That'll be $15,000.

Photographer: Kathryn Scott Osler/Denver Post/Getty Images

Save Medicare, Starting with Your Hips

Peter R. Orszag is a Bloomberg View columnist. He is a vice chairman of investment banking at Lazard. He was President Barack Obama’s director of the Office of Management and Budget from 2009 to 2010 and the director of the Congressional Budget Office from 2007 to 2008.
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Sylvia Burwell, the secretary of health and human services, just took a big step toward controlling health-care costs: She proposed fixed Medicare payments for all the costs associated with hip and knee replacements in 75 metropolitan areas. If we really want to control health-care spending, changes like this -- payment that rewards value, not volume -- need to become the norm.

In January, Burwell set goals for Medicare: By the end of 2016, 30 percent of payments are to be based on value, and 50 percent by the end of 2018. To get there, we won't be able to rely exclusively on voluntary programs, in which providers choose whether or not to shift to value-based payment. Instead, Burwell needs to use her statutory authority to introduce mandatory, and preferably national, programs.

Hip and knee replacements are a great place to start. The evidence suggests massive differences in how much Medicare ends up paying for both types of surgery across regions, hospitals, and doctors within a hospital. For example, Medicare pays for about 300,000 knee replacements each year. The average cost for a first-time knee replacement is now roughly $15,000, but payments often vary by thousands of dollars around that average

A 2011 study found wide variation in Medicare's payments for hip replacements, too: The most expensive fifth of hospitals had average costs that were almost $7,000 higher than hospitals in the cheapest fifth, even after adjusting for regional price differences and the severity of the patients' condition. (This variation isn't limited to Medicare. A January 2015 Blue Cross Blue Shield study found substantial variation in commercial insurance payments for hip and knee surgery.)

A big reason for this variation is that Medicare typically pays for each individual service or test associated with the surgery, rather than paying for the entire episode in one fixed payment. Paying piecemeal creates an incentive to tack on unnecessary services and diffuses responsibility for the overall results, which means costs are higher than necessary and quality is harmed.

Over the past several years, Medicare has been therefore conducting pilot projects, such as the Acute Care Episode demonstration project and its successor, the Bundled Payments for Care Improvement initiative, in which the payments for all the care associated with a medical procedure, such as a hip or knee replacement, are bundled into one total, rather than paid for individually. (Thus the name "bundled payment.") Private insurers have also been experimenting with this approach. These programs are generally encouraging, suggesting that when hospitals and other providers receive a bundled payment, they are able to deliver care more efficiently -- with a combination of lower cost and higher quality.

The results are encouraging and provide hope that Burwell's move to make bundled payments mandatory for hospitals will produce lower costs and improved quality. That shift is geographically limited, so that we can continue to study and adapt the model, but make no mistake: This is a big deal.

Here's how it works. Medicare will pay a fixed amount for all the care provided within 90 days following a hip or knee surgery. Bonuses will be available for hospitals that both reduce costs and exceed quality thresholds. At the beginning, hospitals will simply share in any savings, but over time they will also owe Medicare money if their costs are too high. (Evaluating quality should include knowing exactly which artificial hips and knees were implanted.)

This caps a week of momentous Medicare proposals, including a little-noticed shift in how Medicare will pay for home health care and a more-noticed change that would pay doctors to engage in voluntary discussions with patients about end-of-life care. As concerns rise about cost growth returning, it's good to see the beginning of mandatory bundled payments. Thursday's announcement is a signal to providers who may doubt that fee-for-service payment is really coming to an end. It is -- and they need to adapt.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Peter R. Orszag at porszag3@bloomberg.net

To contact the editor on this story:
Christopher Flavelle at cflavelle@bloomberg.net