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PAYING FOR PHYSICIAN SERVICES IN CANADA: THE INSTITUTIONAL, HISTORICAL AND POLICY CONTEXTS Part 1 of Incentive Effects of Physician Remuneration Schemes J.C. Herbert Emery1 , Chris Auld1,2 , Mingshan Lu1,2

Working Paper 99-6

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Department of Economics, University of Calgary, Calgary, Alberta, Canada

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Institute of Health Economics, Edmonton, Alberta, Canada

Legal Deposit 1999 National Library Canada ISSN 1481-3823

ACKNOWLEDGEMENTS We thank Cam Donaldson and David Feeny for comments.

Institute of Health Economics Working Paper 99-6

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TABLE OF CONTENTS INTRODUCTION .....................................................................................................................1 1. PHYSICIAN COMPENSATION ARRANGEMENTS IN CANADA ...............................2 2. WHY DO WE HAVE FSS PAYMENT IN THE FIRST PLACE? .....................................6 3. PROBLEMS WITH FSS ....................................................................................................12 3.1 FFS Payment and the Problem of SID..................................................................12 3.2 FFS Payment and Cost Containment ....................................................................16 4. THE CAPITATION ALTERNATIVE TO FFS.................................................................21 5. CONCLUSIONS ................................................................................................................24 REFERENCES ........................................................................................................................26


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INTRODUCTION Over the last 20 years, expenditures on physician services in Canada have accounted for around 15 percent of annual total health care costs (Barer et al. 1988, Deber et al. 1998). Not only are physician incomes a significant portion of total health care costs, physicians also directly influence the use of hospitals and other health care services. In this context, how we pay physicians affects how much we pay for physicians' services, how health care resources are allocated within the health care sector, and how much of society's resources go to the health care sector. Since the introduction of the public medical care system in Canada, the majority of physicians in Canada have been compensated according to fees for services provided. "Fee- forservice" (FFS) payment arrangements are not positively regarded outside of physicians in Canada. For example, Taylor (1990, 205) argues that "The Canadian public medical care system adopted the patterns of medical services delivery pioneered by the prepayment plans that the medical profession sponsored -- mainly solo practice and fee- for-service payments. It is a wasteful and unnecessarily expensive system, with built- in incentives for over-servicing and unnecessary surgery and hospitalization." Birch, Goldsmith and Makela (1994) go so far as to suggest that FFS is "widely recognized" as an open-ended system that sends the wrong signals to doctors by rewarding them for performing more services regardless of how much benefit the services benefit patients' health. Because FFS payment arrangements encourage higher levels of health services utilization, it would appear that too much of society's resources go to health care when physicians are paid according to FFS. In addition, because FFS influences the type and mix of health services provided, resources are not used in a socially optimal way once they are in the health care sector. Thus, alternative payment mechanisms for physicians, such as salary or capitation payment arrangements, promise greater control over the levels of expenditure on compensating physicians and on health care generally; more efficient uses of health care facilities, and physician selection of treatment methods which serve patients independent of a physician's income. Governments have not ignored the potential benefits of changing how physicians are paid. Hutchison, Birch


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and Gillett (1996, 7) report that "recent government task forces, reports and commissions have been virtually unanimous in recommending alternatives to fee- for-service physician payment." Given the interest and arguments in favor of changing how physicians are paid, we survey the literature on physician compensation in Canada to assess the desirability and feasibility of changing physician payment arrangements. We establish several points of information along the way. First, we describe the institutional details concerning physician compensation in Canada so that we can assess the releva nce (for Canadian policy) of incentive effects of alternative payment mechanisms identified in the scholarly literature. Second, we examine why FFS payment arrangements were adopted in Canada in the first place. One purpose of this exercise is to establish the political, and practical, feasibility of changing the payment arrangements. In other words, we need to know if we can change the payment arrangement, or whether we are limited to improving the existing arrangement. Third, we discuss the focus on the difficulties of containing health care costs under FFS remuneration that dominates the scholarly and policy work of the Canadian health economics community. We wish to highlight the extent to which this focus has motivated a desire to change the arrange ments by which physicians are paid. Fourth, we examine the popular choice of payment arrangement to replace FFS, a blended capitation-FFS system. Finally, we present conclusions and comments.

1. PHYSICIAN COMPENSATION ARRANGEMENTS IN CANADA Deber et al. (1998) report that 67.7 percent of Canadian physicians bill fee for service for over 90 percent of their practice. According to a 1990 Canadian Medical Association questionnaire, 84 percent of Canadian physicians are paid by FFS. 16 percent of physicia ns are paid a salary. This latter group consists of physicians paid directly by the provinces to work in under-serviced areas, those working in special arrangements in groups or clinics, administrators, researchers and teachers. 40 percent of Canadian physicians are in solo practices. 30 percent work in groups of six or more or in a hospital or clinic (Ferrall et al. 1998, 8). Recently, some "payment experiments" have been established in Ontario and Alberta where physicians forego FFS payment in return for capitation based payments. These experiments have involved small numbers of doctors (compared to the total supply) and it is not clear that they have been "successful" (See Section 4).


