8VC traditionally invests in companies that tackle industry-wide problems by reimagining traditional paradigms and helping modernize some of our oldest technological infrastructure. That’s why we invested in and launched Esper, a platform that helps modernize the regulatory process in our oldest and most important institution: government. Esper’s mission is to help government regulators make data-driven decisions.
We witness first-hand as many of our innovative companies struggle to navigate complex regulatory landscapes. Overlapping and sometimes conflicting federal and state regulations can be costly and confusing to even the most seasoned entrepreneurs. Startups, which rarely have a team of lawyers and compliance specialists, often live in a shadow of legal uncertainty and are afraid to ask questions for fear of heightened scrutiny.
Meanwhile, regulators struggle to balance critical administrative tasks with shifting political priorities and urgent health and safety concerns from their constituents. Both federal and state regulatory agencies confront a staggering volume of rules: The Federal Register contains over 100,000 final rules and 1.08 million individual restrictions, and the average state code contains between 100,000 and 200,000 individual restrictions.[1] The sheer scale of work demanded of our agencies means that regulators seldom have time to properly evaluate and update policies with internal data and feedback from citizens, business owners, and other stakeholders.
At present, regulatory data such as cost-benefit analyses, lists of impacted industries, expiration dates, guidance documents, forms, and applications is scattered across the internet in turn-of-the-century websites like this one, or worse, in file cabinets. Regulators typically create a flurry of rules when a law is passed and revisit them only when a new law is enacted or they receive serious public complaints. There is no coordinated operating system to connect regulatory data points and flag which documents are affected by which legal events, so thousands of outdated, duplicative, and contradictory rules have accumulated at the federal and state levels.
It’s a daunting task for policymakers to revise the regulatory corpus. It would literally take years for the average citizen or business owner to parse out which rules apply to them, and recent economic literature has confirmed that regulations slow economic growth by an average of 2% per year.[2] Now more than ever, regulators face pressure by legislatures, governors’ offices, agency heads and others to conduct retrospective reviews and instill safeguards against excessive rulemaking. Many agencies have been ordered to review mountains of rules and conduct better cost-benefit assessments but aren’t sure how to begin.
Whatever one’s politics, making the administrative state more adaptive, intelligent, and transparent is vital for the American economy and for good governance. Indeed, modern software infrastructure with a coherent ontology for regulatory data is necessary to preserve our distinctly American tradition of checks and balances on government. Unless regulators can organize rules for themselves, legislators, and the public, our ship of state will be rudderless and adrift on a dark sea.
Esper is a software platform that allows administrative bureaucrats to run a fair, logical rulemaking process. Our company collates existing digital regulatory data to chart when a rule was last updated, when it will expire, and whether it contains a reference to a repealed law. This detailed analysis allows regulators to swiftly determine where to focus their attention and when they need to create, revise, or eliminate rules. In addition, Esper has built an algorithm that helps regulators compare their rules to similar rules in other jurisdictions (and was thrilled to find that regulators love being able to compete against their counterparts in other states!).
Esper’s product also equips regulators with a suite of tools to draft proposed rules, amend existing rules, and repeal outdated or costly rules. This workflow system is a significant departure from pen-and-paper or Microsoft Word-and-email exchanges. Regulators can now collaborate with each other, save amendments as drafts in a mutual library, and enter important information such as “how much will this rule cost?”, “who will this regulation impact?”, “how many businesses or individuals must comply?”, and “which special interest groups are lobbying to change this rule?”
We are making huge strides in capturing information on affected industries and persons and will ultimately be able to synchronize regulatory data with empirical data on the effects of rules. Esper also allows regulators to hold each other accountable to deadlines and specific goals, such as “update 50% of rules in Texas by the end of 2018.” The next evolution of the product will help agencies to synthesize public comments (e.g. number of complaints vs. encouragements) and enforcement data (e.g. number of penalties levied for non-compliance) to support data-driven policies.
Taken as a whole, Esper’s product features allow regulators to perform their jobs quickly, effectively, and verifiably. Deconstructing complex processes within government agencies allows governors’ offices, legislatures, and independent bodies to hold regulatory agencies to account, set new policy agendas informed by quantitative metrics, and track goals to completion. Government executives can now make more informed decisions about which sectors of an economy to monitor, how to allocate monetary resources and personnel, and when to reward or discipline appointed officials.
Technological infrastructure is transforming the ancient vocation of governance and rebuilding one of the largest, most broken industries in the world according to the principles of common sense. In the recent wave of blockchain enthusiasm we saw an obsession with new modes of governance and representation, from “liquid democracy” to “futarchy”, but we submit that the most important innovations in governance lie closer to home. Esper secured a contract with the state of Kentucky and a pilot in Arizona within a year of its inception, and several other states have expressed strong interest in the product. We’ve been very excited to see the rapid uptake of the product in line with our core investment thesis, but we’re not surprised. Esper’s technology completely revamps existing public policy infrastructure to enable real, living bureaucrats to govern in more thoughtful ways, and measure themselves more carefully against the will of the American people and their elected representatives.
Fix the International Price Index for Part B Drugs
Joe|January 9, 2019
American drug spending is out of control. At $330B a year, American expenditures on prescription drugs subsidize pharmaceutical R&D for the rest of the planet and allow foreign governments use price controls to keep drugs artificially cheap for their citizens. One remedy for this unfair situation is for the federal government to only pay pharmaceutical companies the average price of drugs paid by other developed countries. We were excited to see the Department of Health and Human Services (HHS) propose piloting this reform in Medicare Part B earlier this year, but were shocked to discover that the proposed rule is not an “international price index” as advertised but rather a blunt price control. Insisting on a dynamic price index for Part B drugs would save America billions of dollars annually and allow our public drug pricing system to adapt to new circumstances over time.
The American federal government spends about $140B annually on prescription drugs. Medicare Part D, which reimburses drugs an American senior would pick up at the pharmacy, accounts for over $100B of this spending.[1] Medicare Part B, which reimburses drugs administered in a clinical setting, accounts for another $28B in spending a year.[2] The federal government relinquished all rights to negotiate the price of Part D drugs in the Medicare Modernization Act of 2003, but fortunately HHS can experiment with different negotiation strategies in Part B.
Medicare Part B covers drugs used to treat cancers, esoteric diseases, and other rare conditions. These drugs are often offered by only a single manufacturer and tend to be much more expensive than other drugs. For example, in 2016 Medicare Part B spent $2.2B dollars on prescriptions of Eylea (a macular degeneration treatment) and $1.6B on Rituxan (which is used to treat certain types of cancer and autoimmune diseases). Part B spending is growing at an alarming 11% annually, compared with 3.2% annually for Part D.[3]
Part B reimbursement operates on a “fee-for-service” model. Manufacturers sell drugs to wholesalers and distributors, who then sell drugs to providers such as physicians and hospital networks. Providers purchase drugs, and then are reimbursed by the federal government through regional “Medicare Administrative Contractors” for the average sales price of the drug (ASP) plus an “add-on fee” worth 6% of the price of the prescribed drug. This “buy-and-bill” system rewards providers for prescribing the most expensive drugs possible, and manufacturers are only too happy to inflate the prices of drugs before selling them to providers. The American taxpayer suffers the costs of this perverse arrangement.
