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How orthodox managed care stifles innovation. (Part 1: Global Theory and the Nature of Risk).


* The Vacuum or New Ideas in Managed Care

* Recycled Orthodox Concepts

* Global Theory and the Nature of Risk

* Integrated Episodes of Care

* Bifurcated Risk Markets

* Time Compression

NATURE ABHORS A vacuum And as we speak, a vacuum of ideas is dragging managed care Into a whirling vortex of recycled ideas, rehashed techniques, and shopworn policies. Except for those In a state of total denial, most informed observers of managed care today will, in public, cautiously admit that the industry is in trouble. Privately, caution evaporates, and people freely acknowledge that it's in big trouble. In some circles, something akin to panic is taking hold, especially when considering the gathering momentum for invigorated federal intervention. Yet despite the obvious and accelerating implosion of orthodox managed care, few are proposing a complete reevaluation of what managed care" means--in short, the system suffers from the want of an alternative theory.

Recognizing a certain gravitas in the air, health care publications are naturally beginning to ask various experts what they see lurking around the corner, Is this the end of managed care? If so, what will replace it? Surveying some of these responses in the 1999 January/February issue of The growing awareness that managed care is rapidly unraveling has not only produced a good deal of alarm, but also a call for prognostications regarding the future. Unfortunately, old habits die hard, and wedded ideologies die even harder. Instead of paving the way for innovation, most managed care pundits refuse to read the tea leaves properly and acknowledge that the orthodox regime is irretrievably comatose. Not understanding the fundamental flaws inherent in the old model, many persevere with rehashed predictions that only echo the very non-starters that got us in the present jam in the first place. Managed care has so far focused its energies on integrating the wrong objects, insurance and care, with all the predictably bad effects. Part 2 of this article will explore what this means and introduce the global theory of managed care as an alternative vision. Global theory lays a new foundation based on a more sound microeconomic model of risk, bifurcated markets, global fees for integrated episodes of care, and most important of all, patient/physician sovereignty.

The Physician Executive--whose theme was: "Beyond Managed Care...The New Millennium Landscape"--I found many of the comments to be insightful and well grounded. But some appeared to be suffering from the same malady that afflicts the industry as a whole: namely, that in the act of looking ahead, we seem to be intent on gazing through the rear view mirror. Allow me to illustrate what I mean.

The hegemony of orthodox managed care

Nearly 27 years ago, the HMO Act of 1973 was passed. The concept of the HMO was based on the idea, according to Paul Ellwood, that health care companies could "compete on the basis of price and quality [by combining health] insurance with health care in a single organization. Since then, this peculiar economic philosophy of health care reform has come to permeate all levels of the American polity, in both the public and private sectors, ultimately reaching its zenith in the Clinton Administration's thwarted Health Care Act of 1993.

It essentially argues that by integrating" health insurance with health care, organizations can wrap themselves around corralled populations of covered lives, and be held accountable for their health outcomes. In its fullest sense, this philosophy manifests itself as a Kaiser Permanente; in its weaker incarnations, we see It as capitation and population management. Either way, It has become a widespread and rigid orthodoxy. And like an old vinyl record with a scratch, it's trapped the national dialogue in a continuously repeating groove.

Recycled orthodox theme 1: quality and outcomes

For instance, Ellwood and others expressly made quality and outcomes measurement the hallmark of the new paradigm 25 years ago. And as a recurring prophetic theme, it has enjoyed yearly overtures. Consequently, I often find myself wondering: How many more times will we hear that the next and newest "paradigm" of managed care evolution will be quality and outcomes competition? Managed care has failed to produce one widely accepted and replicable metric of outcomes measurement having to do with the clinical content of care and its price. Still, this familiar orthodox refrain continues to be sung. Here's one example:

"The next big movement will be to hone in on outcomes and measurement. This will be the path to increasing the inherent value of the medical care system. This will go hand in hand with accountability, which is where physician-sponsored networks will be an indispensable tool...The first step is to center the PSN-payer partnership around best practices--critical pathways, specifications of acceptable care, or whatever appellation one chooses to use.

But isn't this precisely the claim managed care organizations have been making for well over a decade now? In that time dozens of companies from United Healthcare to Milliman & Robertson have expended prodigious sums of money and time producing thousands of "best practice" guidelines and protocols. Even the federal government briefly got into the act when it founded the Agency for Health Care Policy and Research (AHCPR). The result? Most of them are sitting on shelves or computer discs collecting the equivalent of quantum dust. Susan Horn states the matter succinctly:

"Most of the effort to develop guidelines is characterized by two weaknesses that hamper their relevance to local practice reform:

1. guidelines are developed nationally or centrally, based on expert consensus and literature review! synthesis; and

2. guidelines are too general or inconclusive to be useful to clinicians.

