Managed care and the tort system: are we paying unnecessary billions?

• Author: Jones, William R., Jr.

IADC member William R. Jones Jr. is a partner in Jones, Skelton & Hochuli, a full-service law firm based in Phoenix. A graduate of the University of Michigan (B.A. 1960, J.D. 1962), he has written Arizona legislation on malpractice, products liability, tort reform and workers' compensation.

He expresses his appreciation to U.S. Sen. Jon Kyl of Arizona for his review and comments, and to Walt Davis, Claims Manager of Mutual Insurance Company of Arizona; and to Eileen J. Dennis, an associate at Jones, Skelton Hochuli, and Stephanie Bivens, a law clerk at the same firm, for the research and assistance in the preparation of this article.

THE GOAL of the American tort system is to provide reasonable compensation to those who have been injured by the civil wrongdoing of another. Those compensatory damages are separated into two parts: general damages, such as pain and suffering; and special damages, such as lost wages and health care expenses. While special damages may encompass many items, by far the two largest are lost wages and health care expenses.

For years, tort reformers have attempted, in various ways, to contain the spiraling costs of our tort system. Remedial measures have focused largely on containing awards for general damages--for instance, caps on damages, no-fault automobile insurance and other devices, which have met with varying degrees of success. Each positive effect these reforms may have offered, however, has been criticized for causing some perceived loss to claimants' rights to "full compensation."

What tort reformers have overlooked is the special damages side of the ledger. Billions of dollars in special damage awards can be saved, without any claimed loss of full compensation to claimants, simply by taking into account the fact that one of the major costs of the tort system--health care--is no longer being provided by the fee-for-service contract but at a greatly discounted rate by managed care.

Managed health care plans pay health care providers a predetermined fixed fee for particular services. While the actual amount paid for these services is greatly discounted, the tort system still "reimburses" claimants for the much higher "billed" costs of the health care, not the actual lower out-of-pocket managed care cost. Claimants are thus "reimbursed" for costs they never incurred. Moreover, because insurance benefits frequently are not integrated, claimants recover these "phantom" costs multiple times. The expense to the tort system is staggering.

Health care costs that are included as an element of special damages should be calculated and reimbursed on the basis of the actual out-of-pocket cost--the predetermined fixed fee that the managed health care plan actually pays the provider--not the inflated "billed but never expended" cost. Insurance benefits also should be integrated so that these costs are reimbursed only once. The entire tort system, not just the health insurance industry, could thereby benefit from the economic efficiencies of managed health care.

MANAGED CARE SYSTEM

The concept of managed care is not new. Henry J. Kaiser formed the Kaiser Foundation in the 1940s to provide a type of managed care for his employees and eventually for the public. The welfare system has utilized managed care for decades. In the mid-1960s, managed care systems came into their own with the advent of Medicare and Medicaid.

In the early 1980s, when health care costs were spiraling to uncontrollable levels, the federal government, through the Medicare program, adopted a system of diagnostic related groups, called DRGs, which abandoned the prior cost-plus approach to reimbursement for health care services, and substituted a predetermined fixed fee to providers for particular services. The DRG system rewarded efficient providers and penalized the less efficient. A premium was paid to providers who could move. patients through the system more quickly and at less expense.

The DRG system increased the importance of hospital utilization review committees, because if providers could not treat patients efficiently, hospitals suffered a loss. On the other hand, if the patient was treated rapidly and effectively, the system prospered. The average length of hospitalizations dropped dramatically. Surgical procedures that once required prolonged hospitalizations were done on an outpatient basis. The private health care insurance industry was not far behind. HMOs, PPOs, PSOs, PROIs, FAREIs, and the like developed rapidly. These plans have dramatically slowed...