Previous month:
March 2013
Next month:
May 2013

April 2013

Links I like

Today’s post will be a quick overview of recent Health Affairs papers I liked.

Payers and Reference Pricing. In “Payers Test Reference Pricing and Centers of Excellence to Steer Patients to Low-Price and High-Quality Providers” (September 2012), Robinson and MacPherson, both from UC Berkeley, examine two major new benefit design instruments currently being tested to encourage employees to make price-conscious choices: (1) reference pricing, where “an employer or insurer makes a defined contribution toward covering the cost of a particular service and the patient pays the remainder,” a bit like a reverse deductible, and (2) centers of excellence where “employers or insurers limit coverage or strongly encourage patients to use particular hospitals”

Episode-Based Payment. In “Episode-Based Payment for Cancer Care: A Proposed Pilot for Medicare” (March 2011), Bach, Mirkin and Luke, all from the Memorial Sloan-Kettering Center in New York City, “propose a framework for episode-based payment during chemotherapy treatment, which would cover the costs of drugs and their administration for a predefined period of treatment and would have the potential to reduce costs and improve patient outcomes.” They focus on metastatic lung cancer treatment to provide guidelines for a payment reform program that could be implemented as a pilot program by Medicare, and later be extended to “longer time periods, other cancer diagnoses and additional care components.”

Consumer-Directed Plans. In “Growth of Consumer-Directed Health Plans to One-Half of All Employer-Sponsored Insurance Could Save $57 Billion Annually” (May 2012), Haviland, Marquis, McDevitt and Sood, respectively from Carnegie Mellon, RAND, Towers Watson and UCLA, discuss the challenges associated with consumer-directed health plans, which have the potential to reduce health care spending by the equivalent of a 4 percent decline in total health care spending for the nonelderly, but may also “reduce the use of recommended health care service as well as increase premiums for traditional health insurance plans.”

Capitation & Shared Savings. Finally, Frakt and Mayes, from Boston University and UC-Berkeley/ University of Richmond, “chronicl[e] the expansion and decline of the capitation model in the 1990s” (capitation is a lump sum per person per month to provide all care to a patient), “offer lessons learned and assess the extent to which these lessons have been applied in the development of contemporary forms of provider cost sharing” in “Beyond Capitation: How New Payment Experiments Seek to Find the ‘Sweet Spot’ In Amount of Risk Providers And Payers Bear” (September 2012). A key insight is that capitation in the 1990s shifted liability for health costs from insurers to providers and that consolidating practices to spread risk across patients did not always prove successful in controlling risk. Today’s suggested reforms differ in substantial ways, which the authors describe in detail.

Book review: "Decisive" by the Heath brothers

Decisive Some time ago I read “Switch: How to Change Things when Change is Hard” by the Heath brothers (Chip and Dan) and reviewed it on this blog. My post started as follows: “Here is my one-sentence review: The book is so good I feel sorry the authors have to sell it at the same price as the other hardcovers out there. If that's enough to convince you to give it a try, great. Otherwise, read on.”

I wasn’t quite sure I’d like “Decisive” as much. I felt that the topic (how to make better decisions) was less original, the green cover of the book is simply hideous, and the introduction, which I’d read before the release date, just didn’t grab me. But the preview I got included Chapter 1, not just the introduction, which meant I got to read the story about the brown M&Ms that a rock star had set as a “tripwire” for his national tour (to figure out whether people had read the contract full of technical specs he’d made them sign, with severe safety implications for his crew) and “Switch” was truly very good. So I bought the book.

And enjoyed it immensely. Now, for me “Switch” was a six-stars-out-of-five sort of book, and “Decisive” doesn’t rise to that level, but I give it a solid five stars nonetheless. I still had that feeling of being sorry for the authors that they have to sell their books at the same price as the other hardcovers out there, especially the puffed-up magazine pieces that find their way into bookstores these days. Also, while the topic of making better decisions has received significant attention, the Heath brothers do manage to give fresh insights and make the reader re-think his or her approach to looming big decisions ahead. In other words: “Decisive” is a much-needed book, and it delivers.

