MODULE 2 – ESSAY ANSWERS
Chapter 4
In Whose Interest Does the Physician Act?
1. Why do physicians play such a crucial role in the delivery of medical services?
Although only 25 percent of personal medical expenditures are for physician services, the physician controls the use of a much larger portion of medical resources. In addition to their own services, physicians determine admission to the hospital, the length of stay once in the hospital, the use of ancillary services and prescription drugs, referrals to specialists, and even the necessity for services in nonhospital settings, such as home care.
The role of the physician has been shaped by two important characteristics of the medical system. The first is the legal system: only physicians are permitted to provide certain services. Second, both patients and insurers lack the necessary information to make many medical-related decisions. Patients depend on the physician for diagnosis and recommended treatment and have limited information on the qualifications of the physician or the specialists to whom they are referred. The patient’s lack of information places the physician in a unique relationship to the patient. The physician becomes the patient’s agent.
2. How might a decrease in physician incomes, possibly as a result of an increase in the number of physicians, affect the physician’s role as the patient’s agent?
In addition to being the patient’s agent, physicians are suppliers of a service, and their incomes depend on how much of that service they supply. Many physicians are believed to behave differently when their own incomes are adversely affected. As a “perfect agent” for the patient, the physician would consider only the patient’s medical and economic interests when prescribing a treatment. However, according to the supplier-induced demand theory, an increase in the supply of physicians will cause some to induce demand by prescribing additional services to prevent their incomes from falling. These physicians no longer act as a perfect agent for the patient and may even provide misinformation to increase the demand for physician services, thereby increasing their own income.
3. What is the “target income” theory?
This is the idea that physicians induce demand only to the extent that they can maintain or achieve a given level of income. Thus one might envisage a spectrum of demand inducement, depending on the psychological cost to the physician of greater demand inducement. At one end of the spectrum are those physicians who act solely in their patients’ interest; they do not induce demand to increase or even maintain their incomes. At the other end of the spectrum are physicians who attempt to increase their income by inducing demand as much as possible; this group presumably incurs little psychological cost when they induce demand. In the middle are physicians who induce demand to achieve some target level of income.
Chapter 5
Rationing Medical Services
1. What determines how many physician services an individual demands?
As people become wealthier, they prefer to spend more on medical care, to receive a greater quantity of services, and to receive higher-quality services by making greater use of specialists. An increase in income allows consumers to buy more of everything. However, the demand is also determined by the value the patient places on particular services and the price he or she pays for those services. When the cost to the consumer exceeds the value he or she places on those services, the quantity demanded decreases.
2. What is moral hazard, and how does its existence increase the cost of medical care?
When patients use more medical services because their insurance lowers the out-of-pocket cost of those services, the insurance industry refers to this behavior as “moral hazard.” This increases the cost of medical care because people who have insurance (or more comprehensive insurance) use more services, see more specialists, and incur higher medical costs than those who do not have insurance (or have less comprehensive insurance). These higher costs in turn increase insurance premiums, leading some to drop their health insurance because it has become too expensive.
Chapter 10
How Does Medicare Pay Physicians?
1. What were the reasons for developing a new Medicare physician payment system?
There were two reasons. The most important was the federal government’s desire to limit the rise in the federal budget deficit, which was of great political concern in the early 1990s. In 1992 physicians received 75 percent of all Part B payments (this has decreased to 30 percent as of 2009). The remainder is for other, nonhospital services. Part B expenditures had been increasing rapidly at a rate of approximately 10 percent per year. As Medicare physician payments continued to raise, the government’s portion, 75 percent of the total, contributed directly to the growing federal budget deficit. Both Republican and Democratic administrations believed that growth of Part B expenditures had to be slowed.
Second, many physicians and academicians believed that the previous Medicare payment system was inequitable and inefficient. Physicians who performed procedures such as diagnostic testing and surgery were paid at a much higher rate per unit of physician time than were those who performed cognitive services such as office visits. Medicare fees for the same procedure varied greatly across geographic areas, unrelated to differences in practice costs. The fee-for-service payment system encouraged inefficiency by rewarding physicians who performed more services. These inequities and inefficiencies caused differences in physician incomes and affected physicians’ choice of specialty and practice location.
