Notes on Engineering Health, March 2024: Notes on Providers

Jonathan Friedlander, PhD
Geoffrey W. Smith

Jonathan Friedlander, PhD & Geoffrey W. Smith

March 28, 2024

In his historical novel Bloodletting and Germs: A Doctor in Nineteenth Century Rural New York, author Thomas Rosenthal romanticizes the daily life of an actual rural physician (Dr Jabez Allen, of Aurora, New York) traveling from house-to-house to provide emotional support, the few medical treatments available at the time, and some pieces of home-spun advice to his suffering patients. The evolution from this type of local provider to the large, high-tech hospitals that exist today is the topic of the fourth installment of our series on the American Healthcare system. How medicine is delivered to patients and consumers has changed dramatically over time. Demographics, legislation, technological advances, and market forces have combined to shape the landscape of care. As medicine has grown more complex and costly, the way to organize its delivery has had to adapt.

How has the work of delivering care evolved, how has it been integrated with the health insurance system, and what trends have emerged that point to ways in which hospitals may continue to evolve?

Early days
In the 18th and early 19th centuries, healthcare in the U.S. was predominantly local and community-based. Early hospitals were largely charitable institutions founded by religious organizations to care for the poor and disadvantaged. Wealthier people who could afford care were seen at home by family doctors. Physicians at the time could perform little other than bloodletting and bowel purging. Women administered most of the care, especially when it came to childbirth. There was virtually no government regulation or attention paid to public health. The first medical society was formed in Boston in 1735, the first general hospital was established in 1750 in Philadelphia, the first American medical school in Philadelphia was founded in 1765, the medical department of King's College was established two years later in New York, and in 1770, they awarded the first American M.D. degree. This professionalization of medicine was the foundation for the modern definition of a healthcare provider: an individual health professional or a health facility licensed to provide healthcare diagnoses and treatment services, including medication, surgery, and medical devices.

The advancement in medical practices and insurance policies
Historically, wars have often been catalysts for medical progress, and this has held true in American history:

– During the Civil War, there was progress in surgical techniques, research, and nursing methods, and improvements to care facilities. The Union built army hospitals nationwide, federal and state resources were poured into medical organizations, and new health-related agencies were created to help with acute war needs and raise public consciousness. After the war ended in 1886, the Library of the Surgeon General's Office was built to centralize all data and archives of the war records. It later became the National Library of Medicine, the most extensive medical library in the world. This came as the American Medical Association (AMA) grew its constituency and the medical profession further organized.
– After WWI, as the cost of care started ascending, the healthcare insurance industry emerged, and Blue Cross/Blue Shield appeared (see our Notes on Payers).
– The post-WWII era and the 1950s saw great medical developments and advances. In 1955, Jonas Salk’s team’s effective polio vaccine was approved. In 1954, the first organ transplant was performed when Dr. Joseph Murray and Dr. David Hume took a kidney from one man and successfully placed it in his twin brother. Advances like these led to the price of hospital care doubling during the 1950s.

Public health policies evolving under the pressure of interwar social movements also set the pace of medical practice evolution. For example, the expansion of organized healthcare during the Industrial Revolution was led by strong unions that wanted to protect their constituents from catastrophic financial losses due to workplace injuries.

Along with the development of more effective medical practices, the availability of health insurance led to an expansion in the demand for medical services, encouraging the growth of hospitals and specialty practices. As health insurance covered medical care through a fee-for-service model, it changed the financial dynamics of medical practices which were incentivized to increase the volume of services provided. This shift influenced medical decision-making, emphasizing procedures and treatments that were well-reimbursed by insurance companies.

