Mystery Diagnosis: An Era of Uncertainty for the Health Care Sector

The U.S. health care sector is experiencing a time of enormous change and uncertainty. Although President Obama’s health care reform plan was signed into law last year, several legal challenges to the legislation are working their way through the courts. Questions also remain about whether the law will deliver on its promises of greater access to care and stricter containment of soaring health care costs.

Meanwhile, the pharmaceutical industry is also dealing with a period of insecurity, with generic markets soon opening up for some of the world’s best-selling drugs. And although the health care sector is one of the few employment bright spots in a stagnant job market, questions arise as to whether it is in danger of becoming too bloated. Wharton health care management professors Arnold Rosoff, Patricia Danzon, Lawton Burns and Mark Pauly discussed their research on these issues and others during a recent presentation to incoming health care MBA students.

Politics over Policy?

After decades of debate over national health care reform, Wharton legal studies and health care management professor Arnold Rosoff warned that struggles over the Affordable Care Act (ACA), signed into law by President Obama in March 2010, may be far from over. It is uncertain whether the reform legislation, which was passed in a greatly compromised form after years of “partisan wrangling,” can deliver on its promises of cost containment and expanded access to health care for the uninsured, Rosoff noted. “But before we get to that, we have to ask, ‘Will ACA even stay on the books?’”

Several court challenges threaten to upend the landmark reform. Most of the cases, according to Rosoff, focus on the so-called “individual mandate” requiring individuals to carry insurance for themselves and their dependents, with a secondary focus on the “employer mandate,” which requires larger employers to cover their workers. The ACA provides subsidies for those who are unable to pay premiums and imposes penalties for failure to buy health insurance.

Of the six cases that have been tried on the merits in the federal district courts, three U.S. District judges, all appointees of former President Bill Clinton (a Democrat), have upheld the reform law. The three other judges, ruling on cases filed in Virginia, Florida and Pennsylvania, have decided that the law violates the U.S. Constitution. Those three judgeswere appointed by Republican Presidents George W. Bush and Ronald Reagan. “This divide highlights the fact that the contest is baldly partisan and political,” Rosoff said.

A key issue raised in the challenges to the law was whether the individual mandate can be considered a tax. If it can, Rosoff stated, the mandate would be sustainable because the federal government has broad constitutional authority to “tax and spend.” It clearly has the power to levy taxes to finance Social Security and Medicare, which are government-run social insurance programs. However, the courts have uniformly held that ACA is not a taxing statute. The Act uses the word “penalty” instead of “tax,” which now clearly appears to be a bad choice legally, Rosoff noted. Given the pre-passage political pressures, however, it was not much of a choice, he added. “If you think back to the debates in Congress, you can see why the Obama Administration didn’t characterize the mandate as a tax. Tax is a dirty word.”

The cases in Virginia, Pennsylvania and Florida turned mainly on whether the individual mandate goes beyond Congress’s authority to regulate interstate commerce. This “commerce power,” according to Rosoff, has historically been defined very broadly. It applies not just to rules governing tangible commodities that are sold across state borders, but also to financial transactions that flow over state lines, including the collection of insurance premiums, investment of insurance company funds and claims payments.

In the Virginia case, filed by state attorney general Ken Cuccinelli, District judge Henry Hudson ruled last December that ACA exceeds the government’s commerce power because it regulates a person’s decision not to engage in interstate commerce. The distinction between action affecting commerce and inaction affecting commerce may well be the deciding factor, Rosoff noted. On Tuesday, U.S. District Judge Christopher C. Conner ruled in Harrisburg, Pa., that the federal government’s power to regulate commerce does not give it the jurisdiction to mandate that individual citizens buy products against their will. The Pennsylvania lawsuit was filed by a married couple who said they dropped their health coverage because of the high cost, which was more than their monthly mortgage payments.

The Florida case, which includes among its plaintiffs 26 states and a group of independent businesses, goes further. District judge Roger Vinson ruled in January that not only does the individual mandate violate the Constitution’s “commerce clause,” but it is so integral to the overall law that if it goes, the entire 2,000-page law is unconstitutional and must fall.

