THE CURRENT U.S. health care system has many accomplishments to its credit, but it is saddled with serious problems that must be addressed. Costs, many of which are unnecessary, are on the road to levels that cannot be sustained. The health care system has evolved in a way that has produced a two-legged stool. One leg of the stool consists of providers of services, including hospitals, physicians and other practitioners, and insurance companies. Another leg of the stool is composed of those who finance health care, primarily employers and the federal and state governments. Until recently beneficiaries of the health care system had little incentive to evaluate its relative costs from the standpoint of a normal consumer. Instead, they had every incentive to use the system with little restraint because they did not bear a significant part of the costs. For the stool to stand over a prolonged period of time, the provider leg and the financier leg must be joined by a consumer leg. This process has begun, but it has a long way to go.
What does it take to make this third leg, representing the consumer, sturdy? The first step is to ensure that consumers have a significant financial stake in the system and an ability to make informed decisions about their own health care coverage. Competition among insurers is needed to lower the cost of premiums and to properly align coverage with the varying needs of those seeking insurance. This ability to choose can make the consumer an active player in the system with some degree of control. In order to be an effective participant, the consumer must have the ability to make intelligent choices through access to information about costs, quality of care, and outcomes. What is not directly available to the consumer could be available through insurance companies or other organizations. This means that careful thought must be given to ways in which to remove current inhibitions against the provision of information that were established to prevent lawsuits or the invasion of personal privacy. With empowered consumers, competitive markets for providers, and information about alternatives available to consumers, all the elements for a successful health care system—a sturdy three-legged stool—will be in place.
Can competition work as effectively in the area of health care as it does in other industries? Ample evidence exists that the answer is yes, and Michael Cannon and Michael Tanner, economists at the Cato Institute, cite numerous examples to make this point in their book Healthy Competition.1 A dramatic case is the relatively recent emergence of laser eye surgery, a service for which patients pay directly and in which surgeons compete for their business. Cannon and Tanner summarize:
Patients…weigh the costs and benefits of laser eye surgery, a…highly competitive market where prices have fallen dramatically…. The average price for Lasik surgery in 1999 was about $2,100 per eye. Within two years, it had fallen to less than $1,600 per eye. Many patients pay less. The price of refractive surgery dropped even more relative to overall inflation and medical inflation. Were [the numbers] to adjust for quality improvements—a driving factor behind recent price increases—it would show that average prices have fallen even more dramatically. It is also notable that these falling prices occur despite the fact that more than 80 percent of Lasik patients search for an experienced surgeon with a strong reputation, rather than just the lowest price.2
Against this background, what has been happening as employers and federal and state governments, the large financial players, have experienced increasing pressure? Remember, the yearly double-digit growth in the cost of health care is the source of the pressure and many of the problems in the system. Individuals can be priced out of the insurance market, and employers confronted with out-of-control health insurance costs may sharply modify the benefit structure they offer their employees or discontinue health benefits altogether, despite their tax-advantaged status. Pressure on state, city, and federal government budgets can create a sense of urgency about the need for change.
Information
If consumers are to be intelligent buyers, they must have access to information about the prices and outcomes of services they might need. Health care lags behind almost every other category of products on this score. Nevertheless, an explosion of information about diseases, treatments, prices, and outcomes seems to be under way.
Internet and health care entrepreneurs are playing a major part in bringing medical information to consumers, who currently have access to approximately twenty thousand health-related Web sites. About 80 percent of the estimated ninety-five million adult Internet users in the United States have searched for health information online.3 Of them, 42 percent report that their medical searches had an effect on their own or someone else’s health care; another 11 percent said that the information they gleaned had a major impact.4 Physicians are increasingly turning to the Internet for help with research and diagnosis of rare conditions.5 Patients can find Web sites for therapeutic and generic substitutes for brand-name drugs. Other sites provide links and references to local doctors and health care providers who are friendly to Health Savings Accounts (HSAs) and other types of consumer-directed health care.
Some new health care providers offer alternatives to the traditional physician consultation. Small clinics staffed by nurse practitioners are proliferating in pharmacies and large retail stores such as Target and Wal-Mart, where no appointments are needed and information is provided along with minor treatments. Christopher Bowe, in the New York Times on December 6, 2007, notes that “Take Care, acquired this year by the drugstore group Walgreens, estimates it will open one clinic a day and have more than 400 by this time next year. The industry is expected to reach 5,000–10,000 retail clinics in the next few years.”6 This is a development of great importance and great potential for reducing the cost of relatively routine health care and guiding people to less expensive generic drugs. According to Dr. Jerome Grossman of Harvard’s Kennedy School, clinics and similar retail activities are part of an important long-term trend in health care delivery. He notes that “there is growing evidence that a significant majority of physicians’ work could be done more consistently and cost-effectively by technicians under the supervision of physicians and using advanced evidence-based decision support systems.”7
Some health insurers, such as Aetna and Blue Cross of Minnesota, are experimenting with various transparency initiatives that would provide their customers with access to the insurance companies’ actual prices and to quality data on doctors in their area.8 This is an important step if consumers are to make intelligent, cost-effective decisions.