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The fees that Canadian doctors can charge are set by negotiation between provincial medical associations and the provincial government. Prior to 1992, the focus of negotiations was the overall percentage increase to the existing schedule. Since 1992, the focus has shifted to negotiating the size of the total budget for paying for physician services. The allocation of incomes amongst general practitioners and among the various specialties is the prerogative of the medical association's tariff committee. Each province's negotiated fee schedule is binding on all physicians, and since the 1984 Canada Health Act physicians cannot bill their patients above these rates. Physicians are free, however, to bill patients directly for noninsured services (Deber et al. 1998, 477). In contrast to Canada with its binding fee schedules, the US has a system of independent physician fee-setting and direct charges to patients over and above the negotiated fee schedule (Evans 1983, 5). At the risk of over-simplification, provincial governments have the power to influence the average level of physician fees, but they have little influence on the determination of relative fees other than when some fee schedule items appear to be "out of line." The relative prices of medical services are set internally by the medical associations. The medical association tariff committees consist of General Practitioners (GPs) and representatives of the various medical specialties. As the relative fee schedule is the outcome of deliberations within the tariff committee it reflects factors such as the "relative costs" of treatments, history and the strength of internal influence of various groups within the association (Lomas et al. 1992). Evans (1983) points out that Canadian fee-schedules provide little differentiation among types of office visits particularly with regard to the length of visit or the content of the visit. Long and detailed examinations generate the same fee as a short and superficial examination, hence there is an incentive to provide quick and frequent office visits. At the same time, verifying the nature of an examination as detailed versus not-detailed is generally not feasible. If distinctions between services are imprecise, "fee-schedule creep", where physicians reclassify a visit or a procedure into a higher-paying class of treatment, would be a problem. Reducing the numbers of billing classes is one way to control "billing-creep". Prior to the Canada Health Act of 1984 physicians were allowed to "extra-bill" or "balancebill". This meant that the government paid the fee for the service as established in the negotiated


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fee schedule, but the physician reserved the right to charge a given patient extra. With the 1984 Canada Health Act there is an automatic requirement of "dollar for dollar reductions in federal cash contributions for extra-billing or user charges" hence the provinces have a strong incentive to enforce the requirement that doctors do not extra-bill. Only a small percentage of physicians took advantage of the right to extra-bill prior to the elimination of that privilege. This was true even before government health insurance was introduced in the 1950s and 1960s. Fee schedules at that time dictated how much pre-paid health insurance plans would pay physicians and they were interpreted as minimum tariffs for services provided. The majority of physicians in Canada accepted the minimum tariff as full payment for the service (Naylor 1986). Heiber and Deber (1987) point out, however, that while the proportion of doctors who did extra bill was small, it tended to increase as physicians perceived the adequacy of the levels of their fees to be declining. This feature of extra-billing has led to a characterization of extra-billing as a "safety-valve" for physicians to protect their incomes and professional autonomy (Barer et al. 1988). Another interpretation would be that extra-billing, by putting costs directly on patients, would pressure the government into negotiating, and pressure them during fee negotiations (Hieber and Deber 1987). Extra-billing was eliminated across Canada by the late 1980s, but with considerable conflict. In many provinces, the government eliminated extra-billing but in return agreed to participate in binding arbitration for fee schedule negotiations. In Ontario, the notorious doctor's strike of 1987 resulted when the provincial government banned extra-billing but did not offer anything like binding arbitration for fee disputes in return (Heiber and Deber 1987). In Canada, fees are paid only for services of practitioners, not their employees (Evans 1983). As such, compensation for employees of physicians amounts to overhead costs for the independent FFS practitioner. This is one of the contributing factors to the tension between physicians and health policy makers over the adequacy of fees. Health policy makers, and researchers, tend to equate any increase in average physician fees with an increase in average physician incomes. Physicians contend that while it could explain increases in average revenues, the increases in overhead costs, which must be covered out of their fees, have been larger than the increases in fees.


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Evans (1983) highlights another important constraint on physician income opportunities in Canada. In Canada, laboratory and diagnostic services are centralized within hospitals or government approved private laboratories. Physicians in Canada do not have the opportunity, or incentive, to prescribe such services to supplement income. In contrast, American physicians supplement their incomes with private labs or radiology facilities which gives them an incentive to prescribe diagnostic procedures. An important theme in the evolution of physician compensation systems in Canada has been the elimination of its "open-ended" cost character. Essentially, from the 1960s until the early 1980s, provincial governments had little influence on total expenditures on physician services beyond the negotiation of increases of the average fee levels. With increasing levels of health care utilization, a lack of direct control over the supply of physicians, and overall fiscal tightness, provincial governments have moved from focussing on controlling fees to controlling the incomes of physicians, to imposing global budget caps to limit total expenditures on physician services (Lomas et al. 1992). Deber et al. (1998, 493-494) describe the change in general terms as follows: Throughout most of the 1980s, all provinces but Quebec financed medical care on an open-ended basis. Since then, caps on earnings have been negotiated by some provinces for physicians individually, or for all billing physicians collectively, or both. For example, Ontario and British Columbia have introduced caps and clawbacks on physicians earning above a certain income per year. Other provinces have introduced caps on the global budget available for physician services. If aggregate billings exceed this amount, all physicians contribute to a repayment of the amount exceeding the cap. In more detail, Lomas et al. (1989) describe how in Canada there have been two approaches used to attempt to control the increases in health care costs associated with increases in health care utilization. The first, the threshold approach, sets the threshold level utilization at either the previous year's volume adjusted for factors such as population increase, growth in physician supply, natural disasters, new insured services or technologies or public health epidemics. Threshold levels for the volume of service can be set prospectively (set before the start of the