To solve the buy-and-bill problem and drive down the price of drugs, HHS recently proposed a rule that would reimburse vendors (not physicians) at a price determined by indexing reimbursement to the price of drugs in 16 other developed countries. In a price-per-gram comparison of 27 Part B drugs across these countries, HHS found that, on average, Medicare Part B pays 1.8x the average sales price of drugs in other countries. A true international price index could therefore be expected to drive down Medicare Part B expenditures about 45%. According to the proposed rule, the international price index will pilot in 25 states, and roughly $10.5B of annual Part B expenditures will fall within the scope of the program.[4]
So far so good. A true price index would drive international markets for Part B drugs into new equilibria where the US saves billions of dollars a year and it would be more difficult for foreign governments to freeride on American R&D. However a crucial paragraph buried on page 40 of the proposed rule document reveals that HHS actually plans to impose a blunt 30% price control on selected Part B drugs rather than allow drug prices to dynamically respond to prices in the international marketplace. The paragraph reads:
CMS would also establish the model ‘Target Price’ for each drug by multiplying the IPI [International Price Index] by a factor that achieves the model goal of more closely aligning Medicare payment with international prices, which would be about a 30 percent reduction in Medicare spending for included Part B drugs over time, and then multiplying that revised index (IPI adjusted for spending reduction) by the international price for each included drug.
We reread the page a dozen times and were nonplussed when we realized that after defending the virtues of a price index, the authors of the rule actually just plan to multiply the price index by a coefficient to achieve a number that represents a 30% reduction in Medicare Part B payments. We hope that HHS has made a mistake and strongly suggest revising the document so that the price of any Part B drug is just directly pegged to the average of prices in the countries used to create the index. If the real aim of the document is to implement an arbitrary 30% price reduction over time, HHS should eliminate any references to price indices in this document.
A blunt price control defeats the entire spirit and purpose of an international price index, which is to allow prices of drugs to fluctuate naturally in response to aggregate demand and pricing strategies in foreign markets. Even if phased in gradually, a true price index would save taxpayers vastly more money (a ~45% price reduction would save 10–20 billion more than a 30% price index over the next decade). An adaptive index would also closely approximate an actual international market for drugs rather than the arbitrary rigidity of a Soviet price control.
This rule is currently in “advance notice for proposed rulemaking”, which means it must clear three more rounds of internal review and five rounds of external review before HHS can launch the pilot. There is plenty of time to correct this error and remove the paragraphs in question; we encourage HHS to do so.
The pharmaceutical industry is the largest lobby in the country by a huge margin, and PhRMA, the drug manufacturers trade organization, will certainly fight this proposal.[5] In the past it has successfully quashed several promising Medicare Part B pilot studies, including a program that would have paid for cancer drugs at the price of the least costly equivalent (where multiple drugs offer similar efficacy).[6][7] Nonetheless, we are optimistic that the Trump administration will be able to launch a pilot with a real price index, and are confident that a price index would save Americans billions on physician-administered drugs per year.
[4] The program will only operate in 25 states and will be restricted to (1) drugs incident to physician services, or 84% of Part B prescriptions and of this class, 2) only biologicals and single source drugs, or 90% of drugs in (1).
How to Save $900 Billion Annually in American Healthcare
Joe|October 29, 2018
The American health care industry wastes $1T by some estimates,[1] and possibly as much as 30% of health care spending by others.[2] US health care expenditures are twice the OECD average — for instance, we spend twice what the UK does on health care (as a percentage of GDP) — and American health care costs are growing at 5% a year.[3][4]
Notes: GDP refers to gross domestic product. Dutch and Swiss data are for current spending only, and exclude spending on capital formation of health care providers. Source: OECD Health Data
Healthcare presents one of the greatest policy challenges for our country because profit incentives and care for the patient are often misaligned. It’s clear that the government is going to play some role in making sure the least well-off Americans have access to medicine, but we need healthcare policies that incentivize providers and payors to educate patients to make informed, data-driven choices. Only intelligent consumer choice will stimulate functioning, competitive markets in insurance, patient care, the pharmaceutical industry, and elsewhere. Today, pharmaceutical companies, health providers, electronic health record (EHR) systems, and other actors often have misaligned incentives and fail to enable more efficient solutions that do more for the patient per dollar — indeed, often the winners in these areas are those that unnecessarily charge more. Aligning incentives will spur top technology startups to develop innovative healthcare solutions, bring down costs, and deliver superior outcomes to American patients. Here are a few necessary reforms:
1)Medical Schools
Experts project a total physician shortfall of between 42,600 and 121,300 by 2030.[5][6]* We need more medical schools fast, but the Liaison Committee on Medical Education accreditation process takes 8 years on average and most states require new medical schools to obtain a “certificate of need” before beginning construction.[7] In addition, medical schools are required to sustain the high overhead of medical research rather than focusing exclusively on training doctors, and inflexible requirements prevent medical schools from experimenting with new curricula. Organic chemistry and other undergraduate prerequisites are completely irrelevant to becoming a good practicing doctor, and should be optional.[8]
High medical school costs force students to become high-earning specialists, e.g. plastic and orthopedic surgeons, when our country really needs more primary care physicians (PCPs). Primary care physicians, nurse practitioners, and physician’s assistants are far cheaper than specialists, but limited medical school and residency supply as well as occupational licensing concerns keep them out of the market. In addition, foreign doctors are almost always required to complete a full residency before being allowed to practice in the United States.[9] Given a current skills gap of 30,000 doctors, adding 30,000 new PCPs, nurse practitioners, or physicians assistants could save $2.3B, $5.1B, or $6B in salary costs alone relative to the current mix of specialists and primary care doctors.[10][11][12]
In addition, primary care doctors achieve better health outcomes for patients than specialists by engaging in long-term counselling, tracking, and preventive care.[13] Scholars estimate that replacing specialists with primary care physicians at a density of 1 per 10,000 population could save $931 per beneficiary a year.[14][15] Adding a supply of 30,000 primary care physicians would save our country about $150–200B a year.[16]
*If implemented correctly, data-driven telemedicine can ameliorate demand for physicians somewhat. Doctors should be able to digitally prescribe most drugs, and data from increasingly sophisticated wearables will enable physicians to swiftly and efficiently diagnose patients.
2)Reform PBMs
In 2017 the Centers for Medicare and Medicaid Services (CMS) spent $175B on prescription drugs alone, and there are curr\ently shortages of vital drugs across the country.[17][18] An oligopoly of Pharmacy Benefit Managers (PBMs) generates $200B a year in revenue by forcing drug manufacturers to pay rebates and other kickbacks in order for the PBM to place their drug on the “formulary”, or list of insurable drugs.[19][20] Securing a place on the formulary is a matter of life and death for manufacturers, and by one estimate the current value of rebates and other price concessions from manufacturers to PBMs increased from $59B in 2012 to $127B in 2016.[21]
After speaking extensively with politicians on both sides, we were thrilled to see the Senate recently outlaw PBM “gag-orders” on pharmacies by a 98–2 vote. We are encouraged to see that Alex Azar’s Department of Health and Human Services (HHS) is planning to subject PBM rebates to anti-kickback law, but we would go further and require full price transparency on PBM contracts in the style of Colorado HB 1260.[22] Although some rebate money flows to insurers, we estimate that reforming the space could save America on the order of $50B.
