HMGT 435 WEEK 3 PRO 3

CHAPTER

43

IN WHOSE INTEREST DOES THE PHYSICIAN ACT?

Physicians have always played a crucial role in the delivery of medical services. Although only 23.5 percent of personal medical expenditures in 2016 were for physician services, physicians control the use of a much

larger portion of total medical resources (Centers for Medicare & Medicaid Services 2017). In addition to their own services, physicians determine admis- sions to the hospital; lengths of stay; the use of ancillary services and prescrip- tion drugs; referrals to specialists; and even the necessity for services in nonhospital settings, such as home care. Any public policies that affect the financing and delivery of medical services must consider physicians’ responses to those policies. Their knowledge and motivation will affect the efficiency with which medical services are delivered.

The physician’s role has been shaped by two important characteristics of the healthcare system. First, only physicians are legally permitted to provide certain services. Second, both patients and insurers lack the necessary informa- tion to make many medically related decisions. The patient depends on the physician for diagnosis and treatment and has limited information regarding the physician’s qualifications or those of the specialist to whom the patient is referred. This lack of information places the patient in a unique relationship with the physician: The physician becomes the patient’s agent (McGuire 2000).

The Perfect Agent

The agency relationship gives rise to a major controversy in the medical eco- nomics literature. In whose best interest does the physician act? If the physi- cian were a perfect agent for the patient, he or she would prescribe the mix of institutional settings and the amount of care based on the patient’s medical needs, ability to pay for medical services, and preferences. The physician and the patient would behave as if the patient were as well informed as the physi- cian. Traditional insurance, once the prevalent form of health plan coverage, reimbursed the physician on a fee-for-service basis; neither the physician nor the patient was fiscally responsible or at risk for using the hospital and medical services.

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Health Pol icy Issues: An Economic Perspect ive44

Before the 1980s, Blue Cross predominantly covered hospital care; all inpatient services were covered without any patient cost sharing. Although hos- pital stays are costlier than outpatient care in terms of resources used, patients paid less to receive a diagnostic workup in the hospital than in an outpatient setting. Although doing so was an inefficient use of resources, the physician acted in the patient’s interest and not the insurer’s. Similarly, if a woman wanted to stay a few extra days in the hospital after giving birth, the physician would not discharge her before she felt ready to return home.

As the patient’s agent, the physician prescribed the quantity and type of services based on their value to the patient and the patient’s cost for that care. As long as the value exceeded the cost, the physician would prescribe it. By considering only the services’ costs and benefits to the patient, the physician neglected the costs to society and the insurance company.

Insurance and the role of the physician as the patient’s agent led the physician to practice what Fuchs (1968) referred to as the technologic imperative. Regardless of how small the benefit to the patient or how costly to the insurer, the physician prescribed the best medical care technically possible. Consequently, heroic measures were provided to patients in the last few months of their lives, and inpatient hospital costs rose rapidly. Prescribing “low-benefit” care was a rational economic decision because it still exceeded the patient’s cost, which was virtually zero with comprehensive insurance.

Supplier-Induced Demand or the Imperfect Agent

The view of the physician as the patient’s agent, however, neglects the physician’s economic self-interest. As shown in exhibit 4.1, large increases in the total num- ber of physicians and the number of physicians relative to the population have occurred since the 1970s. The number of physicians has tripled since 1970, and the physician-to-population ratio has doubled. The standard economic model, which assumes the physician is a perfect agent for the patient, predicts that growth in supply—other things (e.g., higher consumer income) being equal—results in a decline in physician fees and, consequently, in physician income.

Increases in the physician-to-population ratio, however, did not lead to decreases in physician income. This observation led to the development of an alternative theory of physician behavior. Physicians are believed to behave differently when their own income is adversely affected. In addition to being patients’ agents, physicians are suppliers of a service. Under fee-for-service payment, physicians’ income depends on how much service they supply. Do physicians use their information advantage over patients and insurers to benefit themselves? This model of physician behavior is referred to as supplier-induced demand.

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Chapter 4: In Whose Interest Does the Physic ian Act? 45

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Health Pol icy Issues: An Economic Perspect ive46

The supplier-induced demand theory assumes that if the physician’s income falls, the physician will use her role as the patient’s agent to prescribe additional services. The physician provides the patient with misinformation to influence the patient to demand more services, thereby adding to the physician’s income. In other words, the physician becomes an imperfect agent.

Physicians who are imperfect agents might rationalize some demand inducement by arguing that additional services or tests would benefit the patient. However, as the physician prescribes more and more services, he or she must choose between the extra income received and the psychological cost of knowing that these services are not really necessary. At some point, the former is not worth the latter. The physician must make a trade-off between increased revenue and the dissatisfaction of deliberately providing too many services.