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new fiscal year), or retrospectively (after the actual level of utilization is known). In either case, allowable increases in threshold level of services for which the government will pay are negotiated between the government and physicians. Provincial governments have different ways to recoup expenditures on "excess utilization". In Ontario and Manitoba, next year's fee increase is adjusted downward. In British Columbia the profession works at temporarily reduced fees. The second approach, the capping approach, has only been implemented in Quebec. This approach establishes individual income ceilings for GPs and separate caps for overall expenditures on services provided by specialists and GPs. Once a GP reaches his/her income ceiling, his/her fees are discounted substantially. Lomas et al. argue that the more interventionist capping approach is only possible in Quebec because of the province's political culture and linguistic barriers which prevent professionals from seeking careers outside of the province. So while physicians still operate on a FFS basis, provincial governments in Canada have placed limits on how high aggregate billings can go. In the past, physicians dissatisfied with their incomes due to what they perceived as too low a fee for their service, could work more hours, or bill more aggressively for services provided. Physicians in Canada today will find these strategies at best can maintain their income given the fixed total budget and an increasing supply of physicians. The immediate impact has been to pass the cost burden of increased demand for health services, increased physician supply and "billing-creep" away from the taxpayers and onto the physicians themselves. In this sense, the search for a "solution" (although its not clear one is needed) to rising physician supply and total expenditures on physicians has been handed over to physicians.

2. WHY DO WE HAVE FSS PAYMENT IN THE FIRST PLACE? As we discuss below, FFS payment arrangements are perceived to be far from the socially efficient payment arrangement. Interestingly, despite the perceived problems with FFS payment, little attention is paid to why we have FFS in the first place, beyond pointing out that it was a continuation of the FFS remuneration arrangements that were in place prior to the introduction of government health insurance in the 1960s. For example, Deber et al. (1998, 459) argue that:


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(M)edicare institutionalized the prevailing FFS payment system for physicians, retained professional fee schedules negotiated under the private plans, and did little to threaten the continuity of physician control over the content and conditions of medical work, including the work of other health professions. Despite the recognition of the potentially negative consequences of FFS payment mechanisms, there is little concern over why FFS was the mechanism adopted. Why we have FFS in the first place may be one of the most important questions to answer if we are seeking to reform the systems by which physicians are paid in Canada. In turn, this involves asking why physicians prefer the FFS arrangement in the first place and why they are unwilling to abandon it. It is to these tasks that we now turn. The reasons physicians prefer FFS payment over capitation and salary payment include the desire to engage in price discrimination (charging fees according to a patient's income or ability to pay); to retain professional autonomy; to protect themselves from the income controls of government single payer medicine, and to avoid bearing the cost burden of the increase in health utilization that would accompany the introduction of universal government health insurance coverage. Physician preferences have not arisen out of thin air. They are the products of historical experience with salary and capitation arrangements. Historically, capitation payment schemes were prevalent in the medical services market place. Prior to 1920, a major source of pre-paid medical coverage in England and North America was through membership in a fraternal organization. This was a period of consumer control over the medical market place and the payment arrangements for physicians reflected this. Rather than paying physicians on an individual FFS basis, fraternal lodge memberships hired physicians either on an annual retainer, or on a capitation basis, where the practitioner received a set amount per patient regardless of the volume of services provided (Naylor 1986, 14). This capitation based lodge practice arrangement co-existed with other physicians operating independently on a FFS basis. Physicians viewed lodge practice as one way to build up the client list for their FFS practice. Physicians' work conditions and professional autonomy were fundamentally different under capitation and FFS payment arrangements. Naylor argues that in capitation based "lodge


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practice" the economic leverage of the physician was curtailed resulting in heavy work loads and low pay: Capitation fees were generally low and the volume of work high. So longs as GPs underbid one another in an effort to win the yearly contract to attend a given consumer organization, there was little chance of getting capitation fees up. Moreover the complaint was made that some patients tended to call the doctor in for no good reason, and the doctor in turn was unable to refuse a call for fear that a disgruntled patient would agitate against renewal of his contract with the organization at the year's end. (Naylor, 27) As Naylor points out, this consumer control of doctors and the threat of loss of an entire practice, created much greater risk for physician incomes. The doctor in private-fee practice with a clientele of individuals would, or course, have a financial interest in maintaining and building his practice, but he could afford to lose the occasional client who was excessively demanding or unpleasant. In "lodge" or "club" practice, one disagreeable patient could agitate against renewal of the doctor's contract with the entire fraternal organization. (Page 15) These problems with non-FFS payment arrangements from the physician's perspective were not restricted to this earlier period. Following World War I, Saskatchewan, and to a lesser extent Manitoba and Alberta, started to employ doctors under salaried contracts by municipality. By 1930, Saskatchewan had 32 "municipal doctors" (Naylor 1986, 50). Several of these physicians when surveyed in 1928: …complained of mediocre salaries, too many unnecessary calls, and a perception that they were tied into being available to the public at all times. When a private practitioner turned down a suggestion that an out-of-hours call be made, both doctor and patient knew that the practitioner was foregoing fee income. The municipal doctor, in contrast, would simply seem to be shirking duties that had already been paid for by local taxpayers. (Naylor 1986, 51)