3)End of Life Palliative Care
Although discredited by hyperbolic language about “death panels”, counselling patients at end-of-life is both cost-effective and humane. 30% of Medicare expenditures are attributable to 5% of beneficiaries who die each year, and acute care in the final 30 days of life accounts for 78% of the costs incurred in the final year of life.[23] While acute-care for the dying should obviously be available to those who want it, our country must shift to a model of counselling and palliative care at the end of life.
Just having an end of life discussion with the cancer patient reduces medical costs by 35.7% on average, and given that there are roughly 600,000 cancer deaths in the United States a year, would have saved $687M a year for cancer patients in the last week of life alone! In addition accountable care organizations (ACOs) have saved $12,000 per patient during the final three months of life by implementing home-based palliative care. If extended to all cancer, end stage renal disease, and congestive heart failure patients this program could save the country $11.7B a year.[24]
We all agree that we must treat families of the dying with delicacy and compassion. But introducing a program by which families will share in Medicare/Medicaid savings from palliative care would help families and patients factor the overall social cost of end-of-life care into their decision calculus. We estimate that extending proven programs and testing different incentives structures could save our country $30–50B a year.
4)FDA Reform
Clinical trials are an arduous multi-year process and have become drastically more costly in the last 30 years.[25] Phase II and III efficacy trials cost roughly $400M per new drug, which severely limits the number of drugs that make it to the final stage of Food and Drug Administration (FDA) approval.[26] A “progressive approval” approach would allow drugs to be repurposed for other uses and possibly sold after passing Phase I safety trials, which establish that a drug has a favorable risk balance and qualifies as value-based care.[27]Drug companies could gradually establish efficacy by logging the effects the drug has on each person who opts to use it over the next several years.
The extreme costs of clinical trials and FDA approval not only stymie drug development and the application of treatments to new indications, they effectively privilege Big Pharma over other innovators, inhibiting innovation and medical progress. While ramping up the number of drugs approved may not save our healthcare system money on net, a framework which encourages innovation will positively impact millions of lives by improving quality of care.
5)Give Medicare Negotiating Power
To pass the Affordable Care Act (ACA), the Obama Administration made a critical concession: Medicare would not be able to negotiate the price of drugs by controlling which drugs make it onto Medicare’s formulary. As a consequence, our federal government is a “price taker” that must blindly accept whatever prices drug companies demand, and the American government winds up subsidizing drug development costs for the rest of the world. Drug prices at home are extremely high, representing 10% of total healthcare expenditures, and about $144B of federal healthcare spending.[28]
In many other developed countries, governments use their monopsony or near-monopsony buying power to force pharmaceutical companies to sell drugs at much cheaper rates. For instance, Canada spends 70% of what the US spends on brand name drugs, the UK 40% of what we spend, and Denmark only 35%.[29] If the US federal government used its considerably larger “countervailing power” to negotiate reduced drug prices — whether on a case by case basis or by pegging the value of a Quality Adjusted Life Year at a generous but fixed rate — savings could be in the range of $30–40B, possibly even as high as $90B a year.[30]
Pharmaceutical industry lobbyists (PhRMA) argue that high drug prices are necessary to stimulate R&D which generates many new life saving drugs every year. But in fact, median R&D spending on new cancer drugs — the most difficult to develop — is only around 40% of total revenue.[31][32] In addition, most R&D is funded by American universities, and manufacturers of silver-bullet specialty drugs could continue to charge high prices to a federal payor.[33] Giving government negotiating power isn’t a novel solution, but it’s one of the correct solutions to driving down drug costs for Americans.
6)Tort Law
The threat of malpractice lawsuits forces doctors to engage in costly defensive medicine. Although the current administration has made some progress on tort reform (making arbitration legal for federal contractors and nursing homes), Congress must insist on Texas-style reforms including capped punitive and noneconomic damages from healthcare providers, eliminating contingency fees for speculative tort lawyers, reinforced federal preemption doctrine for food and drug products, and more. [34][35][36] Unfortunately the trial lawyers lobby — one of the biggest political donors in the country — will fight reform at every step of the way.
Some studies estimate that reducing physician malpractice fears to “somewhat concerned” about malpractice would decrease costs by 14%, saving the country $100B a year. Others argue that medical liability reform could save our country up to $210B a year.[37] Congress must protect our doctors from being attacked by unscrupulous prosecutors in order to reduce the cost of healthcare for American citizens. We all agree that we must insist on protecting patients, but unchecked tort lawsuits just punish American patients and taxpayers with an unaffordable system.
7)Data Interoperability
The ACA’s “meaningful use” requirements did little to make healthcare data accessible. As of 2015, only 6% of health care providers could share patient data with other clinicians who use an EHR system different from their own. Although 21st Century Cures Act made “information blocking” illegal, big EHR vendors routinely prevent their competitors from importing patient data by disclosing health records in garbled, incoherent formats.[38][39] As a result, physicians are unable to make fully informed decisions about their patients.
Judy Faulkner, CEO of EPIC, famously condescended then Vice-President Biden, “Why do you want your medical records? They’re a thousand pages of which you understand 10.” The answer is that only real, semantic interoperability which makes health data available to third parties via and open application programming interface (API) will allow an innovation ecosystem of apps, medical devices, and novel insurance plans to flourish. Granular, transparent healthcare data will allow entrepreneurs — whether college students or IBM executives — to invent new solutions from the bottom up and swiftly incorporate best practices into their businesses. In addition, direct service-to-service comparisons will allow consumers to make informed decisions about how to stay healthy, stimulating market competition for their dollars.
We have been excited to see CMS’s Blue Button 2.0 API program formalize the Fast Healthcare Interoperability Resources (FHIR) standard for health records, which includes programmer resources, a complete API, and gives beneficiaries full control over their data — but EHR providers are refusing to use it.[41] While any EHR system should ensure compliance with the Health Insurance Portability and Accountability Act (HIPAA) by storing protected health information on secure servers, we need to make interoperability truly mandatory.
If patients could easily share their medical records with new providers and selectively reveal their data to health apps, fitness devices, diagnostic companies, insurers, and academic researchers, our entire healthcare industry would become hugely more affordable and effective. Reliable, real-time information about which treatments work, which failed, and what they cost will enable hospitals to identify and minimize cost centers as they strive to produce care more cheaply than federal benchmarks and share in the savings.
8)Financing Reform
Overtreatment and poor physician incentives may be the main driver of health care costs.[42] Most hospital networks are local monopolies with limited incentives to innovate or save money. Replacing this broken system with value-based care models will immediately save over $100B in total, and should grow steadily over time to $200–300B as doctors harness digital technology interventions and other new techniques to make care cheaper and more effective. We break down a few potential sources of savings below:
Bundled Payments
The Bundled Payment Care Initiative (“BPCI”) introduced in 2013 shows serious promise in making acute care clinical workflows more efficient, particularly in orthopedic care and oncology. Results continue to improve as providers adapt to the program.