Thus, clinicians are unwilling to follow many current guidelines."

It is true that there are some health systems making good use of guidelines as metrics to report their outcomes in the delivery of care. But their use as a means of purchasing health care will continue to play an ineffective role unless managed care begins to learn how competitive price systems actually function in every other legitimate marketplace. More on this later.

Recycled orthodox theme 2: PSO/PSNs

Perhaps the response is, yes, that's true, but they weren't generated by provider organizations. When providers start forming integrated systems (so-called PSO/PSNs), you may say, then it will occur. But once again, this is also old hat. Almost six years ago, writing in an article entitled, "The New World of Managed Care: Creating Organized Delivery Systems," Steven Shortell et al concluded that providers would integrate into new delivery systems that would combine insurance and health services. Each of these integrated delivery systems would then be held clinically and fiscally accountable "for a defined population." Anticipating the integrated delivery system (IDS) rage, Shortell and his colleagues predicted that the "new" managed care economics would be dominated by a demand for "value," which they defined as "being able to provide additional quality enhancing features that purchasers desire for a given price."

But even as Shortell was writing, the evidence was mounting that IDSs would not work, regardless of who sponsors" their formation. Commenting on IDS performance in a July, 1997 issue of Medical Network Strategy Report, Jeff Goldsmith reported:

"Many nationally prominent integrated systems are performing terribly along every dimension of performance that you can think of--earnings, customer satisfaction, productivity, morale...Their theories about what would happen once they reached a certain mass or scale are not proving valid."

Strangely enough, with IDSs performing miserably across the land, the closed-panel HMO model breathing its last gasp, and physician practice management companies (PPMCs) moribund, many are still assuring us that these systematic failures will be corrected when physicians "sponsor" their formations. But as we shall see, it makes no difference whether physicians or hospitals sponsor vertical integration, capitated population management is inherently inefficient and is economically incapable of generating usable outcomes information.

Solon in 1967. Since then, a rather significant body of scientific literature has accumulated building upon his pioneering work, the most famous of which was the RAND Health Insurance Experiment. In a chapter from my new book on global theory and episodes, Michael Pine, MD, and I have summarized the literature and updated Solon's definition. An episode of care is:

"The complete, self-contained sequence of medical interactions between a patient and provider(s) of health care services in pursuit of a defined clinical objective over a specified period of time."

Or, as Mark Hornbrook and colleagues put it in their definitive paper on episodes in 1985: "A health care episode is a higher-order concept that deals with all reasons for contact with the health care system. As such, episodes of care form the key economic concept for defining the products of health care.

At this juncture, we can make an important observation: Technical risk is fundamentally different from probability risk. In the first place, it's priced in a radically different way. Since probability risk is about pricing uncertain future events, it's primarily a statistical artifact, which makes it the productive domain of actuaries. Technical risk, on the other hand, is about pricing clinically integrated episodes of care, which makes it the productive domain of physicians. In the second place, and this really follows from the first, the business logic of health insurance is categorically different from the business logic of health care. They're like oil and water, or, if you please, two cooks in the kitchen: the conflicting incentives mean that one must eventually dominate over the other. A capitated house is a house divided, as the experiences of FHP, Humana, Harvard Pilgrim Health Care, and Kaiser Permanente amply demonstrate.

Third and last, technical risk is sold in a different market than the ex ante market for insurance. It's sold at the point of service, after demand for medical care has become certain. This is known as the ex post marketplace [ex post is Latin for "from after (the fact) "I, where medical services--as opposed to insurance--are transacted because a patient now requires care. Until the industry learns how to bifurcate these two types of risk into the specialized ex ante and ex post risk markets, the economics of managed care will continue to fail.

3. Choice-utility risk

All consumers face choice-utility risk when they trade off dollars in exchange for some good or service, and the uncertainty that the sacrifice in costs will not satisfy their expectations. Economists often refer to satisfaction as "consumer surplus" or the level of utility consumers perceive over and above the sensed sacrifice of the purchase. Because there is an information asymmetry between buyer and seller, and buyers seek value for their dollars, markets put tremendous pressure on producers to make the case for their products.

