New Profit Opportunities In American Health Care

I notice there is a lot of handwringing over the Affordable Care Act’s “government takeover” of the health care system. So let’s take a look at some exciting new markets that are still thriving.

1) At the beginning of the summer, I noted some problematic drug shortages (bottom half of post). The problem keeps getting worse. There is a steady stream of heartrending stories about care being compromised. Reform measures to assure an adequate supply are moving at a snail’s pace, thanks both to truculent manufacturers and the bipartisan drumbeat to “cut health care costs.” But at least some folks are thriving: as the NY Times notes, ‎”Unscrupulous wholesalers have made matters worse by scooping up scarce drugs and offering them to hospitals at markups that often reach 20 times the normal price or more.”

What a great business model! So glad the “free market” is working its magic on health delivery. While we’re at it, let’s allow ER docs to force patients to sign over half their bank accounts before treatment. That will certainly increase the supply of emergency rooms, even if the transition is a little bumpy for some people.

By the way, I’m sure some will argue that, if only Medicare weren’t paying for many of these drugs, we’d be fine. (Or at least the “we” capable of paying for the drugs at a “market price,” whatever that is, would be fine.) Query: Would there have been adequate incentive to create the drugs if a major purchaser like Medicare hadn’t paid what it did while the drug was on patent? No, I didn’t think so. Income and wealth in our society is still equally distributed enough (and coordination problems severe enough) that the top 1% won’t sustain a thriving hospital and drug research system all by themselves, even if they are the critical factors in one’s policy calculus. As I noted earlier, it’s hard to imagine individuals, or even wealthy groups, stockpiling all drugs they might need, particularly the sterile injectables or biotech solutions that are critical to advanced medicine. Even the very wealthy must rely on a steady, more general demand for these products. They can’t just order them up for just-in-time delivery, like a Tiffany watch. Public subvention—ranging from research grants to Medicare and Medicaid funding for the products research generates—provides that demand.

2) Pauline Chen reports on an “insurance maze” for US doctors, based on a new Health Affairs study comparing their practices to those of their neighbors to the north:

Physicians in Canada, where health care is administered mainly by the government, did spend a good deal of time and money communicating with their payers. But American doctors in the study spent far more dealing with multiple health plans: more than $80,000 per year per physician, or roughly four times as much as their northern counterparts. And their offices spent as many as 21 hours per week with payers, nearly 10 times as much as the Canadian offices.

Clearly the US has a comparative advantage in generating insurance-based hassles. Maybe we can keep specializing there, and aim to spend five times as much as the Canadians by 2014. The more choice, the better, whatever the cost, right? Think of all the people employed by this gauntlet of private sector checks and balances:

A young patient complaining of extreme fatigue, for example, might benefit from a $40 blood test that could confirm infectious mononucleosis in 10 minutes. But a doctor cannot order the simple test without first checking with the insurance company to see if it is covered and if there are any constraints on where the patient’s blood can be drawn and the test run.

Tracking down answers often means phone calls with long periods on hold, digging up old patient information and even recruiting office workers to act as specimen couriers to other labs and hospitals in order to expedite results or save frail patients or harried family members the hassle of traveling to an “approved site” for a test or procedure. “If someone comes in with a sick infant who needs a test, we often eat the costs and draw the blood ourselves,” Dr. Star said. “We aren’t going to tell them to put that kid in a car seat, drive a mile to an approved lab, park, register, then wait in line.”

If you’re an insurer (or the insurance industry), you’ve “won” to the extent you’ve foisted these costs and inconveniences onto doctors and patients. You certainly don’t want to abide by new Medical Loss Ratio requirements that limit the extent to which you employ these strategies of cost-shifting, delay, and denial of needed care. The “free market” is your friend, as is anyone who insists that health care delivery can be guided by the same economic principles that govern every other commodity.

Private Equity & British Care Homes

In earlier posts I have discussed the “care/profit tradeoff in nursing homes,” focusing on the role of private equity firms in reducing costs by limiting the liability of their enterprises. Cutting nursing staff and increasing the risk of elder neglect isn’t so costly for private equity barons when “complex corporate structures . . . obscure who controls their nursing homes.” One firm constructed a particularly notable series of corporate moats between itself and the nursing home which it first controlled, and then rented land to.