After adopting a bundled payment model, the NYU Medical center reduced costs to Medicare by 10% and reduced patient stays by 25% for total hip arthroplasty procedures, and a private practice joint arthroplasty generated 20% savings for CMS per episode while decreasing readmissions.[43][44]The Congressional Budget Office estimates that a voluntary bundled payments system could save Medicare $6.6B a year.[45] If CMS makes bundled payments mandatory for both Medicare and Medicaid, achieves health record interoperability, and allows the ecosystem to iterate on data-driven incentives, we expect savings to surpass $100B.
Accountable Care Organizations
ACOs are widely seen as the Affordable Care Act’s main instrument to rein in health care spending, and ultimately we expect that bundled payments will be folded into a broader ACO model.[46][47] To date ACOs have generated modest savings on average, but some, such as the Memorial-Hermann ACO, have generated 11% savings for Medicare.[48][49] ACO contracts are more efficient if they involve two-sided risk (rewards for savings, penalties for overages), but studies have shown that even early versions of upside-risk only ACOs are associated with a 3% reduction in Medicare reimbursement.[50] In addition, Medicare ACOs have improved quality measures across the board, despite their elderly populations.[51]
Provider networks are still adjusting to the ACO model, and returns will increase in the future. Projecting savings at 5–10% and assuming that all Medicare beneficiaries are enrolled in ACO providers, ACOs would save Medicare $30–60B a year.[52] If extended to Medicare and Medicaid, full ACO enrollment could generate between $56–112B a year.[53]
Preventive Medicine
The ACA now mandates coverage for all evidence-based prevention in non-grandfathered plans, so preventative screening and vaccinations have increased since the advent of Obamacare.[54] However we need to drastically increase the scope of preventive medicine under the aegis of value-based care. Preventable chronic diseases are 7 of 10 top causes of death in the country, and account for 75% of health care costs.[55] Half of American adults have chronic disease, and surprisingly, chronic illness among those younger than 65 years accounts for 67% of total medical spending.[56] 70% of American adults are overweight, and 1 in 3 American kids and teens is overweight or obese.[57] Prevalence of obesity has tripled since 1971.[58]
Some of the most cost-effective, successful preventive health interventions include childhood immunization, youth and adult tobacco counselling, alcoholism interventions, aspirin use for people with heart disease, and screenings for common cancers, STDs, and chronic conditions like hypertension.[59] Evidence suggests that many other preventive health interventions are cost-neutral or increase long-term medical costs (because they extend lifespans). However critics often miss the fact that preventive health measures will extend the working careers of Americans, and pay for themselves in the long-run.
In kidney care, for example, the federal government subsidizes extremely costly dialysis treatments for end stage renal disease patients but has not crafted incentives to perform preventative treatments before a patient advances to this critical, debilitating condition. Rather than fill the coffers of the corrupt duopoly that runs the dialysis industry, we should give providers incentives to halt the progression of kidney disease in its tracks. As a country we spend $42B on hemodialysis. Just getting prevention right here could save our system north of $10B a year.
Conclusion
Fixing our sprawling, tangled healthcare system is one of our nation’s greatest policy challenges. In the coming years, America should move swiftly to embrace value-based care models which align market incentives to produce a wealth of patient data and an ecosystem of new information technologies geared at preventive treatment. At the same time, we must address specific areas where poor incentives have throttled the production and delivery of medical services. Replacing bureaucratic mandates with proven Western values of entrepreneurial innovation and educated individual decision-making will yield better patient experiences and results for Americans from every walk of life while saving our country $600-$900B annually — a transformative amount of money for the well-being of our nation.
This paper is a work in progress and we intend to publish new versions of our recommendations as we continue to talk to practitioners and refine our views on healthcare policy. This is the latest version of our views as of October 15, 2018. American healthcare is a complicated space, and we would appreciate any feedback or suggestions.
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Endnotes
[1] Sahni, Nikhil et al. “How the U.S. Can Reduce Waste in Health Care Spending by $1 Trillion.” Harvard Business Review, 2015.
[2] Blumenthal, David et al. “Health Care Spending — A Giant Slain or Sleeping?” New England Journal of Medicine, December 2013.
[3] Squires, David and Chloe Anderson. “U.S. Health Care from a Global Perspective.” The Commonwealth Fund, 2015.
[4]“Average Annual Percent Growth in Health Care Expenditures per Capita by State of Residence.” Kaiser Family Foundation, 2014.
[6] “The Complexities of Physician Supply and Demand: Projections from 2016 to 2030: 2018 Update.” Association of American Medical Colleges, HIS Markit Ltd. March 2018.
[7] Stark, Roger. “The Looming Doctor Shortage.” Washington Policy Center, November 2011.
[10] The average yearly salary of a doctor (given current percentages of specialists vs. PCPs) is $300k, see Kane, Leslie. “Medscape Physician Compensation Report 2018.” April 11, 2018.
[12] Physicians Assistants can handle 86% of the diagnoses seen in outpatient primary care settings. See Eibner et al. “Controlling Health Care Spending in Massachusetts: An Analysis of Options.” Rand, 2009.
[13] Starfield et al. “The Effects of Specialist Supply on Population’s’ Health.” Health Affairs, 2005.
[14] American College of Physicians. “How is a Shortage of Primary Care Physicians Affecting the Quality and Cost of Medical Care?” 2008.
[15] Adjusted for inflation. See: Baicker, Katherine and Amitabh Chandra. “Medicare Spending, The Physician Workforce, And Beneficiaries’ Quality of Care.” Health Affairs, 2004.
[16] Our current physician skills gap is currently around 30,000 doctors, see: “The Complexities of Physician Supply and Demand.” Since the current physician workforce composition is 2/3rds specialists and 1/3rd PCPs, a base case for solving the skills gap would be to create 20,000 more specialists and 10,000 more PCPs. Replacing 20,000 specialists with PCPs would generate savings of $931 * 20,000 doctors * 10,000 beneficiaries per doctor, or $186B a year.
[18] “Urgent Call to Action!” Physicians Against Drug Shortages,
[19] Neeraj Sood, Dana Goldman & Karen Van Nuys, Follow the Money to Understand How Drug Profits Flow, STAT (Dec. 15, 2017)
[20] “Amber Rainey, Christina Kollmeyer, and Lisa Vogel v. Mylan Specialty L.P.” United States District Court, Western District of Washington at Seattle. 2018.
[21] Fein, Adam. “New Data Show the Gross-to-Net Rebate Bubble Growing Even Bigger.” Drug Channels, June 14, 2017.
[23] Zhang et al. “Health Care Costs in the Last Week of Life.” Arch Intern Med, 2009.
[24] 600,000 cancer mortalities + 287,000 congestive heart failure mortalities + 89,000 ESRD mortalities yields 976,000 mortalities a year that could be addressed with palliative care. For ACO savings, see: Lustbader et al. “The Impact of a Home-Based Palliative Care Program in an Accountable Care Organization.” Journal of Palliative Medicine, 2017.