The book is centered on a 4-step framework to avoid common unconscious biases in decision-making: the WRAP process. (They’re business experts. Of course they had to have an acronym for their method.) Below I provide the four parts of WRAP and keywords for some (but far from all) ideas that the Heath brothers give in their book:

  • Widen your options
    • Think AND not OR
    • Run the “vanishing options test” (if the options you’ve thought about so far weren’t available/allowed, what would you do?)
    • Toggle between the promotion and prevention mindsets (if you had suddenly more time/money, how would you spend it? what if there was a severe cutback?)
    • Find someone who has solved your problem
  • Reality-test your assumptions
    • Ask disconfirming questions
    • Consider the opposite
    • Zoom out: respect the base rates (for instance in a medical situation: what are the averages?)
    • Zoom in: take a close up (for instance, the reviews on a website like Yelp might be summarized into a lackluster average, but if you analyze them more carefully, you may realize people either love or hate the restaurant for specific reasons that may not be relevant to you)
    • “Ooch” into it (as in: lean into it, although the authors caution against “emotional tiptoeing”, which is used to delay commitments)
  • Attain distance before deciding
    • Try 10/10/10 (how will you feel about it in 10 minutes? 10 days? 10 months?)
    • Fight the “status quo bias”
    • Shift perspectives to gain distance (imagine it’s not you but your best friend who has to take the decision – what would you tell your best friend to do? And at work, imagine you’ve been replaced and ask the “Andy Grove question”: what would your successor do?)
    • Identify your core priorities to resolve dilemmas (what would an outside investigator conclude about your priorities by reading your calendar?)
  • Prepare to be wrong.
    • Create a “realistic job preview” (what are problems people in this situation often encounter?)
    • Set a tripwire (for instance a deadline by which something must have happened, or you’re switching to Plan B)
    • Run a premortem and preparade (you’ll have to read the book to understand what that means)
    • And more!

If you’re still on the fence regarding the book, you can download free resources to make better decisions by signing up on the Heath Brothers’ website. I can attest that they email their list very rarely, and only with relevant information, so readers definitely get the best of that bargain, given the great resources – podcasts and summary sheets – available for download upon registration. (It’s because I had signed up after I read “Switch” that I got a sneak peek into “Decisive”.) SSIR - Stanford Social Innovation Review - also has an excerpt of the book here.

In summary: “Decisive” is not quite as earth-shattering as “Switch,” less profound research, but far better than 99% of the business books out there.

White House Science Fair

The White House held its 3rd annual Science Fair yesterday Monday, which, in the words of the Washington Post, was "designed to call attention to the importance of STEM — science, technology, engineering and math — and to honor the innovations dreamed up by young minds."

The projects the young inventors have worked on include:

  • building cheaper robotic arms,
  • cool pads to prevent dehydration on the football field,
  • using the computing cloud to combat breast cancer (Grand Prize at the Google Science Fair),
  • a drawing robot that paints watercolors,
  • a pedal-powered emergency water sanitation system,
  • a Offshore Rip Current Alert System (a buoy that alerts swimmers of dangerous conditions in the water, and a 2012 Lemelson-MIT program InvenTeam),
  • a launch rocket that propels eggs to a certain altitude and returns them to earth unbroken in less than a minute,
  • a non-pharmaceutical remedy for sleeplessness in senior citizens,
  • turning biomass waste products (such as banana peels) into a viable wood alternative for cooking - part of the winning team of Siemens We Can Change the World challenge,
  • innovative urban water management (Future City National Award for Best Management of Water Resources),
  • connecting high school students with underprivileged youth through collaborative hands-on science experiments,
  • a robot mimicking space elevators, 1st Place Robot Award for this BEST Robotics team.

I was struck, but not surprised, by some of the students' quotes in the Washington Post:

  1. Student who created a cheap prosthetic arm: "I’m all self-taught. School is basically a waste of time. I’d be better off with those seven hours if I could just use them working on my own."
  2. Student who studied algae as a biofuel: "My school really doesn’t do anything with this." The journalist continues: "When it comes to science, too many schools stress formulas and memorization, instead of encouraging creative thought, she said."
  3. In addition, "Many students at the science fair said they created their projects outside of school, teaching themselves the science involved or seeking out mentors in the community or at universities." (Emphasis mine.)

I can't help but think that many innovative high school students are terribly underappreciated, skill-wise, and underchallenged in school and even in college - especially college underclassmen. By the time the "fun" electives and capstone projects come around, junior and senior year, how many of those talented students will have lost their interest in using their skills to make a difference?

You can find the full list of student participants here. The fact that not all 50 states were represented did bother me a whole lot. Here is a quick list of the states that had students exhibiting their work at the White House Science Fair: Colorado, Georgia, Florida, California, Michigan, Tennessee, New Mexico, New Jersey, Oregon, Alabama, Illinois, North Dakota, Idaho, Texas, Massachusetts, New Hampshire, Rhode Island, Maryland, North Carolina, Indiana, Virginia. (That's a total of 21 states, some having sent multiple students.)