Daniel JH Greenwood has called a good deal of private equity activity a form of looting, and I have explored its shortcomings in a review of a book on the topic. Sadly, it appears that the private equity influence in Britain is undermining a key part of its health care system. Having stacked various care homes with debt in order to buy them, many private equity firms have abandoned (or are about to abandon) the homes:

[A new] report, delving into the running and funding of the care industry, reveals that the collapse of Southern Cross may not be a one-off, as a number of other social care companies are also on the brink. Private equity takeovers of public services that use similar high risk business models, could leave taxpayers picking up the bill for more company failures. The in-depth study of privatisation shows that the second largest care provider, Four Season, is also in severe financial difficulties and others may follow. If both Southern Cross and Four Seasons were to collapse, around 1,150 nursing and residential care homes would be at risk of closure, affecting nearly 50,000 vulnerable people and their families and hitting over 60,000 staff.

Another of the top four largest residential care home operators is Barchester Healthcare — a sister company to Castlebeck, the operators of the Bristol care home exposed by a Panorama documentary . . . for patient abuse. The home owners have admitted that serious wrongdoing took place at Bristol. The report shows that Barchester and other operators of care homes, have repeatedly changed ownership, often through private equity firms buying, consolidating and selling companies. The UK’s largest union is warning that the Government must tackle the crisis in the care industry.

However disruptive the private equity takeovers have been, they have fulfilled their main purpose: huge gains for a few entities that bought and sold at the right time:

Southern Cross was floated on the stock market by Blackstone, which obtained a 400% return in two years on its acquisition. Southern Cross is now at risk of collapse. Allianz Capital Partners made a return of 100% by acquiring Four Seasons in 2004 for £775 million, selling it four years later for £1.4bn - the business then collapsed in value.

3i private equity fund brought a 38% stake in Care Principles for £1.5m in 1997, the remaining amount in 2005 and sold to to Three Delta in 2007 for £270m — a return of 390%. Tunstall was acquired by Bridgepoint Capital in 2005 for £225m, merged with Bridgepoint Investment and sold on after three years for £514m.

Here are more details on Southern Cross. This story and other critical commentary suggest that the goal for owners has been rapid profit rather long term investment in more efficient processes. When the “music stopped” in the acquisition game, it was left with mounting debts.

Chris Sagers’ article “The Myth of Privatization” (59 Admin. L. Rev. 37) suggests that there is very little difference between “public” and “private” operationally, except that “one of them lacks even a nominal obligation toward the public interest.” I have seen little evidence to contradict that idea in the eldercare industry. Further research may reveal more support for Daniel JH Greenwood’s diagnosis of the rise of private equity:

The success of private equity firms challenges mainstream corporate governance theory: according to standard agency cost analysis, this should not have happened. Agency problems—the shorthand term for the tendency of fiduciaries in a capitalist system to work for themselves as well as, or instead of, their clients—cannot be solved by adding an additional layer of extremely highly paid agents supported by an ideology that justifies the most extreme forms of self-interestedness. Therefore, private equity is unlikely to be an innovative solution to the age-old agency problem.

Instead, it is better understood as a clever bit of legal arbitrage: by reclassifying agents as principals, it allows former fiduciaries to instead view themselves, and be viewed by others, as entitled to look out only for themselves. And look out for themselves they have: the private equity managers have extracted hitherto unseen sums from our corporations, appropriating for the private benefit of a handful of individuals surplus that otherwise might have gone to other corporate participants, including consumers, ordinary employees, taxpayers and investors in the public securities markets, or might have been devoted to increasing productivity or innovation for the benefit of future generations.

The basic private equity technique, like the basic hedge fund technique, appears to be to borrow money in order to increase potential returns or losses. If the loans were correctly priced, this would not create new value under standard valuation theories, nor would it be a service that could possibly warrant the high fees typically charged in the hedge fund and private equity worlds. The simplest explanation is that either lenders or fund investors are mispricing risk and have done so for several years at a stretch, contrary to the claims of the efficient market theorists.

This explanation suggests, moreover, that private equity is simply the modern equivalent of the pyramid schemes, margin loans and highly leveraged utility holding companies of the 1920s. Like those earlier edifices built on borrowed money, the contemporary schemes are likely to be highly unstable: if the underlying assets decline in value or fail to provide expected income by even small margins, the lenders are likely to take losses out of scale with their potential profits. Once lenders wake up to this possibility—most likely only after losses have begun—they are likely to cut back lending rapidly, which will, in turn, make the underlying assets both less valuable and less saleable still, thus beginning a new round of lender panic. Any minor downturn, in short, runs the risk of starting a self-reinforcing cycle of credit and business contraction. The rise of private equity in its present form, then, appears to be another step towards the pre-New Deal world of inequality and instability.