[25] Berndt, Ernst and Iain Cockburn. “Price Indexes for Clinical Trial Research: A Feasibility Study.” 2014.
[26] Adjusted for inflation. See: DiMasi et al. “Innovation in the Pharmaceutical Industry: New Estimates of R&D Costs.” Journal of Health Economics, 2016.
[27] Caplan, Arnold and Michael West. “Progressive Approval: A Proposal for a New Regulatory Pathway for Regenerative Medicine.” Stem Cells Translational Medicine, 2014.
[32] Prasad, Vinay and Sham Mailankody. “Research and Development Spending to Bring a Single Cancer Drug to Market and Revenues After Approval.” JAMA, 2017.
[33] Kirkwood, John. “Buyer Power and Healthcare Prices.” Washington Law Review, 2015.
[34] Carter, Terry. “Tort Reform Texas Style.” ABA Journal, 2006.
[37] 2016 data from CMS indicates that America spent $665B on physicians; 665*.14 = $93B, and it’s certainly higher today. Reschovsky and Cynthia B. Saointz-Martinez. “Malpractice Claim Fears and the Costs of Treating Medicare Patients: A New Approach to Estimating the Costs of Defensive Medicine.” Health Services Research, 2018.
[38] Reisman, Miriam. “EHRs: The Challenge of Making Electronic Data Usable and Interoperable.” Pharmacy and Therapeutics, 2017.
[39] Adler-Milstein, Julia and Eric Pfiefer. “Information Blocking: Is it Occurring and What Policy Strategies Can Address It?” The Milbank Quarterly, 2017.
[40] Feldman et al. “The State of Data in Healthcare: Path Towards Standardization.” Manuscript, 2018.
[42] Gawande, Atul. “The Cost Conundrum.” The New Yorker, 2009.
[43] Iorio et al. “Early Results of Medicare’s Bundled Payment Initiative for a 90-day Total Joint Arthroplasty Episode of Care.” The Journal of Arthroplasty, 2016.
[44] Preston et al. “Bundled Payments for Care Improvement in the Private Sector: A Win for Everyone.” The Journal of Arthroplasty, March 2018.
[48] Colla, Carrie and Elliott Fisher. “Moving Forward with Accountable Care Organizations: Some Answers, More Questions.” JAMA Internal Medicine, April 2017.
[49] Kim et al. “A Direct Experience in New Accountable Care Organization: Results, Challenges, and the Role of the Neurosurgeon.” N13% of health care expenditures eurosurgery, April 2017.
[50] McWilliams, J. Michael. “Changes in Medicare Shared Savings Program Savings from 2013 to 2014.” JAMA, October 25, 2016.
[51] Bleser et al. “ACO Quality Over Time.” The American Journal of Accountable Care, March 2018.
[52] Total Medicare expenditures in 2017 were $702; excluding part D prescription drug payments yields $602B. See: Cubanski, Juliette and Tricia Neuman. “The Facts on Medicare Spending and Financing.” KFF, Jun 22, 2018.
[53] Non-drug Medicaid spending in 2017 was around $520B. See: “Rudowitz, Robin and Allison Valentine. “Medicaid Enrollment and Spending Growth: FY 2017 & 2018.” KFF, Oct 19, 2017.
[54] Maciosek et al. “Updated Priorities Among Effective Clinical Preventive Services.” Annals of Family Medicine, 2017.
[55] Chatterjee et al. “Checkup Time: Chronic Disease and Wellness in America.” Milken Institute, 2014.
For-Profit College Incomes Should Mirror Student Outcomes
Joe|October 29, 2018
Many for-profit colleges, like many publicly funded community colleges, are failing American students. The best way to improve higher education is to harness entrepreneurial innovation, aligning incentives so that for-profit colleges earn financial rewards only if they help students succeed in the American economy.
Our Western framework of property rights and other freedoms rewards entrepreneurs who succeed in bringing people together to execute clever ideas about how to serve others. The way to harness entrepreneur-driven innovation at the college level — a major step towards broader education reform — is to ensure that for-profit colleges have their profit incentives aligned with students’ success. If we carefully tethered for-profit college profits to the future salaries of students, higher-education entrepreneurs with students’ interest in mind would be allowed in to compete and revolutionize education, resulting in more high-paying jobs and greater career success for millions of students.[1]
American for-profit colleges (FPCs) have an abysmal record of preparing students for successful careers. Lured into enrolling by flashy billboard advertisements and cheap loans, FPC graduates are less likely to be employed and face lower earnings than their public-school counterparts.[2] As a consequence, 52% of FPC students buckle under the weight of their student loans (vs. 13% of public school students).[3] Meanwhile, 2.5 million STEM jobs will go unfilled in 2018, and millions of students are being steered into frivolous Bachelor’s and Associates of Arts degrees instead of trade schools and vocational training programs.[4][5][6]
Federal government student loans account for at least 70%, and often up to 90% of for-profit college revenues, but our government does little to ensure that FPC executives are motivated to do what’s best for the country. [7][8] In fact, the federal government often richly rewards FPCs that underperform their peers. Take, for example, the following pair of for-profit colleges:
Data collected from 2018 10K statements and New York Times Upshot data on student outcomes*
Although Grand Canyon University was extraordinarily more profitable than Strayer University on a per student basis, its students earned only marginally higher salaries and were less upwardly mobile than lower-income students at Strayer University. This is a completely unacceptable outcome. Instead, Secretary DeVos should combine the best features of free markets and Obama-era gainful employment regulations in the form of a scalar rewards policy in which FPC profits increase in lock-step with the real salaries of their graduates.
One strategy for aligning for-profit colleges with the career success of their students is to introduce what we call a “synthetic income share agreement”. Whereas in a traditional “income share agreement”, the government would loan money to students in return for a stake in their future income, we propose that the federal government grant money to FPCs proportionate to the salaries of their past graduates.
A grant to an average FPC could be around 105% of the last year’s outlay. Assuming a normal distribution, a school whose graduates perform a standard deviation above the mean would receive 139% of last year’s funding; a school whose graduates perform two standard deviations below the mean would receive 57.5% of last year’s funding, etcetera.
A scalar rewards model would unleash all the positive forces of capitalism, forcing board members, administrators, and educators to focus on producing high-earning students. Top financial analysts and investors would intensely scrutinize emerging signs and data to determine what coursework is working and help successful schools grow much more rapidly than they could as government sponsored or non-profit entities. Finance can be enormously destructive when at odds with the interests of our communities, but aligning brilliant financial minds towards the career success of our young people will advance education in ways that we can scarcely imagine.
In this new, competitive system, schools like Grand Canyon and Strayer would have to innovate rapidly or die. They would try out various approaches such as:
· Addressing quantified skills gaps by focusing on professions such as vocational nursing, K-12 education, and construction — and teaching work-ready skills.
· Partnering with large corporations in need of new recruits; using industry certification programs to communicate with potential employers instead of traditional credentials; developing databases of regional businesses and their hiring needs. [9] Most mid-to-large companies would love dedicated recruiting programs, but do not currently have them.
