U.S. Healthcare’s Evolving Business Model
I am upset by the fact that the 5,000 year-old practice of medicine, which was built upon scientific research and a set of ethical standards, is currently evolving into just another commercial industry driven by a quest for profits. Not only is this rapidly becoming a reality in the U.S., but there is a serious question whether healthcare’s new business model will result in lower healthcare costs or whether it will even be sustainable. In many respects it is an out-of-control profit-seeking monster with an increasingly voracious appetite that was nurtured by our federal government and neither political party is seemingly willing to restrain it.
There is no question that the medical profession is now evolving and doing so at a very rapid pace. Stated succinctly, doctors are merging their practices into medical groups; medical groups are being acquired by hospitals; hospitals are expanding their operations into other communities; and not-for-profit and government-owned hospitals are being acquired by for-profit entities. The result is that between 2012 and 2024 the percentage of self-employed licensed physicians decreased from 60.1% to 42.2% and is even lower in certain medical specialties like cardiology which has dropped to 30.7%. Conversely, during that same period the percentage of physicians directly employed by hospitals increased from 5.6% to 12%; and the percentage of physicians working in practices groups owned by hospitals increased from 11% to 23.4%. Contrary to expectations, all of these changes are working to increase the cost of medical services.
As late as 1900, America’s hospitals were largely owned by governmental, religious and charitable organizations and groups of practicing physicians. In short, hospitals were essentially created as not-for-profit institutions for the purpose of serving the healthcare needs of the surrounding population. It wasn’t until the 1980s that hospitals began to be operated for the purpose of generating a profit. That change was spurred by the passage of the Medicare and Medicaid programs in 1965 which provided ample new sources of funding for medical services.
Thereafter, the movement toward for-profit hospitals began to accelerate. Between 2000 and 2022 the percentage of hospitals owned by for-profit entities increased from 17.9% to 26.7% and the percentage of Medicare-enrolled hospitals owned by for-profit entities grew to 36%. It wasn’t just that the practice of medicine was becoming more and more controlled by for-profit entities, but that by 2024 the number of hospitals acquired by private equity firms had grown to roughly 480 (or 8.5%) and the number of medical practices taken over by private equity firms had grown to 5,779 . This is significant because private equity firms tend to be very short-term investors looking to achieve outsize profits within a very short period with little concern for the long-term viability of the enterprises they acquire.
Behind these changes are a number of demographic factors. First, the demand for healthcare services has exploded notwithstanding the fact that the rate of global population growth has been slowly decreasing. Between 1900 and 2020 the average human lifespan’s increased from roughly 32 years 70 years. Even more relevant, the percentage of Americans over the age of 65 grew from 4.1% to 17.3%. This trend is likely to continue with the percentage of Americans over the age of 65 projected to rise to 22% in 2040 and to 25% in 2060. Because the human body tends to deteriorate with age, the healthcare costs of senior citizens tend to be much higher than those of the remaining members of the population. Specifically, in 2020 the average healthcare costs of Americans over the age of 65 was roughly twice that of other working class adults.
While the resulting increased demand for healthcare services has been causing healthcare costs to increase rapidly, the income growth of working class Americans (commensurate with increases in the price of consumer goods) has not been able to keep pace with the rise in healthcare prices. Between 2000 and 2024 the cost of medical care increased by 121.% compared to 86.1% for all consumer goods and services. This, in turn, has prompted our federal government to constantly increase the amount of monies it has been expending to enable working class Americans attain their healthcare needs.
Even though the demand for medical services has been rapidly increasing, that has seemingly not reduced the economic problems facing doctors in private practices. That’s because the practice of medicine has become highly specialized so the days of a doctor’s treating the full range of his/her patient’s medical problems are long gone. In addition, the threat of malpractice litigation, which exploded in the 1960s, has also required doctors to purchase expensive malpractice insurance in addition to utilizing a broad range of expensive diagnostic equipment and generally proceeding in an overly cautious manner.
Lastly, because only patients with medical insurance can afford to pay for healthcare services, doctors must bargain with a large number of medical insurers, all with far greater financial resources. Those insurers, in turn, impose a number of obstacles before they remit payment for the services rendered to insured’s doctors. This expanded administrative burden, along with greater reimbursement restrictions imposed by medical insurers, explains why the number of self-employed doctors, including those in sizable practice groups, has declined. In fact, between 2019 and 2024 more than 127,000 physicians started working for hospitals and corporations; and this trend is likely to persist.
Similarly, it’s getting financially difficult for government-owned and other not-for-profit hospitals to continue their operations. They too must constantly acquire the latest diagnostic equipment and bargain with Medicare, Medicaid and the 1000+ independent medical insurers for payment for their services. This in part explains why they are constantly seeking to acquire independent medical practices to assure a steady flow of patients to help them amortize the costs of that equipment. Expanding their operations also gives themselves greater bargaining power in dealing with the medical insurers.
