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De facto South Dakota healthcare reform: an emerging "managed competition model."

When healthcare experts gather in Pierre on July 13 and 14 to participate in Governor Mickelson's "Summer Healthcare Reform Conference" they may observe that at least three significant developments in recent months have signaled that the "healthcare reform train" has already left the station; that it is being driven by an uncommon fuel in the healthcare marketplace: price information; and, its destination appears to be a "managed competition model". The purpose of this article is to identify and comment upon the three developments and to propose a four-step plan that may allow South Dakota to respond to the healthcare cost crisis in a manner consistent with the State's aversion to governmental regulation.

The three marketplace developments are:

1) The quasi-public disclosure by Sioux Valley Hospital of its 1990 Medicare "average charges" in comparison to those of intra-city rival McKennan Hospital and 10 regional hospitals located in South Dakota, Iowa, Minnesota and Nebraska. The disclosure was the subject of an article in the March issue of this periodical and the May 11 issue of the national healthcare trade journal Modern Health Care. The Rapid City Journal published the display of comparable hospital "prices" with an emphasis on Rapid City Regional Hospital being the lowest cost hospital among the twelve. The Associated Press wire service picked up the story which in turn was published in the Sioux Falls Argus Leader and Sioux City Journal.

2) The construction of the new Central Plains Clinic in Sioux Falls which contains the capacity to provide diagnostic and treatment services generally provided by community hospitals. This follows the national trend of physician-directed clinics and ambulatory care centers reaping the "facility" fees heretofore traditionally paid to hospitals.

3) The issuance of a request for proposal by the South Dakota Bureau of Personnel seeking a firm or company to establish a "managed care" capability for the purchase of healthcare on behalf of the some 20,000 persons covered by the State Employees Benefit Plan. The proposal contains three components: 1) Claims Processing, 2) Managed Care, and 3) Actuarial and Plan Design Service.



A review of the same 1990 Medicare price information used by Sioux Valley Hospital in its regional comparison contains a similar "average charge" comparison for the group of smaller hospitals included in the accompanying table. Charges at the most expensive hospital were reported at a level 96 percent higher than at the least expensive hospital. The disclosure of price and "average charges" information in a comparative format provides hospital trustees, insurers, communities, and patients with a source of data which can facilitate informed purchasing. If such data is published in a regular and predictable manner, as hereinafter suggested in this article, the major cornerstone for a "managed competition" model will be set for South Dakota.



In the authors' opinion, regional physicians will constitute a major force in driving healthcare reform over the next five years. Establishment of the Sioux Falls Surgical Center in 1985 is an illustration of how a physician-owned, for-profit healthcare facility is capable of introducing competition into the marketplace. This competition produced substantial and verifiable reduction in the price for specified procedures. In 1984, during the Certificate of Need process, a community hospital reduced its ambulatory surgery charges by an estimated 45 percent. As a result, both Sioux Falls hospitals currently maintain ambulatory surgery charges at a level comparable to the Sioux Falls Surgical Center. The impact of such competition can be measured by examining the level of ambulatory surgical prices charged by Sioux City's Marian Health Center and St. Luke's Regional Medical Center where there is no competing surgery center.

Competition provided to the Sioux Falls hospitals by the Sioux Falls Surgical Center is likely to impact the prices charged by area hospitals. For example, payers like HMO, DakotaCare and Blue Cross are likely to balk at paying outlying hospitals $2,000 for an arthroscopy procedure that can be performed at a free standing surgery center for $1.300. This suggests that the full-service community hospital may be no match for the leaner and more efficient clinics and ambulatory care facilities.

Minnesota Blue Cross Blue Shield, desirous of using the leverage of emerging competition, has issued its own request for proposal to Sioux Falls cardiac programs. The request is evidence of additional competition in an area that until now has been relatively free of meaningful managed care. A substantial portion of the cardiology services sought by the Minnesota organization can be provided in a clinic setting, outside of the community hospitals. Such pursuit of lower cost, contracted services is likely to act as a catalyst for the expansion by physicians of facilities which will allow them to reap the fees traditionally paid to community hospitals. The installation by Central Plains Clinic of a CT scanner is another indicator of the national trend of services moving from a hospital to a private clinic.



The third development signaling a move toward the "managed competition model" of healthcare delivery--the Bureau of Personnel move toward managed care--will provide an additional impetus toward a price-sensitive marketplace. The Bureau, representing some 20,000 active and retired State employees and their dependents, will bring a coordinated purchasing clout to the marketplace. The State's intent is to transfer its data base from the Boston-based John Hancock Insurance Company to a South Dakota base for use in purchasing health care. Presumably the managed care firm will have both utilization review and contracting capability.



The role of competitive markets in healthcare reform is yet to be determined, but the recent developments in South Dakota described above suggest that the role could be substantial. If competitive markets are successful in promoting efficiency, society at large will be the winner.

