), a loosely aligned network of stakeholders (patients, physicians and payers) agreed to operate under a fixed fee system without aligning their financial motivations. However, the similarity between the old capitation model and the IFF model ends there. Stakeholders in the HMO model couldn’t agree on how the fixed fees should be allocated for various services, and both physicians and patients resisted insurance companies making healthcare decisions on behalf of patients. Thus, while it was successful at curbing costs, it failed to gain long-term support.

In spite of these challenges, as the financial burden on the healthy continues to rise, we should see more employers and individuals desiring a fixed fee model that encourages its members to receive care in the most effective and least costly ways. Additionally, if the Affordable Care Act continues to push for value-based payment that reimburses physicians based on successful outcomes rather than procedures alone, some physicians will likely prefer the stability of the IFF model. For its participants, the IFF provider model aligns all of the key motivations of its stakeholders. Patients are promised the best care possible. Providers are rewarded for keeping patients healthy, satisfied, and out of hospitals. Lastly, payers are paid a lump-sum premium each year that should be effective at curbing costs of care.

The IFF model is also beneficial to those who struggle with multiple health issues, because the system can responsibly afford to treat these patients. Instead of continuously increasing premiums on healthy members to cover rising costs of care for the diseased population, the IFF model responsibly subsidizes high-cost patients by minimizing costs of care among healthy members and by increasing the number of fee-paying members. To be clear, this is in stark contrast of the existing FFS model in which health networks profit by increasing patient volume.

Some critics might argue that disappointing outcomes from recent attempts at integrating providers and payers raise questions about whether the IFF model is sustainable long-term. But, these stories just reaffirm the importance of full integration. Merely combining payers and providers in pursuit of patient volume will do little to improve financial performance. The nature of fixed fees needs to change from pure subsidies to value-providing membership fees, and the IFF model is the answer to this puzzle. Rather than continue to focus on making money by treating ill patients, as many past and current fixed fee models have mistakenly done, a true IFF model should do the opposite: keep members out of hospitals, and earn money through membership fees.

Although we continue advocating that current health systems transform themselves into IFF providers, it is most likely that they will resist change. Instead, we expect that new IFF providers will emerge over time and disrupt the incumbent fee-for-service establishments. Self-insured employers and small and medium companies like the one that Bob manages are already eager to consider alternatives to the status quo. Once businesses begin migrating to the IFF model, it will only be a matter of time before the rest of the healthcare industry follows. For the providers, physicians, and payers, being the last ones on the current ship might prove to be a titanic mistake.

Spencer Nam

Spencer researches disruptive innovation in the healthcare industry. He has over 15 years of professional experience working with U.S. and international healthcare enterprises, most recently as an equity research analyst covering medical technology companies.