The Basics of Healthcare Economics Number 4: Whose Costs?

by Ellis M Knight MD, MBA


The overarching imperative in the healthcare economy today is to maintain or improve quality while reducing costs. That being said, perhaps the most important question those of us who aspire to move the system toward a more value-based model need to ask is — whose costs are we talking about anyway?


Consider the following examples and decide whose costs are being affected in each case:

  1. A clinically integrated network of clinicians working for a health system work diligently to put together a bundled payment model around total joint replacement. They then contract with a commercial payer in their area to be paid on a bundled payment basis, where each service item (CPT code) is charged against the bundled price and if the sum of these fee-for-service payments is less than the bundled price then the clinicians / health system and the payer get to split the savings 50 / 50. Under this model, whose costs are being reduced?
  2. The same group of clinicians and hospitals contract with Medicare under an at-risk Medicare Advantage Program. Under this payment model they are paid a per member per month payment (PMPM)for each patient assigned to the MA program. At the end of the year Medicare says they’ve spent less than the annual budget projection and therefore can keep a share of the savings, i.e. the difference between the projected budget for their patient population and the actual amount that was spent. Whose costs are being reduced in this model?
  3. The same group of clinicians / hospitals goes to a large self-insured employer in their area and directly contracts with the employer to provide primary care services on a PMPM basis for their employees. The employer compares what they are now paying in premiums to the health plan who serves as their third party administrator (TPA) and realizes that the PMPM contract with the clinically integrated network (CIN) would result in significant savings compared to what they are now paying the health plan / TPA. Whose costs are being reduced in this model?
  4. The same group contracts directly with a large self-insured employer to do total knee replacements for their employees at a bundled priced which they have calculated by analyzing the actual costs required for the CIN to perform each case. These costs include the pre-operative, operative, and post-operative (90 days) care given to each patient. Whose costs are saved here?


  1. The costs saved here are those of the payer, i.e. the commercial health plan. These costs are unlikely to be returned to the members of the health plan as lower premiums, but instead are likely to be added to the health plan’s profits and used for things like executive salaries or bonuses. The CIN also is unlikely to return their share of the cost savings to the patients they care for, but instead use them to pay bonuses to the clinicians and to make up for the discounted up-front pricing they had to accept from the payers (supposedly to account for the improved efficiencies of the CIN). These providers share of the savings simply get them back to the baseline rates (or slightly less) that they were receiving under the old FFS payment contracts.
  2. The costs saved here are also those of the payer (Medicare), but in this case the payers are you and I, i.e. taxpayers. Cost savings here can be used by the federal government to expand healthcare coverage for other elderly Americans, to reduce out of pocket expenses for Medicare beneficiaries, to pay off debt, to reduce taxes, and many other purposes.
  3. Here, the cost savings are those of the self-insured employer and ideally, these savings will be passed on to their insured employees through reduced premiums.
  4. The cost savings here also accrue back to the employer who again, will hopefully pass them on to the employees as lowered premiums, or lower cost shares, e.g. co-pays and deductibles. Note, the CIN participants benefit by locking in a large market share (volume) of referrals for joint replacement with its associated downstream revenues


In scenarios 1 and 2 the underlying transaction continues to rely on a fee-for-service payment model which has its own problems, most importantly that it creates perverse incentives for overuse within the healthcare system. But, in a model where the government is the payer, ideally the taxpayer will ultimately benefit if savings are produced.

In scenarios 3 and 4 the success of the underlying transaction depends on the clinical providers knowing their true costs and then using these costs to develop a price which covers those costs and attracts a large volume of business. This is what I like to call closing the cost / price disconnect which is prevalent throughout the healthcare system where prices are negotiated between payers and providers and have no connection to the true costs of providing the services. The exceptions to this rule are the payment models used by the Centers for Medicare and Medicaid Services (CMS). CMS sets its own prices and does not negotiate. Ostensibly CMS bases these prices on a cost report that every Medicare provider is responsible for producing on a regular basis.


It is very important in any supposed value-based payment arrangement to know whose costs are being lowered or saved. As the above examples show this is not always obvious. Terms like savings, cost reductions, and others get thrown about quite freely, especially by the payers. In order for true value-based care delivery to occur however, the cost savings need to accrue to the consumers — employers, individuals, taxpayers etc. who are ultimately footing the bill and literally paying the price for the out of control cost inflation in the healthcare economy.

It is also very important that prices in healthcare reflect true costs. This should be similar to the way cost of goods sold (COGS) are used in manufacturing as the costs that must be covered in order for the sale of any goods to generate a profit. If prices don’t have some connection to costs then all the price transparency rules and regulations in the world will not give consumers the information they need to make informed healthcare purchases and ultimately improve the value (quality / cost) delivered to the patients we serve.



Semi-retired physician and healthcare executive / consultant spending my time advocating for value-based care reform in the US healthcare system.

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store
Ellis Knight

Semi-retired physician and healthcare executive / consultant spending my time advocating for value-based care reform in the US healthcare system.