According to Rosoff, it is not uncommon to have one or more provisions of a complex law struck down by the courts. But most laws are written with a “severability” clause so that if one part of the act is ruled unconstitutional, the rest will stand. “Quite significantly, there is no such provision in ACA,” said Rosoff, adding that its absence is unlikely to have been “just a careless oversight.”

“Undoubtedly, there were backroom political negotiations between the Administration and the insurance industry,” said Rosoff. The individual mandate was added to protect insurers from “adverse selection”; without it, people might choose not to buy insurance until they were actually sick, or felt themselves about to get sick, thereby distorting insurers’ risk. Since the ACA prohibits insurers from engaging in “medical underwriting” — that is, choosing to insure only healthy people or excluding coverage of preexisting conditions — the quid pro quo was imposing the mandate, which keeps consumers from gaming the system and burdening insurers with adverse selection. Regardless of whether or not the ACA could function as intended with the mandate removed, the question remains: Would it have passed at all without the mandate to counter insurance industry opposition? Both of these considerations are factors in the Supreme Court’s severability analysis.

Since one federal appeals court (the Sixth Circuit, ruling on July 3, 2011) has upheld the individual mandate and another (the 11th Circuit, ruling on August 12, 2011) has struck it down, Rosoff said there is little doubt that this “conflict between the Circuits” will take the dispute before the U.S. Supreme Court, where it will likely be decided by a close vote. A 5-4 vote would normally be expected, but Justices Elena Kagan and Clarence Thomas are both under pressure to recuse themselves. Kagan was U.S. Solicitor General when the law was being drafted and so, arguably, cannot be impartial in her deliberations. Clarence Thomas’s wife has been an active and outspoken critic of ACA and has worked very aggressively to undo it, a fact that calls his objectivity into question. Another very interesting factor, Rosoff noted, is that the 11th Circuit, while finding the mandate unconstitutional, ruled that it was not essential; thus the rest of the law could remain intact with the mandate removed.

Rosoff has studied Congressional initiatives in health care for more than 30 years and, in most cases, even when legislative battles have been intense, upon passage of a law the opposing parties have cooperated to implement it, trying in good faith to make it work. “That’s not happening here,” he said. “Too many of our elected officials are playing political football rather than trying to solve the nation’s critical health care problems. They are putting politics above policy.”

The Cost of Going Generic

Over the next 14 months, seven of the world’s 20 best-selling medications — including Lipitor, whose annual revenues total $11 billion — will lose patent protection, opening markets to cheaper generic copies. Pfizer, the manufacturer of Lipitor, is reportedly considering a plan to make its own generic version and may seek government permission to sell it over the counter when Lipitor loses patent protection in November.

Adjusting to the introduction of these new generic drugs has important implications for the bottom lines of pharmaceutical firms. Research by Wharton health care management professor Patricia Danzon shows that while branded pharmaceutical products are priced higher in the U.S. than in other countries, generic drugs, which account for more than 70% of all prescriptions in the country, tend to cost less.

In a paper titled, “Cross-National Evidence on Generic Pharmaceuticals: Pharmacy vs. Physician-Driven Markets,” Danzon and Michael F. Furukawa, a professor at the W.P. Carey School of Business at Arizona State University, studied global data supplied by IMS, the drug industry’s sales monitor, and found that when a generic drug comes on the U.S. market and displaces a branded product, the generic initially sells for 75% of the branded price. However, after two years, the generic price is only 36% of the branded drug. In other countries, the generic price remains higher than in the United States. In the United Kingdom, for example, the generic price falls to 60% of the branded drug after two years. In Germany, the price falls to 55%, and in Mexico, it declines to 75% of the price for the name-brand prescription.

Danzon attributes the price differences to regulatory and reimbursement policies for generic drugs that lead countries to develop either pharmacy-driven or physician-driven generic markets. The U.S. market, she said, is highly pharmacy-driven, leading to a competitive market for generics and lower prices than in other countries.

The pharmacy-driven market is based on a number of key characteristics, Danzon noted. The Hatch-Waxman Act, which regulates the marketing of generic versions of drugs coming off patent, demands bioequivalence between generics and the original patented drug — that is, that the two drugs be essentially the same. As a result, patients and doctors have little concern that the U.S. generic drug will be of any less quality than the original drug marketed by a research-based manufacturer.