· Offering classes in the evenings when continuing-education students such as single moms and full time workers can actually attend them. Today, 30% of undergraduates in America are over the age of 25, and 25% of full-time college students are also working full-time.[10]
· Tinkering with the ratio of online educational material to focused physical classroom time or 1-on-1 mentorship sessions; conducting prior learning assessments; concentrating classes into 8-week vs. 16-week terms and seeing what gets results and is profitable for all involved.
Schools would independently test which strategies work for them, with marketplace competition determining what scales and succeeds. As in any other capitalist system, solutions for particular student demographics and geographical regions will vary, and the blend of educational techniques employed will fluctuate in real-time in response to changing labor market conditions. Private sector educational institutions, which are more nimble and adaptable than public schools, are ideally situated to swiftly respond to the automation of inefficient industries and the introduction of new forms of labor.
One objection to our proposal is that colleges and universities will naturally be incentivized to cherry-pick students from wealthy families, who are more likely to earn higher salaries after college. Policymakers could adjust for these types of effects by adjusting funding to schools with a regression that accounts for parental income in cases where students’ parents are socio-economically challenged. Thus, in the example above, adjusting median graduate income for the median family income of students would likely make Strayer University more profitable per student than Grand Canyon University. Policymakers will have to refine their funding calculus to account for this objection and others as they strive to implement a fair, bipartisan education policy.
Education in America will continue to be suboptimal until it reinforces the pillars of liberty, open innovation, and good profit upon which Western Civilization rests. The only major education reforms worth supporting are those that enable entrepreneurial educators to compete, experiment, and innovate to better prepare students to succeed in the labor market — scaling the ideas that work and eliminating the schools that do not. To address the shortcomings of our education system we must hew to the liberal, bottom-up policy frameworks that make our country great, and reforming for-profit colleges is one obvious place to start.
8VC is a San Francisco based venture capital firm investing in industry-transforming companies. For more information, or to sign up for our newsletter visit www.8vc.com
Grand Canyon University recently converted to a non-profit, but was a for-profit college at the time of 10k filing.
[1] Approximately 2.5 million STEM jobs will go unfilled in 2018. See: Smith, Lamar. “To fill STEM jobs, federal programs need to focus on results.” Committee on Science, Space, & Technology. December 20, 2017.
[2] Cellini, Stephanie and Nicholas Turner. “Gainfully Employed? Assessing the employment and earnings of for-profit college students using administrative data.” NBER, 2018.
[3] Scott-Clayton, Judith. “What Accounts for Gaps in Student Loan Default, and What Happens After.” Brookings, June 21, 2018.
[4] Smith, Lamar. “To fill STEM jobs, federal programs need to focus on results.” Committee on Science, Space, & Technology. December 20, 2017.
[5] Schneider, Mark and Matthew Sigelman. “Saving the Associate of Arts Degree.” AEI,
[6] McCarthy, Pat. “Leading Practices for the State’s Secondary Career and Technical Education Programs.” Office of the Washington State Auditor. December 19, 2017.
[7] Kelchen, Robert. “How much do for-profit colleges rely on federal funds?” Brookings, 2017.
[8] Cellini, Stephanie Riegg. “For-profit higher education: an assessment of costs and benefits.” National Tax Journal, March 2012.
[9] Monroe Community College in Rochester, NY has begun using this database model. See: Alvarez, Joshua. “The Twelve Most Innovative Colleges for Adult Learners.” Washington Monthly, October 2017.
End-Stage Renal Disease (ESRD), or kidney failure, afflicts more than 660,000 Americans a year and is growing at an annual rate of 5%.[1][2]While waiting for a transplant or living indefinitely without one, nearly half a million patients are on dialysis, an onerous treatment that siphons blood from the patient, filters it in an external machine, and then cycles it back into the patient’s body. Dialysis is an unpleasant, emotionally exhausting process, which typically involves three separate 4-hour visits to a clinic every week. At a government-negotiated price of $232.37 per treatment and a private-payor price of over $4,000 per treatment, it is also extremely costly.[3] Medicare spends nearly $35B per year on dialysis treatments alone, representing fully 7% of total Medicare expenditures.[4],[5]
The American dialysis industry hit an inflection point in 1972, when President Nixon signed a law that required Medicare to cover dialysis treatment for any American suffering from kidney failure, regardless of their insurance coverage. In the 1970s and 1980s the dialysis market consisted exclusively of small, privately-owned nephrology clinics. However, in the 1990s, two companies — DaVita and Fresenius — began packaging kidney drugs such as Venofer and Zemplar in unnecessarily large quantities, pushing doctors to overprescribe kidney medicine that was often thrown away, and thus overbill Medicare.[6]
Ultimately the government issued a warning to patients asking them to double-check prescription amounts with their physicians. A storm of negative PR forced DaVita and Fresenius to discontinue their fraud (DaVita later paid $450 million to settle a whistleblower lawsuit), and prescription quantities fell by a full 75%.[7] Bruised but not beaten or deterred, DaVita and Fresenius used their ill-gotten cashflow to launch a wave of consolidation, buying up many dialysis clinics in the country. Market dominance allowed the two giants to dictate the prices of inputs such as medical devices and buy out major manufacturers of dialysis machines.
In the 2000s DaVita and Fresenius embarked on a series of illegal schemes to boost their earnings including charging the government for unnecessary blood tests and paying kickbacks to physician groups for patient referrals.[8][9] Most recently, the duopoly used one of the largest nonprofit groups in the nation, the American Kidney Fund, to cover premiums for privately insured payers and encourage low-income patients to switch from government provided healthcare to private insurance.[10][11] Since private insurance is 17x as profitable as public reimbursement, analysts estimate that this scam was responsible for 30–45% of the giants’ annual pre-tax income.[12]
Today DaVita and Fresenius control 70% of the dialysis market, roughly 35% each.[13] DaVita has experienced truly explosive growth over the past two decades, climbing from a market cap of $724M to over $12.6B today.[14]Together, these corporations received $11.4B Medicare dollars last year, and did nearly $2B in after-tax profit.[15][16]
Of the remaining $22.6B paid out by Medicare last year, we estimate that roughly $5B went to DaVita and Fresenius’ smaller competitors, and the remaining $17.6B went to hospitals and other healthcare providers that typically own stakes in dialysis clinics and provide healthcare services.[17]The provider half of the market is extremely fragmented and regionalized, but DaVita and Fresenius’ unsavory maneuvers enable hospital and nephrology clinic partners to profit as well.
The cost of a broken dialysis industry is measured not merely in payor dollars but in human lives. DaVita and Fresenius have little incentive to introduce cheaper, more effective treatments, and consequently the United States has one of the highest kidney failure mortality rates of any industrialized country.[18] Mega-chain dialysis centers have far higher mortality rates than nonprofit dialysis centers — 19% higher at Fresenius facilities, and 24% higher at DaVita facilities, respectively.[19] Patients routinely complain about filthy dialysis facilities, and incompetent nursing staff. As many as 47% of dialysis patients are depressed or suicidal, which is orders of magnitude larger than CKD patients who are not on dialysis.[20][21]
America needs to drastically rework the incentives structure for CKD healthcare providers so that DaVita and Fresenius are encouraged to innovate and deliver cheaper services. We are optimistic about the introduction of “bundled payments” — capitated payments for complete treatment of a condition rather than for each individual service — which force dialysis clinics and drug manufacturers to internalize costs. To save money, providers are now using cheaper drugs such as Triferic (an iron booster) instead of Erythropoiesis Stimulating Agents (hormonal drugs which cause bone marrow to produce more red blood cells).[22] The jury is still out, but value-based care may decrease Medicare expenditures by incentivizing mega-chains to build holistic, preventative treatments around personalized medical data.
