Healthcare Reform

William B. Weeks

Healthcare cost escalation continues to encroach on gross national product and challenge the ability of the United States to compete in a global marketplace.

Through Medicare and Medicaid funding, the federal government pays for more than half of U.S. healthcare costs. However, federal efforts to contain cost growth either by reducing per-unit physician payment rates or by bundling services have failed: The former appears to be politically unviable; the latter, effected through the establishment of DRG and ambulatory payment classification payment mechanisms, has reduced the growth in the per-service federal costs, but has been more than offset by accelerated utilization. What is required is a mechanism for using market forces to reduce utilization, and thereby bend the overall healthcare cost curve.

The Evolutionary Problem

Incentives of financial rewards caused healthcare to evolve into the acute-care-based, illness-responsive system that it is. Comprehensive technology-intensive healing palaces have created tremendous innovation, generated highly paid employment settings for an increasing proportion of the population, and healed a great number of people.

Healthcare systems' vulnerabilities to cost reduction lie in their cost structures: The very high fixed costs that are required to deliver health care create incentives to ensure that available capacity is not idle.a Even though healthcare administrators realize that the new environment will require streamlining, less technology, and more focus, they remain reluctant to reduce capacity in the short run because doing so reduces revenues without concurrently reducing depreciation costs. If they could extract payment for reducing capacity, they might be more willing to do so; such bridge payments could help the healthcare system of the future evolve more quickly.

Cap and Trade

The concept of "the tragedy of the commons" was popularized in an article in a 1968 issue of Science.b The tragedy occurs when multiple individuals, acting independently and in their own self-interest, deplete a shared limited resource, even when it is clear that doing so is harmful to all in the long run. Examples include ranchers overgrazing their livestock on publicly owned land, causing the land to become fallow, and energy producers dispelling their waste into the air without restriction, resulting in widespread pollution.

One mechanism that is effective at limiting such an unchecked deletion of public resources is the market-based "cap-and-trade" system. In this system, a maximum allowable amount of a depleting activity-the number of sheep that could sustainably graze on a commonly owned piece of property or the total tonnage of carbon emissions that could be emitted without causing widespread pollution-is identified. Current users are allocated proportional rights to continue their use. Should there be a desire to reduce the maximum allowable amount over time, these allocations are reduced-frequently at a faster rate for those with high initial allocations of the scarce resource. Those wanting to use more scarce resources than they have been allocated can purchase the right to use them from those who can do with less; those exceeding the caps are fined.

Application to Health Care

Another article in Science, published in 1971, identified variation in consumption of scarce healthcare resources across hospital service areas in Vermont.c In this and later work, medical resource utilization has been associated with healthcare system capacity: A higher supply of beds per capita is associated with more healthcare consumption per capita.

Healthcare utilization in the United States has the features of a "tragedy of the commons." The scarce publicly owned resources are federal expenditures on health care, and it is largely healthcare providers that are depleting these resources. The current payment system propagates the problem: Even if hospital capacity might be reduced, financial pressures to keep the beds full will result in the lowering of treatment thresholds. Although certificate-of-need programs have been marginally successful in reducing healthcare expenditures, their effectiveness is limited because they operate at the state level and are fraught with political entanglements.d  

A Proposal

An effective method of reducing per capita healthcare capacity, and thereby costs, could be introduced at the federal level. To be eligible for Medicare payment, hospitals must receive an accreditation certificate, generally from The Joint Commission. This accreditation is available to virtually all U.S. hospitals. The federal government's ability to make Medicare eligibility contingent on adherence to a third party's certification is well established.

Similarly, Medicare could impose a "hospital bed capacity per resident" cap at a regional level that must be met to receive Medicare payment. The Dartmouth Atlas Project has identified 306 hospital referral regions on which measures of healthcare capacity can be derived that could serve as an organizing feature of the program. For instance, in 2006, hospital beds per 1,000 residents ranged from 1.5 in Contra Costa County, Calif., to 4.7 in Monroe, La., which translates into a 2009 price-adjusted Medicare payment per beneficiary ranging from $8,527 to $12,914, respectively.

The initial cap could be set at the 50th percentile (2.4 beds per 1,000 residents in 2006): Hospital referral regions at lower levels would receive no penalty, but hospitals in regions at higher levels might be required to reduce the region's capacity by at least 10 percent or be penalized with lower Medicare payment rates. Incentives for collaboration among regions to reduce capacity would then be in place.

The use of a cap-and-trade system would achieve three objectives.

First, it would help healthcare institutions survive the transition to new models of care. If a hospital in a high-capacity area did not want to reduce its individual capacity, it could purchase capacity from other hospitals that do, thereby facilitating market consolidation, concurrent capacity reduction, and cooperation: Individual hospital capacity might increase, but as long as that did not cause the hospital referral region's overall capacity to increase, the region would not be penalized.

Second, the cap-and-trade system would use a market mechanism to create such change: Innovation and best practices could arise from 306 regions, promoting collaborative learning (administrators from Monroe could visit administrators in Contra Costa County).

Third, and perhaps most important, the system would create value for the underperforming assets-that is, excess hospital bed capacity. The sale of the right to use such capacity would provide capital that would promote the healthcare system's evolution.

Undoubtedly, such a program would face political resistance. Because hospital referral regions cross political boundaries, their use should render this strategy less subject to political manipulation. An adaptive design would be best: Targets could be refined iteratively over time. Possibly, health systems might become adept at simply transferring care to nonhospital settings; then, expansion of the caps to encompass other technologies besides hospital beds, such as radiographic technologies, might be warranted.

Establishment of a cap-and-trade system by the Centers for Medicare & Medicaid Services could harness the market mechanism as part of a comprehensive plan to reduce hospital capacity and thereby address the healthcare utilization explosion that underlies the U.S. healthcare crisis. The cap-and-trade mechanism has helped other industries address overutilization issues, generally at the state level. Health care offers a highly promising opportunity for its use at the federal level.

William B. Weeks, MD, FHFMA, is professor, The Geisel School of Medicine at Dartmouth, The Dartmouth Institute for Health Policy and Clinical Practice, Lebanon, N.H., and a member of HFMA's New Hampshire-Vermont Chapter (


a. Rauh, S.S., Wadsworth, E., and Weeks, W.B., "The Fixed-Cost Dilemma: What Counts When Counting Cost-Reduction Efforts?" hfm, March 2010, pp. 60-63.

b. Hardin, G., "The Tragedy of the Commons," Science, Dec. 13, 1968, pp. 1243-48.

c. Wennberg, J., and Gittelsohn, A., "Small Area Variations in Health Care Delivery," Science, Dec. 14, 1973, pp. 1102-8.

d. Hellinger, F.J., "The Effect of Certificate-of-Need Laws on Hospital Beds and Healthcare Expenditures: An Empirical Analysis," American Journal of Managed Care, October 2009, pp. 737-744.

Publication Date: Thursday, November 01, 2012

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