McKinsey Study Explains Why Americans Pay More For Health Care

The December 2008 issue of the McKinsey Quarterly includes an in-depth look at the hows and whys of spending on health care in the U.S. A related report by the McKinsey Global Institute, "Accounting for the cost of U.S. health care," provides additional details. McKinsey's research indicates that the United States spends $650 billion more on health care than might be expected given the country’s wealth and the experience of comparable members of the Organisation for Economic Co-operation and Development (OECD). The research also pinpoints where that extra spending goes. Roughly two-thirds of it pays for outpatient care, including visits to physicians, same-day hospital treatment, and emergency-room care. The next-largest contributors to the extra spending are drugs and administration and insurance.

Are we paying so much more because our people are less healthy than those of other countries? McKinsey's research indicates that the answer is no. While lifestyle-induced diseases, such as obesity, are on the rise in the United States, the most common diseases are, on average, slightly less prevalent there than in peer OECD members. The factors contributing to the lower disease rates include the relatively younger (and therefore less disease-prone) population of the United States, as well as the low prevalence of smoking-related problems. Factoring in the average cost of treatment for each disease, researchers still find that the relative health of the US population does not account for the higher cost of health care.

McKinsey proposes a framework for reform. For health care reform to generate lasting improvements in cost, quality, access, and equity, it must effectively address demand, supply, and payment (intermediation).

Demand
In the Unite States, the “average” consumer of health care pays for only 12 percent of its total cost directly out of pocket (down from 47 percent in 1960), as well as for 25 percent of health care insurance premiums, a share that has stayed relatively constant for the last decade. Well-insured patients who bear little, if any, of the cost of their treatment have no incentive to be value-conscious health care consumers. Moreover, even if they wanted to be value conscious, they don’t know enough. Despite recent efforts to expand consumer access to information on health care, its cost and quality remain opaque—arguably more so than in any other consumer industry. Consumers also know vastly less than providers do and therefore understandably rely on the advice and guidance of physicians. If Americans are to become more value-conscious consumers of health care, reformers must therefore determine how to create an appropriate level of price sensitivity and to give patients the right information, decision tools, and incentives.

Supply
In many industries, such as consumer electronics, innovation tends to drive down prices. The opposite is true in health care, where lower prices don’t necessarily boost sales and may even create the perception of low quality. Instead, innovation tends to focus on the development of increasingly more expensive products and techniques. High-priced technologies, from imaging to
surgical equipment, also mean higher reimbursements for providers, who therefore demand cutting-edge products. So what emerges is a constant cycle of cost inflation along the entire health care value chain—from manufacturers of health products to equipment manufacturers to physicians to hospitals to payers and, ultimately, to employers and patients. At each step, the
stakeholders absorb part of the cost increase and attempt to pass an even larger one onto the next stakeholder. Reformers must determine how to address this cost inflation cycle while retaining the beneficial aspects of innovation.

Intermediation
Medicare and many commercial payers base their reimbursements for inpatient care on episodes or diagnosis-related groups (DRGs). This forces providers to bear part of the risk of treating a patient and largely creates incentives to use resources efficiently. But fee-for-service reimbursement, the predominant method in outpatient treatment, does not have that effect and
actually gives providers strong financial incentives to provide more (and more costly) care, not more value. Fear of malpractice suits boosts care volumes too. Reformers therefore need to develop more effective financing and payment approaches ensuring that care providers have the right incentives to give patients an appropriate type and amount of care.

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