And don’t forget about the role of private equity in influencing our political process. Blackstone billionaire Pete Peterson helped fuel concerns about government spending, while doing very little to advocate for increased taxes on the wealthy. And now we see that the CLASS Act—an innovative program to promote full funding for future long-term-care in the US–is likely to be on the chopping block. The primary value of both care homes and care plans to P/E firms appears to be their susceptibility to rapid sales and purchases. The P/E firm’s employees can earn massive bonuses if the value of entities goes up, and can’t lose those bonuses even if things eventually fall apart. It is a heads they win, tails they win scenario. The losers include all the other stakeholders in firms which are treated primarily as ATMs for fleeting owners.

A Hollywood Ending for Pharma?

Photo by Sten Rüdrich

There is an interesting article at Xconomy San Diego on the growing tensions between venture capitalists, biotech startups, and pharmaceutical companies. Many entrepreneurs feel like they’re getting a raw deal from big pharma firms. One source alleges that dealmakers are about to kill the geese that lay the golden eggs.

In an earlier post, I worried that big pharma firms were becoming virtual to the point of ghostliness, mere nexuses of certifications, patent and trademark portfolios, tax dodges, and contractual obligations. If these trends continue, what types of controversies are likely to develop?

Gains from Gatekeeping

The just-in-time, ad hoc nature of movie production has led many economists to see in it a model for collaboration in other industries. As Marty Neumaier puts it, “By switching to a network model, the studios . . . avail themselves of the best talent for each project, thereby creating unique products and shedding unnecessary overhead.” But one-off, one-sided contracts can lead to epic conflicts. Consider, for instance, the recent rash of news about Hollywood accounting:

Michael Moore . . . claims $2.7m in unpaid royalties from Fahrenheit 9/11 [from his studio]. . . At the heart of the lawsuit is a dispute about Hollywood accounting practices that have for decades been a source of contention between the studios that release movies and “the talent” . . . Moore alleges the Weinsteins improperly deducted expenses from his share of the film’s profits – including the cost of a private jet to fly Weinstein from the US to Europe.

When an intermediary has access to extraordinary distribution networks, it has enormous leverage vis a vis “the talent.” Studios might respond that it’s a lot more fun to be Michael Moore than it is to be Harvey Weinstein: one gets to express his ideas, the other has to meet a payroll. But the enormous amounts of money generated by the film (between $228 and $500 million, according to Moore’s lawyer), and the frequency of complaints like Moore’s, lead to concerns about transparency and bargaining power in the industry.

Terry Fisher has written compellingly on the economics of Hollywood and pharmaceutical research (with Talha Syed). Intellectual property is key to both industries, and that’s one natural point of connection. Another is the economic role of middlemen, a topic that’s becoming increasingly important as certain dominant companies aim to own the “celestial jukebox,” “master switch,” or “Digital WalMart” of content connectivity.

Consider Apple’s demand for 30% of revenue from publications delivered via the iPad–and its refusal to share key customer data (for example, ads clicked on, time spent per page, etc.) with publishers. Seth Godin does not approve of this move:

The web has been a hotbed of siloed content, of deep dives for small audiences. The large scale stuff, though, has tended to be mostly about gossip and other quick reads that’s cheap to produce. Tablets offer a new chance to create content worth paying for.

[But] Apple has announced that they want to tax each subscription made via the iPad at 30%. Yes, it’s a tax, because what it does is dramatically decrease the incremental revenue from each subscriber.

These debates are very old in the tech world: when the VCR was introduced, Hollywood said its makers should pay for all the copyright infringement it enabled. Sony eventually retorted that the studios should be glad to see all the new customers that electronics would bring them.

Health Care’s Middlemen

Moore, the disgruntled biotech firms, and Godin each in their own way bring up issues that are going to be very big in health care over the next decade. Private insurers were supposed to be the magical mediators between providers and consumers in health care, demanding value and driving down prices. But, as Joseph White has shown, it was far easier for insurers to “stick it to” their customers than to constrain prices of “must-have” providers:

Remembering the pain of the late 1990s, [by 2001] managers of health care providers and insurance companies were determined to keep prices up through “pricing discipline.” “I’ve never seen discipline in the industry from a pricing standpoint like I’ve seen now” (HSChange 2004, p. 2), said one insurance industry consultant, providing part of the answer to why the underwriting cycle had yet to turn back toward lower margins. . . .