To be sure, those hospitals are also constantly employing other ways of enhancing their economic viability. This includes slowing the rate of increases in the compensation of their doctors, nurses, support and administrative personnel. In addition, they are in a continuing quest to maximize the productive time of their doctors by having nurses and other quasi-medical personnel provide those services which have traditionally been performed by doctors. Among the more annoying innovations employed by hospitals are their use of automated telephone answering systems and websites for dealing with patients so as to minimize the time doctors “waste” while interacting with patients which will not be reimbursable by medical insurance companies.
Even those not-for-profit hospitals that have successfully employed strategies for expanding their operations have found it difficult to compete with for-profit hospitals. That’s because they have a voracious need of capital to implement their growth strategies and are at a disadvantage in competing with for-profit entities which have greater and faster access to capital. This is a particular problem for government-owned hospitals in an era when our federal and state governments are seeking to minimize their tax revenues. While not-for-profit hospitals rely heavily on large donations to satisfy their capital needs, this technique is heavily dependent upon private donors seeking to receive tax benefits for their donations. During periods of low interest rates (which existed from 2008-2022) for-profit hospitals enjoyed a distinct advantage over not-for-profit entities in raising capital. Government-owned and not-for-profit hospitals are also burdened by their policies of treating indigent patients.
More recently private equity firms, which have been characterized as the most aggressive class of business entities, have begun to acquire hospitals and medical practice groups. They have been attracted by the growing portion of the American economy devoted to healthcare expenditures. They concentrate on providing their investors with high rates of return which they generate by maximizing their use of borrowed funds and employing a host of business practices designed to maximize their cash flows.
Unlike other for-profit acquirers of hospitals and medical practices, private equity firms operate on a relative short-term agenda, seeking to achieve a maximum return on their investments with six years. For example, they have utilized such techniques as selling hospitals assets in sale-and-leaseback transactions which generate immediate large amounts of cash which they use to further expand their operations which they ultimately abandon or sell to the medical professionals whom they employed. In some cases those operations are unable to support the lease payments required under the sale-and-lease-back arrangements. The growing prevalence of such short-term operating strategies does not bode well for the future well-being of the healthcare industry.
Economic theory postulates that when the creation of goods or services takes place in larger quantities “economies of scale” (a term used by economists to refer to a reduction in the cost of producing a single unit) are created. Stated in layman’s terms, the per unit cost of baking ten pies is less than the per unit cost of baking three pies). Thus, combining several medical practice groups into one large practice group theoretically should bring about a reduction in the costs at which their services will be provided to the public. Similarly, when multiple medical practices are a acquired by a hospital, the hospital should be able to offer their services at a lower price. While this sounds perfectly logical, the reality is that in both cases the costs of medical services have increased significantly and not declined.
Lost in this reasoning is the fact that the reduction of production costs does not necessitate that services will be offered at a reduced price. To achieve that result there must be a multitude of patients seeking to purchase those services at the lowest available cost. What actually happens in practice is that enlarged practice groups also achieve local monopolies for their services enabling them to freely raise their prices. They are assisted in that strategy by a complicit private insurance industry and a federal government that are willing to allow them to do so. Simply stated, the greater efficiency achievable by large hospitals and medical practice groups has only benefited their owners and not the public.
Admittedly, hospitals and medical practice groups owned by for-profit entities tend to be more economically efficient than those owned by medical practitioners and not-for profit entities. This is true for a number of reasons. Most importantly, medical providers operated by for-profit entities are under no obligation to provide their services to patients who are unable to pay for them. Similarly, they are under no obligation to maintain excess capacity (in terms of facilities, equipment and personnel) to enable them to handle unexpected demand for their services. They also tend to have more flexibility to change their operations and terminate unproductive employees. Lastly, many for-profit medical organizations seek to enhance their profitability by allowing less-trained individuals perform services that require the expertise of a licensed physician and/or by cutting back on staffing needed to assure proper patient care.
It's not that the medical profession is oblivious to the fact that some cost-cutting actions jeopardize the quality of care being provided (or worse, not provided) to patients. In fact, a few states (like Michigan, Florida, Massachusetts and Oregon) have enacted laws limiting for-profit ownership of medical practices (generally referred to as “Corporate Practice of Medicine (or CPOM)” laws. The problem is that most states have not enacted such laws and those laws that have been enacted are rather easily circumvented. This is generally achieved by having the for-profit entity acquire the facilities and equipment utilized by licensed physicians and having their practices administered by management companies owned by the acquiring entity. While the medical professionals ostensibly remain free to make all medical decisions, they generally defer to their management personnel in making many decisions that affect the quality and costs of patient care. This concern is magnified by the fact that the medical professionals operate under employment agreements which largely place them at the mercy of the for-profit acquirers of their practices.
