The squeezing-the-balloon fallacy: Why savings from site-of-care shifts are wildly overestimated

The popularity of shifting site-of-care

For decades, initiatives to encourage shifting care from hospitals to lower-priced non-hospital settings have been popular among health plan medical directors tasked with “bending the trend” in health care benefit costs.   In response, physician groups and other entrepreneurs have constructed ambulatory care facilities such as ambulatory surgery centers, urgent care centers, infusion centers, post-acute care facilities, medical imaging centers, and various types of home care services which offer lower prices than what hospitals charge.   This post will explain why the seemingly straightforward “grocery store” approach to calculating savings from health plans’ site of care shifting initiatives is deceptive because it fails to account for fix costs, a type of “squeeze the balloon” fallacy.

Hospitals offer both inpatient and ambulatory services within their facilities.  Therefore, the shift of care from hospitals to non-hospital settings includes two main types of shifts: (1) shifting inpatient hospital care to ambulatory settings, and (2) shifting care from hospitals’ ambulatory care departments to other ambulatory settings, such as shifting an ambulatory surgical procedure from a hospital operating room to an independent ambulatory surgery center, or shifting a chemotherapy infusion from the hospital’s infusion room to an independent infusion center or possibly to a home setting.

Health plans encourage the shifting of services to those non-hospital facilities through both patient-facing and physician-facing incentives.   Patients can be motivated to seek care from lower priced facilities through deductibles, coinsurance and copayments.  Physician pay-for-performance initiatives and accountable care gain-sharing initiatives can motivate physicians to refer their patients to non-hospital settings. 

Unlike prior authorization programs that aim to reduce the utilization of services, site-of-care initiatives do not involve fighting with doctors and health plan members about whether or not a service is medically necessary.  You just have to overcome objections that the quality or safety of care might be higher in a hospital setting because it might be easier to access emergency care if there are complications and easier to coordinate care.  When proposing to shift inpatient hospital services to non-hospital settings, those objections are strong, and one could expect that only a minority of inpatient care could safely be shifted, at least with today’s telemedical capabilities.  When proposing to shift hospital ambulatory care to non-hospital settings, those objectives are relatively weak, and one could expect that the majority of care could be safely shifted to settings that charge less.

Site of care shifting initiatives are also attractive because the savings seem straightforward.  Unlike care management initiatives, for which savings calculations are complex and require counterfactual assumptions regarding what would have happened without the care management intervention, savings from site of care initiatives seems on the surface to be far simpler.  You just multiply the volume of services that shifted by the price difference – just like calculating how much you saved from buying the generic rather than the brand name product at the grocery store, right?

No, not right, at least not in the long term.

New McKinsey / Harvard / JAMA analysis says site-of-care shifting could save billions

Before I explain why, let me first summarize a recent, prominent example of how to do it wrong.  In this week’s JAMA, Nihil Sahni and colleagues from McKinsey Consulting, Harvard, and Washington University published a paper entitled Potential US Health Care Savings Based on Clinician Views of Feasible Site-of-Care Shifts, for which I submitted a published comment. The authors had two aims. 

The first aim was to address the objection I described above about the quality of care or safety differences that might make it inappropriate to shift care to “alternate care sites.”  They interviewed 1,069 clinicians, 75% of whom were physicians with the remainder being nurse practitioners, physician assistants, nurse anesthetists, radiology and imaging techs and clinical psychologists.  They asked about 312 services (“care activities”) and 16 sites of care grouped into seven types, shown below.

They showed the clinicians the current distribution of services across the sites of care and asked them to propose an alternative distribution of care (still adding up to 100%) that could be safely achieved.  The clinicians’ responses suggested that, among the 33-38% of care activities delivered in inpatient hospital settings, a little more than 10 percentage points could be safely shifted from inpatient hospital settings to various ambulatory care settings.  The proposed shifts were higher for services that involved procedures, rather than just evaluation and management.  The clinicians proposed the greatest shifts for certain specialties, including physiatry and rehabilitative medicine, radiology, general surgery, and orthopedic surgery.

