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Interview With Ipsita Smolinski, President, Healthcare Consulting Firm Capitol Street: Imperative Cost Controls, Like Lower Subsidies, Higher Cost-Sharing And Co-Pays, And End-Of-Life Care Limits

Ipsita Smolinski is founder and president of Capitol Street, a consulting firm focused on U.S. healthcare policy. Previously, she was the senior equity research analyst for healthcare policy at JPMorgan Chase. Before that she held a similar position at Citigroup.

Harlan Levy: Is our big healthcare problem more a problem of cost rather than anything else?

Ipsita Smolinski: I would say there are two problems: cost and volume. There really is no measure for people to reduce utilization. If you are insured, that is, have Medicare or Medicaid or a private plan, you can largely get the care you need. There's not too much stopping you, and, as you can imagine, the fragmented system of doctors and clinics may lead to duplicative costly tests and such. For government-funded programs like Medicare and Medicaid and now the Affordable Care Act, the government is shelling out a ton of money to care for people, and most don't have enough skin in the game for this to work.

Yes, some insurance programs have a prior authorization process where they say, "No, you can't get that expensive test," or "No, you're not eligible for this orthopedic surgery." However, for the most part, with the backlash after managed care in the 1990s, most insurers will largely acquiesce, so there's no one really trying to ration care. And that eventually drives up healthcare costs and the deficit.

Out of every $4 spent by the government, $1 is spent on healthcare, and that's growing extraordinarily, especially now with the new law. The next phase in the healthcare debate is to reduce entitlement spending: Medicare, Medicaid, and Social Security.

H.L.: Do you think Congress will actually do that?

I.S.: Because of the distrust between the two parties and the 11 o'clock at night fiscal cliff deal, there's not a whole lot of political will to get to a Grand Bargain. I think this year will be marked by smaller patches versus a grand deal on entitlements. I hope I'm wrong, but that's what the political climate looks like currently.

H.L.: So how would you improve the healthcare system?

I.S.: First putting in some cost mechanisms into the Act is imperative. Massachusetts is now going at it with cost control legislation, and of course, Massachusetts' program is the model for the Affordable Care Act. There are several ways to confront costs in the coming years. You could be less generous with the subsidies for the insurance exchanges [that become operational Jan. 1, 2014 for those who don't have insurance], request higher beneficiary cost-sharing and co-pays, and potentially address end-of-life care. I doubt that Americans will ever get there on the latter point, because it is such an emotional issue.

Second, as of 2016, about half of the newly covered people will be covered by Medicaid -- which is for low-income families and the disabled -- and the other half will get insurance from the exchanges where people will get subsidies to gain coverage. Medicaid is already a program fraught with problems: State budgets are grim, and Medicaid rates to providers aren't the best. Some would argue that expanding an already hobbled program is a bad idea.

As for the expansion of Medicaid starting in 2014, states can participate in the Medicaid expansion, or they don't have to. But they are for the most part, because they're getting additional dollars, paid for by the federal government. It's an expansion up to 133 percent of the federal poverty level. Thus far, 10 states have refused to expand Medicaid. Five states are leaning against expansion.

H.L.: What cost control measures are in the new law, and how effective will they be?

I.S.: Reforming our fee-for-service system is something that's promising in the new law. Among other payment reforms, there are something called Accountable Care Organizations, new bundled payment systems, where hospitals are incentivized towork with doctors to work with nursing homes to work with home health agencies. These guys would get one fixed payment, and they would be at risk of caring for the patient.

Things like that are the "cost control mechanisms" of the Affordable Care Act, but over time, people are starting to understand that they're not necessarily going to save a whole lot of money.

ACOs are approved by the Centers for Medicare and Medicaid Services, and were developed by a new part of CMS called the Center for Innovation, something that I like that came out of the Affordable Care Act. It's an office which has people trying to design different payment demonstrations or pilots to see what works and what doesn't. The Center just announced 106 ACOs. ACO savings are slated to be less than $1 billion over the next 10 years, which is kind of a pittance. Medicare spends $500 billion in one year. So it's not really a game changer currently. If there is fast and widespread adoption over the next few years, then I would feel differently.

