Editor's Note: In the post below, Uwe Reinhardt proposes to move from the present, price-discriminatory system of private-sector pricing of health services toward an all-payer system that could serve as a transition to an eventual system based on bundled payments per episode of illness for acute care, or capitation for chronic care.

In a response to Reinhardt’s post, Paul Ginsburg suggests that an all-payer system could apply pressure on providers to contain costs in a “far less radical” manner than the public plan proposed by many advocates of health reform. Ginsburg discusses the success of Maryland’s all-payer system. For a thorough discussion of the Maryland’s regulatory scheme and its results, look for the article by Robert Murray, chair of the Maryland Health Services Cost Review Commission, in the Sept/Oct issue of Health Affairs, to be released Sept. 9.

In my capacity as chair of Gov. Jon Corzine’s New Jersey Commission on Rationalizing Health Care Resources, I had asked two major private health insurers what they actually paid different hospitals for a number of fairly standard medical procedures. The tables reproduced at the bottom of this blog posting exhibit their responses.

These remarkable data should raise two questions in the minds of health reformers. First, what is actually meant by “a level playing field” between the proposed public health plan and private health plans, when there are much larger variations of payment levels within the private sector than there are between the public health programs (Medicare and Medicaid) and the private sector?

Second, should a reformed U.S. health system go forward with this bizarre set of private-sector prices – prices that do not seem to be rooted in relative costs or any other factor besides pure bargaining power among different insurers?

In this commentary I propose a way of simplifying the pricing of health care in the private sector in a way that should (1) substantially reduce the administrative cost of health insurance and (2) also be much more transparent and understandable to all parties in health care, especially in a competitive environment.

The Proposal

Basically, my proposal is to move our health system to a common relative value platform, for at least physicians and hospitals, to be used as a platform for charging all patients. For starters, one could use the diagnosis-related groups (DRGs) and resource-based relative value scale (RBRVS) now used by Medicare as the first-stage relative value scales, which could be refined over time on the basis of either cost or imputed value.

If price competition among providers were desired, one would allow each individual provider to set their own monetary conversion factor for their relative value scale and compete on that simple, one-dimensional price indicator. Employers, insurers, and patients all would be able to understand this price indicator. It would replace the 20,000 or so itemized “charges” (list prices) now in each hospital’s charge master, and the 9,000 or so prices in the physicians’ fee schedule.

One could also, however, have these conversion factors negotiated between associations of providers and associations of insurers with a region (e.g. a state) and make them binding on all providers and insurers in the region, as is now done in some European countries – notably Germany – which operate all-payer systems within regions.

Thus, to do away with the unwieldy and unseemly price discrimination now prevalent in American health care, a physician or a hospital would charge all insurance carriers or patients the same price for identical procedures. The system would work best if there were not a large number of uninsured people and if the public insurance programs – Medicare, Medicaid, and the Children’s Health Insurance Program, or CHIP – were part of the arrangement.

Rationale

Former Centers for Medicare and Medicaid Services (CMS) administrator Tom Scully described Medicare as a “dumb price fixer.” Perhaps so. One would be hard put, however, to defend the current bizarre private-sector price system that produces data such as those shown in the tables as any less dumb. Dumber might be the more appropriate word.

In their Redefining Health Care (2006), Michael E. Porter and Elizabeth Olmsted Teisberg have remarked on this issue:

Within the private sector, patients enrolled in large health plans are perversely subsidized by members of smaller groups, the uninsured and out-of-network patients. . . . This administrative complexity of dealing with multiple prices adds costs with no benefit. The dysfunctional competition that has been created by price discrimination far outweighs any short-term advantages individual system participants gain from it, even for those participants who currently enjoy the biggest discounts. The lesson is simple: skewed incentives motivate activities that push costs higher. All these incentives and distortions reinforce zero-sum competition and work against value creation (p.66).

The “zero-sum” competition among payers referred to by the authors is a massive and endless game of cost shifting among private payers. It is an expensive game, because every insurer must negotiate these price-discriminatory prices with every provider every year. That administrative expense, which, as Porter and Teisberg note, is unlikely to yield social benefits, could be avoided with a move to the system I propose here – one, incidentally, I had proposed as early as 1993.

Bundled Payments As An Alternative

In the current debate on health reform, payment reform has come to mean “evidence-based case reimbursement,” a term used by the think tank PROMETHEUS Payment Inc., which is now experimenting with this approach. A more popular term is simply “bundled payments.”

Bundled payments are a great idea. One would hope that, ultimately, most standard, acute episodes of care will be paid for on that basis, along with capitation for chronically ill Americans and some fee-for-service payment for nonstandard cases.

However, rummaging around the Web site of PROMETHEUS Payment Inc. should convince anyone that a wholesale move of the American health care system from the current fee-for-service system to one of bundled payments and capitation will be a long and hard-fought campaign. Not only does it raise a whole host of technical problems of how to calculate the proper bundled payments without incorporating in them an incentive to underserve patients, but it also would trigger vast redistributions of economic and professional power among the providers of health care.

The Advantage Of An Intermediary Step

The scheme proposed here should be thought of as a transition toward bundled payments, but one whose components are in place now. Nothing new needs to be invented. It could be fairly quickly initiated – certainly much, much sooner than a full-fledged system of bundling.

Of course, moving from the current system to the alternative proposed here should be phased in over, say, 4 to 5 years, just as was done with the DRGs in the 1980s and the Medicare physician fee schedule in the 1990s. Once the system is in place, it could be the platform for moving towards bundled payments. Most hospital episodes would already be bundled substantially though the DRG system. From there it would be relatively easier to incorporate convalescent care or, say, the mainly hospital-based services of radiologists, anesthesiologists, and pathologists. There is no reason to think that the DRG system would stand in the way of further bundling, once the mechanics and politics of it had been worked out. Nor would the scheme proposed here stand in the way of bundling payments for those services that could now be bundled or to apply that method in settings hospitable to it.