Economically efficient provision of a good or service requires that price be appropriately related to costs. Specifying this relationship precisely can be a complex matter and is beyond the scope of this article, but in the simplest case price should be equal to the marginal cost(1) of providing the service. Efficiency also requires that costs be at a minimum. This requirement corresponds to common sense, as non-minimum costs imply resource wastage, and efficiency and waste are incompatible.

Efficiency will be achieved only if there is some mechanism which forces producers to produce at minimum cost, and which enforces appropriate price-cost relationships. One such mechanism is the competitive market. Competitive markets are merciless in penalizing producers which have excessive costs, and competitive markets will not permit prices which are inappropriately related to costs.

For competitive markets to perform it is essential that price information be available to consumers. Without this information the consumer is blind to price, and is as likely to purchase from expensive providers as from anyone else. This permits high price and high cost providers to survive, and the resources consumed in providing health care is larger than it need be. Of course, it is painful to high cost providers to be driven out of the market, but if high cost producers are permitted to survive then it follows that scarce resources are wasted, and few would claim we are so rich as to be able to afford this. Price information can be a powerful ally in rooting out waste and improper pricing practices. Public access to prices charged by hospitals and other health care entities is vital to efficiency in the healthcare industry.

Another element which is essential for good market performance is the ability of new firms to enter the market and provide services in competition with incumbent firms. It is this phenomenon that disciplines errant decisions with an iron hand, and rewards appropriate decisions with equal verve. If prices are above costs, the lure of profit will induce new suppliers into the market, and the increased supply will defeat the price increase. In like manner, if a supplier's costs are excessive, new and more efficient entrants can charge lower prices and survive, driving inefficient producers from the market. To stop entry is to eliminate the very mechanism which enforces efficiency in production and in pricing. Entry is occurring in South Dakota, as described in Section 11 above, and it is to be observed that even the threat of entry can have an effect on prices charged by incumbent firms.

While the applause for recent developments may not be universal, we believe publishing prices is an important move in the right direction. We applaud the innovation shown by entrepreneurial physicians in the establishment of new clinics. We believe that these practices signal greater use of the market in providing health care and that health care can be best delivered to the American people if markets play a significant role in the industry. Properly functioning markets constrain excessive costs and prices inappropriately related to cost more effectively than any known alternative institutional arrangement.



The State of South Dakota, in developing its "comprehensive state plan" as referenced by Governor Mickelson, should examine the feasibility of implementing the following:

STEP ONE: PRICING DATABASE. Establish a healthcare database which will provide a regional equivalent of the data maintained on a national scope by the Johns Hopkins University Center for Hospital, Finance and Management. South Dakota healthcare providers and purchasers should participate in the design of the database and the public portrayal of hospital pricing profiles.

STEP TWO: HEALTHCARE PURCHASING ORGANIZATION. Establish through the cooperation of regional employers and purchasers of health care a "Regional Healthcare Purchasing Organization" which would utilize the database described in Step One. The organization should be private and supported by fees charged to its corporate and individual users. It should have the expertise and capacity to negotiate and contract on behalf of its clients and users.

STEP THREE: DIRECT CONTRACTING. The "Regional Healthcare Purchasing Organization" should have the capacity to encourage and promote "direct contracting" between its clients and the providers of health care.

STEP FOUR: CO-PURCHASER DESIGN/EDUCATION. The "Regional Healthcare Purchasing Organization" should have the capability to assist in the design of benefit plans which properly place employees, insureds, and subscribers in a position of being "informed" co-purchasers of health care. Additionally the organization should assist in providing education to insured groups and individuals regarding the financial aspects of purchasing health care in the region.


Some 24 states have proposed or adopted bills designed to address healthcare cost and access issues. The majority of state efforts to address the cost crisis have increased government spending. The Minnesota program is an example. South Dakota should pursue a plan that utilizes the marketplace to temper the rate of healthcare cost growth. The "managed competition" model is an approach deserving consideration.

[TABULAR DATA OMITTED] (1) Marginal cost is the increase in total cost incurred as a result of expanding output by one unit.

Authors: Michael J. Myers, J.D., is the director of the Department of Health Services Administration at the School of Business, with associate professor appointments to the School of Business and to the School of Law. Prior to joining the USD faculty he served as chief executive officer of Saint Marys Hospital, Rochester, Minnesota and Riverside Medical Center, Minneapolis. Dennis Johnson, Ph.D., is Professor and Chair of the Economics Management Science, Management Science, and MIS Division, School of Business, University of South Dakota, Vermillion, SD.
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Author:Myers, Michael J.; Johnson, Dennis A.
Publication:South Dakota Business Review
Date:Jun 1, 1992
Previous Article:South Dakota hospital price disclosure: implications for the healthcare marketplace.
Next Article:South Dakota personal income update.

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