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Naylor's view of the fundamental tension with the rural doctors was one of market power. The salaried rural doctor was not an independent, fee-earning service-seller dealing with an individualized clientele. A rural doctor practicing under FFS payments was accountable only to individual patients, who, if dissatisfied with their treatment, could not easily find another doctor locally. As Naylor concludes, the Municipal doctor scheme undercut the doctor's position as a self-employed monopoly seller of an essential service, substituting a local near-monopsony situation wherein the doctor was subject to dismissal by municipal councilors. The experience of physicians with lodge practice, and later with salaried municipal doctors on the prairies, bolstered physician preference for FFS payment arrangements. Rosen (1977) goes as far as to suggest that it was the hatred of the lodge practice arrangement which led physicians to reject any remuneration arrangement other than FFS. FFS payment arrangements allowed physicians to engage in price discrimination which is method by which they could maximize their income (profits) (Kessel 1958, Naylor 1986). Essentially physicians could assess a patient's ability to pay, and scale fees accordingly. So physicians may not charge lower income patients at all, but charge very high fees to wealthier clients. Price discriminating doctors do not price this way out of compassion for the poor, but instead because they are profit maximizers (Brown and Lapan 1979). Physicians often expressed support for capitation payment arrangements for lower income clients so that they could secure some payment for services for which they would otherwise have received no payment at all. Service with no payment often represented a significant portion of a physician's efforts. For example, Andrews (1978-79) shows that the proportion of medical visits for which a physician was paid could regularly be below 50 percent. In 1929 in British Columbia, one estimate has 29 per cent of all medical patients as non-paying. By the early 1930s, the majority of patients were non-paying (Naylor 1986). Thus, what little enthusiasm physicians did have for government reimbursed health care was primarily for governments to take responsibility for paying for services provided to low-income patients. The main contention was that higher income clients should be ineligible for capitation based health insurance coverage and hence would be left to physicians to charge on a FFS basis. This was true in both


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fraternal lodge practice settings (Riley 1997, Green and Cromwell 1984), and in the design of government health insurance in Canada (Irving 1988). A desire to price discriminate is not a complete explanation for physicians' rigid views on FFS versus capitation remuneration. In 1935, the British Columbia Health Act would have left higher income patients outside the government health plan, hence physicians would have continued to bill these patients privately on a FFS basis as they had always done. The lower income patients would have had uniformly provided government health insurance that would remunerate doctors on a capitation basis. Physicians seemed to have the best of both worlds since they still had FFS for their best paying clients, and the government would pay them for service provided to lower income patients for which in the past they would often have received no payment. The B.C. physicians felt strongly, however, that only FFS remuneration was acceptable to them. Harry Morris Cassidy, the economist in charge of setting up the health insurance plan attributed the main opposition of the doctors, "particularly the younger ones, to the fact that health insurance threatened their òpportunity to make a killing'" (Irving 1988, 74). The British Columbia College of physicians provided a different explanation for their opposition to capitation based payment. The College recognized that the government health insurance program would lead to increased demands on doctors as more services would be demanded with the expansion of health insurance coverage. The experience with capitation and lodge practice arrangements convinced physicians that FFS had an important advantage: …only under a FFS system would incomes rise in lockstep with the greater volume of services provided. This coupling of every item of service with a given payment sustained the doctors's self-image as a small businessman and also meant that the more enterprising practitioners could increase their incomes by altering the volume and mix of services provided. (Naylor 1986, 87) With FFS, the patient and/or taxpayer bear the cost risks associated with unforeseen increases in the demand for medical services. If a physician had the misfortune of taking on a particularly unhealthy patient, FFS put the burden of ill health onto the patient who must pay for all the treatments. Under capitation pre-payment arrangements, the physician bears the cost burden having to provide all the required services for a pre-paid flat fee. FFS was not necessarily a


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disadvantage for patients. A healthy patient may actually benefit under the FFS as compared to capitation. Further, with FFS, the physician had the discretion to spare the unfortunate patient if they truly could not pay. The difference between who bears the cost risks between FFS and capitation payment arrangements was important for understanding why B.C. physicians refused to participate in the government's health insurance program in the 1930s. According to the scheduled capitation payments for registered British Columbians in 1935, physicians would have had higher average incomes under the government capitation scheme than under the status quo of non- government insurance FFS medical markets. Physicians rejected the higher income under capitation payment because it came with more risk. This suggests that if additional compensation for physicians for assuming the additional income risk is required, then the cost of a capitation remuneration system may be considerably higher than a comparable FFS remuneration system. Without physician participation, you cannot have a government single payer health care system. In 1937, the Canadian Medical Association Committee on Economics issued two statements asserting the profession's economic autonomy: (a) That the Schedule of Fees in any Health Insurance Scheme shall be the Schedule of Fees accepted by the organized profession in the province concerned. (b) That all Schedule of Fees be under complete control of the organized medical profession in each province. (Naylor 1986, 92) By 1955, the CMA's position had hardened even further and the willingness to consider alternative payment modes had disappeared. Naylor (1986) concludes that by 1955 it was clear that state medical care would not be organized with capitation based payment for GPs. Government health insurance in Canada would only come to be if it included FFS remuneration.


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3. PROBLEMS WITH FFS Changing the way in which physicians are paid, such as by replacing FFS payment with capitation or salary payment methods, has been a popular focus for health policy researchers and governments in Canada. Labelle et al. (1994) argue that this policy prescription has followed from cost containment in the health care sector being a major, if not the primary, policy objective for not only provincial governments but governments in most developed countries. FFS payment in this policy setting becomes a target for reform since it embodies incentives for physicians to exploit their information advantage over what services patients need in order to shift the demand curve for their services outwards. This phenomenon where physicians can generate additional demand to maintain their incomes is known as Supplier-Induced-Demand (SID). Beyond addressing government fiscal objectives, in reducing the levels of (or at least reducing the growth rate of) ineffective health interventions, cost containment strategies have been viewed as complementary for achieving other health policy targets such as cost-effectiveness of health interventions and ultimately allocative efficiency within the health care sector. Cost containment strategies like global expenditure caps are thought to be "blunt instruments" for dealing with inefficient allocations of health care resources since they are unresponsive to clinical needs (Deber et al. 1998). Labelle et al. point out that where FFS payment allows for SID that results in treatments of patients which only serve the physician's income level, reforming the system by which physicians are paid is the preferred policy prescription. The extent to which cost containment strategies, and ultimately eliminating FFS payment for physician services, can improve allocative efficiency of health care resources hinges on the extent to which SID is a problem under FFS. It is this latter issue that remains unresolved in the health economics literature. Labelle et al. summarize the view that what a researcher finds concerning the existence, and extent, of SID often reflects the researcher's ideology rather than a body of empirical or theoretical evidence.