The demand for information is so strong, and consumers are often so out of their league when it comes to technically judging the quality of the products they buy (cars, computers, homes, stereos, etc.) that secondary markets for information frequently evolve to meet that demand. Consumer Reports and Underwriters Laboratory are good examples of suppliers acting in secondary markets. And this is where orthodox managed care stumbles: people seek information for discrete products when they need them, never when they don't need them.

Except in the cases where people already know they are sick (and this produces all kinds of adverse selection problems), it is not possible for people to effectively shop health care when they shop health insurance plans. Unless the quality and outcomes movement transposes itself onto the ex post marketplace, where patients really need it, little of substance will be accomplished. This is why health plan "report cards" are, for the most part, a waste of time. For a discussion about choice-utility risk, please see "Choice-Utility Risk and Orthodoxy's Great Economic Non Sequitur" on page 40.


Probability risk, technical risk, and choice-utility risk constitute very real market forces, and the managed care industry ignores them at its peril. The reality of the ex ante and ex post marketplaces, and the public will for choice in both markets, explains the tidal forces now ripping to shreds traditional managed care structures. It also explains why PPOs, point-of service plans, and open-access plans are now the only managed insurance products experiencing profitable growth. If the managed care industry wants to resuscitate itself, it must come to understand that it is impossible to efficiently purchase health care through health insurance. Managed care has so far focused its energies on integrating the wrong objects, insurance and care, with all the predictably bad effects. In Part 2, we'll discuss what this means, and introduce an alternative vision for managed care.



(1.) Kelley, T. An Interview with Paul Ellwood Jr. MD, Managed Care, November 1997, 53-67.

(2.) van Amerongen, D. The Next Stage of Managed Care, The Physician Executive, 25(1) (January/February 1999). pp. 28-32.

(3.) Horn, S.D. Introduction: Overview of Clinical Practice Improvement, In ed., Horn, S.D., Clinical Practice Improvement Methodology: Implementation and Evaluation. New York, New York: Faulkner and Gray, i997, 1-11.

(4.) Shortell, S.M., Gillies, R.R., and Anderson, D.A. The New World of Managed Care: Creating Organized Delivery Systems, Health Affairs, (Winter 1994), pp.46-63.

(5.) Emery, D.W., Fawson, C., and Herzberg, R.Q. The Political Economy of Capitated Managed Care. The American Journal of Managed Care, 3(3) 1997. pp. 397-416.

(6.) Coile, R.C. Challenges for Physician Executives in the Millennium Marketplace. The Physician Executive, 25(1) (January/February 1999), pp. 8-13.

(7.) Wehrwein. P. The March of Capitation: Reversed or Just Delayed? Managed Care, November. 1997. pp. 29-35.

(8.) Simon. C.J., and Emmons, D.W. Physician Earnings at Risk: An Examination of Capitated Contracts. Health Affairs. 16(3) 1997, pp. 120-126.

(9.) "The 1997 State of the Union Address," Health Care Advisory Board. Washington, DC. 1998. pp. 31, Figure SU-117. The same study also shows no advantage to system capitation, see pp. 35, Figure SU-119.

(10.) Goldener. J. Twenty Steps to Survive Managed Care. The Physician Executive, 25(1) (January/February 1999), pp. 46-52.

(11.) Beckham, J.D. The Beginning of the End ofHMOs, Part 1: The Awakening Market. The Healthcare Forum Journal. 40(6) (November/December 1997).

(12.) Freudenheim, M. Baby Boomers Force New Rules on HMOs, The New York Times. November 26. 1997. Sec. A1.

(13.) Lohr, K.N., et al. Use of Medical Care in the Rand Health Insurance Experiment Diagnosis- and Service-Specific Analyses in a Randomized Controlled Trial, Medical Care. 24(9. suppl) 1986. S1-S87.

(14.) Emery, D.W., and Pine, M. Episodes of Care: The Scope and Sequence of Medical Reality, in ed, Emery, D.W., Global Fees for Episodes of Care: New Approaches to Healthcare Financing. Chicago. IL: McGraw-Hill. 1999, 27-60.

(15.) Hornbrook, M.C., Hurtado. A.V., and Johnson, R.E. Health Care Episodes: Definition, Measurement and Use, Medical Care Review. 42(2) (Fall 1985). pp. 163-218.

(16.) Bodenheimer, T., et al. How Large Employers are Shaping the Health Care Marketplace. New England Journal of Medicine. 1998, 338(14, 15). pp. 1003-1007. 1084-1087.