Other examples abound, but significant work remains to be done. Medicare records contain vast amounts of useful price and outcome information that could be made available without revealing patients’ names. Early efforts in this area show that extensive work to resolve privacy and litigation concerns is necessary before this practice becomes widespread.9
The emergence of information on prices and outcomes has been spurred by the empowered consumer and is a critical ingredient in improving health care. It represents an encouraging trend because it means that the consumer leg of the stool, under the pressure of mounting costs, is being strengthened by the diversion of money from providers to consumers. More payments are being made at the point of service. More consumers are gaining greater ability to choose among health providers, fueling the demand for more accurate information about prices, alternatives, and outcomes. Many problems remain, but conceptual breakthroughs, particularly with the expanding authorization of states to experiment with the structure of their Medicaid programs and the emergence of tax-advantaged Health Savings Accounts, open the way to further improvement.
Individual Health Accounts
Somehow, the U.S. body politic has gradually realized that something is missing when expenditures on health have a tax advantage only when they are made through an employer. The scope for individual choice is narrowed, insurance is lost when individuals change jobs, and care in spending is not rewarded. The result has been an evolution of the concept of tax-advantaged individual accounts that has by now come a long distance, even though the journey is not quite completed.
Authorized in 1978 by Section 125 of the Internal Revenue Code, Flexible Spending Accounts (FSAs) are designed to give employees greater control over their tax-free health care spending than they have with traditional employment-based health insurance policies.10 Employees of companies offering FSAs can deduct a certain portion of their salaries to be set aside, tax free, in these accounts. Money in FSAs can be spent on anything from the health insurance deductible on an emergency room visit to a dental appointment to over-the-counter drugs. For example, a hypothetical worker with a salary of $50,000 may choose to send $500 to his FSA, leaving $49,500 in taxable income. This worker can spend this tax-free $500 as he sees fit, as long as it is spent on health care.
The biggest drawback of an FSA is that the money put into it is forfeited if it is not spent by the end of the year, a feature that can lead to wasteful and unusual behavior. Individuals can only guess how much money to put into their FSAs at the beginning of a year. Faced with expiring funds at the end of the year, many purchase items or services they normally would never buy, such as Botox injections, cases (rather than single bottles) of contact lens solution, designer prescription sunglasses, and unnecessary visits to the doctor.
The Health Reimbursement Account (HRA) is a logical extension of the FSA and has been on solid tax footing only since 2002. HRAs have several limitations that FSAs do not have, but they have one dramatic advantage: The balances deposited in them roll over from year to year. If an individual had $300 in an HRA on December 31, the money would still be there on January 1. With an FSA, the money would have disappeared. HRAs, however, are not portable from one job to another; an individual who switches jobs or health plans will forfeit his or her HRA balance. The HRA is similar to a company expense account in which the employee does not have full ownership of the money.
An HRA might work in the following way: A company that would normally spend $3,000 on a worker’s health insurance plan might instead spend $2,500 on a higher-deductible health plan and put $500 into an HRA. The worker could spend the $500 as he or she saw fit as long as it was on health care, such as doctor visits, prescription or generic drugs, or the deductible. If the worker spent nothing on health care during the year, he or she would have $1,000 in his account in the following year (the current $500 would roll over and be combined with the $500 for next year). If the worker were to switch jobs, however, the entire HRA would disappear.
Consider two key observations:
The first point is the main idea behind FSAs and HRAs. The second notion is completely missing from FSAs and is tenuous in HRAs because the HRA balance disappears if a worker changes jobs. Growing out of work by John Goodman at the National Center for Policy Analysis, legislation in 1996 created the Medical Savings Account (MSA). The bill passed only after heated debate and was sponsored by a bipartisan group of senators led by Nancy Kassebaum and Edward Kennedy. MSAs, which were required to be coupled with a high-deductible health insurance plan, were structured like Individual Retirement Accounts. Employers could make contributions to an MSA, and that money could be spent, tax free, on health care. Balances would roll over from year to year and from job to job.
MSAs represented a conceptual breakthrough, but their success was limited by the numerous restrictions placed upon them. For example, only the self-employed or businesses with fewer than fifty employees were allowed to fund MSAs. Deposits into an MSA were limited to 65 percent of the individual deductible and 75 percent of the family deductible of the associated health plan.11 Insurers were not eager to spend money developing products for such a limited market. Because of these drawbacks, the MSA was replaced by the Health Savings Account (HSA).