2. How is the fee for a particular service determined using the RBRVS?
Three resource components are used to construct the fee for a particular service. The first, the work component, is an estimate of the cost of providing a particular service, including the time, intensity, skill, and mental effort and stress involved in providing the service. Second are the physician’s practice expenses, such as salary and rent. Third is malpractice insurance. Each component was assigned a relative value unit (RVU) based on the cost and time required for the service. The actual fee is then determined by multiplying these relative value units by a conversion factor, which is politically determined. For example, “transplantation of the heart” was assigned 44.13 work RVUs, 49.24 practice expense RVUs, and 9.17 malpractice RVUs, for a total of 102.54. The 1992 conversion factor was $31, making the fee for this procedure $3,178 ($31 × 102.54). This fee was then adjusted for geographic location. The new payment system reflected the cost of performing 7,000 different physician services.
3. What are some of the drawbacks of a uniform fee schedule for medical services?
A uniform fee schedule cannot indicate that a shortage (demand by Medicare patients exceeds the supply of physician services at the regulated physician fee) is developing in some geographic areas or among certain physician specialties.
Similarly, uniform fees cannot eliminate such shortages. Unless a national fee schedule is flexible, allowing fees for some services, physicians, and geographic regions to increase more rapidly than others, shortages will arise and persist. Permitting physicians to balance bill their Medicare patients would be a market mechanism to indicate that an imbalance between demand and supply has occurred.
Uniform physician fees also do not differentiate between physicians who provide higher and lower quality services. In December 2006 Congress for the first time allocated a very small amount of money to pay those physicians who voluntarily report certain quality performance measures in the care of their patients (pay for performance).
Chapter 11
1. Describe and evaluate how a rate of return to a medical education would determine the existence of a physician surplus or shortage.
Economists rely on the concept of rate of return rather than a physician-to-population ratio to determine whether a physician surplus or a shortage exists. Medical education is viewed as an investment, similar to other types of investments. The rate of return is calculated by estimating the costs of that investment (tuition, books, income forgone by going to school) and the expected financial returns (higher future income) achievable as a result of that investment. (Because this income is earned in the future, it must be discounted to the present.) High rates of return in medicine shift more students to medicine (eventually lowering the rate of return) whereas low rates of return shift them to other professions.
Economists prefer the rate-of-return approach, because it incorporates into its calculations all of the relevant economic factors, such as likely income lost if the person did not become a physician (opportunity cost), the longer time to become a specialist (greater opportunity costs), likely physician incomes by specialty, and educational costs including tuition. Changes in any of these factors will cause changes in the rate of return to a medical education.
2. What demand and supply trends in the physician services market will affect the incomes of surgical specialists and primary care physicians?
The aging of the population, which uses more medical services, has increased demand for physician services. So has the growth in private insurance, which reduced the out-of-pocket price of physician services, paid by private patients? Patients became fewer prices sensitive to what physicians were charging, and physician fees rose sharply. During the 1980s, growth in medical technology increased demand for new diagnostic and surgical procedures. The high volume of these procedures, particularly in outpatient settings in the 1980s, and physician productivity gains in performing these procedures resulted in procedure-oriented specialists receiving much higher profit margins per hour than physicians in primary care, who performed few procedures.
However, the growth of managed care in the 1990s forced physicians to deeply discount their fees in return for a high volume of managed care organization enrollees. Managed care also reduced access to specialists and thus increased the demand for primary care physicians while decreasing the demand for specialists. Recent anecdotal information suggests that the shift from specialty to primary care is beginning to cause imbalances in the supply and demand for specialists and generalists. As managed care permits easier access to specialists, specialty practice is once again becoming relatively more attractive than being a generalist.
Physician incomes are, however, significantly affected by Medicare’s payment policies, and this will become even more important as a larger number of aged become eligible for Medicare. Although demand by the aged will increase as their out-of-pocket payment under Medicare is reduced, an increased demand does not necessarily translate into much higher physician incomes. Total physician Medicare payments are now tied to a “sustainable growth rate” (SGR) that unfairly ties physician payments to changes in GDP per capita. Given the recession that started at the end of 2000, the SGR formula has resulted in lower Medicare physician fees, yet Medicare revenue is too important to most physicians for them to stop serving these patients. Medicare payments to physicians were to be reduced by 5 percent each year since 2002; however, Congress has prevented these reductions from being instituted. Similar reductions are projected for the future and it is uncertain whether Congress will change the SGR formula to prevent these reductions from occurring. If they occur, both specialists and primary care physicians will be adversely affected.
