Saving Medicare by Reducing Waste

The Crisis:

The federal government spent $525 billion on Medicare in 2010 and is projected to spend more than $900 billion by 2021^[1].  Medicare is thus growing at 5.5 percent per year, faster than the economy has ever grown over a similar period, which will ultimately bankrupt America. We must begin reducing Medicare spending in 2013 in order to eliminate the deficit by 2017. This paper shows how this can be achieved without cutting benefits or increasing cost to seniors.

The Strong America Now plan will eliminate the Federal deficit by 2017 by reducing waste in government including Medicare spending.

The Proven Solution is Waste Reduction:

A significant insight of the Ryan Plan is to reduce spending in part by creating a competitive health care market. The Strong America Now plan reduces Medicare spending 20 percent by 2017 by reducing waste in the entire medical industry and creating a competitive market for quality healthcare. This eliminates the need in the Ryan plan to shift cost to seniors.

Waste by definition is any cost that does not benefit the patient. Waste can only be detected and eliminated by examining the data within each process, not by shaking your fist in the air and shouting “cut out the waste”. Caterpillar, Xerox, Alcan, ITT, Avery-Dennison, and most of the Fortune 500 companies use a waste detection and elimination process known as Lean Six Sigma, which is described in six books written by Mike George. The U.S. Army and Naval Aviation initiated waste reduction using these industry models. Most members in Congress are unaware of the significant impact of waste reduction due to their lack of private sector experience. The Congressional Budget Office Director, Doug Elmendorf does not believe that waste is significant^[2], and of course, has no private sector experience. We provide just two examples below, of the 50 examples on www.strongamericanow.com, that prove that government spending contains 25% waste and that at least $500 Billion per year can be eliminated. We hope that Mr. Elmendorf will study the unchallengeable data in the examples below so that he can provide better guidance to the Super Committee which is charged with cutting the deficit.

The Cost of Medical Care Contains 30 – 40 percent Waste:

Mr. Elmendorf should also study the National Academy of Engineering (NAE) and the Institute of Medicine (IOM) joint NAE/IOM study^[3] which estimates that 30-40 percent of health care spending is waste due to:

"...over-use, under-use, misuse, duplication, system failures, unnecessary repetition, poor communication, and inefficiency.”

An example of the “inefficiency” portion of waste is instructive:  Insurance companies informed Stanford University Hospital that the cost for Coronary Artery Bypass Graft surgery was not competitive, and unless they became competitive, they would no longer receive their patients.

Stanford responded by applying waste reduction methods and found that 70 percent of the cost of the surgery was waste. Removing waste not only reduced costs by 70 percent, it also caused the number of deaths associated with the surgery to fall by 52 percent!  This was achieved by cardiologists, surgeons, nurses, procurement personnel, and administrators all receiving training in waste reduction methods and working as a team to detect and eliminate waste.

For example, the team discovered that each of the six cardiothoracic surgeons had their own unique surgical packs.  Each surgical pack had entirely different retractors, clips, sutures, connectors, sponges, etc. The waste reduction team standardized to a single surgical pack, which dramatically reduced the number of different items while increasing unit volume per item, thus reducing prices, administrative costs, nurse setup costs and errors. The excess cost of the six different surgical packs is of no benefit to the patient and hence was waste^[4]. This is just one of 70 different projects that the team executed to reduce the cost of bypass surgery by 70 percent. Applying waste reduction across the hospital reduced spending by $120 million or 19 percent of total hospital cost.  This could not have been achieved without a cost conscious hospital. 

Reducing the Cost of Medical Care by 20 percent Nationwide:

The secret of Stanford’s success was that a hospital CEO led the drive to implement waste reduction throughout the entire hospital.  Medicare should therefore require that each participating hospital, nation-wide, commit all executives and administrators to attend two days of training and implement waste reduction according to industry best practices^[5].  The payback is more than $10 of waste reduction per dollar of consulting expense, with the Army reporting even higher numbers because waste in government is greater^[6].Waste reduction will cut all Medical costs by 20 percent by 2017, freeing the economy of a $500 billion per year drag. This will make Medicare affordable if and only if  Medicare requires deployment of waste reduction by all participating hospitals and doctors starting in 2013.