HSAs, created by the Medicare Prescription Drug Improvement and Modernization Act of 2003, were a more polished and better-constructed version of the MSA and represented a major advance in consumer-directed health care. Proponents of HSAs have put forth several proposals to improve them and remove tax oddities that still exist, but their core concept makes them useful for many Americans.
To qualify for an HSA in 2008, an individual must have coverage under an HSA-qualified high-deductible health plan covering catastrophic—that is, high-cost—illnesses. The annual deductible must be at least $1,100 for an individual and $2,200 for a family, and the total deductible and copayments cannot exceed $5,600 for an individual and $11,200 for a family. Yearly contributions are pretax and cannot be higher than the deductible. Employers or employees can contribute, and the money in the HSA can be spent without tax on qualified medical expenses. Many suggestions have been made to improve HSAs, but in their present form they offer a widely available tax-advantaged system that allows consumers to decide on their own medical expenses and be protected from large outlays by catastrophic insurance. While HSAs are portable, the accompanying catastrophic insurance may not be.12
Strengthening the Consumer Leg in Medicaid and Medicare
The federal government has also taken important actions in the Medicaid field. Section 1115 of the Social Security Act enables states to apply for waivers to change their Medicaid programs in ways that depart from general federal standards. States are applying for waivers to institute a variety of innovative programs from disease management and preventive care to the use of the HSA concept, the classification of recipients according to risk, and the use of funds for private-sector health insurance as distinct from eligibility for benefits.
The federal government’s Deficit Reduction Act of 2005, estimated by the Congressional Budget Office to reduce direct Medicaid spending by $26 billion over the next ten years, expands the costs that states can require Medicaid beneficiaries to pay themselves.13 The maximum level of these shared costs, usually in the form of copayments and deductibles, varies depending on a family’s income in relation to the poverty line. A family with income above 150 percent of the federal poverty line can have more cost sharing imposed upon it than a family under 150 percent of the federal poverty line. The DRA also tightens the rules surrounding eligibility for long-term care and takes a tough stand against abuses of Medicaid through Medicaid planning, which is the spending down of assets in order to qualify for Medicaid.
Two examples of state initiatives to control cost growth and enhance the quality of service are instructive. South Carolina ranks fourth highest in state and local Medicaid spending per resident but forty-seventh highest in health outcomes, according to Governing magazine, a monthly publication whose primary audience is state and local government officials.14 In Florida, 24 percent of the state’s budget goes to Medicaid, and the cost of the program has grown 13 percent per year over the past six years. These states are not unique in their levels and growth rates of Medicaid spending or coverage levels. They do stand out among the states, however, in their proactive efforts to confront the problem.
Under the South Carolina Healthy Connections plan proposed by Governor Mark Sanford, every Medicaid beneficiary would receive a Personal Health Account (PHA). PHAs would be funded by the state’s Medicaid program and would receive money sufficient to purchase health coverage. The amount of money in these PHAs would vary according to an individual’s health history on a basis adjusted for the presumed variations in risk associated with the insured individual. For example, an older individual, who would be expected to have higher health spending, would receive more than a younger individual, and someone with diabetes would receive more than someone without diabetes because his or her expected health care costs would be higher. Risk adjustment makes insurers willing to accept patients with different risk characteristics on an equal basis because they are compensated for the risks by variations in premiums paid.
Medicaid beneficiaries could use the funds in their PHAs to purchase health coverage. Their options would include plans similar to those that employers offer their employees, such as Health Maintenance Organizations (HMOs) or Preferred Provider Organizations (PPOs). Another option would be a catastrophic insurance policy with a high deductible, in which the PHA balance would be used in a way similar to an HSA. Whichever option is chosen, the PHA could be used for the premium, copayments, and any additional health services the enrollee might want to purchase.
Florida has also applied for a waiver under Section 1115 of the Social Security Act to reform its Medicaid system. Florida’s Medicaid reform plan essentially switches Medicaid’s fee-for-service system to a managed care system. Under the reform, a Florida Medicaid enrollee chooses a qualifying plan provided by a Health Maintenance Organization (HMO) or Provider Service Network (PSN), the state of Florida pays risk-adjusted premiums to the plan, and the health care plans pay for services used by the enrollee. Copayments and coinsurance costs cannot exceed those allowed under Florida’s traditional Medicaid plan. Individuals may also opt out of the state Medicaid program and instead direct their Medicaid premium dollars toward a health plan sponsored by their employers.