One might wonder why consolidation among insurers did not allow them to resist the providers’ demand for increased payments. The simple answer is that there were two concentrated parts of the market and one fragmented part. The insurers had to choose between fighting a full-pitched battle with the providers or exploiting their own market power vis-à-vis the employers. Raising premiums to employers was a lot easier. In theory, employers could have demanded restrictive networks (at lower prices). But since everyone had agreed that employees did not like restrictive networks, and providers (especially hospitals) were not willing to discount much to get into such networks, there were not many available for purchase. Individual employers could not invent such a product; they could only shop around and find the relatively best deal by customizing other contract terms, such as cost sharing.

Just as insurers began to align more with the interests of concentrated providers than with fragmented, disorganized consumers, so too do many Group Purchasing Organizations appear to be failing to fulfill their promise as cost-constraining intermediaries. As one analyst testified before the DOJ and FTC, “the compensation of most GPO management is almost always based on . . . fee income [from suppliers] rather than on the real savings to hospital members.” Again, the ostensible “protector” of one side of the health care equation ends up aiding one side of the deal.

Of course, the masters of all such deals work in finance. As Karen Ho suggested in her excellent ethnography, Liquidated, their values inform all the tough and opportunistic dealmaking mentioned above. As I taught health care finance over the past few years, I continually felt the topic stood in relation to finance proper as chemistry might stand in relation to physics: a discipline in its own right, but ultimately reducible to a more fundamental science. (I’m not saying I endorse this reductionism, just that it is an intuitively plausible model for what’s really driving developments in health care.)

Are there any policy lessons for health care? As Louis Uchitelle has suggested, we might want to question an economic system that delivers risk-free riches to those who invest or market future cures and little but anxiety (with limited or very unlikely upside) to many of those who create them. If we hesitate at awarding Apple a perpetual 30% bite of publisher profits merely for becoming the hippest platform, or question a finance sector that grabs 30% of all corporate profits, we might also want to articulate some decent maximum multiple of dealmakers’ over researchers’ compensation.

Reflecting on his book “The Great Stagnation” a few weeks ago, Tyler Cowen noted that many of the biggest winners in today’s economy are structuring “heads I win, tails you lose” deals. Wall Street has mastered the concentration and privatization of gain and socialization of loss. Will key players in pharma and the rest of the health care sector scramble to follow its lead?

Sunlight is a Weak Disinfectant

Palace Guard with Two Leopards, Jean-Joseph Benjamin Constant (1845-19020

One of the most robust “memes” in contemporary law is the power of disclosure. In health law, disclosure comes up again and again: patients need to give “informed” consent, insurers are supposed to explain their policies clearly, and conflicts of interest, when not proscribed, should at the very least be exposed. But there are growing challenges to the disclosure meme, both within health law and without.

George Lowenstein and Peter Ubel note some problems with disclosure approaches in this article on the weaknesses of behavioral economics generally:

It seems that every week a new book or major newspaper article appears showing that irrational decision-making helped cause the housing bubble or the rise in health care costs. Such insights draw on behavioral economics, an increasingly popular field that incorporates elements from psychology to explain why people make seemingly irrational decisions, at least according to traditional economic theory and its emphasis on rational choice. . . . But the field has its limits. As policymakers use it to devise programs, it’s becoming clear that behavioral economics is being asked to solve problems it wasn’t meant to address.

[T]ake conflicts of interest in medicine. Despite volumes of research showing that pharmaceutical industry gifts distort decisions by doctors, the medical establishment has not mustered the will to bar such thinly disguised bribes, and the health care reform act fails to outlaw them. Instead, much like food labeling, the act includes “sunshine” provisions that will simply make information about these gifts available to the public. We have shifted the burden from industry, which has the power to change the way it does business, to the relatively uninformed and powerless consumer.

The same pattern can be seen in health care reform itself. The act promises to achieve the admirable goal of insuring most Americans, yet it fails to address the more fundamental problem of health care costs. . . . [T]he act tries to lower costs by promoting incentive programs that reward healthy behaviors. . . . [But s]tudies show that preventive medicine, even when it works, rarely saves money.

