Health Care Industry Insights: Accountable Care Organizations

Accountable Care Organizations (ACOs) are a new type of legal entity created by the Affordable Care Act. They are, as defined by the Center for Medicare Services,  “groups of doctors, hospitals, and other health care providers, who come together voluntarily to give coordinated high quality care to their Medicare patients.”

Put simply, the purpose of ACOs is to lower total overall health care costs and enhance quality of care.

ACOs are making big waves in the health care space (something like 15-20% of the US population is already being served by them), but are not widely understood. The goal of today’s article is to explain why health care costs are out of control, what ACOs are and how they can control costs, how effective they’ve been thus far, and what future challenges await them.

Why are Health Care Costs so High?

Let’s begin by examining health care costs in the United States:

Overall Health Care Expenditure

As you can see, the US spends about $8,402 per person per year, and has increased 60% in the last decade alone. If we calculate the total health care expenditure in the US (population x per person spend) we get an astounding $2.6 trillion, which represents 17.9% of the nation’s total GDP.

OK fine you say, it’s a big number. However, the above graph doesn’t mean that this is a uniquely American problem. Perhaps all developed countries have similar health care spending? Let’s take a look at the evidence:

Health Care Spending by Country

As it turns out, the US is spending the most by far on health care of all the countries on that list, both in per capita and absolute terms.

OK fine you say, so maybe our health care system is more expensive. But isn’t that because it’s better than the other countries on that list?

Not so, it turns out. According to this study, the US health care system is equivalent (better on the high end but worse on the low end) in terms of quality when compared to other westernized nations. We’re outspending everybody else almost 2:1 on a per capita basis and for most of the population the care is actually worse here than if they lived elsewhere.

OK fine, so it’s high and the quality of our health care is similar. But where is the money going?

Distribution of Health Care SpendWell, it seems like ~50% of the spending is going towards hospital care and clinical services, so if we were to try to lower health care spend that seems to be a good place to start. But who can do something about this?

Who's Paying for Health Care

(credit: Kaiser Health Foundation)

Well, as of now we can see that the federal government is the single biggest payer of health care related expenses (29% of total), and thus has the greatest ability to incentivize health care providers (hospitals / clinical service providers) to lower their costs. Thus, the concept of Accountable Care Organizations was born.

Anyway, why are health care costs so high? According to the McKinsey Global Institute, there are five main reasons:

1. Provider capacity growth in response to high outpatient margins. This one’s surprising. Apparently, the US has a higher proportion of outpatient care (one-off tests, emergency care, rehab) and a lower proportion of inpatient care (hospital stays) than other developed companies. This is most likely because outpatient care generates higher margins for the hospital. Of course, the issue is that the volume of outpatient care in the US is much, much higher than other developed nations, explaining why costs here are so high.

2. The judgment-based nature of physician care. Physicians have it tough under our present system. On the one hand, they probably don’t want to order unnecessary tests and procedures. On the other hand, if they don’t order a test / procedure and they miss something, they may be sued for malpractice. They’re also compensated based upon how many tests / procedures they order as opposed to how effectively improving the patient’s health.

As a result, all the incentives are pushed towards physicians ordering as many tests / procedures as possible, increasing overall health care spend.

3. Technological innovation that drives prices higher rather than lower. The US has one of the most innovative health care systems in the world. The problem is, unlike in most industries technological innovation actually increases prices.

The reason is that patients aren’t paying directly for procedures, so if they have the option for a new technology and an old technology procedure which do you think they’ll choose? And as a result, everybody has to invest in new technology to keep up, increasing health care spending across the board.

4. Demand growth that appears to be due to greater availability of supply. In most industries, if businesses add increased supply prices will go down due to increased competition. Healthcare does not behave in this fashion because there’s no easy way to compare health care costs of different facilities and because people value getting as much care as possible. What we end up seeing is that different players in this market add capacity to their hospitals, which doesn’t drive up prices but instead increases volume. As a result, total health care spending increases.

5. Relatively price-insensitive patients with limited out-of-pocket costs. Insurance companies and the government end up paying most of the health care costs at the end of the day. As a result, the patients have no reason to ask for care that is less costly.

OK, so now that we have a solid grasp of the issues – what are ACOs and what can they do?

What are ACOs and How Can They Control Costs?

Accountable Care Organizations (ACOs) are groups of hospitals, physicians, and other health care providers who agree to be held accountable for quality and cost of care for their patients.

Basically, they agree to be rewarded (through payments from Medicare) if they are able to lower cost of care for their patients, but also agree to be punished (by making payments to Medicare) if they fail to control costs for their patients.

Of course, you may be wondering – how is this all supposed to work? On the one hand, health service providers are paid based upon the services they provide for their patients. On the other hand, they are supposed to find ways to reduce the services their patients need by improving their health, which cuts into their revenues and profits.

