With projected expenditures of $4.4 trillion in 2018, national health spending could potentially grow more than 300 percent over the course of just 18 years (CMS, 2009). According to projections from the Congressional Budget Office (CBO), federal spending on Medicare and Medicaid alone will increase from about 5 percent of GDP in 2009 to more than 6 percent in 2019 and approximately 12 percent by 2050, mostly from growth in per capita costs (Elmendorf, 2009). Research indicates that, if costs per enrollee in Medicare and Medicaid grow at the same rate over the next four decades as they have over the past four, those two programs will increase from 5 percent of GDP today to 20 percent by 2050 (Figure 1-1) (CBO, 2007).
The costs of health care have therefore not just strained the federal budget; they have affected state governments and the private sector as well. In 2008, Medicaid spending accounted for approximately 21 percent of total state spending and represented the single largest component of state spending (National Association of State Budget Officers, 2009). These levels of healthcare expenditures have restricted the ability of state and local governments to fund other priorities, most prominently the needed investments in education (The White House, 2009). Beginning in the early 1980s, as healthcare costs began to rise, salaries began declining at public institutions relative to private institutions at all academic ranks, putting public universities at risk and at clear competitive disadvantage with their private counterparts in faculty recruitment (Figure 1-2) (Kane and Orszag, 2003).
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1
The Healthcare Imperative
INTRODUCTION
With projected expenditures of $4.4 trillion in 2018, national health
spending could potentially grow more than 300 percent over the course of
just 18 years (CMS, 2009). According to projections from the Congres-
sional Budget Office (CBO), federal spending on Medicare and Medicaid
alone will increase from about 5 percent of GDP in 2009 to more than
6 percent in 2019 and approximately 12 percent by 2050, mostly from
growth in per capita costs (Elmendorf, 2009). Research indicates that, if
costs per enrollee in Medicare and Medicaid grow at the same rate over the
next four decades as they have over the past four, those two programs will
increase from 5 percent of GDP today to 20 percent by 2050 (Figure 1-1)
(CBO, 2007).
The costs of health care have therefore not just strained the federal
budget; they have affected state governments and the private sector as well.
In 2008, Medicaid spending accounted for approximately 21 percent of
total state spending and represented the single largest component of state
spending (National Association of State Budget Officers, 2009). These levels
of healthcare expenditures have restricted the ability of state and local gov-
ernments to fund other priorities, most prominently the needed investments
in education (The White House, 2009). Beginning in the early 1980s, as
healthcare costs began to rise, salaries began declining at public institu-
tions relative to private institutions at all academic ranks, putting public
universities at risk and at clear competitive disadvantage with their private
counterparts in faculty recruitment (Figure 1-2) (Kane and Orszag, 2003).
9
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0 THE HEALTHCARE IMPERATIVE
FIGURE 1-1 Long-term fiscal gap and health care costs.
Figure 1-1.eps
SOURCE: CBO, 2007.
bitmap
In the private sector, healthcare costs have contributed to slowing the
growth in wages and jobs (National Coalition on Health Care, 2008). While
health insurance prices rapidly escalate and employers cut back on the
provision of health insurance benefits (Kaiser Family Foundation, 2009b),
the number of uninsured rose from 45.7 million in 2007 to 46.3 million in
2008 (U.S. Census Bureau, 2009).
FIGURE 1-2 Ratio of public to private research university salaries.
Figure 1-2.eps
SOURCE: Kane and Orszag, 2003.
bitmap
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THE HEALTHCARE IMPERATIVE
On the individual level, the average cost of annual health insurance pre-
miums for a family of four exceeded $13,000 in 2009, growing 5 percent
in just a single year (Kaiser Family Foundation, 2009a). Health insurance
premium increases have consistently exceeded inflation and the growth in
worker’s wages, forcing individuals to spend increasing amounts of their
income simply to maintain health coverage (Kaiser Family Foundation,
2009b). Estimates of the real increase in per capita income devoted to
health spending over the next 8 decades have been calculated to be almost
120 percent (Chernew et al., 2009). Fifty-three percent of Americans said
their family limited their medical care in the past 12 months because of cost
concerns, 19 percent reported serious financial problems due to medical
bills, with 13 percent depleting all or most of their savings and 7 percent
unable to pay for basic necessities such as food, heat, or housing (Kaiser
Family Foundation, 2009b).
