The Revolution Continues

The AMS Performance Based Incentive System® has now received 3 approvals by Medicare for use in large scale gainsharing demonstrations.  But the roots of our methodology date back to 1976, to the New Jersey demonstration that designed, developed and implemented “payment by the case”.  A recent article in the Annals of Internal Medicine lauded payment by DRG as “…arguably the most influential innovation in the history of health care financing”.  In this blog we fill in missing pieces, including the fact that the
“physician component”, part of the original demonstration design, was purposely left out at the last minute, in 1980.  Almost 20 years later, the AMS principals, two people at the center of the original revolution, returned their focus to the task of adding physician payments based on performance to the framework for IPPS.

“After the Revolution: DRGs at Age 30”, Annals of Internal Medicine (Quinn, 2014) began with the following summary:

“1 October 2013 marked 30 years since Medicare began paying hospitals by diagnosis-related group (DRG), arguably the most influential innovation in the history of health care financing.  Initially developed as a tool for hospital management, DRGs became the basis for the inpatient prospective payment system that Medicare implemented in 1983.  The strong incentives were revolutionary in their impact.  Medicare spending growth slowed sharply, and, more remarkable, hospitals posted record profits.  After the link between cost and payment was broken, hospitals moved quickly to cut costs.  Nevertheless, a literature survey concluded that none of the worst fears about adverse effects on patients was realized….The DRG experience offers lessons about the effectiveness of financial incentives, the likelihood of adverse effects, the usefulness of case-mix measures, the risks of growing complexity, and the example that sensible policy need not be the domain of any one political party or other entity.”

The initial commitment of Medicare to cost reimbursement created an explosion in costs which left the Medicare Trust Fund 5 years from insolvency.  The article characterized controls to limit increases as “tight, crude and temporary”. In 1972 Congress “authorized state-level demonstrations of ‘prospective payment” under which payment rates would be fixed in advance.  Without case-mix adjustment, however, adverse selection was a major problem.  In 1980, New Jersey incorporated DRGs into its demonstration.”

Two of the AMS principals were at the center of the New Jersey demonstration:  I served as project manager from 1976-79, the period of design and development. I worked together with Jo Surpin, the president of AMS, during this initial phase, with Jo assumingthe responsibility for implementation in 1980 – 1982.   We are both naturally pleased with the article, including the New Jersey mention, and we understand that our saga was not the primary focus of Mr. Quinn’s article.  But nothing springs fully grown from thin air. I think the New Jersey experience, particularly from 1976, the project’s beginning, through 1983, when our model was adopted by Medicare, may shed some light on why the experiment became such a miraculous overnight success.  It may also provide some helpful insights and lessons about how to move forward – particularly at a moment in time when the current round of Medicare structural reforms to the delivery system (ACOs, shared savings, bundled payments) is struggling.

Payment by the Case

The relationship between DRGs and the NJ demonstration, as characterized in the article, is misleading; DRGs were not a mere adjustment incorporated into a larger methodology.  What distinguished NJ from the beginning was that it was completely centered on the idea of “payment by the case”.  As for me, I distinctly remember how that elegant idea, and the opportunity to implement it, captured my imagination.  I thought I could make a difference.  And I was not alone:  That vision, the opportunity to accomplish something that dramatic, was the inspiration that enabled us to attract a highly talented team, a team that included geniuses and misfits, straight arrows and drop outs, a group of  hard partying young people that was drawn to a specific mission and then, once accomplished, dispersed.  Yes, the flawless implementation of PPS by Medicare featured in the article seems miraculous, especially by today’s standards. But rather than an immaculate conception, it was perseverance, an act of will, and a good deal of luck, that led to payment by the case.

Codman, Fetter and Thompson deserve the credit for redefining the “product” of the hospital as the patient, the first act in a long running saga.  Our colleague and friend Richard Averill, (3M Health Systems, but then an employee at Puter Associates), did the heavy lifting on DRG development and refinement at the time, (and from that point forward).  Dr. Joanne Finley, the Commissioner of Health in NJ, and a former student at Yale, should receive credit for recognizing the importance of the idea and for committing her agency to the new application, and Bruce Vladeck, Assistant Commissioner (later, Administrator of HCFA, and now with the Greater New York Hospital Association) for overall administration of the system’s implementation.