At its worst, disclosure can become merely pro forma; as Kafka (via Trudo Lemmens) puts it, “Leopards break into the temple and drink to the dregs what is in the sacrificial pitchers; this is repeated over and over again; finally it can be calculated in advance, and it becomes part of the ceremony.” Omri Ben-Shahar has argued that disclosure is one of many aspects of consumer protection law with little real impact on individual welfare. As Amelia Flood reports,

Ben-Shahar, who spent last summer studying all the mandated disclosure statutes in Illinois, Michigan and California, argues that consumer protection advocates have gotten it wrong when it comes to mandating information access for consumers. He says consumers get lost in a sea of technical language, unread disclaimers and long-shot lawsuits. . . . According to Ben-Shahar, disclosures are of more use to consumer ratings groups like Zagat and Consumer’s Digest than they are to most consumers.

So perhaps there is some hope here: third-party aggregators and raters might use disclosures as part of an overall effort to rate various hospitals or doctors. The question then becomes–who shall pay (and rate) the raters? One irony here is that doctor rating sites have themselves been accused of being insufficiently transparent about the ways in which they evaluate physicians. New York Attorney General Cuomo even pursued the matter. His office eventually settled with insurers who ran rating sites. They pledged to “fully disclose to consumers and physicians all aspects of their ranking system.”

What’s the lesson here? First, that consumers are, by and large, too busy to process piecemeal disclosures by professionals like physicians and other health care providers. Second, third party raters can fill some of this information gap by aggregating information. Third, this process of aggregation and rating itself will likely need to be closely supervised by a good-faith regulator, lest it fail to take into account the full range of interests (and quality of information) proper for the task.

Coping with Commodified Caregiving

Roger Scruton has complained that, in our society, “too many goods have a price.” He makes a Walzerian argument that certain experiences cannot be bought and sold without doing violence to their ultimate social meaning:

A century and a half ago John Muir in America and John Ruskin in England initiated the movement to save our world from spoliation. They rightly understood that nothing would  be saved if we simply defend it on economic grounds. A valley might be useful as farmland, but it might be even more useful as a reservoir or an opencast mine. Only if we recognize the intrinsic value of nature will it be proof against our predations; hence we should esteem landscapes and forests for their beauty, for their sacred quality, for the part they play in defining us and ennobling our settlements, rather than for their use. Only this will keep the market at bay and prevent us from consuming our world. . . .

Love is priceless, not because its price is higher than we can pay, but because it cannot be purchased but only earned. Of course, you can purchase the simulacrum of love, and there are people who are accomplished providers. But love that is purchased is only a pretense. Goods like love, beauty, consolation, and the sacred are spiritual goods: they have a value, but no price.

Economists don’t like spiritual goods. Such goods are connected to us not as things to be used, consumed, and exchanged but as parts of what we are. To lose them is to lose ourselves.

Perhaps the ultimate revenge of the economic mindset on commitments like Scruton’s is the rise of the caring industry, which Ronald W. Dworkin incisively examines in a recent article:

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More Institutional Health Economics, Please!

Elinor Ostrom with Indiana University president Michael McRobbie at press conference announcing her Nobel Prize. Photo by aschweigert via Flickr

Today’s Nobel Prize award for institutional economists Oliver Williamson and Elinor Ostrom is a welcome step toward methodological pluralism in the profession. Both have looked outside markets to understand the organization of economic life. Ostrom is not even an economist–she is a political scientist by profession. As Bob Shiller observes:

This award is part of the merging of the social sciences. Economics has been too isolated and too stuck on the view that markets are efficient and self-regulating. It has derailed our thinking.

According to the NYT, “The Nobel judges, in their description of Mr. Williamson’s and Ms. Ostrom’s achievement, said that ‘economic science’ should extend beyond market theory and into actual behavior, and the two award winners, in their empirical work, had done this.”

There is a great need for more of this type of work in health economics. Joe White’s Markets and Medical Care: The United States, 1993–2005 is one good exemplar of needed work here; he eschews “discussions of how economic theory can be applied to medical care production and delivery” and instead “focuses on ‘the market’ in its actual, not theoretical, form, as it existed in the United States.” White describes case after case where consolidation, not medical need, drove industry structure. He leaves the reader with a clear and convincing image of a space where varying levels of provider and insurer power, not productivity, is the key to understanding changes in the profitability of services. I’ve seen few better brief explanations of rising medical costs than the following: Read more