We need to fundamentally realign economic incentives so that CKD healthcare providers are rewarded for screening at-risk patients and intervening to prevent progression towards ESRD. Currently, the medical definition of “pre-dialysis screening” is any screening at least 3 months in advance of a dialysis treatment.[23] This is an absurd benchmark. Real preventative treatment such as weight loss, dietary changes, and the introduction of angiotensin-inhibitor medication must take place years in advance to make a difference. Today only 25% of patients have been followed by a nephrologist for at least a year before they reach end-stage disease.[24]
Universal coverage of dialysis treatment creates moral hazard by dis-incentivizing healthcare providers from attempting preventative treatments. Only by rewarding providers for prevention can we bring about real clinical change. One exciting model for preventative treatment is Medicare’s Diabetes Prevention Program (DPP), which reimburses providers for lifestyle interventions that meet certain criteria (education, coaching, check-ins) and achieve weight loss in patients at risk for diabetes. DPP programs have achieved an average of 5% weight loss for participants, directly reducing their chance of developing diabetes and saving Medicare $2650 per patient per 15 months.[25] Reimbursements are available to traditional health care providers or more innovative programs on mobile health apps.
Finally, Medicare must revise policy so that providers treating chronic kidney disease are similarly incentivized to engage in real preventative care. In this mold, Kaiser Permanent conducted an experiment which assigned nephrologists to give physicians advice on how to test and advise Hawaiian patients with early-stage CKD. Kaiser’s experiment successfully reduced the number of patients who progressed to more advanced stages of the disease.[26]
Of course, preventative treatment isn’t a complete panacea. In the case that a patient progresses to ESRD and needs dialysis to stay alive, insurers and healthcare providers should encourage patients to pursue in-home dialysis over in-clinic dialysis at DaVita or Fresenius. Successful in-home dialysis requires that providers carefully teach patients how to self-administer treatment, a network of nurses to visit these patients, and tools for patients to report statistics on their blood composition. But in-home dialysis possesses many advantages over in-clinic dialysis: it is up to 5 times cheaper, is favored by most nephrologists, and is less stressful for patients.[27] In addition, haemodialysis nurses report higher job satisfaction and lower burnout rates in an in-home environment.[28] As you might expect, DaVita and Fresenius strongly discourage patients from pursuing this cheaper option.
We must shift market incentives so that payors and healthcare providers make money by experimenting with new strategies and technologies for treating chronic kidney disease rather than by allowing patients to accelerate to a government-covered terminal condition. Only a framework in which the best ideas win and spread through market forces — in which the market is aligned to lower costs and better outcomes with solutions such as value-based care — will ensure that Americans are able to secure the kidney care they need. In the case of chronic kidney disease, cheap, effective care is quite literally a matter of life and death.
8VC is a San Francisco based venture capital firm investing in industry-transforming companies. For more information, or to sign up for our newsletter visit www.8vc.com
[1] “End Stage Renal Disease in the United States.” National Kidney Foundation, 2015.
[2] “Statistics” The Kidney Project, UCSF Department of Bioengineering and Therapeutic Sciences. 2014.
[3] This is standard Medicare reimbursement; the figure is much higher for private insurers.
[6] Pollack, Andrew. “Lawsuit Says Drugs Were Wasted to Buoy Profit.” New York Times, July 25, 2011.
[7] “DaVita to Pay $450 Million to Resolve Allegations That it Sought Reimbursement for Unnecessary Drug Wastage.” Department of Justice, June 24, 2015.
[8] Freudenheim, Milt. “Dialysis Provider to Pay $486 Million to Settle Charges.” New York Times, Jan. 20, 2000.
[9] Osher, Christopher. “DaVita to Pay $389 Million to Settle Anti-Kickback Investigations.” Denver Post, October 22, 2014.
[10] Thomas, Katie and Reed Abelson. “Kidney Fund Seen Insisting on Donations, Contrary to Government Deal.” The New York Times, December 25, 2016.
[15] See Fresenius Form 20-F for year ending in December 31, 2017, and DaVita 10-K for year ending in December 31, 2017.
[16] Shinkman, Ron. “The Big Business of Dialysis Care.” New England Journal of Medicine, June 9, 2016.
[17] Extrapolating from the fact that DaVita and Fresenius control only 70% of their market, the other 30% controlled by their smaller competitors would proportionally receive about $5B. Then, $34B minus $16.4B yields $17.6B.
[18] Fields, Robin. “God Help You. You’re On Dialysis.” The Atlantic with ProPublica, December 2010.
[21] Jong et al. “Prevalence of depression and suicidal ideation increases proportionally with renal function decline, beginning from early stages of chronic kidney disease.” Medicine, November 3, 2017.
[22] Charnow, Jody. “How ‘Bundling’ Changed Dialysis Care.” Renal and Urology News, March 2, 2017.
[23] Quaglia et al. “Early Nephrology Referral: How Early is Early Enough?” Archives of Internal Medicine, 2011.
[24] Lee et al. “Effects of proactive population-based nephrologist oversight on progression of chronic kidney disease: a retrospective control analysis.” BMC Health Services Research, 2012.
[26] Lee et al. “Effects of proactive population-based nephrologist oversight on progression of chronic kidney disease: a retrospective control analysis.” BMC Health Services Research, 2012.
[27] McFarlane et al. “Cost savings of home nocturnal versus conventional in-center hemodialysis.” Kidney International, 2002.
[28] Hayes et al. “Work environment, job satisfaction, stress and burnout among haemodialysis nurses.” Journal of Nursing Management, 23.5, 2013.
Align Incentives to Solve Recidivism
Joe|May 15, 2018
With a prison population of 2.3 million inmates, the United States has the highest incarceration rate of any country in the industrialized world. On the face of it, housing one quarter of the world’s prison population costs America $80 billion a year.[1][2] But in fact America’s incarceration nightmare represents a true opportunity cost of hundreds of billions of dollars a year, and unnecessarily devastates many of our most vulnerable communities. A major problem is that prisons are incentivized to “warehouse” prisoners rather than provably reintegrate them into society. A competitive, market-based rewards system for private prisons would encourage talented entrepreneurs to help convicts into society in compassionate, effective ways and allow the very best rehabilitation strategies to spread.
The US incarceration rate multiplied by 700% between the 1970s and the present as America abandoned rehabilitative models of criminal justice for more punitive responses. This surge in convictions was partially precipitated by a global crime wave in the 1980s. But the incarceration rate has remained extraordinarily high even though the crime rate has decreased 45% since the early 1990s.[3][4][5]
[6]
To tackle prison overpopulation our country must address a host of issues including aggressive public prosecution, the failure of the war on drugs, exorbitant sentencing guidelines, and the fact that 94–97%[7] of charged criminals opt for plea bargaining over a jury trial. But one obvious strategy for decarceration is to reduce the recidivism rate, or the rate at which criminals reoffend and wind up back in prison. We need to shift from a “custody” model of detention to a “treatment” model. Private prisons, properly incentivized, may be the answer.
