President's Page July 2003

Robert W. Haley, MD

The Train Wreck in Medicare
Perverse incentives drive us toward disaster

Reeling from Medicare’s 5.4 percent cut in physicians’ reimbursement rates in 2002, we all breathed a sigh of relief when Congress, under the leadership of Texas Senator Kay Bailey Hutchison, voted to eliminate the further 4.4 percent rate cut for 2003. Only days later, however, Tom Scully, administrator of the Centers for Medicare and Medicaid Services, confided at a meeting with Dallas physicians that another 5 percent cut soon will be announced for the 2004 Medicare budget, and this time relief is unlikely. The news from the recent Texas Legislature was no better. To balance the ailing budget, state lawmakers further cut physician and hospital reimbursement rates under Medicaid, while also cutting deeply into patient eligibility. What’s happening?

These are the first screeching sounds of wheels sliding on a track in a slow-motion train crash. For years train watchers have been predicting trouble as the amount spent on health care accelerated faster than the gross domestic product. Lawmakers have been trying to slow the train by cutting costs (eg, cutting reimbursement rates, establishing low-cost drug formularies) and by constraining utilization (eg, reviewing necessity, managing care, reducing eligibility for coverage). But the train has continued to pick up speed.

As we come around the last bend, we can make out a large, solid object on the track ahead. The object is the total annual expenditure on health care—a large pie in an increasingly hardening shell that prevents it from growing more than a few percentage points a year. The pie has slices for hospital expenditures, payments to physicians, nursing home revenues, money for pharmaceuticals and medical devices, and a miscellaneous piece.

Inside the engine of our accelerating locomotive, we find a set of perverse economic incentives pressing on the throttle. The system of third-party payment, developed to spread an individual’s healthcare bills across the entire workforce and tax base, has created incentives for patients to want more and more care, for physicians and hospitals to deliver and prescribe more, for pharmaceutical companies and device manufacturers to develop and market more, for insurance companies to cherry-pick more, for voters to ask Congress to buy them more—all regardless of the costs and the relative impact on health.

As these perverse incentives drove expenditures, corporations found their profits withering under rising health insurance premiums. They whittled away at health plans, embraced managed care gimmicks, and attacked the positive image of the medical profession over medical errors. Because these measures did not affect the perverse economic incentives propelling the train, they had little real impact. But as long as the economy was strong, the pie grew rapidly enough for all the slices to expand with relatively minor distortions at the edges.

Then the train came around that last turn, which resulted partly from the present downturn of the economy but more from the long-term change in demographics—the aging of the babyboomer population bulge. We are seeing corporations and voters lobbying hard for Congress to reduce their tax burdens by curtailing healthcare spending growth. As the babyboomers retire, the smaller workforce will become more and more vocal to constrain it, or even reverse it.

Anticipating the impact, pharmaceutical companies have immunized themselves against constraints on growth by bringing out new drugs with greater efficacy and fewer side effects, advertising directly to consumers, and spending furiously on drug reps and political contributions. Device manufacturers have developed higher tech medical devices and more dazzling patient comforts. Patients now come to their physicians demanding prescriptions for the “purple pill” advertised on TV or a motorized wheel-chair like their neighbor has. To keep their patients’ business, physicians write the prescriptions. In some instances, physicians’ income directly depends on the volume of drugs and devices prescribed.

The result is that the slice of the pie for the pharmaceuticals and device manufacturers continues growing relentlessly. At the end of the year, Congress finds the Medicare pie growing too quickly. With no statutory authority to constrain the pharmaceuticals and devices prescribed by physicians, Congress’ only option is to cut physicians’ reimbursement rates. Recent experience has shown, however, that when physicians’ rates drop, physicians make up the lost income by seeing more patients. This results in more prescribing of expensive drugs and devices, and the cycle accelerates.

This is why physicians will sustain another 5 percent cut in Medicare reimbursement rates next year…and probably the year after that. When asked what physicians can do, CMS Administrator Scully replied to the effect that there’s no national will for the needed overhaul of Medicare, so maybe we’re just going to have a disaster before things can get better—the train wreck.

Next month I will discuss a possible solution, a way to redirect the incentives from perverse to responsible so the system will control itself.

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