3.1 FFS Payment and the Problem of SID Physicians have an information advantage over patients as to what are required treatments. With FFS reimbursement, they can use this informational advantage to induce demand for their


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services, hence the label for this source of increased demand for health services -- "Supplier Induced Demand" (SID). Evans (1983, 15) puts this in the following way: If utilization drops, so do physician workloads and, in a FFS system, incomes. Their response will be to recommend more care for each illness episode, and over the longer run, to educate patients to be more sensitive to systems in initiating care. The 'demand for care' is shifted up at any given out-of -pocket price, a process currently being observed in the U.S. as the physician/population ratio and medical prices are both increasing rapidly. It [This effect] shows up in the U.S. as increased service rates per visit or per hospital day, and in Canada as increased visits and procedures per capita… SID is not just increases in services provided to patients at the doctor's discretion. A more precise definition of SID is the amount of demand, induced by doctors, which exists beyond what would have occurred in a market in which consumers are fully informed (Donaldson and Gerard 1993). Similarly, Pauly (1994, 370) states his favored definition of inducement as one where there are "alterations in the quantity and quality of services consumers demand as physicians change the accuracy of the information provided in response to economic incentives." Thus, a necessary condition for SID is that patients are not knowledgeable about what treatments are necessary and which treatments are unnecessary other than for the doctor's income. Labelle et al. (1994) seek to broaden definitions of SID like that of Donaldson and Gerard (1993) to incorporate the impact of SID on the health status of the population. In particular Labelle et al. argue that as an agent of the patient, the physician has a responsibility to induce services that will improve a patient's health (Positive SID). The main problem from a social perspective is that physicians can also induce services that are useless for improving a patient's health, or worse which worsen a patient's health (Negative SID). The existence and extent of negative SID have obvious implications for the remuneration of physicians. At a minimum it suggests that governments have a strong incentive to intervene in fee-setting or to attempt to move to a different payment arrangement for physicians altogether. No consensus exists, however, over whether SID exists, or if it exists, how extensive it might be (Labelle et al. 1994).


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Mooney (1994) feels that we can never truly measure the extent of SID since we can never observe the demands of fully informed consumers. Donaldson and Gerard (1993, 104) conclude that it is hard to assess how much "over-utilization" exists since "so little is known about what represents best medical practice in the sense of being either effective or efficient". In addition, they also point out that any increases in health care utilization that SID could explain, could also be explained by "straightforward market forces". Donaldson's and Gerard's conclusion is illustrated by the literature on area (or geographic) variation (AV) in health care use that is thought to provide evidence for the existence of SID. Coyte (1994, 275) summarizes the intuition that AVs can in part be explained by the number of doctors per capita. High utilization can be expected in locations where many doctors compete for patients and use their information advantage over knowing what the appropriate procedures and quantity of procedures are to get "borderline" patients to receive certain interventions. As it is often found that the health status of populations in high utilization rates of health services is no different from that of populations with low health care utilization rates, this suggests that health care utilization in the high utilization area can be reduced without harming the population. Coyte's view is that calculated attempts to manipulate information for self- gain do not account for much of the AV in health care use. Instead, honest differences in beliefs, attitudes and opinions of clinicians appear to be the more important determinants of observed variations in health service use. Effectively, the absence of "gold standard" as to the choice of best practice makes it impossible, empirically, to distinguish between SID and difference in clinician opinion. While the potential for SID exists under FFS, professional ethics of physicians, politics and socialization of physicians clearly are other important determinants of physician behaviours (Woodward and Warren-Boulton 1984). Evans (1983, 33) recognizes such forces on physician behaviour, but points out that they do not eliminate the problem of SID or other problems of FFS: …, one is relying on the professional ethics of the provider to discourage inappropriate care. Such ethics can in fact sustain a substantial burden of conflict with economic self-interest; otherwise FFS medicine would have


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collapsed long ago. But the severity of the conflict can be substantially moderated or exacerbated by the structure of the funding process. The work of Wilson et al. (1986) provides some support for the idea that physician ethics may be an important constraint on SID. They could not identify any significant abuses of the FFS payment system in British Columbia beyond one or two high profile examples. While these authors conclude that physician self-regulation has been ineffective in the identification of the extent of abuse that they believe exists, it is possible that physicians have not systematically abused the system. On the surface, the existence of SID may suggest that health care costs are not minimized under FFS payment mechanisms. But there is also evidence that physicians have not billed for all they were entitled to suggesting that health care costs were artificially low. For example, Physicians often renewed prescriptions ove r the phone, a service for which they could not bill. In a study of how physicians practicing in the Hamilton Ontario area billed for "standardized patients", Woodward et al. (1997) found that 17 of 59 physicians in the study did not bill anything for at least one of the four patients. Similarly Hurley et al. (1996) suggest that Alberta physicians consciously restrained billings when health care budgets were cut in the early 1990s. In this environment, to protest inadequate fee schedules, or global budgets, physicians could be "working to rule" and billing for all they are entitled to. Thus, it is an absence of labour peace between physicians and government leads to a more expensive health care system with FFS payment as opposed to unprovoked SID. Hurley and Labelle (1995, 420) provide one of the better summaries of the state of our knowledge about the existence and extent of SID: It appears that in response to economic considerations, physicians can induce demand for their services, they sometimes do induce demand, but that such responses are neither automatic nor unconstrained. Further, physicians do not always respond in ways that can be predicted. The key question is whether this enough to justify a radical departure from FFS payment for physician services?