Today 8% of U.S. prisoners are currently detained in private prisons (though disproportionate press coverage would lead one to believe that the figure is much larger).[8] The largest private prison operations today are CoreCivic (formerly the Corrections Corporation of America) and the Geo Group, which have achieved a duopoly over the private prison market.
Private prisons gained a poor reputation as early as the late 19th century for subjecting prisoners to barbaric treatment and lax security, but today private prisons are roughly as humane as public prisons.[9] Evidence as to whether private prisons are better than public prisons at reducing recidivism is inconclusive, and a meta-analysis found that private prisons even cost about the same as their public counterparts.[10][11][12] The central problem is that private prisons, like public prisons, are payed on a per-diem/per-prisoner basis. Under this statutory regime, “privatization can come to resemble an exercise in who can better pretend to be a public prison.”[13]
We propose that private prison contracts tie financial incentives to performance measures such as reducing inmate recidivism. If entrepreneurs were given clear lanes to erect new private prison businesses and explicitly incentivized to reduce recidivism, they would experiment with new modes of rehabilitation to find the best ways to reintegrate convicts into society. Operating in a more competitive, transparent environment would force private prisons to rapidly innovate and develop new techniques for rehabilitating the maximum number of prisoners. Private prisons could escape their legacy of mediocrity and brutality by embracing this new mandate.
The first country to experiment with this model was the United Kingdom, which raised a social impact bond in 2010 to fund a rehabilitative program for short-term inmates at a private prison in Peterborough.[14] On this model, investors in the bond were rewarded on the condition that Peterborough Prison reduced the frequency of reconviction events by more than 10% relative to a public prison control group. Investors partnered with the prison to supply paid caseworkers, specialist practitioners, gym volunteers from nonprofit organizations such as the YMCA, and other 3rd parties. These workers engaged in a pragmatic, flexible style of relationship-based therapy, and successfully reduced the recidivism frequency by 11% even while recidivism frequency rose 10% in the control group (2010–2014). Similar programs have been piloted in Massachusetts, New York, Australia, and New Zealand.[15][16][17] These projects are only the beginning — in an evolving market framework the most refined, effective prisoner rehabilitation programs could eventually scale to deliver recidivism reductions on the order of 50% or more.
There are a variety of ways to set up an incentive structure aimed at reducing recidivism. We favor rewarding private prisons with a combination of financial payouts and new inmates to replace the old inmates who will not return to prison. The contract could replace traditional per-diem/per-prisoner rewards with scalar incentive payments that vary with the percentage of the inmate population that doesn’t reoffend over some period (e.g. 2 years). Another possibility is to reward the prison with a flat bonus such as $11,000 per rehabilitated prisoner,[18] or to make upside for prison staff contingent on running successful programs and spreading ideas that work.[19] Many state legislatures explicitly encourage pay-for-success models, and these states should begin experimenting immediately.[20]
Private prisons should only house inmates who will be released in a relatively short time period (e.g. <5–10 years). Prisoners sentenced to life or virtual life would not be eligible for rehabilitation, and it would be unfair to force a private prison to house a convict for whom they have no expected financial upside.[21] Each private prison’s population should be compared against a representative, comparable population in a private prison, or against historical re-offense rates. As a safeguard against mistreatment, prisoners could be allowed to opt out of the private prison and into public prison every 6 months, and would be able to express their grievances in public fora.
Operating in a more competitive, transparent environment would force private prisons to rapidly innovate and develop new techniques for rehabilitating the maximum number of prisoners. Private prisons could escape their legacy of mediocrity and brutality by embracing this new mandate.
Strategies for reducing recidivism are virtually endless — the challenge is to create incentives to make sure the best ideas are documented and spread. We strongly believe in the value of prison-work programs where inmates receive either pecuniary or in-kind rewards — for instance better food, more time in the prison yard, better access to books, and more.[22] Educational programming, employment programming, cognitive behavioral therapy (CBT), chemical dependency treatment, sex offender treatment, mental health interventions, domestic violence/family life programming, and prisoner re-entry programs are all time-honored methods for helping convicts reintegrate into normal American life. [23][24][25]
One successful example is the Texas Prison Entrepreneurship Program (PEP), a selective MBA-style educational program for inmates who demonstrate work ethic and a desire to take charge of their own lives.[26] Another is “Code.7370,” a 6-month program at San Quentin Prison which teaches eligible inmates how to develop websites.[27] Graduates of these programs have recidivism rates of only 7%![28]
Programs with no selection bias have also been highly successful. In Saskatoon, Canada a sexual offender treatment program used cognitive behavioral therapy to treat male sexual offenders between 1981 and 1996. In a comparison of 296 treated and 283 untreated offenders, only 14.5% of the treated group reoffended vs 33.2% in the control group.[29] In Hillsborough County, Florida, 18,000 domestic violence offenders were subjected to a tiered treatment program from 1995–2004. The program reduced domestic violence recidivism to 8.4% vs 21.2% in the control group.[30]
As these examples illustrate, the main challenge is not discovering what the best ideas are, it is crafting a market mechanism that rewards innovators for iterating on different holistic treatment regimes until they achieve the lowest possible recidivism rates. The fundamental problem with American criminal justice is not a lack of good ideas, it’s the system itself. We need to literally create a marketplace of ideas — a bottom-up, competitive arena in which the best ideas win. If we reward innovations which demonstrably reduce America’s prison population, bright entrepreneurs will deploy their talents to fix our broken prison system.
Regulators should supercharge this new competitive market by lowering regulatory barriers to entry, which will force CoreCivic and the GEO group to innovate just as intensely as their nimbler competitors. Relationships with state legislatures and regulatory bodies should not be enough for these giant corporations to win procurement contracts. In the medium-term, we hope that the industry will evolve to become more diverse and competitive. In the long-run, we envision a system where transparent, compassionate private prisons have become so successful at rehabilitation that they have replaced public prisons as the dominant mode of incarceration in the United States, and would continue to compete to successfully reintegrate former prisoners into their communities.
Though we’re excited by the prospects of rewiring the private prison market to solve America’s incarceration problem, we recognize that challenges for American criminal justice remain. In his seminal essay on the “prison-industrial complex”, Eric Schlosser wrote that we are fighting an establishment
…composed of politicians, both liberal and conservative, who have used the fear of crime to gain votes; impoverished rural areas where prisons have become a cornerstone of economic development; private companies that regard the roughly $35 billion spent each year on corrections not as a burden on American taxpayers but as a lucrative market; and government officials whose fiefdoms have expanded along with the inmate population.[31]
Dismantling this complex of special interests — which also includes prison guard unions and aggressive, careerist public prosecutors — will be difficult. Fortunately, prison reform is one of the few truly bipartisan issues in our nation today. Harnessing America’s brightest entrepreneurial talent to heal inmates and reduce recidivism could be a powerful antidote to America’s prison crisis.