Moreover, Danzon continued, pharmacists are the key decision-makers on generic drugs in the United States because they are authorized to substitute a generic unless the physician explicitly orders a name brand, which Danzon said rarely happens. U.S. pharmacies also have financial incentives to distribute cheaper generics when the brand or manufacturer is irrelevant in the market due to bioequivalence. Generics compete on price, and centralized purchasing by large chain pharmacies has intensified price competition among generic drug makers. Meanwhile, tiered co-payments enacted by medical insurers — to reward patients who opt for cheaper generics over the branded version of a drug — encourage competition from the consumer.

By comparison, generic substitution in many other countries is difficult. Because pharmacies receive dispensing fees based on the price of the drug, they have little incentive to push the sale of lower-priced generics. In these countries, generic drugs compete more on brand recognition and are heavily promoted by salespeople who attempt to get physicians to write a prescription for their specific generic brand –much the way name-brand drug company representatives do in the U.S. Danzon said European nations have recently been moving more toward a U.S.-style generics market.

However, Danzon does not expect that the same type of pricing dynamics will evolve for generic biotech drugs, which are based on more complex biological processes than the traditional chemical-based drugs covered under the Hatch-Waxman Act. For drugs based on biotechnology processes, the question of bioequivalence is not as easily resolved. Indeed, regulators who are now developing a process for the approval of generic biotech drugs after patents expire use the term “biosimilar.” The U.S. Food and Drug Administration (FDA) this summer presented some guidance on how it intends to regulate the market for biotech-based products, such as insulin and emerging cancer treatments. According to Datamonitor, this market could grow from $243 million in annual sales last year to $3.7 billion by 2015.

In an article published in The New England Journal of Medicine, top FDA officials suggest the guidelines, expected to be completed by the end of this year, will be product-specific and will require examination of the “totality of evidence” about a particular class of biotech drugs. “The biosimilar market will be largely physician-driven, rather than pharmacy-driven, because most biologics are dispensed directly by physicians,” Danzon noted. “There is not going to be anywhere near the savings in biosimilars.”

Integrated Health Care and Fighting ‘The Change Monster’

A key element of the health care reform legislation — Accountable Care Organizations (ACOs) designed to integrate care in order to cut costs and improve quality — are the latest twist on a long-standing quest to better integrate health care, according to Wharton health care management professor Lawton Burns.

Burns, an expert in integrating health care systems, noted that in the 1990s, the industry underwent a similar push toward integration as hospitals and doctors offices combined into vast networks. “Will they get it right this time?” Burns asked.

In March, the Centers for Medicare and Medicaid Services (CMS) released proposed rules for establishing ACOs made up of hospitals, doctors and other health care providers to improve coordination of care for patients. Medicare will offer incentive payments to ACOs that are able to improve quality of care while eliminating redundant costs.

According to CMS, more than half of Medicare beneficiaries have five or more chronic conditions, such as diabetes or hypertension, that require care from multiple physicians, raising the odds that they will receive costly, duplicative treatments or that they will experience a medical error. On average, each year, one in seven Medicare patients admitted to a hospital suffers from a medical error, and one in five Medicare patients discharged from the hospital is readmitted within 30 days due to improper or poorly coordinated care. According to a CMS analysis, ACOs could lead to Medicare savings of $960 million over three years.

Burns noted similarities to medical integration schemes of the 1990s that also were based on the goal of displacing the traditional fee-for-service model. This payment system has been faulted for rewarding the volume of medical treatment rather than results, driving costs up with little regard to the quality of patient care.

This time around, Burns pointed out, efforts to integrate medical services are placing a greater emphasis on information technology to help coordinate complex patient care. In addition, ACOs look to bundled payments — which offer a single payment for one episode of care such as a pregnancy or knee replacement — and other reimbursement methodologies designed to provide financial incentives for high-quality, cost-effective care rather than volume.

However, Burns said, many of the basic elements of integration remain the same. In both eras, he added, three crucial elements figure into system design — access to care, cost and quality. The troika is often referred to as “the iron triangle” in health care systems research.