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3.2 FFS Payment and Cost Containment The fact that FFS allows physicians to offset the effect of fee controls on incomes by increasing the quantity of services provided makes FFS a problem for health policy makers interested in containing health care expenditures. Barer et al. (1988, 16-17) report that from 1971 to 1984 increases in utilization per physician offset the impact of fee controls on health care expenditures. While physicians' fees fell by 18 per cent in real terms (or 1.7 per cent per year) from 1971 to 1984, utilization per physician per year rose at an average rate of 1.4 per cent. Real total billings claimed per physician fell by a total of "only 3.4 per cent over the twelve years." Since 1977/78 by steady increases in billing activity, Canadian physicians managed to maintain growing real incomes in the face of stable real fees. Evans (1983) suggests that physicians have target incomes. As the real value of the fees for their services fall, they maintain their incomes either by billing extra over the prescribed fee schedule, or by encouraging more visits by the patients, or by billing for more major procedures. This phenomenon, known as "cost creep" or "billing creep", can occur in several ways according to Barer et al. (1988, 14). First, new procedures or techniques are introduced at a high fee. As their use becomes more common, and the cost of performing the procedure falls, the fee paid for the service is not adjusted downward. Second, since fee schedules do not distinguish between single and multiple services, comparatively trivial procedures or services when performed in conjunction with related services receive the same fee as any other service. In other words, the physician, not the taxpayer, benefits from economies of scale and/or scope in providing medical treatment. Third, if the reimbursement rate for a service exceeds the cost to the physician in terms of "time and trouble", performance of that service will proliferate. Finally, as mentioned earlier, if the distinctions between services are imprecise, latitude is provided for physicians to "relabel" services to higher fee classifications of services. In Canada it is not only SID and other forms of "billing creep" that are the problems with FFS payment for physicians. There is also the problem with the use of FFS payment arrangements with open-ended physician supply. As Evans (1983) points out, with no extra billing or user fees, and no ability to multiply procedures through task delegation, the scope for over-servicing in Canada is limited since a physician is forced into an income leisure trade-off to


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increase his/her income. In Canada, there is also limited scope for physicians to supplement incomes through diagnostic services since the laboratories and the hospitals providing those services are not controlled by physicians as they are in the U.S. Evans' bottom line is that in Canada the supply of physicians (or number of physicians) has more impact on expenditures. In the longer run, however, servicing volumes rise proportionately with the supply of physicians. More manpower implies more utilization and more expenditure for a given fee-schedule. (p. 12) Canadian health economists believe that in an environment of growing physician supply and FFS reimbursement, controlling the level of fees is paramount to controlling health care utilization expenditures. Evans (1987, 175) argues that "the ever-expanding supply of physicians is creating a proportionate expansion in demand for physician services… either new resources must be added to the system as a whole, or physicians' average incomes must fall." In this setting, FFS is a problem in that increasing the quantity of billings or quantity of services provided limits the government's ability to control health care expenditures. Thus, in Canada, a key focus of policy makers remains the problem of limiting the rise of health care costs through control of physician incomes under FFS payment arrangements. For example, Evans (1983,15): The critical variable in a FFS system is the physician's income, which must fall, on average (for a given stock of physicians), if total expenditures are to be reduced. Threats to income will be resisted; if they take the form of reduced external 'demand', the response will be more internal generation of services. Fee increases, on the other hand, add to incomes without extra servicing, hence the enthusiasm for extra billing. Or from Barer et al. (1988, 2): Since costs of physicians' services are equivalent to incomes of physicians, and a principal objective of fee control is to limit the growth of physician incomes, it would be naïve and foolish to expect their (doctors) representatives to accept the general objective of cost control. Institute of Health Economics Working Paper 99-6

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Canada has fared better than the US in controlling health care costs because of the role of government in Canada as the "single payer" in containing the increase in physician fees. Essentially, the market power of organized medicine in Canada is countervailed by the market power of the government on the demand side of the medical services market. Government negotiation with physicians over the level of fees has contained the increase in expenditures on physician services: In the case of physicians' services, the trends of increase in manpower and utilization are very little different on either side of the border. The major difference, and it has been major, is in the rapid escalation of fees. Since 1970, indices of physicians' fees in Canada have run about 3 per cent per year below corresponding US rates. Thus cost containment in this sector has been entirely a matter of price and income control, and has had no effect on the availability of services to patients. Ùnderfunding' of physicians' services means, not that patients are suffering insufficient care, but that physicians would like to earn more money. Evans (1987, 173) Still, Barer et al. (1988, 44) argue that fee controls alone will at best only be partly successful in controlling costs in an environment of increasing physician supply. Thus, further controls on health care expenditures as the supply of physicians increases under a FFS system have included limits on global expenditure on physician services. This has addressed the physician supply problem in two ways. First the caps passed the problem of expanding services onto the physicians, and second, the expenditure caps have helped "cull the herd" of physicians: Every province in Canada has in recent years been trying not only to hold down physicians' fees but also to cap total payments. Some have tried to discourage new physicians from entering practice. Correspondingly, total payments to physicians have flattened out since 1992 and, as a share of national income, have actually fallen. Medical associations have quickly grasped the economic implications of increased numbers of physicians sharing a fixed budget… Payment policies are clearly designed to limit the growth of service volumes. The recent outflow (of physicians to the US) may well reflect physicians' responses to