Thus, one might envisage a spectrum of demand inducement that reflects the psychological cost to the physician. At one end of the spectrum are physi- cians who act solely in their patients’ interests; they do not induce demand to inflate or even maintain their income. At the other end of the spectrum are physicians who attempt to earn as much money as possible by inducing demand; these physicians presumably incur little psychological cost. In the middle of the spectrum are physicians who induce demand to achieve or maintain some target level of income (referred to as the target income theory).

The extent to which the physician is willing and able to generate addi- tional demand for medical services is controversial. Few people believe that the majority of physicians generate demand for services solely to maximize their income. Similarly, few people would disagree that physicians are able to induce demand. Thus, the choice is between the concept of physicians as perfect agents for patients and physicians as imperfect agents who induce demand according to the target income theory. The issue is how much demand physicians can and will induce.

Demand inducement is limited to some extent by the patient’s recog- nition that the additional medical benefits are not worth the time or cost of returning to the physician. The patient’s evaluation of these benefits, however, varies according to the treatment prescribed. Patients may easily determine that monthly office visits are not worth their time; however, they may have more difficulty evaluating the benefits of certain surgical services. Presumably, demand inducement is more likely to occur for services about which the patient knows the least; consequently, patients are more concerned about inducement in such cases.

Many studies have attempted to determine the extent of demand induce- ment (e.g., Feldstein 2011, 270–72), but the magnitude of the problem remains unresolved. A recent study found that once information from a clinical trial regarding the ineffectiveness of a certain type of knee surgery was presented to surgeons, the number of such procedures declined; however, the decline

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Chapter 4: In Whose Interest Does the Physic ian Act? 47

was smaller in physician-owned surgery centers (Howard, David, and Hock- enberry 2016).

Evidence shows that cities and counties that have many physicians (in relation to the population) also have high per capita use of physician services. This relationship, however, may merely indicate that physicians establish their practices where the population has a high rate of insurance coverage and, thus, where the demand for their services is great. The positive correlation between the number of surgeons and the number of surgeries has been used as empirical support for the supplier-induced demand theory. Furthermore, studies have found that rates of procedures such as tonsillectomies and hys- terectomies are higher when physicians are paid fee-for-service than through other incentives (e.g., those available to physicians in a health maintenance organization [HMO]).

Increase in Physician Supply

The growth in physician supply since the 1970s illustrates the importance of knowing which model of physician behavior—perfect agent or imperfect agent (operating under supplier-induced demand)—is prevalent. As a perfect agent, the physician would consider only the patient’s medical and economic interests when prescribing a treatment, regardless of the possibility that her income may decline because the greater supply of physicians may decrease the number of patients she sees.

On the other hand, as an imperfect agent, the physician facing a great supply of competitors would generate demand to prevent his income from fall- ing. Total physician expenditures also would rise as more physicians, each with fewer patients, attempt to maintain their income. Thus, whether one believes in the standard economic model (perfect agent) or the supplier-induced demand model (imperfect agent), a larger number of physicians leads to opposite pre- dictions of their effect on physician prices and income.

Insurers’ Response to Demand Inducement

Insurers recognize that under fee-for-service payment, physicians act as patients’ perfect agents or as imperfect agents. In either case, the value of the additional services prescribed is lower than the insurer’s cost for those services. Conse- quently, insurance premiums in a fee-for-service environment are higher than those for managed care plans, which theoretically attempt to relate the value of additional medical treatments to the resource costs of those services. Because of the higher relative premium for fee-for-service plans, more of the insurer’s

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Health Pol icy Issues: An Economic Perspect ive48

subscribers switched to managed care in the 1990s. Since about 2000, insurance companies have developed mechanisms to overcome physicians’ information advantage over both insurers and patients.

Insurers, for example, have implemented second-opinion requirements for surgery. Once a physician recommends certain types of surgery of ques- tionable medical necessity (e.g., back surgery), a patient may be required to obtain a second opinion from a list of physicians approved by the insurance company. Another approach is the creation of preferred provider organizations. Physicians who maintain lower fees, recommend fewer medical services, and are considered to be of high quality are selected by insurers. Utilization review is yet another approach. Before being admitted to the hospital or undergoing a surgical procedure, a patient must receive the insurer’s approval; otherwise, the patient is subject to a financial penalty. The length of stay in the hospital is also subject to the insurer’s approval.

These cost-containment approaches are insurers’ attempts to address the imbalances in physician and patient incentives under a fee-for-service system. Furthermore, they ensure that the patient receives appropriate care (when the physician acts to increase his own income) and that the resource costs of a treatment are considered along with its expected benefits.

