Accountable Care Organizations: The End of Innovation in Medicine?

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The Obama administration is pinning its hopes for controlling Medicare costs on accountable care organizations (ACOs)—a system in which groups of doctors are given responsibility for a large population of patients, with a share of the doctors’ reimbursement dependent on their ability to reduce spending and improve clinical outcomes. The Department of Health and Human Services is expected to release regulations governing the framework for ACOs by the end of February. ACOs are supposed to offer incentives for doctors to improve the coordination of care. While this idea is not inherently wrong, the Obama team relies heavily on hospitals to develop these new organizations.

Yet historically, most of the significant innovation in healthcare delivery has developed in for-profit companies, often started by entrepreneurs, and has aimed to move patient care away from costly hospital settings and into less expensive outpatient settings. But entrepreneurs are now exiting the healthcare services space because the Obama plan tilts the marketplace so heavily against their endeavors. The Obama team is forced to rely on hospitals as much by default as by design, but many hospitals are unlikely to succeed at running ACOs.

Writing in summer 2010 for the medical journal Annals of Internal Medicine, Obama’s former healthcare czar Nancy-Ann DeParle joined 2 of her White House colleagues in arguing that “the economic forces put in motion by [the Obama healthcare plan] are likely to lead to vertical organization of providers and accelerate physician employment by hospitals and aggregation into larger physician groups.”1

In the provocative but little-noticed article, DeParle said doctors who “accept the challenge will be rewarded in the future payment system”1 by changes likely to occur in how doctors are compensated under Medicare. In other words, doctors who consent to these new arrangements will see their incomes rise. “Physicians who embrace these changes and opportunities,” DeParle writes, “are likely to deliver the greatest benefits to their patients, the health system, and themselves.”1

DeParle’s counsel was a nod to the Obama administration’s support for ACOs and the sizable changes the Obama team foresees in the way medical care is organized and delivered as a result of them. The ACO concept has quickly become Washington’s most fashionable vehicle for pursuing cost-savings in the Medicare program. Obama’s recently enacted healthcare legislation, the Patient Protection and Affordable Care Act (PPACA), puts the concept at the center of efforts to change how Medicare patients are managed. The ACOs are supposed to be implemented starting in 2012—not as a pilot or demonstration program, but as an alternative payment system for providers accepting reimbursement under Medicare. The Obama team is placing a bet that ACOs can improve medical outcomes while reducing costs to the government.1

But the president’s team also envisions that hospitals will be at the center of these ACOs. The regulatory effort to tilt ACOs into the hands of hospitals stems from the administration’s impulse to tightly manage how these organizations operate and the president’s instinct to try to centrally plan aspects of how medical care is delivered. As large, geographically distributed, and mostly unionized institutions, hospitals provide the easiest scaffold for the technocratic tinkering of the administration’s health policy team.

Hospitals are accessible, relatively pliable, and already have a business incentive to roll up the providers in their local markets and form these integrated care organizations. As health policy scholar Jeff Goldsmith notes in a recent issue of Health Affairs, “despite the lengthening of the list of possible participants, hospitals are likely to dominate the ACO contracting process for 2 reasons. First, the largest avoidable Medicare costs are hospital related. And second, in many communities, the hospital is the only organized care delivery entity capable of executing the model.”2

By building geographic monopolies, hospitals are in a better position to exact favorable contracts with insurers and local, self-insured businesses. Therefore, hospitals see plenty of financial advantages in becoming ACOs.The Obama team—out of a desire to control the ACOs—provides hospitals with the opportunity to dominate this new construct.

But hospitals are the wrong vehicles to entrust with driving innovation. According to one prominent Wall Street research firm, “hospitals will have to take on an increasing amount of risk going forward as future regulations are likely to place more accountability of patient care on them. In our opinion, this is a risk going forward given hospitals have traditionally been slow to evolve in new operating environments. We would expect for-profit hospitals to fare much better than their less sophisticated non-profit competitors.”3

Indeed, most of the significant changes in how healthcare is delivered have been motivated by private companies— led by entrepreneurs and often backed by venture capital. Their business models were typically aimed at moving patients out of hospitals, not into them. But ACOs, like other inventions in the new healthcare law, try to achieve reform by changing how market power is distributed in the system, rather than creating incentives for innovation in how healthcare is delivered. The legislation makes a leap of faith that once ACOs consolidate enough local-market dominance, they will have the incentive, capital, and wherewithal to introduce meaningful changes in how medical care is coordinated.