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this more hostile economic climate. To react by increasing the number of physicians trained would be, to put it mildly, inconsistent. From the point of view of provincial governments (and medical associations), the outflow is a solution, not a problem. …In Canada, we heard a giant sucking sound to the south; this was not unanticipated. Evans (1998, 758) Not everyone agrees that driving physicians out of Canada is desirable. In particular, Ryten et al. (1998a, 1998b) argue that Canada will face a severe shortage of physicians in the near future unless the exodus of physician manpower is stemmed. Global budget caps may have also created some other problems in the sense that budgets for physician services become a "common property resource" (Hurley and Card 1996). This model has a number of undesirable consequences, including the potential for what is known as the tragedy of the commons, in that providers who voluntarily curb their utilization can nonetheless be penalized if the others do not follow suit. In the absence of mechanisms to discipline all participants, these types of formulae present incentives for everyone to try to increase their own share of a capped pie, leading everyone to be worse off. Such formulae may also accentuate underuse of resources noted in the private clinics case (e.g., waiting lists may grow for eye surgery or hip replacement through the publicly financed system because the surgeon has reached his cap). In contrast to strategies such as moving from FFS to alternative reimbursement methods, such hard caps are blunt instruments, which tend to be unresponsive to clinical need. Deber et al. (1998, 494-494) Deber et al. (1998) argue that these problems created by fixed global budgets make the switch to alternative reimbursement methods from FFS even more desirable. Physicians also point out that global budget caps made them accountable for changes in health care utilization that should be the responsibility of government. Lomas et al. (1989) argue that physicians felt it was not their responsibility to be accountable for increases in use of


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physician services by the population, or the increased productivity of the average physician. Katz et al. (1997, 1424) suggest that physicians now face a zero sum game that has rapidly shifted the locus of economic disputes from government-physician negotiations to intraprofessional negotiations. Ironically, the global budget caps have neatly passed the problem of how to live within the limits directly on to the medical associations. The focus on cost containment seems rooted in the belief that it is possible to have the same quantity, and quality, services provided at a lower cost. One unresolved issue, however, is whether the cost containment policies of provincial governments have reduced costs of providing health while maintaining the quality of care. This issue hinges on whether FFS payment creates a more costly health care system than necessary. As Barer et al. (1988, 14) point out, while Canadian provinces have systems of reimbursement that encourages quick and frequent visits, and penalizes practitioners who choose not to practice this way,…the implications for quality and efficacy of care are, of course, unknown We do know that waiting lists are growing, which could be evidence that quality of care has not remained constant, or it could reflect the increasing scope of medicine to do more. For example, Evans (1987, 173): It is conceivable that cost containment is, in fact, resulting in some Canadian patients being denied potentially effective interventions; it is equally possible there is enough ineffective activity going on, even in the Canadian system, to permit further savings. For that matter, both may be true simultaneously. It would be good to know. The widely quoted evidence from the US Health Maintenance Organizations (HMOs), indicating that changing from FFS to capitated medical practice can lead to reductions in hospital utilization of 20 to 40 per cent with no apparent harm to patients, certainly suggests that cost containment is quite compatible with high quality care. Institute of Health Economics Working Paper 99-6

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The implication that physicians use volume of service to maintain incomes when fee schedules are rigid suggests patients are "over-serviced" and potentially are in receipt of lower quality care. At the same time, Labelle et al. (1994) argue that some of this induced service is potentially beneficial for patients. In this case, controlling the determination of relative fees for treatments, rather than the average level of fees may be preferred. Similarly, Donaldson and Gerard (1993, 114-115) point out: Despite doubts about the adequacy of the data, most evidence tends to support the view that FFS remuneration leads to induced demands for fee-yielding services by patients on the recommendation of their doctors. However, the effects of supplier-induced demand on service use by different groups and on health status are not known. Thus, it does seem that if fees are to be used as part of a remuneration package, tight control of fee schedules is required, that is, fees must be targeted in line with priorities in order to maintain effectiveness at least cost.

4. THE CAPITATION ALTERNATIVE TO FFS Critics of FFS payment for physician services argue that capitation based payment arrangements provide an alternative arrangement which will allow health care dollars to go further, spare physicians from the FFS treadmill which undermines quality of care, and allow for a socially responsive health care sector. In fact, a FFS component would remain in a "blended" capitation/FFS system. Physicians would receive base income from the capitation payments for patients under their care, and receive "bonus" fees for procedures deemed to be of a priority to society. Physicians would not set the health priorities such as identifying cases of particular diseases or programs of health promotion per se, but they would be rewarded for meeting goals which are compatible with policy makers, namely "maximizing the health of the population" (Birch et al. 1994). A capitation based system has several potential advantages. First, it would eliminate physicians providing some treatments for patients only to get income. This could translate into more efficient use of health care resources. Second, as physicians only secure income by maintaining a patient base, competition for patients will ensure that physicians provide quality


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care. The logic follows from the idea that dissatisfied clients exit from the deficient provider to purchases services from the higher quality provider. In this way, competition "disciplines" physicians. Competition for patients is important to offset the incentive to under-service patients that exists with payment arrangements that are independent of the services provided. Third, with capitation payment arrangements health care expenditures for governments are more predictable since the payments to physicians are based on the size and characteristics of the patient population, not the quantity of services provided to the patient population. This "solves" the problem of increasing physician supply for taxpayers since the number of physicians has no impact on total expenditures on physician services. The size and characteristics of the population are outside the control of physicians. As such, increasing physician supply will primarily impact on average physician incomes. Fourth, capitation payment allows greater ability for resources to be allocated on the basis of patient need (reflected in capitation formulas) rather than physician activity. Much of the support for capitation payment arrangements comes from dissatisfaction with FFS rather than the proven effectiveness of capitation payment systems. In Ontario, a capitation payment experiment was started in 1973. By 1991, the Health Services Organization (HSO) program had 88 HSOs with over 500,000 enrolled patients. The program was severely curtailed between 1991 and 1993 since the perception was that the program had failed to achieve its goal of reducing health care costs and had produced only "minimal changes in the organization and delivery of primary health care" (Hutchison et al. 1996a, 5). Under the HSO program, it is not clear whether physician productivity was lower, or whether the HSOs were dominated by lower productivity physicians. In more detail, the HSO program attracted physicians who desired more predictable, if not higher, income than under FFS payment; who were uncomfortable with the "pressure" under FFS to maximize service volume irrespective of patient need or health outcomes, and who desired the ability under capitation to take time off for holidays, further education or to pursue interests in teaching or research without losing income. Practice patterns did not change. For example, there was no increase in prevention activities or initiatives aimed at health promotion. Finally, Hutchison et al (1996b) found no difference in hospital utilization rates when physicians were paid by capitation rather than FFS. They conclude that factors other than the method of physician payment appear to be responsible for variations in hospital utilization among physician practices. Institute of Health Economics Working Paper 99-6