But converting DRGs, a system of patient classification, into an operational payment system, was a different kind of challenge.  Hospital cost data and patient data, streams of information collected separately for different purposes, had to be merged at the patient level – and the task accomplished utilizing 1970s computing technology.  Not unexpectedly, the product – costs per case – did not always make sense.  Mysteries could arise from the techniques used to cost and merge, the DRGs, the data, from theoretical issues like “fixed/variable”, or from a bad night at the bar. The group set a high bar – perfection – a goal that led to several significant delays and was not always achievable.

The Pursuit of Perfection

It is important to understand that the first DRG payment was implemented within an all-payor framework.  Unlike the Medicare PPS that followed, reallocating significant revenue, by design or by mistake, would inevitably produce a loud industry outcry and doom the project. Because there was little margin for error, concerns like the lack of homogeneity displayed by some of the original DRGS – an issue raised then by the industry and mentioned in the article – were taken very seriously.  To address the problem, the team developed two lists of costs per case, one reflecting each hospital’s own costs per DRG; and a second one, the “standard”, the average cost per DRG adjusted for teaching, geography, etc.  The two lists were then blended at the DRG level, with the proportions based directly on the predictive strength of each individual DRG – an elegant solution that not only met the problem head-on, but also created a self-correcting feedback loop in which improvements to the system of patient classification would automatically meter in more of the standard.

The rate structure was one of many creative innovations.  For example, the article observes that the DRGs themselves “…create a common language between clinicians and administrators.”  We saw this too and realized that our task, assigning cost to each DRG, would add an important dimension to the clinical language.  So, as a byproduct of determining rates per DRG, we provided each hospital with detailed management reports, a roadmap organized at the cost center level that identified specific ways that providers could respond to the mandate of the new DRG rate structure.  The group set the bar high – perfection – an admirable goal that produced many innovations and won credibility. But the process also exposed the shortcomings of a system in its infancy and added time to the clock.  And then there was the industry.

The Industry

Much national health care regulation seems as if it is developed in a closed room and then handed to the industry – a fait accompli.  In contrast, much of the 4 year period of development of payment by the case was dedicated to countless committee meetings involving the DRG team and representatives from the industry.  There were committees for everything!  Implementation of payment by the case was non-negotiable but, particularly because our mandate called for such dramatic change, our rule was to respond to all legitimate issues raised by the industry.  The article leaves the impression that the industry was ready for a change, noting that “(e)ven a hospital association executive derided such cost reimbursement as ‘just stupid’”.  We certainly had our supporters but, as a whole, the people who ran hospitals and had to make payroll were very nervous about the brave new world. Even the investment in dialogue could not inoculate us against the uncertainty of dramatic change.

After all the meetings and adjustments, the industry initiated litigation to deny us the billing data required to develop rates per DRG.  We survived. Observing that collecting data did not necessarily mean that payment by the case would ever be actually implemented, the judge in the case concluded that the law suit was premature.  In other words, a poor tactical decision by the industry enabled us to fight another day. I do not want to overlook the fact that the industry, especially the New Jersey Hospital Association, eventually became a strong partner and collaborator, and continues to be a long-time partner with AMS. But the takeaway is this:  Nothing was as certain as the impression left by the article; it was more like a race car constantly taking curves at high speed.  The times were tumultuous.

A second example illustrates the thin line between success and failure.  It involved our first attempt to actually pay hospitals by the case.  18 hospitals had volunteered for a pilot to road test the concept.  The pilot involved Blue Cross only.  The team worked diligently using industry standard costing techniques and incorporating industry requested adjustments as noted above.  But inventing necessarily means operating in the dark – the “unknown unknowns” as Donald Rumsfeld might put it.  And so it was with a creeping sense of anxiety that days after the “experimental” rates were issued, there was silence – no phone calls, no feedback.