While the United States has the highest per capita spending on health
care of any industrialized nation—50 percent greater than the second high-
est and twice as high as the average for Europe (Peterson and Burton,
2008), it continually lags behind other nations on many healthcare out-
comes, including life expectancy and infant mortality (Anderson and Frog-
ner, 2008; Docteur and Berenson, 2009). Employers and employees in other
industrialized countries spend about 63 percent of what the United States
spends on health care, but U.S. workforce health trails by about 10 percent.
Indeed, the emerging economies of Brazil, India, and China rank behind the
United States by about 5 percent on workforce health measures, but these
countries spend only a fraction—about 15 percent—of what the United
States spends on health care (Milstein, 2009). The relatively poor perfor-
mance in health outcomes relative to investment suggests ample opportunity
for improvement on both costs and outcomes. This prospect is supported
by findings that high-spending areas in the United States—spending $6,304
per capita compared to $3,922 per capita in the lowest spending quintile in
1996—utilize 60 percent more frequent physician and hospital visits, test-
ing, and use of procedures yet achieve no quality advantage (Fisher et al.,
2003). Together, these findings underscore the opportunities to lower costs
without impacting clinical outcomes.
The necessity of bending the cost curve stimulated the Institute of
Medicine’s (IOM’s) Roundtable on Value & Science-Driven Health Care
to partner with the Peter G. Peterson Foundation, a private philanthropy
dedicated to the nation’s fiscal security, in the conduct of a workshop series
The Healthcare Imperative: Lowering Costs and Improving Outcomes, part
of the Learning Health System series, in 2009. Guided by an IOM Planning
Committee, the meetings were aimed at engaging participants in specifi-
cally exploring, identifying, and characterizing the major causes of excess
healthcare spending, waste, and inefficiency in the United States; consider-
ing the strategies that might reduce per capita health spending in the United
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2 THE HEALTHCARE IMPERATIVE
States while improving health outcomes; and exploring the policy options
relevant to the effective implementation of those strategies. The chapters
in this book highlight common themes from the discussions and provide
summaries of the presentations from a variety of perspectives.
PROMOTING EFFICIENCY AND REDUCING
DISPARITIES IN HEALTH CARE
Peter R. Orszag, M.Sc., Ph.D.
Office of Management and Budget
Rising healthcare costs are not only a critical issue for employers and
for both enrollees and patients who ultimately bear the costs of health
insurance and health care, they also constitute the nation’s central fiscal
challenge.
On our current trajectory, Medicare and Medicaid will double as a
share of spending on federal programs within the next 30 years (OMB,
2009). And, while the aging of the population also contributes to this rise
in spending, healthcare cost growth is the primary driver over the long term
(see Figure 1-3). In fact, slowing the rate of healthcare cost growth by just
0.15 percentage points per year would produce the same amount of sav-
35%
30 %
25%
20 %
Ef fect of Excess Health Cost
Grow th
15%
Ef fect of Aging
10 %
5%
1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080
FIGURE 1-3 Sources of Projected Growth in Medicare, Medicaid and Social Secu-
rity (Spending, % OF GDP).
Figure 1-3.eps
SOURCE: OMB, 2009.
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THE HEALTHCARE IMPERATIVE
ings for the federal budget as closing the 75-year Social Security shortfall
(OMB, 2009).
Put simply, if we do not act to address rising healthcare costs, anything
else we do to reduce long-term federal deficits will be for naught.
Crowding Out Key Investments
While rising healthcare costs are projected to drive the federal budget
toward fiscal insolvency over the long term, they also threaten to crowd out
key governmental investments. State funding for higher education provides
a striking example of this crowd-out effect.
Over the past several decades, state support for higher education has
steadily declined. State appropriations for higher education fell from an
average of roughly $8.50 per $1,000 in personal income in 1977, to an
average of about $7 per $1,000 in personal income in 2002—a drop of
nearly 20 percent (Kane et al., 2003). It is notable that, as this drop-off
has occurred, salaries for professors in public institutions have declined
steadily relative to salaries for professors in private institutions. Whereas,
prior to 1980, salaries were largely comparable for professors in public
and private institutions of higher education, the public/private ratio of
average salaries fell to roughly 0.85 for professors by 1998 (Kane et al.,
2003). Although this is only one metric, it is indicative of the strain placed
on public investments.