There is a rich history of private businesses that introduced successful and enduring reforms in how medical care is delivered, but these entrepreneurs—and the investors who backed their previous ventures—are not placing many new bets. The Medicare program and the Obama health plan are targeting many of these private businesses with new costs and regulations, so private investors are exiting the health services sector. The number of capital investments in healthcare services ventures in 2010 was fewer than half the median number of annual deals since 2000.4 The result is that hospitals are one of the last entities with capital to fund the formation of ACOs.

There will be a handful of regions where large, integrated medical practices have the sophistication and capital to form their own ACOs. The large medical groups found in Texas, California, and Florida might meet the minimum requirements. But most parts of the country do not have the necessary concentration of physician-owned organizations for provider-led ACOs.

Hospitals will therefore end up forming the majority of ACOs, but their incentive will always be to fill hospital beds, not manage patients at lower-cost delivery settings. Even when competitive pressures have previously forced hospitals to reduce stays for some acute procedures, they have compensated by driving the adoption of elective procedures that fill empty beds. Witness the explosion in procedures such as bariatric surgery or the increasing number of orthopedic joint replacements in younger patients.

Origin of the Accountable Care Organization
An ACO is basically a large group of providers who practice as part of a single entity. The organization takes overall responsibility for the care of each patient and the associated costs. An ACO can be a large multispecialty group of doctors or—more likely—a hospital that owns or contracts with many of the local doctor practices in its geographic region. Under the PPACA, an ACO will take “accountability” for a local population of Medicare patients. Patients, in turn, get most of their care from providers working inside the ACO’s network. To encourage efficiency and cost cutting, the doctors practicing inside an ACO can share in any cost-savings they achieve. The idea is to give doctors a financial incentive to reduce utilization of expensive services and work more closely as part of coordinated teams. An ACO needs to be large enough that the savings it generates are a result of improving the quality of care being delivered, not of fluctuations in membership levels or the clinical events that occur from year to year. To these ends, proponents say an ACO should care for at least 5000 Medicare beneficiaries or 15,000 beneficiaries with private insurance.5

The ACO concept is attributed to Elliott Fisher, MD, the architect of the Dartmouth Atlas Project, a program that has documented the seeming variation in the cost of medical care and outcomes across the United States.6 The theory behind ACOs has its origins in the work of the Dartmouth Atlas and its conclusion that Medicare spending can be reduced while also improving clinical outcomes. The term ACO is said to have grown out of an exchange Fisher had with Chairman Glenn Hackbarth at a November 2006 meeting of the Medicare Payment Advisory Committee (MedPAC). Fisher’s findings on the variation in medical outcomes and their inverse correlation to health spending became the intellectual foundation for Obama’s vision of “bending the cost curve” and his proposals for cuts to Medicare that he says will simultaneously improve medical care.

In many ways, the ACO concept builds on the 1990s approach to “capitation,” in which health maintenance organizations (HMOs) gave doctors a lump sum of money to care for a large group of patients. The arrangement put a financial onus on providers to cut costs and pursue efficiencies. It lowered spending for a time but ultimately proved unpopular with patients, who believed that it gave doctors financial incentives to ration care. Eventually, it led to a backlash against managed care and the introduction of the Patients’ Bill of Rights.7 It is envisioned that the ACOs will occupy a middle ground between doctors who are paid on a fee-for-service basis and managed-care plans that are paid under capitated arrangements.8

In a June 2009 report, MedPAC explored the concept of mandatory ACOs. Under such a model, doctors and Medicare patients would be assigned to a given network to form an ACO. Fee-for-service payments would still be made to individual doctors for their services, but part of the money would be withheld. It would only be returned if the entire ACO organization met certain governmentdetermined targets for quality and cost-savings.9

It is worth noting that the formation of ACOs fulfills a longtime regulatory pursuit of the Medicare program: to get more leverage over providers. The geographic dispersion of doctors into small practices has made them hard for a central agency like Medicare to regulate. Failing to get enough leverage to regulate individual medical procedures and doctors’ decisions to adopt certain approaches to care, the Medicare program has turned to regulating the technology that patients and doctors employ. Once doctors are consolidated into ACOs, it will be easier for Medicare to gain more direct leverage over their clinical decisions. Instead of being required to reach down to the individual doctors, Medicare will now be able to regulate ACOs, which will in turn exert the necessary leverage over doctors.

The Obama Team’s Vision for ACOs Takes Shape
Even after the passage of the PPACA, many details of how ACOs will operate are being worked out by the Department of Health and Human Services. The regulations were scheduled for release in fall 2010 but have been delayed until the end of February or early March. While MedPAC’s sweeping vision is unlikely to take shape, it is expected that Medicare patients will be assigned to ACOs. Moreover, it is not clear that doctor participation will be voluntary. Some doctors could be compelled to participate in ACOs if they want to bill Medicare or accept health plans offered in the new statebased insurance exchanges that will begin in 2014.