Of course the industry itself was still trying to understand what the offer meant. But it was only a weekend call from a well-respected hospital CFO that alerted us to the fact we had inadvertently overpaid many hospitals.  We figured out the problem on Monday:  Rates per DRG had been developed for an “all-payor” system.  But the pilot had imposed them on to the existing fragmented system in which each payor – Medicare, Cigna, Aetna, Blue Cross, etc. (not to mention “self-pay”) – was reimbursing hospitals on a different basis.  The rates were immediately withdrawn.  But the phone call was one of several twists of fate that kept us from the dust bin.  So much for the “perfect storm” characterized in the article.

Important lessons were learned:  Despite the lawsuit, collaboration with the industry turned out to be a wise investment.  A project so ambitious necessarily contains dark corners.  You can’t see around every one, but the feedback from the industry enabled us to spot 90% of them.  That said, it was important to distinguish legitimate issues from background noise.  Everyone has a laundry list.  Identify the issues critical to the success of the project and develop solutions as simple and straightforward as the issue will allow.  Leave the others for someone else; health reform is littered with complex failures.  And finally, don’t let the perfect be the enemy of the good.  For example, as the article correctly points out, systems of patient classification have been devised that are more sophisticated than DRGs.  But DRGs were more than adequate for the task.  They were clinically coherent and transparent.  Also, they were designed to run off of routinely collected data – a big advantage when you are charged with operationalizing payment by the case.

And, oh yes, know when you have reached the finish line:  After almost 4 years of litigation, false starts, set backs and hard work, we were finally ready to go live.  Our operational strategy would implement payment by the case, but our transition tactics included revenue neutrality for each hospital, a step important to avoiding a backlash.  But our project plan, developed years before, called for one final task: developing the physician component of payment by the case.  After getting worn down by years of dialogue, the NJ hospital industry was nervous but ready.  As the article suggests, some administrators secretly welcomed the challenge of actually managing an institution. But imposing DRGs on the doctors in 1980?  I suspect that the glowing article in the Annals of Internal Medicine might read differently if we had not decided to turn the page and declare victory.

Spreading the Word

The NJ experiment made 2 important contributions:  It pioneered payment by the case.  But it also demonstrated that something so radical and ambitious could be implemented in the health care industry without causing a furor.  Yes, there was an incident – a finger broken in a softball game was reimbursed at $6,000 because of a technicality – the insertion of a pin – which bumped the case into an unnecessarily higher reimbursed DRG.  Proponents were embarrassed, while critics gleefully derided the system.  Fortunately, however, that was the only incident, and the system was quickly recalibrated to deal with these kinds of cases.  We had done our work.  And one of the surprising side-benefits was the small army of NJ administrators that fanned out around the country to recount their tales of survival.

We fanned out too, but it was to Washington.  After a year of successful operation, some of the program leaders from New Jersey and New Haven began making trips to meet with Congressional staff.  Mirroring the subtext in the article, we found open doors.  Particularly important was Sheila Burke, then senior aide to Senator Bob Dole.  Once we began to tell our story, the rooms filled with staff – both Republican and Democrat.  At the peak of interest, we conducted 3 sessions per day.

We also had some secret allies.  There was the Medicare staff noted in the article.  Most importantly there was also the former president of the New Jersey Hospital Association.  Jack Owen was now the acting president of the American Hospital Association.  On one of our many sojourns to meet with congressional staff, we made an unannounced visit to Jack’s office, across the street from Union Station.  Now it should be evident from the article, as well as this blog, that many people were pulling for us.  But it did come as a bit of a surprise that Jack, who had approved the law suit to deny us the data back in NJ, had met Secretary Schweiker at a cocktail party and asked him if he wanted to leave a “legacy”.  According to Jack, the Secretary went to his office the next morning, called in his staff, and asked them about DRGs.  And, of course, the staff produced that wonderful report mentioned in the article.