While state investment in higher education has been declining relative
to income, state spending on health care has been rising—driven by the
Medicaid program, the costs of which are shared by both the federal and
state governments. These are complementary trends. Research shows that,
having controlled for other factors, higher education appropriations per
capita are negatively related to Medicaid spending per capita. In particular,
a $1 increase in real state Medicaid spending per capita is linked to a real
reduction in higher-education appropriations per capita by about $.06 or
$.07—a relationship that could potentially explain the vast majority of
the decrease in real, higher-education spending per capita from the 1980s
through the 1990s (Kane et al., 2003). Growing health costs, thus, not
only threaten to hinder future economic growth by creating gaping federal
budget deficits, but also by crowding key investments—such as in educa-
tion—that are needed to lay a foundation for future prosperity.
Gap Between Cost and Quality
Even as we spend more on health care, we are not necessarily seeing a
commensurate increase in quality. In fact, there is strong evidence that our
healthcare system is riddled with inefficiency—meaning, quite simply, that
we are not getting our money’s worth.
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THE HEALTHCARE IMPERATIVE
Perhaps the most compelling evidence of this inefficiency is the wide
variation in healthcare spending per capita across the United States. Fig-
ure 1-4 shows this variation in spending per person specifically within the
Medicare system by hospital referral region, adjusting for age, sex, and
race. Furthermore, this very substantial variation in cost per beneficiary in
Medicare is not correlated with overall health outcomes—and, in fact, the
opposite may be the case (Orszag, 2008).
Based on this evidence, researchers have found that as much as 30 per-
cent of Medicare’s costs could be saved without negatively affecting health
outcomes if spending in high- and medium-cost areas could be reduced
to the level in low-cost regions—and those estimates could probably be
extrapolated to the healthcare system as a whole (Fisher, 2005; McGinnis,
2009; McKinsey Global Institute, 2007; Wennberg et al., 2002). This means
that hundreds of billions of dollars per year in healthcare spending in the
United States is not making people better off. Rather, these dollars are
simply wasted.
Embedded in this troubling conclusion is a substantial opportunity:
the possibility to reduce healthcare costs without adversely affecting health
outcomes. This is one of the keys to healthcare reform—transforming
$9,000 to 16,352 (57) 7,500 to < 8,000 (53) 5,310 to < 7,000 (75)
8,000 to < 9,000 (79) 7,000 to < 7,500 (42) Not Populated
FIGURE 1-4 Medicare Spending per Capita (by Hospital Referral Region).
SOURCE: Reprinted with permission from Dartmouth Atlas of Health Care.
Figure 1-4.eps
bitmap with vector key
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THE HEALTHCARE IMPERATIVE
the healthcare system into one that emphasizes quality rather than just
quantity.
Rising Inequality in Life Expectancy
As we consider how to restrain the growth of healthcare costs, it is
also important to keep in mind another disturbing trend: recent gains in
life expectancy have not been shared equally across socioeconomic groups.
Life expectancy in the United States has been steadily increasing for the
past several decades, and the gaps between women and men and between
whites and African Americans have narrowed somewhat. But differences in
life expectancy by educational attainment and income have been growing.
In other words, socioeconomic status has become an increasingly impor-
tant determinant of life expectancy, whether measured at birth or at age
65 (CBO, 2008).
Reducing this disparity in life expectancy should involve both address-
ing the greater incidence of unhealthy behaviors among those with lower
incomes and educational attainment—such as with regard to smoking and
nutrition—and a lack of access to quality medical care. These are two in-
dependent factors.
********
Since I addressed the Institute of Medicine last May, the President
worked with Congress to enact comprehensive health insurance reform.
Much has and will be written about health insurance reform. But, in short,
this reform addresses many of the problems that I identified in my speech
last May.