The Survival of Medicare Depends on a Competitive Healthcare Market:

Prices in a competitive market are determined by supply and demand. However, the Medicare Prospective Payment System (MS-DRG) administratively sets prices for thousands of procedures independent of supply and demand. As in the Soviet Union prices set without respect to supply and demand are always set too high or too low, causing surpluses, shortages, and waste^[7].

Medicare set the price of elective angioplasty too high at $71,000 for Hospitals, and created a surplus of procedures. For example, angioplasties in Clearlake California were performed at five times the per capita rate as in the rest of the state^[8]. One doctor said “Financial incentives are definitely to blame for the high rates” of elective angioplasty.  Medicare sets some prices too low creating shortages. Medicare only pays primary care physicians 60 percent of the hourly rate paid to specialists^[9] creating a shortage. By contrast, in a competitive market in which prices are determined by supply and demand, the shortage of primary care physicians would cause their fees to rise, attracting more doctors into the practice. But Medicare prices are not determined by supply and demand, they are set by the Relative Value Scale Update Committee^[10].

Solution - The only effective approach is to allow prices to be determined by supply and demand in a competitive market. Individuals, insurers and Medicare can then select the efficient waste free supplier of quality services and drive out the inefficient and the greedy.

A Competitive Market Requires Cost Conscious Consumers, Doctors and Hospitals:

To create a competitive market, consumers must become cost conscious so they will pursue low insurance prices for high quality care. Similarly, Doctors and Hospitals must become cost conscious so they will pursue waste reduction^[11]. Employees do not currently pay taxes on employer supplied “Cadillac plans” in which the employee pays little or nothing, and hence these employees are cost unconscious^[12].  Many employers offer these “Cadillac” plans to attract the best employees and Unions have fought for “Cadillac plans” for their members.

A cost unconscious patient will be content to have a more expensive insurance plan that subsidizes wasteful suppliers. Having patients make cost conscious decisions in regard to comprehensive health care insurance is a vital element in continuously driving out waste and inefficient suppliers, just as happens in the rest of the economy. The current healthcare system has been aptly described by Senator Chuck Schumer as a “cost plus” service without any competition. This is proven by the fact that the fee for an MRI in Massachusetts varies from $450 to $1,675^[13]! In the rest of our economy, the $450 supplier would thrive and the $1,675 supplier would fail. Trying to reduce Medical spending by increasing the deductible won’t help matters either, since more than 80 percent of healthcare costs are associated with patients who annually incur over $4,374 of cost, well in excess of any deductible^[14]. 

Solution - The tax code must be reformed to tax any insurance plan that costs more than the most economical high quality comprehensive health care insurance, which is readily available. The tax must be levied in 2013 as a vital part of eliminating the deficit by 2017. Obamacare delayed any such tax increase until 2018, which is far too late to help solve our deficit crisis.

Reducing the Cost of Medical Care by More Than 30 Percent:

Thus far we have only discussed the “efficiency” portion of waste discussed in the NAE/IOM study which accounts for about 20 percent waste in healthcare spending. This $100 Billion+ per year that can be eliminated by 2017 within our present healthcare structure. Eliminating more than 30 percent of spending requires reduction of the “overuse, underuse, misuse, duplication, system failures, unnecessary repetition, poor communication” portion of the NAE/IOM study.

For example, hospitals can save the life of a diabetic by amputating his foot for $30,000 and they can probably reduce that cost by 20 percent through waste reduction. But it is far better and cheaper to correct the patient’s lifestyle and prevent diabetes and the need for debilitating surgery. This approach attacks the “misuse/over-use” component of the NAE/IOM study.  The current medical care system is described as Fee For Service (FFS), and focuses on curing acute episodes of illnesses—broken ankles, pneumonia, bladder infections, back surgery and the like, in which you ultimately get well. However, the major challenge to our health care system lies in preventing chronic illnesses—diabetes, high blood pressure, kidney dialysis, obesity, along with other diseases and conditions whose prevention must be continuously managed over long periods of time.