The rest is history.  The importance of the New Jersey demonstration to that history is this: It worked!  After 4 years of concentrated effort, payment by the case was implemented virtually without incident.  It was not a disaster, there was no mushroom cloud – hospitals did not go bankrupt or even fail to make payroll.  Instead, the favorable results that Quinn notes emerged quickly from the New Jersey experiment. When lawmakers proposed prospective payment by DRG 3 years later, “with unusual speed and unanimity” as Quinn notes, they were able to implement revolutionary change knowing full well that it would work.  Behind them was a tangible, shiny testament to success.

Finally, there is one more meeting that I need to mention.  The numerous trips to DC were made usually by me and Richard Averill, sometimes joined by Fetter and Thompson.  Thompson was a character; an irreverent guy with a handle-bar mustache who happily drank and smoked to excess – very likable.  As time passed, the NJ team kept a project scorecard – a performance comparison of the NJ industry to the country.  We were able to see first the same trends that eventually emerged nationally – sharply slowed growth in cost accompanied by improved hospital profitability. I took the scorecard with me on a trip to New Haven to see family, setting up a side meeting to share it with Thompson.  We met at a Thai restaurant near the university – apparently one of his favorite haunts.  John’s satisfaction grew as we went over the trends year by year.  We drank Mai Thais, his drink of choice, and swapped old stories about allies and enemies, bad luck and good fortune, the long trip to get to this point.  He died 3 weeks later.

But What About the Doctors?

From the early stages of project development, hospital administrators pointed out that physicians make the decisions about resource utilization, not institutions.  The failure to include physicians in the incentive system would necessarily compromise the effectiveness of payment by the case.  While the decision to exclude physicians from the demonstration was essentially political, the designers inwardly embraced a cautious view: better to leave the physicians on fee-for-service as a counterweight rather than go full throttle and risk the whole enterprise out of the gate.  With this “safety first” mind set, we voiced no objection to the GAO Report on Physician Incentive Payments by Hospitals issued in July, 1986.  Commenting on several physician incentive plans that were proposed or operational, the GAO “…concluded that such plans can provide physicians too strong an incentive to undertreat patients.”

Thirteen years after the GAO Report, the Office of Inspector General issued a Special Advisory Bulletin with a more nuanced view.  Entitled “Gainsharing Arrangements and CMPs for Hospital Payments to Physicians to Reduce or Limit Services to Beneficiaries”, the memorandum states that, “The OIG recognizes that hospitals have a legitimate interest in enlisting physicians in their efforts to eliminate unnecessary costs.”  But in the introduction the agency observes, “While the OIG recognizes that appropriately structured gainsharing arrangements may offer significant benefits where there is no impact on quality of care…” incentive payments by physicians to hospitals are prohibited by statute.

Despite the existence of a statutory prohibition against “gainsharing”, the Bulletin identified 3 interrelated points that it felt should be considered as part of the development of a framework to enable physician incentive payments by hospitals:  “In order to retain or attract high-referring physicians, hospitals will be under pressure from competitors and physicians to increase the percentage of savings shared with the physicians, manipulate hospital accounts to generate phantom savings, or otherwise game the arrangement to generate income for referring physicians.”  It then observed that “…gainsharing arrangements will require ongoing oversight both as to quality of care and fraud that is not available through the advisory opinion process”, concluding that gainsharing required “comprehensive and uniform regulation”.

By the time that the OIG issued its Special Advisory Bulletin, it had been almost 20 years since the NJ Demonstration was implemented – plenty of time to observe and realize that physicians were no different than anyone else.  There are a few “bad apples” in any profession but, in the main, physicians try to do the right thing, particularly given their professional oath. Beyond that, physicians, like the rest of us, want to protect their reputations.  There will always be instances of negligence, malpractice, and fraud, but this is the exception.  Moreover, just like the rest of us, physicians respond to financial incentives.  Indeed, much of the inefficiency in health care related to physicians results from existing financial incentives.  For example, physicians may order tests, order consults and discharge patients from hospitals at times that enable them to maximize office (and overall) income, not necessarily when the patient is ready. While there are certainly clinical issues, much of the overall inefficiency in hospitals results from operational issues – things like scheduling – patient management.

