Why Medicare is a crummy business partner

Closeup of Medicare enrollment form and pen by Shutterstock.com

Article Highlights

  • If the Medicare payment reductions stand, it will disrupt providers’ businesses and ultimately impact patient care

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  • These cuts could reverberate across the entire healthcare marketplace, magnifying their impact

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  • By punishing profitability, government actuaries undermine the Medicare program

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Medicare unveiled a series of regulations this month that make annual adjustments to various price schedules that set out what the program pays providers.

The proposals confirm why the agency makes for such a crummy business partner.

The new rates will hit some health care businesses with cuts of as much as 25 percent. If the reductions stand, it will throw some providers over a proverbial cliff, disrupting their businesses and ultimately impacting patient care.

Many private health plans copy Medicare’s payment changes, turning the Medicare prices into a national schedule. As a result, these cuts could reverberate across the entire health care marketplace, magnifying their impact.

How can Medicare adjust its payment schedules so much, so fast, and not expect these abrupt changes to have injurious effects on the marketplace?

In figuring out what compensation providers deserve for taking care of seniors, the Centers for Medicare and Medicaid Services (CMS) seems to work backward by scrutinizing an industry’s profit margins as a way to arrive at the right payment rate.

There’s a view among Medicare’s Baltimore-based bureaucracy that any provider group or health care industry segment that earns something north of a 10 percent profit margin is making too much money. Float above that arbitrary threshold, and the agency will try to whack your profession’s reimbursement rates.

In this way, Medicare’s staffers believe that more profitable segments of the industry can sustain even the most dramatic cuts, so long as some profit margin still remains. But by taking this approach to its payment policies, Medicare undercuts the kinds of innovative delivery changes that are badly needed in health care.

Medicare’s logic doesn’t derive from any particular economic principle. It’s more an expression of political values than finance. Profits are seen as money that could have been spent directly on patient care. Medicare will tolerate some profitability to keep businesses in the market. But if an industry introduces efficiencies or recognizes economies of scale (in turn, growing its margins) such success will invite rate cuts.

There are good reasons why different segments of the health care market often operate at different profit margins. Under normal rules of business, an industry’s margins are closely tied to its cost of capital, the risk inherent in the underlying business, and the returns needed to attract investment in the first place.

One type of health care service provider might have historically wider profit margins for a host of reasons. Many of these reasons tie directly to how much value a particular service is offering to consumers, and to taxpayers.

A business might have wider margins because it has more operating leverage, a scarcity value placed on the services it offers, or it’s simply providing more value to consumers by helping to improve clinical outcomes or moving patients from higher to lower cost settings of care (in the process, capturing the savings they produce).

Not all medical services are the same. By focusing almost exclusively on the profit margins earned by different provider segments as a way to scrutinize the appropriateness of different reimbursement rates, Medicare tramples on these financial norms. It discourages investment in new or higher risk endeavors.

This is one of the reasons why investors have almost completely shunned new facility-based start-ups that do their primary business with the Medicare program. Investors are often choosing instead to put money behind healthcare service endeavors that don’t cater to Medicare eligible populations, or endeavors that don’t require huge outlays of capital, like healthcare IT.

Among the providers hardest hit by Medicare’s latest rate cuts: Radiation oncology providers will see their reimbursement cut an average of 5 percent, while independent pathology labs get a whopping 26 percent reduction. Radiation therapy centers also saw a large reduction of 13 percent, while dialysis providers will see a net cut of 9.5 percent.

These cuts will mostly affect doctors working in outpatient medical facilities. That was the point. Medicare was peeved that some services were better paid when they were performed outside hospitals. In the end, these latest changes will create another powerful economic incentive for freestanding medical practices to sell out to hospitals, driving up costs to the entire system.

CMS is making these abrupt cuts under a new Obamacare authority that enables the agency to “adjust” any “mis-valued” codes. The standard for “mis-valued” is poorly defined, of course. The construct gives CMS broad discretion to tinker with different payment rates. It will add to marketplace uncertainty for years to come.

Most of the cuts that the agency announced this month will get phased in. Some won’t stand up to political scrutiny, simply because they are so dramatic, arbitrary, and severe. But it reinforces why Medicare’s payment process shouldn’t be trusted, and why the program makes for such a bad partner to the businesses that service it.

It’s hard to defend the agency’s current practices and how it arrives at its existing payment levels. The process deserves revision. The complex formulas Medicare uses are rife with opportunities for abuse and waste. But it’s equally hard to defend the agency’s abrupt shifts and whimsical standards for how it goes about changing those payment rules and disrupting established industries and market expectations.

Medicare’s focus on profit margins as a way to “balance” reimbursement rates across different provider segments, in the end, undermines the very goals that the agency’s stewards purport to encourage – innovation in the delivery of medical care that creates more value for patients, and for taxpayers.

In their top-down rate setting process, Medicare would do well to come up with more precise measures of value that don’t rely on a cost-plus approach or on crude comparisons between the overall profitability of disparate services. Medicare would do better by crafting tools that measure how much value beneficiaries derive from different services, or get out of the rate setting business altogether and rely more on survey tools to estimate prevailing payment levels in what remains of the private market (the part of the market that doesn’t already peg its own rates to Medicare).

This is the problem with administered pricing, where the rates are determined by the machinations of a remote agency. Devising prices for the thousands of different medical services that Medicare covers requires some kind of simplified regime. The easiest method is to work backward off an arbitrary measure of profits rather than more unformulated measures of relative the risk, value, and the innovation inherent in different endeavors (or value that they return to consumers).

By punishing profitability, government actuaries undermine the program. If new businesses that successfully lower the cost of care or improve outcomes can’t capture the value they deliver in the form of higher returns on invested capital, then entrepreneurs will simply take their energy to different endeavors.

Of course, the Medicare agency probably believes that their new “Innovation Center” and challenge grants can fill the ensuing void. Real innovations in how medical care is delivered are unlikely to germinate in Washington. If these models are doing business with Medicare, they’re also unlikely to be rewarded in the marketplace.



Dr. Gottlieb consults with and invests in healthcare services companies.

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