3. What are some of the major changes in the market for physicians’ services that are affecting both physician incomes and their practices?
In 1982 The US Supreme Court ruled that the antitrust laws were held to be applicable to the health field. Physician organizations could not engage in anti-competitive behavior, such as boycotting an insurer if the insurer did not agree with the fees the physicians wanted. Further, market competition among physicians occurred. Preferred provider organizations (PPO) formed and selected physicians based on their willingness to discount their fees. Managed care organizations, which include HMOs and indemnity plans that use utilization review, became the norm rather than the exception and questioned physicians on their prescribing patterns, such as their use of the hospital and certain surgical procedures. Physician fees and incomes declined during this period.
The growing number of aged has increased the demand for physicians. The move since 2000 toward broad provider networks by insurers has lessened insurers’ ability to exclude physicians from their networks for not discounting their fees. Technological advances have enabled physicians to move more services, both diagnostic imaging and surgical procedures, out of the hospital into physician owned facilities. These trends have increased the demand for physicians and increased their incomes.
Chapter 12
1. Why has the size of multispecialty medical groups increased?
Physicians in individual and small-group practices were at a disadvantage in a highly competitive managed care market. They would lose patients if they were excluded from the limited provider networks that insurers and HMOs were forming by selecting physicians who were willing to sharply discount their fees in return for a greater volume of patients. It is less costly (administratively) for health plans to negotiate and contract with one large medical group than with an equivalent number of independent physicians. Large medical are also subject to economies of scale, they are able to share administrative personnel and implement software systems for billing purposes. Large medical groups also have greater market power then solo or small medical groups when bargaining with insurers.
An insurer is reluctant to lose a large number of physicians from its provider network. Large medical groups are also able to invest in medical technology for their offices, such as diagnostic equipment, and increase their incomes by performing such tests in their own facility. Large groups are also attractive to new physicians since it assures them of an income without having to invest in an office and staff. Large medical groups are also better able to collect performance data and be paid additionally for providing quality measures to the insurer.
Insurers also preferred dealing with large multi-specialty groups since they could shift their insurance risk to a large medical group by paying that group on a capitation basis instead of fee-for-service. Capitation was more feasible for large groups that could spread the risk of more expensive patients over a larger enrollee population; solo practice or small groups were unable to undertake the financial risks of capitation. Capitation also provides the medical group with financial incentives to be innovative in both the delivery of medical services and in the practice of medicine, because it can increase its profit by saving part of the capitation payment. Under provider capitation payments, large medical groups were also able to negotiate with the hospital to receive part of the savings from reducing hospital use.
2. Why do large medical groups have market power?
Large groups have significant advantages that give them greater bargaining power over health plans than independent and small physician practices. They are able to shift the financial risk from the HMO to the medical group; they are able to lower the HMO’s administrative cost by having the HMO negotiate with only one group than an equal number of independent physicians; and they can serve as a preferred provider organization provider for employers and insurers. An employer or health plan contracting with a large medical group has less reason to be concerned about physician quality because large medical groups have more formalized quality control and monitoring mechanisms than do large numbers of independently practicing physicians.
Large groups also have greater leverage over hospitals. They determine what hospitals will receive referrals for large numbers of enrollees. Hospitals in turn have been willing to share some of their capitates revenues with medical groups. Through a “risk-sharing pool,” savings from reduced hospitalization is shared between the hospital and medical group, enabling physicians in the group to earn more than they would if they were in independent or small-group practices.
3. What are the economies of scale associated with larger medical groups?
Larger groups have lower per-unit costs and are better able to spread certain fixed costs over a larger number of physicians than smaller groups. The costs of running an office and computerized information systems do not increase proportionately as the number of physicians increase. Larger group practices are also able to receive volume discounts on supplies and negotiate lower rentals on leases. In addition, “informational” economies of scale provide large groups with a competitive advantage over small or independent practices. Patients have difficulty getting information on the quality of physicians, their fees, their accessibility, and how they relate to their patients. Being a member of a medical group conveys information to patients regarding the quality of its members; it is equivalent to a brand name for physicians in that group. This is particularly important to a physician entering a market and trying to develop a reputation and build a practice. The reputation of the group is more important to the patient for specialist services that are used less often and are more difficult to evaluate. Multispecialty groups offer greater informational economies of scale than do groups comprised of family practitioners.