The shift from fee-for-service to value-based care and its impact on providers
As the fee-for-service model became more established and the complexity of specialty medicine grew, the cost of healthcare continued to balloon. In order to reverse the trend, the US government made efforts to shift the financial incentive of providers from volume-based care to value-based care for its federal program, such as Medicare. This trend attempted to push care towards a more holistic approach, emphasizing outcomes rather than the number of procedures. This shift prompted the development of new types of insurance plans and new care organizations:

– Insurance plans such as Health Maintenance Organizations (HMOs), which restrict the choice of physicians patients can see to the ones in their network for a lower premium, and Preferred Provider Organizations (PPOs) that allow out-of-network visits for a higher monthly cost.
– Integrated Care Models were developed so patients could receive a more coordinated set of healthcare services across disciplines.  By acting on health promotion, disease prevention, diagnosis, treatment, disease management, rehabilitation, and palliative care services, the goal was to improve outcomes and reduce costs. First implemented and popularized through Medicare programs (public service for people over 65) to improve the care of seniors and reduce costs, the concept and practice of integrated care extended beyond Medicare, first to Medicaid and Veterans Affairs and then to encompass a broad range of patients and insurance types, including private insurance. A central tenet of integrated care models is the primary care provider, the coordinator and gatekeeper to specialty care. Intuitively, this type of coordination is better achieved and offers better efficiency gains in more vertically integrated systems. While it has proven true for the management of some chronic diseases, such as mental health, some studies contradict this intuition, highlighting remaining misaligned incentives that result in worse outcomes and increased costs.
– How healthcare professionals provide care is heavily influenced by how incentives are structured. Although the well-being of patients is surely top of mind, reimbursements and profits also weigh in.

The financialization in healthcare
Considering the extent to which health care is provided in hospital settings, it is important to touch on a recent trend that has attracted a lot of scrutiny: the involvement of a new kind of hospital owner, private equity firms. Data from the American Hospital Association show that out of 6,120 hospitals in the US in 2024, over 80% are community hospitals, defined as all non-federal, short-term general, and non-federal non-psychiatric hospitals. There are three types of ownership structures for community hospitals:

58% are non-government, not-for-profit hospitals;
24% are investor-owned (for-profit) hospitals; and
18% are State and local government hospitals.

The two most significant differences between for-profit and not-for-profit hospitals are tax status and where the profit is directed. Not-for-profit hospitals are not required to pay income or property taxes at the federal, state, or local levels. This gives them an advantage, allowing them to compete on costs for services that are less lucrative. Indeed, studies have revealed that the kinds of services differ between these two types of hospitals. For-profits are most likely to offer relatively profitable medical services; government hospitals are most likely to offer relatively unprofitable services; nonprofits often fall in the middle.

While non-profit hospitals may be owned by academic institutions, religious groups, or charitable organizations, for-profit hospitals are typically owned by private entities or corporations. Profits generated are re-injected into the hospitals in the case of non-profit institutions and distributed to investors by for-profit ones. Although this sounds like a fundamental difference, for a long time hospitals were run in a similar fashion regardless of ownership, and most patients would not have been able to tell the difference between the two.

Starting in the mid-1990s, private equity (PE) firms became large owners of healthcare providers, investing more than $1 trillion in the 2010s alone. The fundamental difference between traditional private hospital owners and PE is debt: PE firms raise some capital from investors and borrow the rest, putting debt on the acquired hospital with its physical assets, such as land and buildings, as collateral for the loan. The acquired hospital must then generate revenue to pay down that debt, burdening already fragile institutions and selling their assets as needed. Alarmingly, the results of this strategy can be seen in damaging shifts in hiring, increased costs, and more problematically, worsening patient outcomes in hospitals owned by PE. A large study recently published in JAMA Network showed that PE acquisition of hospitals, on average, was associated with a 25% increased hospital-acquired adverse events, suggesting poorer quality of inpatient care. Reports also revealed that the long-term financial health of PE-owned healthcare providers is also damaged, with 90% of healthcare companies with financial stress owned by private equity. This trend has attracted the attention of legislators arguing that hospitals should still provide a public good and be driven by considerations other than profits.

There is a lot not mentioned in these notes about the evolution of healthcare providers in the US. We've aimed to highlight some of the deep undercurrents that have affected the practices of the healthcare industry, as it juggles often contradictory goals: making care more affordable and accessible on the one hand while also integrating providers in a market economy focused on profits. These tensions will continue to play out, but as in the time Thomas Rosenthal recounts in his historical novel, healthcare is not, and will never be, a market like any other, just as health and wellbeing are not and will not be commodities like any other.