Healthcare policymakers inside the White House and Centers for Medicare and Medicaid Services (CMS) may also be crafting new rules that would provide ACOs favorable treatment in the health insurance exchanges. These efforts are premised on the belief that ACOs could eventually function in place of traditional for-profit health plans in the new exchanges.

Under this construct, ACOs would market themselves in the exchanges as something akin to staff-model HMOs and offer comprehensive healthcare benefits directly to consumers. The administration has said its goal is to put an additional 30 million Americans under the care of these kinds of “integrated delivery systems” in the next 3 years.

This model has appeal among health policymakers who discount the value added by insurance companies, viewing them simply as costly middlemen. California has advanced state rules that would regulate ACOs operating on its state exchanges and insurance companies. This is a measure of how political authorities intend to position ACOs as a stand-in for traditional insurance companies.

Here again, the problem is not the concept but the government rules that tilt the market in favor of a desired set of winners and losers. The PPACA already gives CMS the authority to grant ACOs waivers that would permit arrangements that might otherwise trigger concerns around “gain-sharing” or violation of antitrust provisions. Among the specific policy breaks for ACOs that the administration is considering are exemptions from some of the Stark Rules (which outlaw healthcare entities that accept government reimbursement from referring patients to facilities they own, a concept referred to as self-dealing) and immunity from some antitrust requirements that would normally prevent local healthcare institutions (such as hospitals) from consolidating and controlling a majority of the healthcare providers in any given region. CMS recently held a joint meeting with the Federal Trade Commission to discuss which antitrust provisions might be loosened to facilitate the expansion of ACOs.

The prospect of consolidated power is already raising costs to consumers.10 Far from improving the delivery of care, many fear that ACOs will simply create local monopolies around hospitals, which will use their concentrated power to drive up costs.11

If ACOs contract directly with patients on a health exchange by setting themselves up as entities that resemble staff-model HMOs (similar to the way Kaiser Permanente operates), some may partner with traditional health insurers to reinsure a portion of the risk they will be taking on. But on the whole, the problem with cutting out the health insurers from these arrangements is that consumers will ultimately be left with fewer provider options if they become tied to a local ACO. The ACOs are likely to maintain closed networks and would have incentives to make it expensive for consumers to go outside their network of local physicians.

Additionally, by displacing traditional insurance companies on the exchanges, ACOs will inevitably lead to less price competition and pressure to improve quality. This is because ACOs will not have the same incentive to form networks with the best providers and inpatient facilities. The primary focus of a hospital-led ACO will be on achieving geographic concentration rather than a high-quality network. In many respects, the idea of ACOs offering comprehensive health plans is a throwback to the 1990s provider-sponsored organizations, which failed largely because of their inability to manage risk or costs.12

Organized medical groups, such as the American Medical Association, have generally favored the development of ACOs. This is premised, in part, on their belief that the market leverage that ACOs afford providers will give doctors the clout to secure better pricing for their services.13 But if ACOs contract directly with consumers and cut out insurers entirely, they will also diminish the market-based pricing for medical services. Instead of negotiating rates with multiple insurance companies, doctors bound to ACOs may find that rates are set by the federal agency overseeing ACOs. The result could be the same kind of administered pricing that doctors are subject to under Medicare.

Private Ventures: The Real Origins of Healthcare Innovation
The Obama administration believes that the ACOs, and the hospitals that operate them, will invest in new innovations in the delivery of medical care that lead to better coordination of healthcare services. The trouble with this vision is that hospitals have never been sources of innovation in the way medical care is organized and delivered. Over the last several decades, most of the notable innovations in healthcare services have been developed in for-profit companies, often run by entrepreneurs and backed by venture capital.

The venture-backed company Surgical Care Affiliates largely developed the concept of outpatient surgery centers. Another venture-backed company, US Healthcare, led the development of the first for-profit HMO in 1982.14 Pioneers in the physician-practice man - agement space that continue to operate today—including Pediatrix (which specializes in neonatology) and US Oncology (which specializes in cancer care)—were similarly backed by entrepreneurs and supported by venture-capital investments.15 Rehabilitation hospitals and subacute care companies such as Integrated Healthcare, outpatient dialysis clinics such as US Renal Care, long-term care hospitals such as Select Medical, and pharmacy-benefit managers such as Caremark also resulted from new concepts in medical care delivery pioneered by entrepreneurs and supported by private capital.