In October, 1999, 3 months after the Bulletin, then President of the New Jersey Hospital Association, sent a letter to Kathleen Buto, Deputy Director, Center for Health Plans and Providers at the Health Care Financing Administration, the predecessor to CMS.  Desiring to make its provider members “part of the solution”, NJHA teamed with AMS to propose a “Demonstration of Performance Based Incentives” that addressed 4 key issues:  (1) the methodology must accurately measure provider performance; (2) the incentive compensation must be appropriate; (3) quality of care must not be compromised; (4)  the system must not contain inducements to refer.

Reinforcing his support for engaging physicians in the challenge to reform health care delivery, Gary Carter, then President and CEO of NJHA, stated in the December 1, 2003 cover article in Modern Healthcare  “For me this is a gigantic experiment.  Let’s just see what happens….Here is an opportunity to look at incentives and make sure they are properly placed.  The problem with skeptics is they’ll do nothing.”

Today, almost 35 years after payment by the case was implemented in New Jersey, about 40 hospitals in New Jersey and New York utilize the Applied Medical Software Performance Based Incentive System^®, and projects in 3 more states are in the planning stages.  It has now been approved by Medicare 3 times. The features of the methodology will be detailed in several forthcoming articles, but there are numerous ways to tell that the gainsharing methodology shares the same DNA with payment by the case:

• Both methodologies rely on routinely collected data.  Like payment by the case, this helped insure that the gainsharing methodology would be replicable, auditable, easy to implement and administer on a large scale;
• In both cases, implementation was preceded by a lengthy gestation period which included extensive industry consultation.  Issues considered essential to success were each addressed with the solution that was simplest and most straightforward.  For example, the problem of existing physician incentives that conflict with the larger goal – enlisting physicians to help improve hospital performance – was solved through a physician-specific loss of income adjustment.  This removed any excuses.
• Another industry concern related to the problem of conflicting objectives:  At the same time that hospitals wanted to encourage inefficient physicians to improve, hospitals also felt it was important to recognize and reward physicians that were already efficient.  Like the problem of non-homogeneous DRGs, an elegant solution was developed that both solved the problem and made a statement.
• Also like the original experiment, commitment to the basic idea – performance based incentives for physicians – was essential because it provided the energy.  For this reason, protections built into previous gainsharing strategies, like making physicians join groups and distributing savings per capita, were replaced with more direct safeguards; mechanisms that that protected patients, addressed issues of fraud and abuse, and promoted quality of care, but preserved the natural vision of gainsharing.  At the end of the day, the performance of each physician is evaluated individually, and incentives paid based on results.

Just like the demonstration of payment by the case, large scale gainsharing went off without incident and produced impressive results:  Physicians were engaged, costs went down and quality improved. Someday, someone may write an article suggesting how miraculous this all was.  But I hope they will look into the details: the genesis, starting with the letter to Kathy Buto; the years of collaboration between the industry and the designers; the initial implementation that was halted as a result of litigation by hospitals that wanted to get into the project; the “surprising” initial results.   And I hope they won’t overlook the other quote in the Modern Healthcare article, the one from Rep. Pete Stark:  “I’ve got a better plan.  We’ll give the doctors 25% upfront for those who don’t let their patients go to the hospital at all.  They’ll give them an aspirin and make an appointment at the mortuary.  It’s a win-win deal.”   The takeaway: Nothing worth doing is ever that easy. The next chapter, will focus on defining the role that gainsharing will play in the overall strategy for reform.  For this we suggest rereading Mr. Quinn’s article – particularly the part about the importance of “breaking the link between cost and payment.”  The goal is the same as back in the 1980’s: lower cost and improve care.  The revolution continues.

References

Quinn, K. (2014, March 18). After the Revolution: DRGs at Age 30. Annals of Internal Medicine, pp. 426-429.

Coates, R. G. (2014, January-February). The New Jersey Gainsharing Experience. Physician Executive Journal, 46-51.