An estimated 157 million Americans have some sort of chronic illness, and their treatment consumes more than 70 percent of health costs^[15].  An FFS provider typically does not offer an organized diabetes prevention process because it involves continuous diet counseling, treatment by podiatrists, psychiatrists, etc which is far from their capability of curing acute episodes of illness. To prove that FFS does a poor job of prevention, consider this data:  From 1987 to 2005 the incidence of diabetes among Medicare patients has increased by 64 percent^[16]. We clearly need a competitive alternative to FFS that delivers better outcomes at lower cost for both acute episodes and the prevention of chronic illness at lower cost.

The Mayo Clinic, Kaiser Permanente, Geisinger and Intermountain are examples of such and alternative to FFS, the Integrated Delivery System (IDS). An IDS is “A coordinated healthcare system formed by physician groups and hospitals which increases efficiency and reduces redundancy in providing healthcare by offering a broad range of health services–e.g., hospital and ambulatory care services”^[17]. The result of their “ambulatory” prevention services is remarkable^[18]: IDS hospitalizes 40 percent fewer patients than FFS due to superior outpatient prevention treatment.The IDS is far more effective than FFS in managing chronic disease, which is 70 percent of our healthcare cost.

An IDS typically costs 20 percent less than FFS medical care^[19]. The cost conscious patient can pocket the difference between FFS and IDS. Stanford University employees have the choice of selecting low cost IDS or higher cost FFS medical care for which they must pay the difference. About 80 percent of employees ended up freely choosing an IDS plan and pocketing the difference in price. 

Under an FFS solo practice approach; patients are often the victims of poor communication and even economic rivalry among their doctors, which can often result in much slower diagnoses, duplicate diagnostic tests, resulting in higher costs. By contrast the IDS such as the Mayo clinic, sets up multi-specialty consultations in which the patient can meet with all the relevant doctors at the same time, ask questions, and get prompt answers. Thus IDS reduces the waste due to “duplication, system failures, unnecessary repetition, poor communication” discussed in the NAE/IOM study. Thus IDS does a better job at 20 percent less cost than FFS on both episodic and chronic illness.

Medicare should reimburse per beneficiary at the lowest market price of a high quality comprehensive insurance plan in any region, which will likely be an IDS. This natural force will drive more hospitals and doctors to voluntarily adopt the IDS model over time and allow the reduction of waste to approach the NAE/IOM 30-40 percent figure. However, the lower cost of IDS has driven some medical associations, who prefer higher priced FFS, to use their lobbying power to legislatively prevent IDS from operating in their state^[20]. In the 19^th century, the suppliers of illuminating gas tried to similarly kill the infant electric light bulb industry by legislative means because they could not win in fair competition. In addition, fraud amounts to $75 billion a year, which can be eliminated by private insurance practice. ­^[21]

Conclusion - Government must use existing anti-trust laws to assure that competitive IDS providers are allowed to exist side by side with FFS. Cost conscious consumers should be able to pay more for FFS, or pocket the difference by using an IDS. Obamacare must be reformed or replaced to prevent the projected $150 billion per year deficit projected by the CBO^[22]. Waste amounting to 20 percent of medical care cost will be eliminated by 2017 with another 10-20 percent beyond. Medicare benefits and cost to beneficiaries will not be increased beyond inflation while eliminating the deficit by 2017, if and only if, universal implementation of waste reduction is begun in 2013.

 Michael L. George is the Founder of Strong America Now and retired founder of the George Group which applied the waste reduction method known as  Lean Six Sigma to Xerox, Caterpillar, ITT, Alcan, Eli Lilly among other Fortune 500 companies, as well as the US Army and US Naval Aviation,. The George Group was sold to Accenture in 2007. Mike also founded International Power Machines which was sold to Rolls-Royce in 1984. He earned a BS in Physics from the University of California and an MS in Physics from the University of Illinois.

The author wishes to thank Professor Alain Enthoven of Stanford University and Karen Rago, Executive Director of Service Lines, University of California San Francisco Medical Center for many useful discussions and criticisms. References to data in this White Paper can be found at www.strongamericanow.org

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