Health reform uses the best available knowledge and most promising
ideas from across the political spectrum to control healthcare costs by
transforming the health system from one that delivers greater quality with
less quantity. It does so by, among other changes:
• Imposing an excise tax on the highest-cost insurance plans, provid-
ing employers with an incentive to seek higher-quality and lower-
cost health benefits;
• Reforming incentives to improve the way health care is delivered
to patients throughout the country through such mechanisms as
bundled payments and accountable-care organizations; and
• Creating an Independent Payment Advisory Board in Medicare so
that reforming the healthcare system is not a one-time event but
an ongoing process with the goal of improving care and lowering
costs.
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THE HEALTHCARE IMPERATIVE
This represents the first serious piece of legislation to address the forces
underlying rising healthcare costs—and it does so while giving more choice
and security to those with health insurance, providing access to coverage to
those without, improving the quality of health care for all, and generating
the most deficit reduction of any legislation in over a decade.
WHY AMERICANS SPEND MORE FOR HEALTH CARE
Eric Jensen, M.B.A, and Lenny Mendonca, M.B.A.
McKinsey Global Institute
In 2006, the United States spent $2.1 trillion on health care, more
than twice what the nation spent on food, and more than China’s citizens
consumed on all goods and services. With growth in healthcare costs con-
tinually exceeding growth of the gross domestic product (GDP), it begs the
question: are we receiving commensurate value for the money that is spent?
The McKinsey Global Institute published an updated report in December
2008 addressing this question by comparing healthcare costs in the United
States to some of our peer members of the Organisation for Economic Co-
operation and Development (OECD), a multinational association with one
of the world’s largest and most reliable sources of comparable economic
and social data. This paper summarizes some of the main findings in this
published update. By providing a comprehensive analysis of U.S. healthcare
costs and pinpointing where spending is above expected, our objective is to
make a constructive contribution to public debate and decision making on
issues related to the U.S. health system.
Comparison of Healthcare Spending in the
United States and Internationally
To identify the extent of spending above expected, we looked at health-
care spending on a per capita basis as a function of GDP per capita. As
seen in Figure 1-5, wealth is an incredibly powerful predictor of healthcare
spending for most OECD countries. The notable exception is healthcare
spending in the United States, which is far off the expected regression
line.
We then evaluated the gap between “estimated spending according to
wealth” (ESAW) and actual spending for each component of the health sys-
tem. In doing so, we found that the United States spent nearly $643 billion
more than expected in 2006 given U.S. wealth levels. As seen in Figure 1-6,
outpatient care, the largest and fastest-growing cost category, accounts
for $436 billion, or two-thirds of spending above expected. Four other
cost categories—drugs, health administration and insurance, investment
in health, and inpatient care—are responsible for $279 billion in spending
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THE HEALTHCARE IMPERATIVE
Per capita healthcare spending , 20 06
$ at PPP
8,000
20 06 R 2 = 0.88
7,000
United
States Spending
6,00 0 above
ESAW
5,00 0
Switzerland
4,00 0 Austria
France Iceland
Canada
Germany
3,000 Denmark
Portugal
Spain Finland
2,000
South
Poland Czech
Korea
1,000 Republic
0
10,0 00 15,000 20,000 25,00 0 30,000 35,000 40,0 00 45,000 50,000
Per capita GDP
$
FIGURE g power herity.
* Purchasin 1-5 Tpa U.S. spending on health care compared to other countries, ad-
justed for relative wealth.
** Estimated Spending Ac cording to Wealth.
NOTE: ESAW = estimated spending according to wealth; PPP = purchasing power
parity.
SOURCE: Reprinted with permission from the McKinsey Global Institute.
Figure 1-5.eps
$ billion, 20 06
2,053 850
Above ESAW
Below ESAW
43 6
1,410
458
252
40
14 5
98
91 53
64 3 24
178 14 4
19
50
Total Outpatient Inpatient Drug s and Health Long -term Durables Investment
healthcare care* care nondurables administration and home in health
spending and insurance care
* Outpatient care includes physician and dentist of fices, same -day visits to hospitals including Emergency
FIGURE rtments (pending gapsurger y (ASC) and diU.S. and other ers (DIC), acountries. -day care
Depa 1-6 S ED), ambulatory between the agnostic imagin g cent OECD nd other same
facilities.
NOTE: ESAW = estimated spending according to wealth.