Florida’s Medicaid reform also allows for the creation of Enhanced Benefit Accounts. Money can be placed into these accounts as a reward for behavior conducive to good health, such as enrolling in a heart disease management plan, and can be used to fund other health expenditures, such as over-the-counter drugs or first-aid supplies. Funds in an Enhanced Benefit Account roll over from year to year.
Many other states have undertaken more focused Medicaid reforms through the use of Section 1115 waivers. An example is Vermont, with its Choices for Care program for elderly Medicaid beneficiaries needing long-term care. Under normal Medicaid rules, the government would pay for a senior’s long-term care in a nursing home, but it would not pay for cheaper and more flexible care delivered in the patient’s home. The commissioner for Vermont’s Division of Disability and Aging Services called this a “crazy situation” in that “the service that people don’t want and is more expensive” is guaranteed by the government while “the service people prefer and is cheaper, isn’t.”15
Vermont’s Choices for Care program improves this situation by allowing Medicaid dollars to be used in more flexible ways. Instead of entering a nursing home, an elderly Medicaid beneficiary can use Medicaid dollars to pay a family member to provide him or her with home health care. This increased flexibility makes beneficiaries happier and has the potential to help the government save money.
A common trend in all these state reforms is that they move away from entitlement to services toward entitlement to a kind of voucher used to purchase services. In South Carolina, the proposed plan creates a Personal Health Account that can be used to purchase a variety of insurance plans. In Florida’s program, instead of being entitled to services paid for by Medicaid, a beneficiary is entitled to a risk-adjusted amount of money that is used to purchase insurance from among several choices that meet criteria set by Florida’s Medicaid program. In Vermont’s program, rather than simply being entitled to nursing home care, a beneficiary is entitled to funds that can be used for long-term care in flexible ways.
Medicare is also moving in this direction through the Medicare Advantage program, an alternative to standard fee-for-service Medicare. Under Medicare Advantage, Medicare beneficiaries can enroll in a number of private-sector health plans, such as HMO plans, PPO plans, private fee-for-service plans, and various special-needs plans. The provider of the health plan receives a risk-adjusted payment from the federal government, and, in turn, the Medicare beneficiary has a private-sector health plan.
Medicare Advantage plans, which have expanded in recent years, now cover nearly seven million beneficiaries.16 With the use of risk-adjusted payments, health insurance companies are increasingly willing to enroll not only healthy individuals but also sick Medicare recipients requiring costly care.17 A patient with complex health problems would be very expensive to the health insurance company providing his or her coverage, but with risk adjustment, the company would receive a larger check from the government.
An interesting example of competition controlling costs and delivering quality service is the case of the Medicare prescription drug benefit. While it is a heavily regulated form of managed competition, the drug benefit has significantly more private-sector involvement and individual choice than traditional Medicare. Instead of a single government plan with a single set of government-negotiated prices, the Medicare drug benefit establishes certain standards and then lets private-sector plans compete against one another for the business of beneficiaries. Costs are controlled by market forces.
As it turns out, the costs of the prescription drug benefit came in far below expectations. The 2004 Social Security trustees report estimated that the benefit would cost $85 billion in 2006 and $93 billion by 2007. In 2006 the actual cost turned out to be just under $50 billion. Expenditures in 2007 are now estimated to be $50 billion. Part of this difference came from slower than expected growth in overall prescription drug prices, but a significant portion came from higher than expected competition among plans. Plan bids in 2006 came in significantly below expectations, and plan bids in 2007 actually decreased 10 percent on average from 2006.18
The structure of the program presents two potentially large problems: adverse selection and moral hazard. Adverse selection can occur if, sick, high-cost seniors migrate to plans with generous formularies and bankrupt them because risk-adjusted payments are insufficient. This would drive plans to compete only for healthy seniors. Moral hazard can occur if, in response to being insured, seniors begin using unnecessary prescription drugs because the drug costs have been reduced (in some cases to zero). At this point these problems have not been overwhelming. In an analysis of the new program, the Nobel laureate in economics Daniel McFadden concludes that, “so far, the Part D program has succeeded in getting affordable prescription drugs to the senior population…. I think it is reasonable to say that the Part D market has performed as well as its partisans hoped, and far better than its detractors expected.”19
Just as federal and state governments have responded to mounting Medicare and Medicaid costs by giving consumers more say about their own health care expenditures, so too have private employers. These employers often find themselves in highly competitive, internationalized markets where prices, and therefore costs, are under heavy pressure. In some cases, health care costs have risen so drastically that some employers—and particularly smaller employers—have been forced to stop offering health insurance. A further result is widespread movement away from plans that provide essentially open-ended specific benefits to plans with deductibles and copayments. In all types of plans, deductibles have been rising; many have more than doubled in the years from 1999 to 2005.20 All these changes point to the emergence of the consumer as an empowered financial player, thereby strengthening the consumer leg of the stool.