Another major factor in the evolution of the U.S. healthcare industry is the role played by the private healthcare insurance industry. Healthcare is a problem which affects individuals at different times and in different ways and can involve major expenditures. Therefore, insurance provides an obvious mechanism for individuals to finance their healthcare expenditures, not always knowing exactly when and why they are likely to incur major healthcare costs.
Private healthcare insurance, however, essentially only exists in the United States through a quirk of history. That’s because it grew rapidly when our federal government imposed wage and price controls during World War II. A notable exception in that legislation was that while private businesses were prohibited from increasing the wages of their employees, they could offer them healthcare insurance which became a popular tool for attracting and maintaining employees during the then tight labor market. Thereafter, the industry grew rapidly as the demand for healthcare services expanded. More importantly, it became permanently entrenched in our economy through the political clout wielded by the industry itself and the medical profession that resisted the notion that medical insurance should be provided by the government as it was in other developed nations.
Still, by far the major players in the healthcare insurance industry are the Medicare/Medicaid Programs and the Veterans insurance program which together fund almost 50% of all U.S. medical expenditures. Although private healthcare insurers only fund a little over 30% of all U.S. healthcare expenditures, they have an outsize importance, because there are legal restrictions on the Medicare program from negotiating medical costs. Moreover, the private healthcare insurance industry is dominated by less than a dozen companies enabling them to essentially negotiate prices with the medical industry.
Because private healthcare insurers play an important role in our healthcare system, they are also in a position to green-light increases in prices charged by healthcare providers. Private healthcare insurers are for-profit entities which means that their primary goal is to maximize their own profits and not to minimize the healthcare costs of their insureds. It must be understood that purchasers of private healthcare insurance have little understanding of the health insurance market and must rely heavily on TV advertising in making their purchases. Thus, as healthcare providers seek to charge more for their services, the private healthcare insurers are largely free to pass those increases on to their insureds.
Our healthcare system is seemingly evolving into a monster reminiscent of Audrey, the flesh-eating plant in “The Little Shop of Horrors”, an off-Broadway play (later made into a movie) which ran in the 1960s. Like Audrey, our healthcare system seems to have an insatiable appetite.
Let there be no mistake, this is a monster that our federal government nourished to maturity when it facilitated the growth of a for-profit healthcare insurance industry by encouraging private enterprises to purchase health insurance to attract and maintain employees during World War II. That industry grew exponentially when the demand for healthcare services exploded because of an aging population and the increasing effectiveness of medical services. To address that rising demand for healthcare services our federal government began pouring money into the healthcare system initially through its Medicare/Medicaid and Veterans’ health programs. Equally important, it later declined to bring about the healthcare insurance industry’s demise when it was called upon to do so during the Clinton administration. More recently the federal government, through the Affordable Care Act, increased the flow of money to feed this growing beast. That influx of funds invited other for-profit entities to partake in this seemingly endless feast.
This sad tale is the product of a dysfunctional federal government stemming from the differing views of our nation’s two political parties. The Democratic Party, beginning with Franklin Roosevelt (ably assisted by Frances Perkins), expounded the beliefs that (a) our nation is more productive when its citizens enjoy good health and (b) it is the responsibility of government to help them maintain their health. Thus, Democrats championed the Medicare and Medicaid programs and the Affordable care Act. In contrast, the Republican Party has consistently taken the position that an individual’s health is his or her own personal responsibility and that the government should not use the dollars paid by some to support the health of others. As a result, they have consistently opposed all efforts to tap the federal treasury to fund individual healthcare expenditures. More recently, they have cut the federal government’s contributions to the Medicaid Program and its subsidies provided under the Affordable Care Act, asserting as their justification that if you starve the system, it will force the elimination of fraud, waste and abuse. This is akin to prescribing an unproven form of chemotherapy hoping it will only kill the patient’s cancer and not the patient.
There is no question that our healthcare system suffers from fraud, waste and abuse. Yes, there is waste, but that waste is largely in the form of unnecessary profits paid to for-profit healthcare insurers and providers. There is also abuse when (a) medical professionals are caused to incur substantial administrative costs in an effort to comply with the myriad of requirements of a fractured reimbursement process and (b) medical providers are encouraged to perform unnecessary tests and procedure in order to maximize insurance claims. Both of these problems can be greatly alleviated by simply utilizing a single-payer health insurance system like those employed in other developed nations. Lastly, there is fraud when healthcare professionals misrepresent the nature of their services and individuals submit false and duplicate claims in order to maximize insurance payments. The answer to these problems, however, is not to cease funding healthcare, but rather to institute better internal controls much in the same way that business enterprises do to eliminate fraud and waste.
Underlying these differing approaches to regulation of the medical profession is the fundamental flaw in our nation’s Congressional election system which allows healthcare providers and insurers to make outsize contributions to secure the election of legislators who will protect the system that is feeding them.