Jonathan Friedlander, PhD & Geoffrey W. Smith

Engineering Biology
Jacob Oppenheim, PhD, and Entrepreneur-In-Residence at Digitalis Ventures, writes Engineering Biology at Digitalis Press:

This month, Jacob writes about the seemingly mysterious power of Deep Protein Language Models. Not only do they identify related proteins, but they also predict functionality, stability, and immunogenicity, in many cases “out-of-the-box.” Ever larger datasets and better structured models learn representations of evolutionary history that have given us unexpected powers.

Jacob was also on the "Data in Biotech" podcast discussing the place of Data Science and Machine Learning in Biopharma, the tools we need to build to digitize drug development, where the field is going, and how he ended up at Digitalis Ventures in the first place.

First Five
First Five is our curated list of articles, studies, and publications for the month.

1/ AI-powered doctors?

It has been argued that one of AI’s great promises is to help physicians make better diagnoses. Radiology was the poster child of these claims; some people even predicted the end of radiologists altogether. But, a new study published in Nature Medicine showed that AI was actually detrimental to some physicians. In some instances, the research showed the use of AI interfered with a radiologist’s performance and accuracy of interpretation. This discovery underscores the importance of tailored AI-clinician integration over a one-size-fits-all approach.

2/ The first hours of the immune system help to prevent allergies

A study in Science Immunology showed a novel function of the neurotransmitter serotonin. Surprisingly, it is produced in the gut of newborn mice to expand regulatory T-cells (Tregs). These cells suppress inappropriate immune responses to help prevent autoimmune diseases and dangerous allergic reactions to harmless food items or beneficial gut microbes, particularly the ones producing the said serotonin!

3/ A very cool (cold even) discovery

Early spring days in New England offer ample opportunities to feel the cold. Thanks to a team of researchers, the mystery of how the body creates this feeling has been lifted. First identified in a tiny worm, Caenorhabditis elegans, the glutamate ionotropic receptor kainate type subunit 2 (GluK2) was shown to be indispensable for mice to feel the cold. While GluK2 knockout mice responded normally to heat and mechanical stimuli, they exhibited a specific deficit in sensing cold but not cool temperatures.

4/ Breathing and speaking

While singers train to control their breathing and voices, we all do it reflexively. A team of MIT scientists published in Science the brain circuitry that drives vocalization and ensures that we talk only when we breathe out and stop talking when we breathe in. This circuit is under the control of a brainstem region called the pre-Bötzinger complex.

5/ Not just the Princess of Wales

If you have the feeling that young people are diagnosed more often than before with cancer, you’d be right, although the picture is complex. Nature compiled the data around this phenomenon and helped uncover some trends. While early-onset cancers—in adults under the age of 50—still account for only a fraction of the total cases, the incidence rate has been growing, and the number of deaths from early-onset cancers has risen by nearly 28% between 1990 and 2019 worldwide. There are significant disparities between types of cancer, populations, and socio-economic backgrounds worth digging into to uncover what, if anything, can be done to revert these worrisome trends.

Did you know?
In this section of our newsletter, we hope to demystify common terms and notions in our work as investors.

Fund life cycle
The life cycle of a venture capital fund encompasses several key stages. It begins with fundraising, where the fund secures commitments from investors, and proceeds to the investment period, during which the fund actively invests in startups or companies aligned with its strategy. The fund engages in active portfolio management, providing guidance and resources to support the growth of its investments. As the fund matures, it focuses on harvesting returns through exits, such as acquisitions or IPOs. Towards the end of its life cycle, the fund realizes returns on its investments and distributes them to investors, including the fund managers. The fund eventually reaches its sunset, undergoing closure and final reporting to investors. At this point, the fund may start raising capital for a new fund to continue its cycle of investing and supporting startups. The duration and strategies of each stage can vary among venture capital firms, depending on their specific focus and portfolio needs.

Haiming Chen & Dylan Henderson

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