Additional states were represented because student winners of regional competition had been invited as well, but I can't understand why the organizers didn't insist on having a student from every state, for instance the winner of the statewide high school science competition. This would allow strong local PR focusing on the local student honorees.

The White House's webpage has a 35-min video of President Obama touring the Science Fair here. The video would be far more powerful if it'd been broken into segments (uploaded separately) featuring the various students, but it still gives a good sense of the amazing innovations young scientists can come up with, and their pride at describing their inventions to the President.

New commitments to the President's Educate to Innovate campaign were announced in conjunction with the Science Fair and include (but are not limited to):

  • a new AmeriCorps track focused on STEM education: "This effort [called STEM AmeriCorps] will place national service members in nonprofits that mobilize STEM professionals to inspire young people to excel in STEM education." This will include placing "50 AmeriCorps VISTA members across the country to build the capacity of FIRST, a nonprofit organization that sponsors robotics competitions and other tech challenges... to connect more low-income children with FIRST’s exciting competitions."
  • Multi-year STEM mentoring campaign – US2020 – to get many more companies to commit their science and technology workforce to STEM volunteering: "ten leading education non-profits and U.S. technology companies, including Fortune 500 firms SanDisk, Cognizant, and Cisco are launching US2020, an all-hands-on-deck effort to have many more STEM professionals mentor children from kindergarten through college. US2020 aims to make mentoring the new normal in the STEM professions in the same way that pro-bono work is common in the legal profession.

Also check out this answer sheet from the Washington Post.

I'd love to hear what the students invited to the 1st Science Fair have become. Given the enthusiasm they displayed during their visit to the White House and the honor brought upon them by the trip, they're the students we don't want to draw away from science and engineering. Because if we can't keep them excited about STEM, we can't keep anyone. 

Capital Investment Decisions in Healthcare Finance (3/3)

Chapter 13: Capital structure and the cost of capital

The capital structure of a business is the mix of debt and equity financing it uses. Capital structure decisions have important consequences, since debt financing and equity financing have different effects on a business's risk and on its balance sheet & income statement.

This is because the taxable income of the company will change (it will be less if the company chose more debt financing, since interest expense will be subtracted from the operating income), resulting in a higher expected tax liability when more equity is used to finance the business and in turn changes the return on equity ratio, defined by the net income divided by the book value of equity. Gapenski shows on an example with two options (all-equity and 50% debt) how the 50% debt option yields the higher ROE.

However, debt financing also increases risk, in addition to increasing the owner's projected return. Gapenski shows this in a continuation of his example: the expected ROE using 50% debt is indeed higher, but the standard deviation of the ROE is also higher, turning this problem into a classic risk/return trade-off.

The author discusses how to identify the optimal capital structure in practice and the special case of not-for-profit businesses (which do not have access to the equity markets). Once the target capital structure has been determined, the cost of a business's financing - a business's corporate cost of capital - for that structure has to be estimated.

In Gapenski's words, "the corporate cost of capital is a weighted average of the component debt and equity costs." The cost of debt will be after-tax, to capture the "tax benefit for the business because interest expense is tax deductible." To compute the cost of equity to investor-owned businesses, the manager can use three methods:

1. the Capital Asset Pricing Model,
2. the Discounted Cash Flow Approach, using a constant-growth dividend valuation model,
3. the Debt Cost Plus Risk Premium Approach.

The cost of equity (fund capital) to not-for-profit businesses can be computed in several ways, using different assumptions:

  • Fund capital has a zero cost.
  • Fund capital has a cost equal to the return forgone on short-term securities investments.
  • Fund capital has a cost equal to the expected growth rate of the business's assets.
  • Fund capital has a cost equal to that required to maintain the business's creditworthiness.
  • Fund capital has a cost equal to the cost of equity to similar for-profit businesses.

Gapenski also discusses the special case of small businesses and provides an economic interpretation of the corporate cost of capital.

Capital Investment Decisions in Healthcare Finance (2/3)

Chapter 15: Project risk analysis

Gapenski defines three types of financial risk:

  1. stand-alone risk (assumes the project is held in isolation),
  2. corporate risk (views the risk of a project within the context of the firm's portfolio of projects and is measured by the project's corporate beta, i.e., "the slope of the regression line that results when the project's returns are plotted on the Y axis and the overall returns on the firm are plotted on the X axis"),  
  3. market risk (from the perspective of an owner who holds a well-diversified portfolio and measured by the portfolio's market beta).