Many of these companies proved that they could simultaneously improve the delivery of medical care while lowering healthcare costs. Many of these innovations were first aimed at hospitals and sought to move patients treated in costly, inpatient facilities to less expensive outpatient settings. In many cases, the innovations they introduced were eventually adopted by hospitals, which started operating their own rehab facilities, long-term care hospitals, and home dialysis services. The problem is that under today’s market rules, hospitals do not have the incentive to innovate and invest in improved delivery models. They lack the managerial experience and financial incentive to drive change in the delivery of healthcare services.

But post–health reform, the entrepreneurs and investors who built new companies and drove improvements in healthcare delivery are leaving the sector because the new political landscape is tilted so heavily against their success. The PPACA targets these for-profit health endeavors, in some cases with new taxes on their profits. This is not being done to improve the delivery of care but to generate additional revenue to help pay for the expansion of other government-run health programs. As a result, the capital that has flowed into startup healthcare services ventures has diminished since the passage of the PPACA.

This also means that there is little private capital available to fund the formation of ACOs. A number of large medical practices and private entrepreneurs have circulated business plans to secure the capital needed to form an ACO. However, there are no meaningful examples to date in which these non–hospital-based ACO ventures have acquired private funding. Integrated medical practices are also struggling to raise the capital needed to expand and form ACOs. Surveys show that credit being extended to physicians has declined. The hospitals are stepping in to form ACOs as much by political design as by default, since they are the only entities that still have capital cushions to invest in them.

In 2009, the year healthcare reform was debated and voted on, healthcare services attracted just $40 million in new, early-stage venture-capital investment, according to a July 2010 survey published by Pricewaterhouse- Coopers and the National Venture Capital Association. In 2010, it garnered a little more than $100 million in traditional venture investment. By comparison, medical devices still attracted $338 million in investments in 2009, and biotech $500 million—levels similar to 2000.

These 2 sectors—medical devices and biotech— attracted even more venture money in 2010. This demonstrates that the scale of the falloff in healthcare services investments is not explained by the economic effects of the recession on overall venture-capital flows into the healthcare sector. To gauge the magnitude of these investment disparities, consider that in 2000 healthcare services attracted about $450 million in venture- capital investments annually. Even though the economic downturn has brought overall venture-capital flows in biotech and medical devices back to 2000 levels, investors are still disproportionately shunning the healthcare services sector.

Today, many of the venture-capital firms still investing in new health services endeavors are placing their bets in countries such as China, Brazil, and India, but there was one notable exception in the healthcare services space. Venture investors did increase their investment in a sector at the intersection of healthcare and technology: medical software and information services.16

Political and regulatory uncertainty created by health reform has a direct impact on both capital investment and entrepreneurship in healthcare services. One recent survey of early-stage healthcare investors found a close association between regulatory and policy risk and the willingness of venture-capital firms to enter a healthcare sector such as drugs, medical devices, or healthcare services. Two thirds of respondents said that increases in political and regulatory risk would lead them to shift investments within or across healthcare sectors or to reduce healthcare investments altogether. Shifting investment capital out of healthcare and toward other endeavors is often as easy as rebalancing a portfolio. Of the billions invested in healthcare by venture firms since 2000, about 80% came from firms that invested in other areas such as media and clean energy. Because firms that invest across other sectors are making most of the healthcare investments, it is easy for them to take money out of one declining sector and steer it into other areas of their portfolios.17

The largest flows of new capital into health services are coming not from venture capitalists focused on developing new concepts in how healthcare services are delivered, but from private equity investors who are raising funds to acquire—and consolidate—existing healthcare companies. More than $7 billion was invested in healthcare private equity last year alone. Most of that came from leverage buyout shops,18 and much of this money is aimed at buying hospitals and other service providers. Private equity is focused on consolidating and streamlining healthcare businesses. In some cases, it has been used as a way to wring money out of existing entities, consolidate them, and gain market leverage that lets providers drive up prices. But such financial engineering rarely creates new innovation.

In Britain, for example, private equity firms control more than 70% of the private hospitals, and private equity investors run 5 of the 7 largest hospitals. These hospitals play an increasingly important role in providing services to a crumbling National Health Service, but they have not led to advances in the way care is delivered. They have developed simply to bring some new efficiency to the same outdated hospital-based model on which Britain relies.19

Can Entrepreneurship and Healthcare Coexist?
When venture capitalists spot a profit opportunity, it usually involves a shift of patients from one setting of care to another—for example, moving patients from inpatient to outpatient care, moving from general hospitals to specialty hospitals, and developing new sites for care. This latter opportunity explains the rise of rehabilitation, hospice, or long-term care hospitals, among others. This is how new ventures can grow market share under the existing regulatory rules. Many of these endeavors have been shown to reduce costs while improving outcomes, but these site-based innovations challenge the established order—especially nonprofit hospitals that have considerable political clout in Washington—so the private ventures become a political mark.

