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Why Are We Still Paying for Quantity—Not Quality?

A doctor checks a pacient's throat at onA doctor checks a pacient's throat at on
Certain medical cultures encourage too many services.Photo by OMAR TORRES AFP — Getty Images

This essay appears in today’s edition of the Fortune Brainstorm Health Daily. Get it delivered straight to your inbox.

In 2009, the surgeon-journalist extraordinaire Atul Gawande wrote a conversation-changing feature for The New Yorker called “The Cost Conundrum: What a Texas town can teach us about healthcare.” If you haven’t read it, you should. If you’re curious at all about what’s driving runaway healthcare costs today, reading this old Gawande piece will be the best 7,800-word investment you make.

Gawande compared the healthcare expenditures in two southern border towns in the Republic of Texas—McAllen and El Paso—which have nearly identical demographics. Though the health status of their overall populations is roughly the same, McAllen spent far more for healthcare per citizen. Indeed, as Gawande reported, providers in McAllen billed more to Medicare per capita than any other place in the country except Miami. Medicare spent a whopping $15,000 per McAllen enrollee in 2006. In El Paso, by contrast, the government health agency laid out about $7,500 per enrollee that year—or a little under what Medicare paid per capita in the typical American city in 2006 (about $8,000.) In 2010, according to a study done this past April, the figures were $13,648 for McAllen Medicare enrollees versus $8,714 for those in El Paso.

Why the huge difference, you wonder? Well, as Gawande explains: “Compared with patients in El Paso and nationwide, patients in McAllen got more of pretty much everything—more diagnostic testing, more hospital treatment, more surgery, more home care.”

The physicians in McAllen hospitals weren’t bad or necessarily greedy or even wholly conscious of their outlier ordering when it came to medical services. They were simply incentivized to order more, and so they did.

Last week, a follow-up of sorts was published in the New England Journal of Medicine—not by Gawande, but rather by MIT economics professor Amy Finkelstein and three colleagues. The study didn’t get the attention it deserves, in part because it was drowned by the news of the CRISPR patent ruling, and in part perhaps because the authors hid their work under a We-dare-you-not-to-read-this headline: “Adjusting Risk Adjustment—Accounting for Variation in Diagnostic Intensity.” But this, too, is amply worth reading.

In our Rube Goldberg concoction of a national healthcare system, payments from Medicare and other agencies to providers are adjusted based on a complex risk-assessment system that factors in the baseline health status and demographics of the area. The thinking behind this is reasonable: Providers who live in places where there are a lot of older and sicker people shouldn’t be penalized for the effort to properly take care of them. (Here’s Medicare’s 75-page explainer on risk adjustment: Definitely NOT worth reading.)

But like virtually everything that we do in the healthcare realm, it’s (a) excessively complicated, and (b) has unintended consequences. And one of those consequences is that areas where providers have a “proclivity for making diagnoses and recording them,” as Finkelstein and her colleagues put it, end up looking sicker than they are, and therefore get proportionally higher Medicare payments.

The authors have a terrific term for this proclivity: “diagnostic intensity.” And even better is that they took the time and energy to sift through all of Medicare’s 306 “hospital referral regions” in the country and figure out where the distortions are—which is to say, where the risk adjustments are based on actual differences in health status as opposed to differences in, say, diagnostic and prescribing practices. (They also suggest a new adjustment to the adjustment system that, they say, can correct the distortions.)

We’ve long known that when we pay doctors for quantity, not quality, that’s what we get. As Gawande wrote some eight years ago: “Imagine that, instead of paying a contractor to pull a team together and keep them on track, you paid an electrician for every outlet he recommends, a plumber for every faucet, and a carpenter for every cabinet. Would you be surprised if you got a house with a thousand outlets, faucets, and cabinets, at three times the cost you expected, and the whole thing fell apart a couple of years later?”

Somehow, we’re all still living in that weird healthcare house.