In my opinion, this strikes me as an impossible mental exercise for clinicians to do intuitively, given the diversity of cases, risks and capabilities across the sixteen sites of care.  Nevertheless, I suppose it is always a good idea to ask frontline people what they think.  To take this cognitive challenge to an even more ridiculous extreme, they also asked the frontline clinicians to imagine advancements in telemedical technology that might occur in the next 7-10 years, and to opine on a safe distribution by site of care that those advancements might enable.  I must have missed the class in medical school in which we were trained how to figure that out in our heads!

The authors’ second aim was to estimate how much money would be saved if those proposed shifts were implemented.  They used the traditional method.  For each service, they used claims data to calculate the average “allowed amount” – the amount that Medicare or a commercial health insurance plan was contractually obligated to pay for each alternative site, without considering adjustments and without netting out subsequent incentive payments.  Since they only had claims data for Medicare and commercial payers, they extrapolated by 0% to 50% to estimate the impact on shifts for people covered by other payer classes.  They took the average of the clinician-proposed distributions by site and compared them to the current actual distributions to determine the magnitude of site-of-service shifts.  They then calculated the savings multiplying the volume of cases shifted by the associated price differences.  Grocery store logic.  They calculated the total annual savings opportunity from implementing the proposed site-of-care mix to be between $113.8 billion and $147.7 billion, including an overall 5.2% net savings for commercial and 8.9% net savings for Medicare.  Based on the “imagine future technology” interview results, they estimated that the savings opportunity would grow over the next 7-10 years to 10.2% of commercial and 13.9% of Medicare cost.

Why grocery store logic is wrong

At the end of the day, health care organizations must charge prices that cover their costs and provide a little margin to allow the organizations to make necessary capital investments over time.  If an organization is for-profit, it must charge prices that also provide a reasonable return on the investment made by their owners.

Consider the example of an elective orthopedic surgical procedure.

Patients can be admitted as in inpatient and receive the procedure in the hospital operating room, then in the recovery room and then receive some additional recuperation and monitoring upstairs in a hospital room.  Or, they could receive the service as an outpatient in the same operating room, recover in the same recovery room, and then go home with instructions about what complications to look out for.  Or, they could receive the service in an ambulatory surgery center, with a similar operating room and recovery room.  In all three sites of care, the patient arrives at the facility, walks by a security guard, and spends a little time with a staff member in registration to enter some data into a computer.  The doctors and nurses spend about the same amount of time with the patient in the pre-op room, the operating room and the recovery room examining the patient, executing the procedure and typing notes and orders into their computers.  The operating rooms are heated to the same temperature.  The same pre-op and post-op tests are ordered.  The same surgical supplies are consumed.  In all three sites of care, the operating room has to be cleaned after the procedure.  If the site of care was inpatient hospital, a floor nurse spends some additional time checking in on the patient periodically, and there are some additional “hotel” expenses to heat and clean a room with a bed and a chair and to provide a few trays of food at a cafeteria level of quality.  No wine list.  Compared to the compensation for the orthopedic surgeon and all the costs incurred in pre-op, the O.R. and recovery, the compensation for the floor nurse check-ins and the hotel costs are small.  If the health care organization sets prices to cover their costs and provide a little margin, one would expect the prices to be about the same for hospital outpatient and ambulatory surgery facility settings, and only a bit higher for the hospital inpatient setting.

So why are the prices charged to the health insurance company so different among these three alternative sites of care for the same orthopedic surgical procedure? The main answer is hospital fixed cost allocation.

Hospital campuses have substantial fixed costs.  The hospital accounting team must keep track of all expenses and revenues.  The hospital departments that deliver care, like the inpatient nursing floors, the operating rooms, the emergency room, and the laboratory and radiology departments, are “revenue centers.”  The revenue centers have associated cost accounts to keep track of the “direct costs” of the clinical operations that provide the care.  Many of those direct costs are to pay for staff time and supplies that are “variable” based on the volume of care that is provided during a month.  But some of those direct costs are “fixed” such as the salary cost of the head nurse in the operating room.    In addition to direct fixed cost, hospitals also have substantial indirect fixed costs, also described as “overhead” or just “indirect” cost.  Hospitals have large buildings and grounds.  They must buy and maintain all the equipment needed to provide a broad set of services.  They have a big IT department and have to pay substantial fees to software vendors.  They have finance people, a legal department, a human resources department, a security team, and a team that recruits medical professionals and handles credentialing and continuing medical education.  They might have to pay staff to administer residency programs.  All of these costs are tracked in indirect cost centers. 