HMO Incentives by Imperfect Agents

The growth of HMOs and capitation payment provides physicians with income- raising incentives that are opposite those of the traditional fee-for-service approach. HMOs typically pay medical groups annual capitation payments per enrollee and may reward their physicians with profit sharing or bonuses if their enrollees’ medical costs are lower than their annual capitation payments. What are the likely effects of the two models of physician behavior—perfect agent and imperfect agent—on an HMO’s patients?

In an HMO setting, a perfect-agent physician would continue to pro- vide the patient with appropriate medical services. Regardless of the effect of profit sharing on her income or pressures from the HMO to reduce use of services, the perfect agent would be primarily concerned with protecting patients’ interests and providing them with the best medical care, so there is little likelihood of underservice. In an HMO, the physician does not need to be concerned about whether the patient’s health plan covers the medical cost in different settings. HMO patients are also responsible for fewer deductibles and copayments. Thus, the settings chosen for the patient’s treatment are likely to be less costly for both the patient and the HMO.

The possibility that patients would be underserved in an HMO exists among imperfect-agent physicians (those who attempt to boost their own

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Chapter 4: In Whose Interest Does the Physic ian Act? 49

income). HMO physicians have an incentive to provide fewer services to patients and to serve a large number of patients. HMO physicians who are primarily concerned with the size of their income are more likely to respond to profit- sharing incentives. At times, a physician (who may even be salaried) may suc- cumb to an HMO’s pressures to reduce use of services and thereby become an imperfect agent.

If HMO patients believe they are being denied timely access to primary care physicians, specialist services, or needed technology, they are likely to switch physicians or disenroll at the next open-enrollment period. A high dis- satisfaction rate with certain HMO physicians could indicate that their patients are underserved. An HMO should be concerned about underservice by its physicians. Although the HMO’s profitability will improve if its physicians provide too few services, an HMO that limits access to care and fails to satisfy its subscribers risks losing market share to its competitors.

The more knowledgeable that subscribers are regarding access to care provided by different HMOs, the greater will be the HMO’s financial incentive not to pressure its physicians to underserve patients. Instead, it will monitor physicians to guard against underservice. Gathering information on HMOs and their physicians and how well enrollees are served is costly (in terms of time and money) for individuals. It is less costly for employers to gather this information, make the information available to employees, and even limit the HMOs from which employees can choose.

Informed Purchasers

Informed purchasers are necessary if the market is to discipline imperfect agents. An HMO’s reputation is an expensive asset that can be damaged by imperfect agents underserving their patients. Performance information and competition among HMOs for informed purchasers should prevent organizations from underserving their enrollees. The financial, reputation, and legal costs of under- service should mitigate the financial incentives to underprescribe in an HMO.

Both insurers and HMOs lack information about a patient’s diagnosis and treatment needs. Thus, the insurer’s or HMO’s profitability depends on the physician’s knowledge and treatment recommendations. Depending on the type of health plan and the incentives physicians face, a potential inefficiency exists in the provision of medical services. Physicians may prescribe too many or too few services. When they prescribe too many services, the value to the patient may not be worth the costs of producing the additional services. Pre- scribing too few services is also inefficient in that patients may not realize that the value of the services and technology they did not receive (and for which they were willing to pay) was greater than their physician led them to believe.

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Health Pol icy Issues: An Economic Perspect ive50

To decrease these inefficiencies, insurers who pay physicians on a fee-for-service basis have instituted cost-containment methods.

Medicare, a fee-for-service insurer for physician services for the aged, has not yet undertaken similar cost-containment methods to limit supplier-induced demand. Until Medicare institutes such mechanisms, imperfect agents will be able to manipulate the information provided to their aged patients, change the visit coding to receive higher payment, and decrease the time spent per visit with these patients. (See chapter 10 for a discussion of the new Medicare physician payment system.)

Monitoring of physician behavior in HMOs and other managed care settings has increased. Physicians who were previously in fee-for-service systems and boosted their income by prescribing too many services are being reviewed to ensure that they understand the change in incentives. Once they are aware of the new incentives, these imperfect agents must continue being monitored to ensure that they do not underserve their HMO patients.

The market for medical services is changing. Insurers and large employ- ers are attempting to overcome physicians’ information advantage by profiling physicians according to their prices, use and appropriateness of their services, and treatment outcomes. These profiles provide imperfect agents with less opportunity to benefit at the expense of the insurer. Information on physician performance is available on the internet, and some states (e.g., New York) pub- lish data on physician and hospital performance (e.g., risk-adjusted mortality rates for different types of surgery).1 Demand inducement, to the extent that it exists, will diminish. One hopes that with improved monitoring systems and better measures of patient outcomes, physicians will behave as perfect agents, providing the appropriate quantity and quality of medical services by consider- ing the costs and benefits of additional treatment.