RELATED ARTICLE: Choice-utility risk and orthodoxy's great economic non sequitur

Technical risk and probability risk describe the kinds of risk appropriate to health plans and health providers respectively, but that still leaves consumers off the hook. And this is where choice-utility risk enters the picture. It Is the risk all consumers face when they make a choice to purchase goods and services When we buy a car or a house or a pair of shoes, there's always the risk that the utility we hope to derive from the purchase won't meet our expectations.

For most people, who work hard for their money this means they also want value for their money As a consequence, this expectation of value for money coupled with the fact that most people live with pretty tight budgets, disciplines the marketplace and forces producers to provide quality in return for profits. By essentially making health care free at the point of service, both traditional indemnity insurance and managed care absolved patients of their reasonable share of cost and risk, and therefore placed them in an economically riskless environment not unlike that of fee-for-service providers.

Orthodoxy assumed that this could be rectified by introducing choice-utility risk in a manner whereby people and businesses would shop competing HMOs on the basis of price and quality. That is, choice-utility risk was to be injected only into the ex ante marketplace for health insurance. But Cs precisely here that the concept defies economic logic and fails apart it's impossible to efficiently purchase discrete medical goods and services through an insurance mechanism. Why?

Among other things, it's a time problem: People do not buy for future, contingent needs--we buy what we need when we need it. If I enter the ex ante market today to purchase health insurance, then the only product I'm buying is what I need right now--health insurance. And the only economic good being sold through insurance is the peace of mind that my financial estate is secure from costly medical events. I can't at the same time shop for the hundreds of complex health care products I may come to need tomorrow or next year or next decade. it's entirely conceivable that I may buy health insurance today and go without a major medical need for years--and wouldn't that be wonderful? Who wants a quadruple bypass operation f you don't need it? But my point is, if one carefully canvasses all the retail markets all around us, one is hard-pressed to find masses of people anxiously shopping future needs they dread having. You just don't see it.

Consider the top figure in the accompanying graphic that represents the orthodox model of managed care in light of how we interact in every other marketplace. In no instance do ordinary people purchase huge bundles of heterogeneous goods and services in one compressed purchasing moment for demands they may or may not need that may or may not occur for years or even decades into the future. As the bottom figure shows, people shop their real needs in real time. And that necessarily entails choice at the point of service. We can't ask people to choose their health care when they choose their health insurance. As we've already seen with consumer dissatisfaction relative to choice in managed care, it's bound to make them very unhappy.

This, then, is orthodox managed care's great economic non sequitur--that it's possible to compress all of a man or a woman's medical lifetime needs into one purchasing moment. The attempt to integrate health insurance with health care is, in reality an attempt to integrate today with tomorrow So here are two paramount questions the advocates of orthodoxy must puzzle out: Is managed care so powerful that it can abolish the Arrow of Time? And, did anybody ever stop to ask the American people if this is what they really want from managed care; for example, cradle-to-grave "intergration"? The answer to both questions is, I think, no.

Now we have the beginnings of an explanation as to why outcomes and satisfaction scores are performing so badly As Thomas Bodenheimer, MD, and Kip Sullivan, JD, articulated in a piece for the New England Journal of Medicine:

Consumers are baffled by report cards on large health plans...[R]eport cards on care systems likewise fail to provide consumers with what they really want: information on individual clinics or physicians. One consumer surveyed about report cards bluntly said, "Quality is how good your doctor is...not any of this other stuff."

Once again, taking stock of every other type of marketplace, we should ask ourselves: Is this how consumers normally shop for information on their needs? The answer, again, is no. This leads me to conclude that we need to search for a more advanced solution.

Douglas W. Emery, MS, is President of Zoadigm Health Systems. Inc., a health care consulting firm in Salt Lake City, Utah. He serves as a Research Fellow at the Institute of Political Economy at Utah State University His newly released Global Fees for Episodes of Care: New Approaches to Healthcare Financing is part of the Healthcare Financial Management Association 's book series on financial management. He can be reached by calling 801/495-0601 or via email at
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Author:Emery, Douglas W.
Publication:Physician Executive
Geographic Code:1USA
Date:May 1, 1999
Previous Article:Equity, equity, that's our cry: an interview with J.D. Kleinke. (Physician-Hospital Partnerships).
Next Article:The promise and perils of evidence-based medicine. (Part 1: Health Care Trends).

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