When a hospital finance team is negotiating the fee schedule and other reimbursement contract terms, they need to make sure that the revenue they project based on the contract terms is more than sufficient to cover all their direct and indirect costs.  One way they do that is to calculate for each of the revenue centers a “contribution margin” by subtracting direct variable costs from revenue, and then making sure that the total contributions of all the revenue centers can more than cover all the direct fixed and indirect fixed cost.   Another way the do that is to allocate the indirect fixed costs and direct fixed costs to each of the services offered within each of the revenue centers.  For example, the allocation for security services and building maintenance services might be done in proportion to the square footage of the space occupied by each clinical department.  Then, the “fully loaded cost” for each service is calculated as the sum of indirect fixed, direct fixed and direct variable cost, divided by the units of service.  Then, the finance team can compare the fully loaded cost to the projected revenue to determine if the service is profitable, and they can adjust the prices as needed to ensure economic sustainability of the enterprise.

So, what actually happens if you shift care from inpatient to outpatient settings, or if you shift ambulatory care from hospital campuses to non-hospital providers?

Over a relatively short period of time, the variable cost should shift from one site of care to the other.  But the fixed cost is, um, fixed.  You could continue to allocate the same amount of fixed cost to the revenue center from which care was shifted and raise the prices for the shifted services to make up for the smaller volume, thereby creating an even stronger incentive to shift more of that care away from the hospital.  Or, more likely, you end up allocating more fixed cost to all the other services, and raising the prices of all those other services a little bit to cover it.  The same thing happens to costs for uncompensated care provided to patients without insurance that cannot afford to self-pay, and for losses from services provided to patients covered by Medicaid, which systematically under-reimburses for care.  Unless the community and the health plans are OK with the closing of the hospital, the prices across the board must increase to cover the costs which are truly fixed.  It is a classic case of squeezing the balloon.  The fixed cost air inside has to go somewhere.

Site of care shifting is beneath us

One could argue that, from the perspective of one payer, if you can shift more care away from the hospital than your competing payers, you get to keep the savings from the price difference, but the compensatory increases in prices for all the other hospital services might fall slightly disproportionately on the competition, giving you a slight strategic cost advantage.  That’s the same kind of rationalization that is used when health plans spend lots of time and money on programs to game diagnosis coding slightly more than their competition for patients covered by Medicare Advantage and other risk-based reimbursement arrangements.   The point is that, when health plan medical directors focus their time on site-of-care shifting (as implicitly advocated by the McKinsey/Harvard/JAMA paper), they are unintentionally deceiving themselves about the savings and participating in a race-to-the-bottom that does not add real long term value. 

In fact, the push to shift care may achieve the opposite.

Health plan initiatives to shift care incentivize the construction of new non-hospital facilities for ambulatory surgery, physical therapy, imaging, infusions, etc.  All those facilities have their own security guard and check-in staff and many other duplications of hospital fixed costs. By spreading care among many facilities, there is a loss of opportunity to achieve savings from economies of scale, specialization and care coordination.  If the new facilities have smarter leaders or use more efficient care processes compared to hospital organizations, then by all means, we should replace the hospital leaders and adopt the innovations.  But intentionally promoting the duplication of infrastructure to create the appearance of savings by evading hospital fixed cost allocation, when the health plans are still paying all the fixed costs one way or the other in the long run, should be considered beneath those on a professional mission to increase population health care value.

To achieve true improvements in value, it is necessary to do the hard work of figuring out more effective and efficient ways to deliver necessary health care services and convincing people to stop delivering low value services.  Admittedly, such work can generate controversy and conflict, particularly since people tend to resist change and defend their interests.  And, such work admittedly requires more complex analytics and modeling than the grocery-store logic used for site-of-care shifting.  But population health professionals can and eventually will overcome those barriers.