The private companies that succeed earn abovemarket returns relative to their former rivals. The profits are a measure of their success, but they also act as a bull’s eye that invites additional targeting. Progressive health policymakers are suspicious of the elements that define success in private healthcare markets—expanding profit margins, increasing revenues, and growing market share.

They regard capital returned to investors in the form of profits as wasted money that should have been spent on providing direct patient care. As a result, when genuine innovation in the delivery of healthcare inevitably leads to successful enterprises and highly visible profits, political recriminations follow.

The current issues swirling around hospice care illustrate the problem. The idea behind hospice is that patients who are terminally ill can stay out of the hospital and instead die more peacefully in a facility that is focused on end-of-life issues such as pain management and comfort care. The concept has its origins in charity work, but it gained wider adoption through the entry of some for-profit hospice providers. Medicare, recognizing the opportunity to avoid costly charges for unnecessary hospital stays while improving the quality of medical care, encouraged the concept by broadening its reimbursement.

Not surprisingly, utilization of hospice services grew, along with the number of private firms providing these services. Like a lot of other good concepts, it has excess utilization on the margins. Patients started to turn up in hospice centers who did not meet the criteria. They ended up living for long periods of time there and, therefore, were not truly “terminal” when they first entered the hospice facility. At the same time, the profits of the hospice providers continued to rise. Medicare has recently announced that the profit margins of the hospice providers are simply too high, so it is in the process of creating a new reimbursement scheme that will cut the current payment levels.

ACOs repeat many of our past mistakes. For one thing, regulators will likely bar them from competing for more patients in an open marketplace. Yet this is the only incentive that would spur an ACO to innovate and improve its delivery of medical care. In addition, they rely too heavily on existing hospitals rather than attracting private capital to form new, entrepreneurial ventures. The entire healthcare plan is explicitly designed to penalize above-average rates of profitability. The end result is to discourage private investment in ACOs, as well as other delivery innovations.

Writing in the Annals of Internal Medicine, DeParle notes that “the healthcare system will evolve into 1 of 2 forms: organized around hospitals or organized around physician groups. These coordinating functions, to the extent that they currently exist, traditionally have been managed by hospitals or health plans. Only hospitals or health plans can afford to make the necessary investments in information technology and management skills.”1

DeParle is quick to point out that this evolution toward a hospital-centered model for the practice of outpatient medicine is not inevitable. Indeed, the prospect that hospitals will soon own a majority of medical practices in the United States is already worrying some doctors and policymakers.20

But many of the provisions of the Obama plan, especially the way ACOs are being envisioned and constructed, push the entire market precisely in this direction. In the meantime, private investors are exiting health services and entrepreneurs are putting their energies into other endeavors. These marketplace developments, more than anything else, make the Obama plan’s reliance on public financing and central planning self-fulfilling and—in the end—make the entire scheme self-defeating. 


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  7. Senate Democratic Caucus. Summary of the McCain-Edwards-Kennedy Patients’ Bill of Rights. Accessed January 28, 2011.
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  13. Big insurance, big medicine: ObamaCare is already driving a wave of health-care consolidation—and higher costs. Wall Street J. October 26, 2010. Accessed January 28, 2011.
  14. The venture-capital firm Warburg Pincus was one of the early backers of US Healthcare. The HMO was later sold to Aetna in 1996.
  15. The venture-capital arm of Welsh Carson was the principal investor behind each of these endeavors.
  16. Spurred by the Obama administration’s stimulus law, which set aside $19.2 billion in spending for healthcare information technology, firms invested $498 million in 2010 in that sector.
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  18. Many private equity shops are still in the midst of raising new pools of capital or have recently closed new funds. In addition, Texas Pacific Group and Welsh Carson, two enormous pools of capital with long track records in the creation of new healthcare endeavors, each recently announced that they would now be allocating new capital to private equity investments in healthcare services.
  19. Pagnamenta R, Kennedy S. Private equity faces healthcare check. Sunday Times. June 19, 2007. Accessed January 28, 2011.
  20. Harris G. More doctors giving up private practices. New York Times. March 25, 2010. Accessed January 28, 2011
Last modified: February 14, 2019
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