The chapter also describes sensitivity analysis (assessing changes in a single input variable), scenario analysis (usually involving a "bad" set of circumstances, a "most likely" one and a "good" one to create a probability distribution of NPV), Monte-Carlo simulation (which allows for more sophisticated representations of uncertainty).

The author provides two methods for incorporating project risk into the capital budgeting decision process:

  • the certainty equivalent method, "in which a project's expected cash flows are adjusted to reflect project risk", and which follows directly from the concept of utlity function. (Managers "specify how much money, with certainty, would be required to be indifferent between the riskless (certain) sum and the risky cash flow's expected value.")
  • the risk-adjusted discount rate method, "in which differential risk is dealt with by changing the cost of capital." ("All average-risk projects are discounted at the firm's corporate cost of capital... above-average-risk projects are assigned a higher cost of capital, and below-average-risk projects are discounted at a lower cost of capital.")

Gapenski also points out that, if projects are analyzed solely on the basis of costs, the risk adjustment for cash outflows (costs) should be the opposite of the adjustment for cash inflows, so that "when cash outflows are being evaluated, higher risk leads to a lower discount rate."

In presence of capital rationing ("when a business has more attractive investment opportunities than it has capital to invest"), the author suggests selecting "that set of capital projects that maximizes aggregate NPV and still meets the capital constraint", or considering the profitability index, defined by the present value of cash inflows divided by the present value of cash outflows.

Capital Investment Decisions in Healthcare Finance (1/3)

This post (in three parts) is a summary of Chapters 13, 14 and 15 in Healthcare Finance, 5th edition, by Louis C. Gapenski, Health Administration Press, 2012. I start with Chapters 14 and 15, which represent the Capital Investment Decisions (Part VI) of the book, and then discuss Chapter 13, which explains some of the terms taken for granted later.

Chapter 14: The basics of capital budgeting

Gapenski decomposes the financial analysis of capital investment proposals into four steps:
1. estimation of the cash flows (further decomposed into: capital outlay (cost), operating cash flows, ending cash flow),
2. estimation of the riskiness of the cash flows,
3. estimation of the project's cost of capital (opportunity cost, discount rate),
4. assessment of the financial impact of the project using the following metrics:

  • Breakeven Analysis: Payback: the expected number of years required to recover the investment in a project (time breakeven), is found by constructing the project's cumulative cash flows up to each time period and determining when they exceed the project cost.
  • Return on Investment (Profitability) Analysis: Net Present Value (measures a project's dollar profitability by using Discounted Cash Flow techniques), Internal Rate of Return (the discount rate for which the project's NPV is equal to zero) and Modified Internal Rate of Return (similar to IRR but with a different reinvestment rate assumptions), obtained by (a) discounting all the project's net cash outflows back to Year 0 at the project's cost of capital, (b) compounding all the project's net cash inflows forward to the last year of the project, at the project's cost of capital, yielding the inflow terminal value, and (c) computing the MIRR as the discount rate that forces the present value of the inflow terminal value to equal the present value of costs.

While the steps above will be familiar with any student or graduate who has ever taken an engineering economy class, Gapenski also adds a section specific to not-for-profit businesses (and many of his examples throughout the book include a not-for-profit healthcare provider and a for-profit one). This section discusses the concept of Net Present Social Value (NPSV), i.e., the present value of a project's social value, and a project scoring approach.

Analytics in Advocacy

The Spring 2013 issue of the Stanford Social Innovation Review has the first article on the use of analytics that I have seen in the magazine so far – specifically, on the use of analytics to guide and inform advocacy efforts.

The authors provide a systematic method that their employer, the Redstone Strategy Group, helped design to “plan, monitor and evaluate advocacy investments”. Such a method can help overcome the subconscious decision biases identified by Princeton’s Professor Emeritus Daniel Kahneman and winner of the 2002 Nobel Prize in Economics in his seminal work.

The analytical assessment framework is built around nine conditions that are viewed as “essential to a successful policy campaign.”

  1. Functioning venue(s) for adoption (i.e., functioning regulatory institutions and the like)
  2. Open policy window (demand for the solution)
  3. Feasible solution (a solution has been “shown to provide the intended benefits”)
  4. Dynamic master plan (“pragmatic and flexible advocacy strategy”)
  5. Strong campaign leader(s)
  6. Influential support coalition
  7. Mobilized public
  8. Powerful inside champions
  9. Clear implementation path.