It’s not an easy task for any organization to hold two, opposing objectives like this. However, based upon people I’ve talked to it seems like health care providers are aware that costs are out of control. They know that if things keep proceeding as they are nobody will be able to afford healthcare services anymore, so reform is necessary.

On a positive note, the Congressional Budget Office projects that ACOs could save approximately $5.3 billion over 2010–19.  This is only a portion of the savings the CBO projects through implementation of all of the care coordination and insurance provisions of the ACA.

How Effective Have They Been?

Beginning in 2013, CMS decided to run a two year pilot, called the Pioneer program, to test out the efficacy of  ACOs. The results of the first year recently came out:

Apparently, nearly a third of the Pioneer ACOs announced they were dropping out of the program, some because they didn’t save enough money. (7 of the 9 ACOs are switching to a related program called MSSP which has similar goals but more relaxed incentives so they can play the long game on lowering costs).

However, all 32 Pioneers succeeded in improving quality and performed better than fee-for-service Medicare in 15 quality measures, according to CMS. And they generated a gross savings of $87.6 million in 2012, the first year of the program. It’s very promising that health care providers were able to make some savings. But the question is, where did these savings come from?

According to the following report by Oliver Wyman, savings come from three areas:

1. Low Hanging Fruit. Lowering hospital readmissions, educating patients about elective operations, and educating them when to use care and when it isn’t necessary

2. Targeted Programs. The sickest 5% of patients account for 50% of health care spend, so any program targeted toward this patient segment can yield dividends. (Note however that participants in the program didn’t get patient data until halfway through the year, so they didn’t really have time to undertake this angle).

3. Quality Measures. ACOs can also help patients indirectly by getting them to exercise more, control their weight, blood pressure, and cholesterol. This will save them on acute care over the long term.

Apparently, most savings have come from the first category (not surprising because that’s the quickest / easiest one to implement). This also explains why some organizations were able to achieve cost savings and others weren’t – some had already taken steps to reduce costs and thus had a harder time meeting their targets (targets were based on each ACOs’ present situation, so more lean organizations had a more difficult time meeting them).

Anyway, the fact that some ACOs were able to save money is very promising. Their methodology is going to be studied and hopefully adapted to other health care provider groups out there, lowering health care costs for everybody. And who knows what we’ll see in the long term? The US Health Care system has always been known for its ability to innovate.

What Future Challenges Await ACOs?

1. Multispecialty Group Formation. ACOs require a variety of physician specialties to coordinate and operate in the same organization. However, this may be difficult because different specialties make different amounts of money and because one of the lowest compensated specialties (primary care physicians) are the most important to keep the ACO functional.

2. Size of the Patient Population.  By law the ACO must manage at least 5,000 patients, but the cost savings with a population this small may be insufficient to make up for the investment costs to transition to an outcomes based system .  The larger the population, the easier it is to measure outcomes and manage the costs of care. However, a larger patient population is also harder to manage in general, and this may prevent smaller hospital groups from becoming ACOs.

3. Cultural.  A strong culture of self-reflection and assessment, continuous improvement, and flexibility may be the key differentiating factor between success and failure.  Trying to integrate the different business cultures of partnering organizations into one can be a significant barrier.

4. Resources. Does the organization have the resources (staff, time, money) necessary to carry it through its journey to accountability, which means completely realigning how money flows and services are delivered?

5. Staffing.  Primary care physicians are critical to the ACO, but finding / training enough primary care doctors will be a challenge for the nation, as well as individual organizations.

6. Lack of Consistent Measures.  Quality measures requested from providers and hospitals by the various payers are often different, presenting resource challenges within the health care organization.

7. Market-Based.  Health care markets vary widely, so the organization must carefully consider its current market position and the impact that an ACO transition might have on its business in the short-term and the long-term.

8. Legal.  there are several legal and regulatory issues that must be addressed to allow for ACO collaboration and integration, the Sherman Act anti-trust laws, anti-kickback laws, and the physician self-referral Stark Laws among them.

credit: (Accountable Care Facts Website)


Health Care spend is an astounding $2.6 trillion annually, which represents 17.9% of the nation’s total GDP and is much higher than equivalent westernized countries on a per capita basis.

There are five main reasons for higher costs in our system:

1. Provider capacity growth in response to high outpatient margins

2. The judgment-based nature of physician care.

3. Technological innovation that drives prices higher rather than lower.

4. Demand growth that appears to be due to greater availability of supply.

5. Relatively price-insensitive patients with limited out-of-pocket costs.

All of these boil down to the fact that consumers are relatively price insensitive and that added capacity / technological innovations result in increased demand and cost, unlike in most industries.

To deal with rising health care costs, ACOs or Accountable Care Organizations were created by the ACA to help transition our health care system to a value based approach. A value based approach is one that rewards health care providers that succeed in making their patients healthy and lowering health care spend as opposed to issuing treatments.

The Pioneer pilot program has shown promise – about $90 million in savings with all participating organizations making some sort of savings, but much more work needs to be done.


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