*Outpatient care includes physician and dentist offices, same-day visits to hospi-
tals including emergency departments, ambulatory surgery and diagnostic imaging
centers, and other same-day care facilities.
SOURCE: Reprinted with permission from1-6.eps
Figure the McKinsey Global Institute.
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THE HEALTHCARE IMPERATIVE
above expected. In the remaining two categories of long-term and home
care, and durable medical equipment, U.S. spending was $72 billion less
than expected.
Outpatient Care Cost Drivers
Outpatient care, which includes same-day hospital and physician office
visits, was by far the largest and fastest-growing part of the U.S. healthcare
system. Part of this growth has been driven by a structural shift in care de-
livery away from inpatient settings to outpatient settings—the United States
now delivers 65 percent of care in an outpatient setting versus an OECD
average of 52 percent. Theoretically this shift might save costs, because sup-
porting fixed costs tend to be lower for outpatient care than when patients
stay overnight in a hospital. Indeed, we estimated that the United States
saves $100 billion to $120 billion a year on inpatient costs from shorter
lengths of stay and fewer admissions. However, these savings only partly
defray the $436 billion in outpatient care costs above expected, suggest-
ing that this structural shift has increased—not decreased—total costs as a
consequence of increases in consumption of healthcare services.
What underlies higher outpatient care costs and use? We identified five
drivers, including (1) the highly profitable nature of outpatient care; (2) the
judgment-based nature of physician care coupled with the fee-for-service
nature of reimbursement; (3) unit price growth linked to technological in-
novation; (4) demand growth linked to greater availability of supply; and
(5) relatively price-insensitive patients with limited out-of-pocket costs.
Inpatient Care Cost Drivers
As noted above, there has been a structural shift in the United States
away from inpatient care, and so the above-expected spending in this
category was relatively modest. The United States has shorter lengths of
stay and fewer admissions than many of its OECD peers. However, the
United States paid far more for each patient bed day than peer countries.
Higher costs per patient bed day were driven by lower patient-to-nurse
ratios, higher nursing salaries, higher supply costs, and higher hospital
fixed costs.
Of note, the United States also performed more surgical procedures
than OECD peer countries at 90 procedures per 1,000 population versus an
OECD average of 71. Higher volumes for four procedures—percutaneous
coronary intervention, coronary bypass, cardiac catheterization, and knee
replacement—alone accounted for an estimated $21 billion in additional
inpatient care costs.
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9
THE HEALTHCARE IMPERATIVE
Prescription Drug Cost Drivers
Higher U.S. drug spending was a result of lower usage rates coupled
with higher prices and a more expensive drug mix. On a standard unit
basis, the United States used 10 percent fewer drugs per capita than OECD
peers. For equivalent drugs, prices were on average 50 percent higher in
the United States than those in other OECD countries. Drug type matters
in this analysis: the United States spent 77 percent more for branded drugs,
35 percent more for biologics, and 11 percent less for generics than peer
countries. Maybe most important, however, is the mix of drugs used by
Americans. When we factor in the effect of drug mix, the United States
spent over 118 percent more for an “average” pill than peer OECD coun-
tries despite the fact that the United States used more generics.
Health Administration and Insurance Cost Drivers
Breaking down sources of above-expected spending, we found that
$63 billion was attributable to private payers: $30 billion in the form of
profits and tax, and $33 billion in selling, general, and administrative ex-
penses. Public administration expenses for Medicare, Medicaid, and other
programs accounted for the remaining $28 billion in U.S. spending above
expected.
These higher costs were partly attributable to the diversity and number
of payers as well as the multistate regulation of the U.S. healthcare system.
Its structure creates additional costs and inefficiencies: redundant market-
ing, underwriting, claims processing, and management overhead. In other
OECD countries, which have less-fragmented payment systems, these costs
are much lower. Interestingly, we found that given the structure of the U.S.
system, its administrative costs were actually $19 billion less than expected,
suggesting that payers have had some success in restraining costs.
Exploration of Alternative Cost Drivers
Among alternative explanations for higher healthcare costs in the
United States, two bear further investigation: (1) Americans are sicker than
people in other OECD countries, and (2) Americans obtain more value
from the health system.