Insurers serving millions of enrollees maintain very large data sets, and information technology allows insurers to use these data sets to analyze differ- ent treatment methods and physician practice patterns. These data will enable insurers to determine which physicians deviate from accepted medical norms.

Not all insurers or employers, however, are engaged in these informa- tional and cost-containment activities. Those who are not are at a disadvan- tage with regard to the physician and the HMO. Insurers and employers who are less knowledgeable regarding the services provided to their enrollees and employees pay for overuse of services and demand-inducing behavior by fee- for-service providers, as well as underservice by HMO physicians. Medicare and Medicaid, whose payment methods are primarily fee-for-service, are also limited in cost-containment activities to reduce demand inducement. At some point, such purchasers will realize that investing in more information will lower their medical expenditures and improve the quality of care provided.

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Chapter 4: In Whose Interest Does the Physic ian Act? 51

Summary

Under fee-for-service payment, the inability of patients and their insurers to distinguish between imperfect agents and perfect agents has led to the growth of cost-containment methods. The changes occurring in the private sector and in government physician payment systems must take into account the differ- ent types of physicians and the fact that, unless physicians are appropriately monitored, the response by imperfect agents will make achieving the intended objectives difficult.

Discussion Questions

1. Why do physicians play such a crucial role in the delivery of medical services?

2. How might a decrease in physician income, possibly the result of an increase in the number of physicians, affect the physician’s role as the patient’s agent?

3. What are some ways in which insurers seek to compensate for physicians’ information advantage?

4. What forces currently limit supplier-induced demand? 5. How do fee-for-service and capitation payment systems affect the

physician’s role as the patient’s agent?

Note

1. Information on websites and reports on physician and hospital performance are from www.consumerhealthratings.com/index. php?action=showSubCats&cat_id=30. That website includes links to different state reports, such as the following: • Massachusetts: Adult Coronary Artery Bypass Graft Surgery in

the Commonwealth of Massachusetts: Hospital Risk-Standardized 30-Day Mortality Rates, Fiscal Year 2014 Report—www.mass.gov/ files/documents/2017/12/14/cabg-fy2014.pdf

• New Jersey: Cardiac Surgery in New Jersey, 2013—www.state.nj. us/health/healthcarequality/documents/cardconsumer16.pdf

• New York: Adult Cardiac Surgery in New York State, 2012–2014 (ratings of hospitals and surgeons)—www.health.ny.gov/statistics/ diseases/cardiovascular/heart_disease/docs/2012-2014_adult_ cardiac_surgery.pdf

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Health Pol icy Issues: An Economic Perspect ive52

Additional Reading

Mitchell, J. M. 2010. “Effect of Physician Ownership of Specialty Hospitals and Ambula- tory Surgery Centers on Frequency of Use of Outpatient Orthopedic Surgery.” Archives of Surgery 145 (8): 732–38.

References

American Medical Association. 2015. Physician Characteristics and Distribution in the US, 2015 Edition. Chicago: American Medical Association.

———. 2012. Physician Characteristics and Distribution in the US, 2012 Edition. Chicago: American Medical Association.

———. 1982. Physician Characteristics and Distribution in the US, 1981 Edition. Chicago: American Medical Association.

Centers for Medicare & Medicaid Services. 2017. “National Health Expenditure Data.” Modified December 21. http://cms.gov/Research-Statistics-Data-and- Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/index. html.

Feldstein, P. J. 2011. Health Care Economics, 7th ed. Albany, NY: Delmar. Fuchs, V. R. 1968. “The Growing Demand for Medical Care.” New England Journal

of Medicine 279 (4): 190–95. Howard, D., G. David, and J. Hockenberry. 2016. “Selective Hearing: Physician-

Ownership and Physicians’ Response to New Evidence.” National Bureau of Economic Research Working Paper No. 22171. Published April. www.nber. org/papers/w22171.

McGuire, T. G. 2000. “Physician Agency.” In Handbook of Health Economics, vol. 1A, edited by A. J. Culyer and J. P. Newhouse, 461–536. New York: North- Holland Press.

US Census Bureau. 2016. Monthly Population Estimates for the United States: April 1, 2010 to December 1, 2017: 2016 Population Estimates. Published December. www2.census.gov/programs-surveys/popest/tables/2010-2016/national/ totals/na-est2016-01.xlsx.

———. 2012. Statistical Abstract of the United States. Various editions. www.census. gov/library/publications/time-series/statistical_abstracts.html.

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