H.L.: Is the private health insurance system the best way to go?

I.S.: Even though insurers are vilified, they are part of the solution and not part of the problem, because they are doing things like disease management and trying to coordinate care. They also have single-digit margins, so it's not like these guys are making money hand over fist.

H.L.: Aren't the insurers going to get lots more customers under the Affordable Care Act?

I.S.: Yes, as long as they price their products and underwrite correctly, they will profit from the Act. Insurershave millions of covered lives coming to them through Medicaid and the exchanges, where they compete againstother insurance companies. Open enrollment starts Oct. 1 of this year for 2014, and there might be some skittishness among investorsjust because it's new, it's uncertain. There are lots of concerns about how affordable the products in the insurance exchanges will be. So maybe you'll have a little bit of nervousness at the very beginning, but over time I think it's a good deal for insurers. They do benefit from this expansion.

H.L.: What effect will the Affordable Care Act have on pharmaceutical companies?

I.S.: Pharma companies have begun to pay a market-share tax to fund health reform. However, the coverage expansion, which should benefit the industry, doesn't start until 2014. In proportion to their market share, all the pharmaceutical companies together have paid or will pay a total of $2.5 billion in 2011, $2.8 billion in 2012 through 2013, $ 3 billion in 2014 through 2016, and it goes up from there. Now, some would say they got a raw deal by having to pay their tax early, but in the long run it likely helps them because of the volume of the newly insured, there will be more people who have access to prescription drug coverage.

H.L.: Hospitals will also make out well, wont' they?

I.S.: Acute care hospitals, some would argue, are the biggest beneficiaries of the Act because of uncompensated care. Before they were eating the cost of caring for uninsured folks who largely came through emergency rooms. Now, people will have some access to coverage, and some pennies on the dollar are better than no pennies on the dollar.

H.L.: How do the healthcare systems in England, France, and other countries in Europe and Canada compare with ours?

I.S.: Generally speaking, the governments you mention provide healthcare to all citizens. However, a two-tiered system can emerge. So, the government provides a basic level of care. You can go to your doctor, and if you need surgery you have it, and if it's an emergency you are seen right away. If it's not a true emergency you might have to wait six months for care. So what ends up happening is that if you have the means to buy a supplemental product or you have an issue that you think the government isn't getting to quickly enough, you can pay for additional coverage.

Many of these government insurance programs are expensive and add to country deficits. It seems like it works pretty well in Europe, but if you don't have the means and want an expensive biotech drug or procedure, then you might be out of luck. It's not all puppies and rainbows.

H.L.: Could that work here?

I.S.: The problem here goes back to World War II and the whole advent of the health insurance system. With wage growth being what it was, companies at that time decided to offer health insurance as an extra benefit. If you were to start from scratch, something like a European program isn't a terrible idea. But the problem is that we're so entrenched in employer-sponsored healthcare, we're now creating this patchwork solution.

H.L.: Will what we end up with will be as good as what's in Europe?

I.S.: It depends on how you define "good." If you look at outcomes, the U.S. is not at the top of the list by any stretch. The Affordable Care Act may not be perfect, but as it progresses a few years out there will be legislative tweaks to improve what isn't working, and I'm cautiously optimistic about it. It could bea step in the right direction. Once you address healthcare costs, manage the chronically ill, and provide the right incentives to all players in the system, such as physicians, hospitals, manufacturers, and other providers, then yes, it could be a very good thing.

H.L.: By the way, what do you think of the economy?

I.S.: We're sputtering along. We're not out of the woods by any stretch. Right now the biggest threat to the economy is the politicians in D.C. Unfortunately with the sequester, with the debt ceiling, with the funding showdown in late March, there's going to be a lot of volatility in the markets because of D.C.

If politicians can come together and do the right thing, which is looking at individual and corporate tax reform along withentitlement reform, that's progress. But because Republicans and fighting with Democrats, and there's a lack of trust, I'm just a little less sanguine that cooler heads will prevail. It's a shame. I see it. I spend my time on the Hill with members of Congress and their staffs, and I just don't see a deal-making environment in Washington D.C.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.