Health care delivery in America was always different. America’s founders rejected the european standard of government-guaranteed and provided health care for all the people— preferring free consumer and provider choice. Letting private hospitals form as wanted in communities and allowing individual providers free choice in choosing practice location. But, excepting a group of DOD/VA facilities, native american reservations, and several large city hospitals and city sponsored clinics, the vast majority of americans have never recieved any service in a government health care organization in their life. Yes, like restaurants, barber shops, and hardware stores, health care in America was clearly not provided by government, but was allowed to form as a private market, where service volumes and prices are set by private firms and customers, both pursuing their selfish interests (as economists would say).

Though our founders would smile, health care wasnt seen by anyone as a real business, but its job was special, and the people that worked there were different. It was there to save lives. Government did acknowledge the uniqueness of the industry (in the first edition of the IRS code in 1916, in Sec 501 (c)(3) ) that qualifying charitable organizations do not have to pay taxes. And, the way it was treated by its customers (eg the ones that paid the bills) reinforced the fact that it wasn’t a real business. In the 1966 bill authorizing Medicare (and Medicaid) the way hospitals and nursing homes would be paid by the new govenment insurances would be by paying the provider’s “reasonable costs”. And, so it was; hospitals, nursing homes and other delivery organizations were private organizations, many even for-profit companies, were somehow special.

But something changed in the early 1980s in America. Here the chart shows the trend in health care per capita spending and life expectancy in many countries. Yes, health care in America has always been special (more spending, poorer outcomes—- less cost effective) than other countries (which generally have a larger government role in health care). But clearly something happened in America in the early 1980s that set the health sector off in a new direction; one with even less value for the money.

My hypothesis is that the implementation of a new way of Medicare paying hospitals may be the “change agent” we are looking for. The Medicare program had been looking for a new way of paying hospitals for a decade. This was provoked by the higher-than-anticipated increases in hospital expenditures (and “reasonable cost” payments to hospitals) in the decade following the implementation of Medicare and Medicaid in 1966. Pilot programs in over a dozen states starting in the 1970s demonstrated the concept of paying hospitals in new ways ranging from fixed budget systems, to prospective rates per type of patient. There was a good deal of political momentum about achieving some incentive payment solution that would encourage hospitals to be more efficient and slow the growth in hospital costs. And, it was no surprise that Congress passed legislation to implement a system of payment reform in 1983, wherin a national system of fixed rates for 383 types of patients (DRGs) was approved, and as demonstrated in a New Jersey pilot, had strong incentives for hospitals to be efficient and to be prudent about the special services provided to admitted patients.

So, what’s the big deal about a change in the payment system by one of the payors for hospital services? Did hospital spending go up because Medicare overpaid hospitals? No, and actually research estimated that hospital expenses went up by less than would have been expected otherwise. And, research later also showed that the new payments system and the inability of managers to keep costs below the fixed rates was instrumental in closing the doors of about a 1000 hospitals. Indeed, most hospital CEOs were also replaced.

The big deal may have been that the actions by Medcare in 1983 may have confirmation that the party was over for hospitals and health care. The days of the protective community climate of health care of “Good people doing God’s work” and protected from financially worry by being paid “reasonable costs” were over. Managers in the good old days before DRGs didnt lose sleep worrying about sustainability of their organization, or strategic partnerships for bringing in new revenue streams, or consolidation to grow, or hiring doctors to better achieve control of practice patterns. No, in the good old days the leadership of hospitals wasn’t losing sleep over survival and financial ruin.

But it all changed. Health care managers and Boards came to quickly realize that the future was not guaranteed any longer by the payors; indeed organizations would sustain only if they could produce services efficiently and generate sufficient volumes of revenue. My hypothesis is that these organizations began to behave like other other private businesses — where competition, taste and technology changes, newspaper headlines, and other stimuli can bring distress and failure of the enterprise. Management changed. Instead of easy going and community-oriented managers, proper business, financial strategy and planning skills became essential. And, executives with pro-active determination to do what was needed to keep organizations moving in a financially sustainable fashion were needed. Hiring executives with such skills became a priority for Boards. Indeed, most hospital CEOS were replaced during the mid 1980s.

The hypothetical story is as follows. Health care executives began behaving like private business leaders and managers in the early 1980s after seeing that payors were no longer going to pay the “reasonable costs” of care, and that nearby hospitals were failing as a result of not being able to get costs to be less than revenues. As a result, hospitals began to behave differently to assure survival. They began to cut business risk by getting bigger (acquiring new health care practices, adding new services), cutting waste (outsourcing some services, adopting lean and quality improvement practice) and they gean to mimic their business counterparts in other industries by paying attention to profits, by looking for new revenue opportunities, and by raising prices early and often (remember, some payors still pay fee for service or a percentage of fees).

These trends dont explain the lack of effectiveness in increasing life expectancy (see the figure). But, of course, this is America, where lifestyle is so important to health. Whether hospitals do more, or do less, or spend more doing it, may have little leverage on life expectancy.