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Newhouse (1992) suggests that a switch to capitation payment from FFS payment could result in a one time reduction in the level of health care utilization, but the switch would have little impact on the growth of health care utilization after that. Newhouse points out that while expenditures on physicians in U.S. HMOs (with non-FFS payment for physicians) are lower than in practices where physicians are paid according to FFS, health care expenditures in both the HMO and FFS settings have grown at the same rate. This suggests that a common factor like technological change is driving the increase in health care costs rather SID under FFS arrangements. The fact that the increases in cost are common to both payment arrangement settings suggests that the adoption of technology is not endogenous to method of payment. More importantly, focussing on how physicians are paid may lead health policy researchers to ignore, or to fail to recognize, more important determinants of the growth in health care utilization. How likely is it that we will see a switch to capitation payment systems for physicians in Canada? A better way to phrase this question is to ask whether physicians will agree to capitation payment as a replacement for FFS. As in the past, physicians have shown some support for capitation payment if their incomes were maintained (Hutchison et al 1996a). Their support for capitation may be growing with the implementation and effectiveness of global budget caps that have already impacted on their real incomes. As their ability to maintain income with FFS has been hampered, at least capitation payment would allow them a regular income with the flexibility to take time off of work. At the same time it is unlikely that physicians would accept a switch to capitation without the promise of higher average incomes than under the FFS status quo. First, FFS has the advantage in that physicians do not bear the cost risks of unexpected increases in demand for health services (at least in the absence of global expenditure caps). In other words, when the state of the world is uncertain, FFS wage contracts and capitation contracts will not be considered perfect substitutes if doctors are risk averse. In particular, to compensate the physician for the risk that demand is higher than expected, a capitation payment arrangement must yield a higher income for a physician than a FFS arrangement since the FFS allows the physician to pass the risk along to the taxpayer.


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Second, capitation involves another important risk for doctors. FFS offers physicians a safety valve; when the fees per service are inadequate from their perspective, they can maintain their incomes by providing more services, or by billing more aggressively. Under capitation arrangements, physicians can increase their incomes only through direct negotiation with the government. If physicians are risk averse over their incomes, FFS, with its safety valve, would clearly be preferred by them. For government to encourage phys icians that they do not need this safety valve, it must engender a climate of trust between itself and physicians. Labour peace between governments and physicians after the banning of extra-billing was purchased by the government's agreement in several provinces to accept binding arbitration for fee schedule negotiations. In Ontario where the government banned extra-billing without offering binding arbitration in return, we witnessed a physician strike. To get doctors to agree to capitation payment arrangements, what will government have to offer them? Can physicians trust the government to offer them fair incomes? or even to bargain in good faith? Given the preoccupation of Canadian health policy researchers with controlling physician numbers and income s, physicians have good reason to be suspicious of a payment arrangement devised and promoted by their harshest critics. Despite the fact that an alternative payment arrangement could be mutually beneficial for both doctors and taxpayers, we may lack the social capital, trust, to make such an arrangement feasible.

5. CONCLUSIONS Despite the widespread criticism of FFS payment arrangements, FFS is strongly entrenched in Canada's medical services markets. Much of the dissatisfaction with FFS in Canada is rooted in concerns over how much physicians are paid and how much we spend on physician services in aggregate. Of lesser importance in the literature examining medical expenditures in Canada is the allocative efficiency of health care resources within the health care sector under FFS payment. Beyond this, the "failure" of FFS to be a socially desirable payment arrangement is rooted in what Canadian researchers believe, as opposed to what they know. Indeed, what evidence does exist suggests that how physicians are paid is not that important for explaining practice patterns.


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Canadian researchers seem to believe that SID leads to higher than necessary expenditures on physician services. Whether or not this is true or not has vital implications for the efficiency of Canadian health care. If SID under FFS is a major problem, then we can lean hard on physicians to get high quality medical care at a lower cost. If SID under FFS is not that important a problem, then the Canadian obsession with controlling physician incomes may be critically wounding Canadian health care. It may be that more resources, not less, should be allocated towards health care and physicians. It may be that capping expenditures on physician services in part to drive physicians out of Canada to eliminate the "physician supply problem" is the wrong thing to do. Is FFS a problem for Canadian health care? Would capitation payment arrangements be the solution? To address these questions, we need to go beyond the Canadian health research literature. A vast theoretical literature exists on the incentive effects of compensation arrangements that we can draw on to determine what would expect to see under alternative payment arrangements. More importantly, a vast empirical literature about the experiences of other countries with alternative payment arrangements exists. Accessing both of these literatures is the first step in developing a better information set for setting policy towards physician compensation in Canada. That is the purpose of PART II of this project.


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