Healthcare Gets a Check-up
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Policy Strategy Economics Apr 15, 2007

Healthcare Gets a Check-up

Examining the diseased economics of U.S. healthcare

Based on the research of

David Dranove

In America, consumers often find ways of tightening their belts when they’re running low on cash. They might opt for low-cost, no-frills shampoo instead of a salon favorite. Or bake a few frozen dinners instead of cooking gourmet, all to make do with less to stretch the elusive dollar.

But while settling for average in household shopping is typically good enough, with medical care it’s not, says David Dranove, the Walter J. McNerney Distinguished Professor of Health Industry Management, who is writing Code Red: Reviving the American Healthcare System, the sequel to his 2000 book, The Economic Evolution of Health Care: From Marcus Welby to Managed Care.

At issue is the reality that today’s Americans are part of a healthcare system ridden with maladies, says Dranove, whose upcoming book takes readers on a journey through the barriers that prevent many from accessing quality care at reasonable cost. Employing an economic framework, Dranove chronicles the rise and fall of managed care, discusses ongoing changes (for better or worse, as he puts it) and concludes with his recommendations.

Making the grade
In its early chapters, Code Red provides an assessment of patients’ needs, expectations and values when shopping for healthcare. It details the comparative benefits of patients pursuing care through the traditional healthcare system (the “Marcus Welby” ideal) and the system of managed care that emerged in the 1990s. Examining government regulation, the performance of managed care and its cost-containing challenges, Dranove considers the backlash against this healthcare option and how it ultimately affects patients’ pocketbooks and health outcomes. The book’s second half chronicles how government and the private sector are coping with access, cost and quality after the demise of HMOs.

A popular strategy today is to move individuals into Consumer-Driven Health Plans that force patients to pay more out of pocket to contain costs. The consumerism movement is only a partial solution, Dranove believes, because most healthcare expenses are borne by chronically ill patients whose costs will still be completely covered by insurance.  He also worries that those who do share in the costs may skimp on necessary medications, therapy or preventive care, leading to dire diagnoses and skyrocketing medical costs down the road.

“Consumerism will force many individuals to worry about costs, but if patients are going to be focused on cost of healthcare, then they also need to be focused on quality. With that in mind, they need tools to evaluate quality,” Dranove says. He explains that provider report cards were designed to achieve that goal, but thus far lack effectiveness.

“The success of report cards is a necessary condition for the success of free market healthcare. Otherwise, cost will become the dominant [consideration] over quality, and markets are supposed to do better than that,” says Dranove.

The grading system evaluates providers based on survey questions and limited patient outcome data by third parties. This is helpful in theory, but applying the data poses challenges.

Says Dranove, who also is professor of management and strategy, “Providing valid information about which providers are bad and good is just not that easy.”

There are important details that never make it into the data he notes. For instance, patients’ actions play a role in their own health outcomes in the form of attitude, family support, adherence to diets, exercise or medication recommendations. And luck is also a factor. But as Dranove points out, “Those [considerations] cannot be captured in the current data reports.”

In other instances, report cards fail to paint an accurate portrait of the provider’s abilities due to circumstances beyond the provider’s control.

“Consider pediatrician report cards that emphasize immunization rates.  A pediatrician might be committed to educating patients on the importance of childhood immunizations, yet might still receive a low grade for those criteria because not all of these patients under age two have been immunized. Perhaps the patients’ circumstances, not the physician’s negligence, affected access to care,” explains Dranove. Transportation challenges, a lack of child care for an ill sibling who needs to stay home, or not enough money to pay for the vaccinations may all affect the grade, though these data remain unseen by those evaluating the physician.

“The report cards have the potential to do some good if they are modified to include more useful data,” says Dranove. “As I often tell people who want to dismiss report cards out of hand, imagine what the auto industry would be like if Consumer Reports had not identified that [foreign] cars were better than American cars.”

Prescriptions for a healthier system
Dranove also offers readers insights into current programs designed to improve healthcare access. Some states, like Hawaii, Maine and Massachusetts, offer intriguing alternatives to the status quo, Dranove says. In these states, most employers are required to fund health insurance for their employees.

The United States federal government should require every state to find a way to cut the number of uninsured in half, according to Dranove, who adds that in California, a similar plan is a ballot initiative. He is less optimistic about risk pools for small employers, a strategy that has failed in most states that have tried it.

Elsewhere in the world, healthcare barriers have been removed altogether. “In Germany, everyone is covered and the federal government sets the ground rules,” Dranove says. “There is a public and private partnership and everyone is covered with about half the expense of what we spend here.” However, there are limitations on access to technology and providers spend less time with their patients to make up for lower fees. Americans might prefer such tradeoffs, but without reform, they may never get a chance to find out.

Aside from federally mandated coverage, improvements in keeping and sharing medical records for evaluation of physicians and practices should be improved.

“Most providers have electronic systems for billing, but electronic medical records are rarer and are not all unified,” says the Kellogg professor. “A link between administrative data and clinical data would be invaluable to assess health outcomes and improve report cards.” Dranove proposes that the federal government allow for the creation of a single medical record standard through a consortium. From his perspective, improved medical records with disease-specific instrument surveys are key to measure outcomes accurately, in turn giving patients a more accurate view of the market. A federal subsidy might also be necessary to get physicians up and running with a standardized system.

“The federal subsidy for physicians would be about $2 billion, and considering that the nation spends $20 billion per year on healthcare technology, that figure is not really that significant,” Dranove says.

Dranove also believes that consumer-driven healthcare plans should be part of the future. A key feature of these plans is the “medical savings account” which allows patients who spend below preset amounts on healthcare to invest the balance in a manner similar to retirement financial planning. Rather than create yet another investment vehicle, Dranove recommends allowing consumers to use their existing retirement plans to pay for healthcare costs and increasing the amount individuals can contribute to those funds. In addition, a cap would be applied for the tax deductibility of contributions.

The author is working to have Code Red circulating by fall 2007, as the 2008 presidential campaign heats up.

Featured Faculty

Walter J. McNerney Professor of Health Industry Management; Faculty Director of PhD Program; Professor of Strategy

About the Writer
Romi Herron, former staff writer at the Kellogg School. Article featured originally in Kellogg World, Winter 2006.
About the Research
Dranove, David (2008). Code Red: Reviving the American Healthcare System. Princeton, New Jersey: Princeton University Press. [Available at Princeton University Press or]
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