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What Mckinsey Could Teach Obama

Members of Congress who hold the balance of power, including Senate Finance Committee chair Max Baucus and the Blue Dogs in the House, have concluded that the health care proposals emerging from committee up to now would do too little to control costs. The next phase of deliberation and bargaining will revolve around strategies for reining in costs without reducing the quality of treatment or the pace of innovation in the health care sector.

Last December, McKinsey & Company published a comprehensive comparison of U.S. health care spending with that of other OECD countries. The report’s findings could help guide the quest for cost containment that can pass both policy and political muster. Here are some of the highlights:

  • In 2006, the United States spent nearly $650 billion more on health care (more than $2,000 per capita) than did comparable OECD countries, even after differences in per capita income are taken into account.
  • Despite this level of spending, key health outcomes in the United States lag behind those of other advanced countries. In particular, the United States is below the OECD average in longevity and above average in infant mortality--disparities that remain even when we look only at white Americans.
  • Contrary to popular belief, Americans are not sicker than the populations of other OECD countries. In most major categories, the prevalence of disease in the United States is significantly below that of other industrialized nations. (Diabetes is the only notable exception.) Because we smoke much less than our peer nations, the incidence of smoking-related diseases is far lower.
  • Much of the spending gap is attributable to the soaring use of out-patient services, which generate much higher profit margins than do hospital-based services. The ability of physicians to control the number of procedures patients receive drives up costs, and physicians’ ownership of testing facilities and ambulatory surgical clinics give them an incentive to drive up utilization.
  • Not only are utilization rates for CT and MRI procedures higher in the United States than in most other advanced countries, but their price is also ludicrously disproportionate. Reimbursement for each CT procedure averages $616 in the U.S., versus $146 in Germany and $62 in Japan; for MRIs, $1,057 versus $216 in Germany and $122 in Japan. At these rates, U.S. owners of imaging equipment can easily recoup their investment costs within one year.
  • Generous physician compensation also contributes to higher costs. On average, U.S. general physicians earn 4.1 times per capita GDP, compared with the OECD average of 2.8 times. For specialists, the gap was even greater: 6.5 times per capita GDP, compared with 3.9 times elsewhere. McKinsey finds that higher than average physician incomes added $64 billion to total U.S. health care expenditures in 2006.
  • Cost-shifting is a real and serious problem. There is a powerful, inverse correlation between Medicare and private-sector reimbursements rates. Whenever Medicare price growth slows, private payer growth accelerates. The report concludes that “care providers have significant leverage in negotiating prices with private insurers, forcing them to pick up the slack if public payment grows.”
  • While Americans use 10 percent fewer drugs per capita than the OECD average, they spend much more per capita because drug prices are 50 percent higher. While some of this is attributable to research and development expenditures, much higher costs for advertising and marketing are also a major factor.
  • Structural changes in health care over the past half century have pushed up the rate of spending by decreasing consumers’ exposure to the real cost of the care they are receiving. Their direct out-of-pocket expenditures declined from 47 percent of the total in 1960 to 12 percent in 2006. The McKinsey report concludes that “for consumers with low out-of-pocket expenditures the price of health care services or the amount of care consumed is not a concern. … These consumers have no incentive to consider trade-offs between high- or lower-cost treatments. … Generous health insurance thus creates a moral hazard in the consumption of health care.”

It is hard to believe that we can achieve significant long-term savings in health care without addressing some of these problems head-on. In particular, we must look for ways of cutting the link between physicians’ earnings and the multiplication of high-cost procedures. Eliminating the loopholes in laws preventing physicians from owning test facilities would be a good start, as would reducing the compensation for high-tech tests to more reasonable levels. In the long run, fee-for-service is an unsustainable model of physician compensation, and health insurance reform should create incentives to move away from it.

We also need ways of exposing consumers more fully to the cost of the services they want without discouraging them from using the services they need. One strategy is to focus insurance coverage more on truly insurable events--the big-ticket medical events that can disrupt lives and bankrupt families--and less on routine medical expenditures and elective procedures. It should be possible to protect average families from spending an unaffordable share of their income on health care without entirely eliminating their awareness of trade-offs and costs.

These are complex and controversial matters. Nonetheless, two things are clear. First, if we focus on increasing access to health care without at the same time reducing costs, we will quickly find ourselves in an unsustainable position. And second, if we restrict cost reductions to public health care programs, costs will shift to the private sector, leaving businesses and families no better off. Done right, health insurance reform would contribute to long-term fiscal balance; done wrong, it would make achieving that balance all but impossible, eroding the foundations of the economy on which we all depend.