This Is the End


Markets, Risk and Human Interaction

August 26, 2012

Profit Incentives, Disruptive Technology, and Health Care

Medical care is famously immune to the usual market incentives; the patient has little reason to make a cost-benefit tradeoff. Doctors and hospitals hardly do either; indeed the opposite seems to be the case. Matters are made all the worse, ironically, by the continual improvements in medicine – improvements which often treat what was previously untreatable, and which improve on existing treatments but at a higher cost.

This is particularly true in the case of life threatening illnesses. The use of co-payments for self-rationing is considered unethical if it allows only those with adequate means to survive. Yet if we are to get control of medical costs, we need to find ways to deal with these, for they make up a significant portion of our medical costs. This is even more the case for terminal illnesses and end-of-life treatment, which are a significant component of the exploding health care costs and the related strain on medical entitlements. The cost of medical care in the last year of life due to terminal illness or decline makes up a third of medical costs. Given the increase in medical costs over time, expenditure for end-of-life care is poised to become as high on average as the total cost of medical care for the preceding portion of life.   

Cost Containment through Economic Incentives
In cases of life and death, only the patient can make the decision of when to terminate aggressive care. And right now those decisions are not made on the basis of economics. Here is a proposal to put economic incentives in place; to keep the decision for care firmly in the hands of those receiving it while adding an awareness of the economics of health care into their personal decision process:

  1. Lay out for the patient the possible modes of treatment along with the estimated cost until death if each of those courses of treatment is taken. The cost includes not only the specifics of the treatment, but the associated costs of care. Obviously a treatment that has the patient hanging on for a year in and out of intensive care will cost more in total than one where the patient has nothing more than palliative care and dies in a month or two.
  2. The patient receives a lump sum payment equal to some fraction of what is saved if he or she pursues a course of treatment with a cost lower than the highest cost allowable treatment. The payment can be assigned to their spouse, children or any other designee; this makes sense for the terminally ill, given that they are not going to have much opportunity to enjoy this windfall.
  3. The recipient pays taxes on the payment, so in an indirect way a portion of it is returned to the system. (In this proposal I am primarily thinking of Medicare).

The total savings will be based on the difference between the cost of the alternatives, the fraction of the difference the patient receives adjusted by the tax rate, and the decisions of the patients based on these incentives.

This incentive structure may be easier to understand in the context of terminal illness and end-of-life care because the costs are high, the quality of life is often low, the benefit of various courses of treatment can be more tightly defined than for curable illnesses. And it is here that outside interference in denying quality medical care is most charged. But the same approach conceptually can apply more broadly as well.

Cost Containment through Disruptive Technologies
There is a benefit to the health care system that comes from this sort of incentive structure that over time may be even more important for containing health care costs. As things stand right now, there is a limited prospect for a new, less expensive treatment to be developed if it provides a notably lower probability of success than the standard and more expensive treatment. That is, suppose researchers come up with a new treatment that has a 20% probability of adding six months to the patient's life and that costs 10% as much as the standard treatment, where that standard treatment has a 40% probability of adding six months to the patient's life. (All else equal in terms of side effects, etc.). The new technique may never see the light of day. With no price incentive on the part of the patient, who will pick a 20% success rate when another gives 40%?

But suppose that with this incentive in place the patient or his children might receive half a million dollars from choosing the cheaper approach. There will no doubt be some patients who are willing to take the tradeoff for the benefit of their spouse, children or other designee. Thus this new treatment will be put into the system – assuming the FDA goes along.

This is important because it is a way new, disruptive technology will enter into the medical system. The classic example of disruptive technology entering the system is in the steel industry. As Clayton Christensen has pointed out, mini-mills came to dominate the steel industry by starting in the lowest margin, lowest quality steel product, rebar, and then over time the mini-mill technology advanced, and the mini-mills rode up the quality curve until they absorbed the steel industry at overall savings to the consumers.

As it stands now, there is no equivalent for rebar in the medical field; there is no equivalent for the low quality steel where the disruptive technologies can cut their teeth. No substantially lower cost/lower quality treatment will be taken, or for that matter, permitted. In having the profit motive added to the process, these disruptive technologies can take root. The low quality process that starts off in rebar-land, with half the success rate but half the cost, might over time move up the quality chain to being of an equal success rate at a tenth the cost. Right now some of these technologies might stay funded in the lab until they get to that point, but many will not.