“What we don’t know about ACOs is how they are going to work,” Burns noted. He said it is clear ACOs will require managers to oversee enormous changes in the way their organizations operate. He referred to the work of Jeanie Duck of BCG who has written about a “change management curve” that bedevils managers attempting large-scale organizational transformation. According to Burns, as executives move toward a major transition, they approach the “lair of the change monster, where you can’t anticipate half of what happens long before you get to the desired state. With ACOs, multiple change monsters show up at the dinner table.”

For example, health care providers, such as hospitals and physicians, will be asked to tackle multiple initiatives simultaneously, initiatives that will require huge amounts of managers’ time and major financial investments. ACOs would need to revamp their payment systems, restructure complex care protocols and design approaches to treating the chronically ill elderly — all while introducing new information technology systems.

Further, Burns suggested, there is little proof that all these efforts will pay off in savings or better quality of care. “When you look at the evidence base for all this, it is weak if not nonexistent,” he said. Providers “will have a bear of a time executing this strategy.” He noted that studies indicate the level of change called for in the proposed ACOs would reasonably take five to 10 years to enact, while CMS is looking for a three-year turnaround.

In addition, he anticipates some clashes among all the different players in the health care ecosystem who have often been in conflict with one another in the past. “What you want to believe is that the beasts will meet in peace at the water hole and get along nicely and sing ‘Kumbaya’. We’re not sure that’s going to happen,” Burns concluded. “Most of these parties never got along very well and now, in three years, they’re all supposed to be getting along nicely?”

The Real Cost of Rising Health Care Employment

Currently 14 million workers are employed in the U.S. medical sector, which continues to outpace other industries in job growth. According to a July labor brief by the Altarum Institute, an Ann Arbor, Mich.-based health data analysis firm, total private sector health care employment grew by 287,000 jobs, or 2.1%, in the past 12 months. By comparison, total non-health payroll employment increased by about 750,000 jobs, or 0.6%, in the same period. Since the start of the recession in December 2007, health care employment has increased by 7.3% while non-health employment has fallen by 6.3%, according to the Altarum analysis.

Wharton health care management professor Mark Pauly said there are concerns that the U.S. spends more than 17% of GDP on health, among the highest in the world and more than most developed countries. According to data from the Organization for Economic Co-Operation and Development (OECD), Canada and Germany spend 10% of GDP on health while the United Kingdom and Japan devote about 8% of total economic output to medical care.

However, from the standpoint of efficiency, Pauly said it is not escalating health spending that should be troubling, but the increasing diversion of real resources into medical care and away from more valuable uses. He stressed that an analysis of health care spending should occur within the overall context of a country’s resources. “You have to ask what else would have been done with the money,” noted Pauly, who co-authored a working paper on the topic titled, “Health Employment, Medical Spending and Long Term Health Reform.”

According to Pauly, other nations spend more on other sectors. For example, in Germany, apparel costs more. In Japan, housing is costly. “We have expensive health care and cheap housing. They have cheap health care and expensive housing. Who’s happier?” Pauly asked.

Beyond that philosophical question, Pauly stated that the share of GDP devoted to health care should be evaluated after adjusting for health care purchasing power in each nation. Moreover, Pauly said, “if prices are rising because wages are rising, it’s bad if you are a consumer of health care. But if you are a nurse or a health care manager, it’s probably a good thing.”

Pauly pointed out that health care employment has been higher than in many other industries and more stable in good times and bad. The Altarum figures show that during recessions, health care employment grows more than other labor categories and does not lose ground, relative to other industries, during recovery periods.

From 2005 to 2010, the growth rate for employment in health care services was 11.42%, while overall employment fell 1.88%, according to the Bureau of Labor Statistics. Between 1995 and 2010, the share of total employment in health services grew from 9.07% to 11.26%. At the same time, the service sector, excluding health, grew from 32.35% to 36.64% while the share of employment in durable goods manufacturing dropped from 9.5% to 6.32%. Non-durable manufacturing fell from 5.93% to 3.81%.

According to Pauly’s research, some of the medical employment growth offset the negative effects of import penetration and improved productivity in other sectors. “The punch line is that as employment in nondurable manufacturing, like textiles, declined, health care moved in to take up the slack,” he said. Pauly urged policymakers to “be careful what you wish for” when attacking health care costs because they could wind up creating problems in the labor markets.

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