These nine conditions can be used as (i) a checklist, to help “grantmakers and campaign leaders consider the full range of influential factors in creating a successful campaign”, (ii) a rubric, which “allows grantmakers and advocates to take a deeper look at the conditions and score them from 1 to 5 on a spectrum from “not at all” present to “fully” present”, or (iii) a quantitative estimator for likelihood of success, which “helps funders and campaign leaders judge returns on financial investments”. Method (iii) is the most quantitative approach, because costs of planned activities and performance measures have to be estimated with and without the contribution of the grantmaker to assess the grant’s potential impact.

The authors point out that “[a]ny formula that provides quantitative estimates of uncertain values, such as the likelihood of achieving policy change, is a decision-making aid, not a scientific truth”, a caveat that is useful to remember when faced with the temptation to blindly follow the conclusions of a mathematical model having required a number of hard-to-check assumptions. They further divide policy change into three stages and estimate likelihoods of success for each: agenda-setting (conditions 1 to 3 above), adoption (conditions 4 to 8) and implementation (condition 9). Because successful policy will need to go through the three stages, the cumulative likelihood of success is the product of the likelihoods in each individual stage.

Conditions 3 to 8 are labeled “campaign conditions”, i.e., conditions that the campaign can influence in the near term. Conditions 1, 2 and 9 are called “context conditions” and “reflect forces that advocates have little ability to influence via the campaign, especially in the near term.” The campaign’s contribution is estimated by comparing the estimated likelihood of success with and without intervention. The philanthropic return on investment for a campaign is then the potential social benefit of a successful policy multiplied by the percentage-point increase in the likelihood of success, divided by the cost of the advocacy campaign.

The framework is valuable at each of the four stages of an advocacy campaign: (a) evaluating pathways (deciding on a strategy), (b) incorporating contribution (deciding on a tactical approach), (c) monitoring progress and (d) assessing results. For each of these four stages, the authors explain how their nine-condition Advocacy Assessment Framework can be used as a checklist, as a rubric and as a quantitative estimator.

The Hewlett Foundation in particular implemented the framework with great benefits when it had to identify five states to give support to for “broad-based advocacies of clean electricity policies.” The Western Energy Project is also using the framework to guide its advocacy efforts to restrict oil shale leasing. Finally, the framework can help analyze completed efforts such as those to protect a remote Wyoming range from further oil and gas exploration, which culminated in the 2009 Wyoming Range Legacy Act. The authors conclude: “The early applications described in this article suggest that it can help grantmakers determine whether they are choosing the right topics and investing in the right grantees to reach their goals.”

Reference Pricing

Reference pricing “establishes a standard price for a drug, procedure, service or bundle of services and generally requires that health plan members pay any allowed charges beyond this amount” (as defined in this action brief by Catalyst for Payment Reform).

In practice, it “aims to offer reasonable alternatives to high-cost providers without compromising quality. Patients have the carrot of lower, and in some instances, no member cost share if they go to providers who charge at or below the reference price.” As a result, it may “help exert pressure on high-cost providers to lower their prices.”

According to the brief, reference pricing is particularly effective for services that are elective, well-defined, with transparent or undistinguishable quality, with transparent price but with also substantial variation in price, and with multiple competing providers in each geographical area.

The simplest form of reference pricing can be found in the pharmaceuticals, to treat medical conditions for which generic drugs are available. (This has been implemented for instance by the state of Arkansas.) The brief notes, however, that “medical services and procedures are far less standardized than pharmaceutical products, making the reference price process more complex.” Examples of implementation can be found in some of Safeway-sponsored health plans as well as CalPERS health plans in a collaboration with Anthem Blue Cross. In cases where significant quality variations do exist, it is advisable to also include a quality threshold.

Implementation challenges include the need for transparent quality and price, the need to encourage health plan members to become informed consumers, and the possible temptation for some providers to use cost shifting, i.e., to increase the price of other services in order to compensate for the losses in the areas covered by reference pricing. Further, “[t]here is some danger that reference pricing could encourage providers to seek patients with fewer co-morbidities whose care is likely to require fewer provider resources.” Full price transparency may also facilitate collusion.

The action brief also provides valuable insights into what more mature versions of reference pricing may look like, including more extensive outcomes measures and integration with Health Savings Accounts.