What Will We Tell the Doctors?

Ken Houghton | April 7, 2011 6:26 pm

“The practice of medicine was accepted to be a chancy way to make a living, and nobody expected a doctor to get rich, least of all the doctors themselves.”  – Lewis Thomas, The Youngest Science, p. 4 (Penguin, 1995 edition, quote via Google Books)

Lost in the discussion of Paul Ryan’s “plan” is the group of entrepreneurs that will be most harmed economically by enacting it: doctors—most especially general practitioners.

I was speaking with David Warsh last week at Kauffman, and pointed out what “everyone knows” but no one will say: U.S. doctors net about twice as much money as doctors in the rest of the civilized world. (As a ballpark, $200K in the U.S. and $100K elsewhere.)  And until you can solve some of that, you won’t really make much of a dent in the High Cost of Medicine.  David noted that solving that “isn’t going to happen.”

Paul Ryan’s plan is a large step toward making it happen—just not in the way David (or I) would have expected it to happen.

Let’s sidebar the usually Capitation v. Fee-for-Service discussion, which will only have an effect at the margin.  Assume that doctors net, say, $25 per patient (net of paying for office staff, supplies, waste disposal, etc.).[1]  If they schedule four patients per hour ($100)[2] for eight hours a day ($800) five days a week ($4,000) for a fifty-week year ($200,000), they make their salary.

Note the assumptions I made: the per-patient return is certainly variable (standard MC/MR curve), so the real return is based on volume and where that volume falls on the MC curve.  So long as a doctor can schedule to see 160 people a week—8,000 visits a year—they are continually busy and receive optimal returns.

But the market is not perfect.  I am of an age where a few visits a year is strongly suggested.  Tom or Rebecca, by contrast, go in once (if at all) and otherwise when they are unhealthy.[3]  It seems intuitive that, given search costs (think labor markets), a doctor’s practice is marginally more profitable with more repeat patients. Customer retention is therefore of enhanced value in the current equilibrium.[4]

But shifting the burden of payment while not capping insurance margins is also an easy first-order solution: fewer insured people, certainly; higher margins, probably (positive, maybe not significant), shifting of funds toward the sector that reduce overall consumption, and—inevitably—fewer doctor visits for the older and most likely to need care.

Note [4] above becomes relevant on the supply side; the relationship is weaker if still positive.  But the discretionary spending is reduced; Fee-for-Service fades except in the “concierge” segment of the market.  Capitation becomes the rule, and the model that has become prevalent—insurance companies guaranteeing doctors a salary—become the rule.

But visits to the doctor have declined, due to those most in need having the least ability to pay and therefore dropping off the insurance rolls.

So the insurance company doesn’t expect the doctor to make 8,000 separate treatments a year.  Or they do, but find at the end of the year that they were mistaken. The next year they offer to pay based not on 32 patients a day, but rather 30. And, given the frictions in the market, the majority of doctors agree, preferring the certainty of $187,500 a year to the risk of treating the uninsured, who are now a much riskier group.

And then the multiplier effect comes in.  Recall that there are fixed costs as well; doctors’s returns mirror the standard MC/MR curve.  So the actual loss begins gradually, but becomes steeper as the years go by—convexity effects appear.

Eventually, doctors have to right-size their practice. The current trend toward Vertical Integration may mitigate effects in the short term. But eventually—probably within 15 years, though it may take 20—doctors will find that their salaries (“net capitation fees”) are significantly closer to those of their European and Canadian peers.

Coincident to its effect on the poor and the elderly, Paul Ryan’s plan will speed the convergence of doctors’s salaries in the world.  The aspiring doctor in the Harvard Class of 2037 may well look at Lewis Thomas’s thoughts of one hundred years previous and say, “Nothing ever changes.”

The question that remains today is “What will we tell the doctors?”

[1]When I looked a few years ago, my doctor was paid $41 for my $125 office visit from insurance, and I had a $15 copay.  If you can’t figure out how $56 gross can become $25 net, go into a heavy-service industry, such as restaurants or doctoring, and look at their cash flows.

[2]Note that there is no inherent need to conform to the schedule, assuming the patients are not time-constrained.  That is, one can spend longer with patients—more than eight hours in a day—and maintain quality of care at the expense of leisure time.  This is a fairly simple equation and is left for when this isn’t a blog post.

[3]Again, the equation to show when the marginally-unhealthy choose to visit the doctor is left as an exercise. All we need for blog post purposes is to know that the choice is dependent on several factors, including disposable income and out-of-pocket cost.

[4]This is in no small part, at the margin, due to the support of the current Medicare/Medicaid system.

[5]Contracts still require both parties to consent, and the 6.6% decline is the net result—one might assume that some insurance companies will reduce their margins to pay doctors more.  One might also assume a pony with a pointy thing sticking out of its forehead with equal likelihood. There may well be a chimera of hope—though the scenario only extends the timeframe instead of ending the process—but it will not be sustainable, though it may be iterative (which would further attenuate the process).

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