Waste Not, Want Not

A recent commentary in JAMA begins with the sweeping condemnation: “An epidemic of waste blights the US health care delivery system.”Sad as this claim is, it is also encouraging, for who wouldn’t want to get rid of waste? Any attempt at reforming American health care should start by eliminating waste—but to do so, we need to know exactly where to find the waste in the system and how best to dispose of it.

Waste comes in several varieties. A RAND study identifies 3 principal flavors: administrative waste (such as excess expenditures on running a health insurance plan); operational inefficiency (for example, duplication of diagnostic tests); and clinical waste (for instance spending money on expensive drugs when cheaper ones would be equally effective).

A good starting point in thinking about reform would be to enumerate all the types of each of these forms of waste and to put a dollar amount on each of them. It turns out that the McKinsey Global Institute, the economics research arm of the McKinsey management consulting firm, has done exactly this kind of analysis.
In fact, McKinsey first undertook to identify where the waste is in the US health care system using 2003 data and then repeated the analysis with 2006 data. What’s fascinating about the report is both seeing where the waste is and discovering how much has changed in 3 short years.

The McKinsey report compares US expenditures on health care with those of a group of 13 countries belonging to the Organization for Economic Cooperation and Development (OECD). Reasoning that richer countries are more willing to spend money on health care, the report computes the Estimated Spending According to Wealth (ESAW), a prediction of how much a given country would spend if it were like the OECD average, adjusted for per capita GDP. In 2006, the US spent nearly $2.1 trillion on health care, or $6800 per person, eating up 16% of GDP. This was an increase of $363 billion since 2003—and $643 billion more than the average spent in the 13 comparison countries (Austria, Canada, the Czech Republic, Denmark, Finland, France, Germany, Iceland, Poland, Portugal, South Korea, Spain, and Switzerland) after adjusting for per capita wealth, or the ESAW

The excess spending produced no discernible health benefit for Americans. In fact, comparisons of the US health care system to that of OECD peers typically find that the US performed worse than everyone else. On one report card, where 1 is the best score and 6 is the worst, the US managed to achieve scores of 5 or 6 on 5 measures: quality care, access, efficiency, equity, and healthy lives.

The waste, according to the McKinsey Report, is in 5 areas: outpatient care ($436 billion or 68% of the excess), drugs ($98 billion or 15%), administrative costs ($91 billion or 14%), investments in health ($50 billion or 7%), and inpatient care ($40 billion or 6%).

By outpatient care, the Report means visits to physicians’ offices, same day surgery, dental care, and treatment in ambulatory surgical centers, diagnostic imaging centers, and other outpatient clinics. What’s striking is that this is the fastest growing component of wasteful care, growing at 7.5% each year since 2003. The higher costs in this sector are due principally to two factors: how much physicians are paid in the U.S. and the high profit margins for ambulatory surgery centers and diagnostic imaging centers. Extremely generous physician compensation adds $64 billion of costs to the system each year. This reflects what we pay specialists and our extravagant use of specialist care: while generalists in the US are paid somewhat better than their counterparts in the comparison countries, specialists are paid much more highly than in the rest of the developed world. Both ambulatory surgery centers and imaging centers are proliferating rapidly, attracted by operating margins of as much as 25%. The result is that the US has 4 times as many CT scanners and MRI machines as the average OECD country, and does 4 times as many imaging studies each year, again with no measurable benefit in terms of patient outcomes.

Drugs are the second major area of wasted spending (this includes both drugs spent by outpatients and drugs spend by hospitals). What’s interesting here is that Americans actually take 10% fewer prescription drugs than the average OECD patient each year. The source of the waste is that drug companies charge on average 50% more for brand name drugs in the U.S. than elsewhere in the world and Americans use a more expensive mix of drugs (a large fraction of brand name or newly released drugs).

Health care administrative costs are next on the list. Most of this relates to operating expenses and profits among private health insurance companies. The American multi-payer system, far from driving down costs through competition, adds costs to the system in the form of marketing, sales, and management overhead. Even Medicare, which until recently had far lower administrative costs than the private sector, has experienced a rise in costs since 2003 because of payments it makes to private plans to administer the Medicare Advantage Plans and the Part D drug benefit.

Investments in health are also higher than in peer countries after adjusting for per capita wealth. This means the US invests more in public health and basic research than other countries. This is one area where the excess, relative to other nations, may well be beneficial and not wasteful. Whether NIH and state public health departments are spending their money in the most effective way—whether they are getting maximum value for their investment—should be carefully examined.

At the bottom of the list, but still a major source of waste, is inpatient care. What’s fascinating here is that both the number and length of hospitalizations are shorter in the U.S. than anywhere else. The waste stems from the cost per hospital day, which is roughly twice the OECD average. This in turn reflects more spending on high tech equipment and subspecialty care.

At least as interesting as the breakdown of the types of waste is the way the distribution has changed in the last few years. The identical analysis by McKinsey using 2003 data found that by far the largest source of waste was inpatient care, accounting for slightly under half of all the waste. Why has the contribution of hospitalization gone from first to last? The mechanism of reimbursement for hospital care by diagnosis related groups, which gives hospitals a fixed amount of money depending on the reason the patient was admitted rather than a per diem rate, has been in effect for older patients since 1983. What has changed is the availability of a more lucrative alternative—day surgery and treatment in ambulatory surgical centers—for the treatment of conditions such as hernias and cataracts. The move from one site of care to another dramatically demonstrates the tremendous adaptability of the health care eco-system.

The implications for health care reform of this type of analysis are profound. If we truly want to decrease wasteful spending, both short term and long term interventions will be required. If we want to manage the flow of procedures from the hospital to the outpatient setting wisely, we need to regulate the proliferation of ambulatory surgical centers and diagnostic imaging centers and to control what they charge for their services. If we want to affect the balance of specialty and generalist care, it will not be enough to provide incentives to medical students to go into primary care: we will need to markedly decrease the phenomenal rate of reimbursement for specialists. If we hope to decrease waste in the medication arena, we will need to determine whether new drugs are better than old ones and if so how much better. We will need to institute some sort of price control over the pharmaceutical industry, at least by negotiating prices (not currently an option under Medicare Part D). And if we truly want to get rid of wasteful administrative costs, we need to consider a single payer system, something that is currently not even on the table as Congress debates health care reform. Finally, we need to recognize that some of what other countries deem wasteful, such as high tech care near the end of life in exchange for a minute chance of life-prolongation, Americans seem to value. If we want to get rid of this type of expenditure, we will need to change the culture that supports this approach, not merely the economic incentives that further facilitate it.