In exploring the hypothesis that Americans are sicker than people in
other OECD countries, we did not find this to be true. As demonstrated
in Figure 1-7, the United States had lower prevalence along most of the
health conditions listed. There were notable exceptions, such as diabetes
and cancer, but generally the United States was in fact healthier than its
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0 THE HEALTHCARE IMPERATIVE
US health care expenditures Disease prevalence : United
by diseas e condition* States vs. p eer countries* *
$ billion US prevalence = peer counties at 10 0
Hear t conditions 76.5 95
Trauma-related
10 6
72.5
disorder s
Lower
10 5
Cancer 69.7
relative diseas e
prevalence in the United
Mental disorder s 56.0 98
States represents an
67
COPD***, asthma 53.8 estimated $ 57 billion to
$ 70 billion in medical
77
Hypertension 42.3 cost savings
Diabetes mellitus 34.3 122
Osteoarthritis /
86
34.2
other joint disorder s
91
Back problems 32.5
Higher US prevalence
Other 28 8.5 97 Lower US prevalence
* Include s 3 5 of 6 0 medical conditions surveyed by US Medical Expenditure Panel Survey; the costs of these
FIGURE 1-7 U.S.35 percent of tprevalencexpcompared to peer countries.
diseases represent disease otal US health e enditures.
a Includes tries are FrancemedicalItaly, Spain, and thesurveyed by the U.S. Medical Expenditure
35 or 60 , Germany, conditions United Kingdom.
** Peer coun
*** Chronic O bstructive Pulmonar y Disease.
Panel Survey; the costs of these diseases represent 35 percent of total U.S. health
expenditures.
b Peer countries are France, Germany, Italy, Spain, and the United Kingdom.
Figure 1-7.eps
c Chronic obstructive pulmonary disease.
SOURCE: Reprinted with permission from the McKinsey Global Institute.
OECD peers. This counterintuitive finding could be explained by the fact
that (1) disease prevalence, particularly that of chronic disease, is growing
globally and not just in the United States; (2) the younger U.S. population
offset relatively higher prevalence of certain conditions in at-risk popula-
tions (such as heart disease for the over-30 population); and (3) Americans
smoke far less than OECD peers and, as a consequence, have lower health-
care costs for related conditions.
On the question of whether Americans obtain more value from the
health system, the evidence was mixed. Parts of the U.S. healthcare system,
such as its best hospitals, are clearly world-class. Cutting-edge drugs and
treatments are available earlier and waiting times to see a physician tend
to be lower. Yet the United States lags behind other OECD countries on
outcome measures including life expectancy and infant mortality. Further-
more, access to health care is unequal; more than 45 million Americans
are uninsured.
Framework for Reform Options
The drivers of high and rising costs are widespread within the U.S.
healthcare system, and if they are not addressed in broad terms, healthcare
spending growth is likely to continue unabated. Indeed, the Department
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THE HEALTHCARE IMPERATIVE
Design Levers
Actively manage
1 Prevent illness and injury
demand for health
What levers must care products and 2 Ensure value -conscious consumption
a health care services
system leader or
interm ediary follow
6 Promote sustainabl e financing
to promote equity,
mechanisms to collect and distribute
quality, cost
funds
ef fectiveness, and
service sustainably?
3 Promote ef ficient creation of capacity for
Ensure that the
labor, infrastructure, and innovation
supply of health
care matches the
Promote improvements to safeguarding
4
quantit y, price, and
and to service levels
quality demanded by
the market 5 Promote improvements to cost
competitiveness
7 Provide adequate organizational framewor k
and deploy adequate approaches to allow
the implementation of strategy levers
FIGURE 1-8 Framework for health reform.
SOURCE: Reprinted with permission from the McKinsey Global Institute.
Figure 1-8.eps
of Health and Human Services projects that health spending will reach
$4.3 trillion within the next 10 years.
As U.S. policy makers look at options for healthcare reform, they must
consider action that addresses both supply and demand, focuses on the
financing of health care, and ensures that any reform takes place within
an effective organizational framework for implementation to be effective
(Figure 1-8). And if the healthcare cost trajectory is going to bend, a focus
on outpatient care spending is essential to that effort.
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