The High Cost Of American Health Care: You Asked For It

Perverse incentives for doctors and hospitals are just one thing driving up U.S. health care costs. (Photo credit: Army Medicine)

The primary debate in health care reform this past year centered on insurance coverage. The next great debate will focus on the cost of providing health care.

For decades, the way we've paid doctors and hospitals has driven up health care costs. And while the pace of health care spending has slowed the last four years, it continues to rise faster and more noticeably than improvements in U.S. health care outcomes.

The reason is not the people. It's the financial model. U.S. Health Care Rewards Quantity Over Quality

Imagine you're planning to remodel your kitchen. You hire a contractor and opt to defer entirely to his judgment on the kitchen's aesthetics and the source of his materials.

Instead of requesting a competitive bid or choosing exactly what you want, you agree to a time and materials contract. By the end of the remodel, the contractor has billed more hours than you expected, marked up the cost of the materials and charged you twice for his construction errors.

Chances are you'd never agree to such a lopsided arrangement for your kitchen. But that's the approach most Americans take when they go for medical care.

The U.S. health care system pays physicians based on a fee-for-service (FFS) financial model. In short, it's that 'time and materials' contract you'd never agree to for your kitchen.

The result is that health care costs over the past several decades have risen twice as fast as general inflation. Without the right financial disincentives, we would expect both kitchen contractors and physicians to act in ways that maximize their own economic benefit. And they do.

But it's not the doctors or hospital administrators who are the fundamental problem. It's the financial model.

Fee-For-Service Model Pervasive Yet Perverse

The FFS payment model was created long ago, during a time when physicians treated less-complex problems and offered only a few inexpensive therapeutic interventions. It worked back then but a significant percentage of patients today have multiple chronic conditions. Meanwhile, the number of complex and very expensive tests, medications and interventions available are practically unlimited.

Economics 101 teaches that as supply goes up, costs should come down. But this tenant doesn't hold true in medical care - not when the supplier also controls demand.

In health care, doctors can stimulate demand because (a) health insurance blinds most patients to the costs of services and (b) patients often don't know whether a complex procedure is as necessary as a non-invasive one.

As a result, we have seen a major increase in utilization of complex services over the past 20 years.