2004, Volume 07, Issue 3

Attempting to Control Health Care Costs—Again

Consumer Driven Health Care Plans and Health Savings Accounts 

Frieda Gehlen, MA, MBA, PhD, and David M. Smith, MA, PhD

This is the “open enrollment” period for many companies—the time when employees select their health care plans from the options offered by their employers. It is also a time that often generates mixed emotions for the management personnel who have put together these options—relief that they have been able to negotiate coverage for employees (including themselves) for another year, but frustration with what seem to be uncontrollable cost increases.

Health coverage is also a matter of considerable concern to employees. The three largest strikes and/or lockouts in 2003, accounting for about 75 percent of all workers involved in such work actions that year, all involved disputes over health care coverage as employers attempted to shift more of the burden of paying for health care to employees.[1]

There was a period of relative quiescence in the rate of health care inflation between 1993 and 1999 when health care costs grew more slowly than did the overall economy, although still faster than the general rate of inflation. Since then the rate of health care inflation has again accelerated, and health care costs continue to outpace general inflation. For example, in 2002 spending on health care increased 7.7 percent while overall inflation in that year was 2.4 percent.[2] The percentage of Gross Domestic Product (GDP) devoted nationally to health care has risen from 5.1 percent of GDP in 1965 to 14.1 percent in 2001.[3]

What is happening? And, perhaps, more immediately pressing, is there anything a business can do to control health care costs so that there is still money available for research and development, pay raises, marketing, and other business needs?

It is our contention that rising health care costs are a societal problem, not just a business issue. Currently businesses provide insurance coverage for 63.4 percent of nonelderly adults in the U.S.[4] However, businesses cover less than 50 percent of the total population, with the remainder uninsured or covered under public programs such as Medicare. To understand the situation of businesses and what they may or may not be able to accomplish in terms of cost control, it is important to consider the broader issues as well as specific business options. Therefore, we will first briefly outline the factors that health care economists point to in order to explain rising costs in this market. Second, we will cover the most recent attempts at containing health care costs. Finally, we will introduce an emerging option available to employers and employees—Consumer Driven Health Plans (CDHPs).

Cost Drivers

Population shifts in and out of different types of health plans, profit levels, and the degree of competition among health care providers and insurance companies can all induce short-term cycles in health care premiums for a given company or industry. In the long-run, there is one clear driver for the upward trend in health care costs: technology. Under “technology” we include drugs based on high tech research as well as gene therapies. While new imaging technologies, joint replacements, organ transplants, drugs that can control various chronic diseases, new surgical techniques, fertility treatments, and many other medical advances make life much better for many people, they are expensive. In addition, shifting demographics are at work. We use more health care as we age, and the average age of the population is increasing.

In most industries, an increase in technology often leads to falling prices, the computer hardware industry serving as a case in point. However, in the medical industry, innovation is often met with such a dramatic increase in demand by patients and doctors for services and procedures that overall costs increase. Several reasons may explain this increased demand. First, a technique that might have been developed for one application, e.g., caring for heart attack patients, can now be applied to all at risk patients. For example, it is now common for patients to have angioplasty or bypass surgery before they experience a heart attack. Second, new medical technologies tend to be less invasive and have fewer side effects than do prior methods. These declining risks have led to more people seeking medical treatment. Some medical innovations do reduce costs on a per patient basis. One example is the use of laparoscopic surgical procedures, which dramatically reduce the length of hospital stays compared with stays following more invasive surgery. However, health economists conclude these “supply-side” benefits are swamped by the effects of increased demand, thereby leading to higher overall costs.

One additional factor that deserves mention is the increased use of direct-to-consumer marketing by drug companies, a practice that has been associated with increased demand for expensive name brand drugs.[5]

Markets for new health technologies continue to expand, particularly in the United States. The outlook for the U.S. is continued growth in health care expenditures of 4 percent or more per year on a per capita basis. Shifting demographics may push this figure higher as the population ages.[6] Employers and the governments will be searching for mechanisms to contain costs for the foreseeable future.

Cost Containment Attempts

There have been several attempts to control costs during the past two decades.

Managed Care

Introduced in the 1980s on a widespread basis, Health Maintenance Organizations (HMOs) and Preferred Provider Organizations (PPOs) were designed to hold costs down by shifting financial risk to health care providers and health plans and/or by demanding steep discounts on services in return for an increased volume of patients. HMOs also constrained access to expensive specialists. While premium increases moderated for a time, employees complained about the limitations on their choices for care and about having to go through a “gatekeeper” for referrals to specialists. With unemployment very low in the mid-to-late ’90s, many employers went back to less restrictive plans in order to recruit and keep valued employees.

Health Education and Wellness Programs

It was hoped that “wellness programs,” including increased access to information about healthy lifestyles and appropriate treatments, would lower the demand for health care by keeping people healthier.[7] While such wellness programs are undoubtedly beneficial for those who take part in them, these programs have not managed to slow down significantly the health care inflation rate. Some companies use another form of “education,” which provides employees with a quarterly statement of the actual cost of their health care, including premiums and money paid to providers on their behalf. The thought is that people will spend less if they are aware of the true cost. If this practice does not actually lower what employees spend, at least it may make them more appreciative of the benefit that is provided and of the employer who provides it.

Case Management

Employers are generally experience rated for insurance over a given period of time. That is, costs incurred in one year are reflected in the premiums of future years. Large companies can spread the risk of a few very expensive cases over their total work force so that overall, the premium rate per employee will not be drastically affected by these cases. A small business that has even one or two very expensive medical cases may find itself priced totally out of the market.

Approximately 52 percent of all health care expenditures in 1999 was consumed by only 5 percent of the U.S. population, while the bottom 50 percent of users accounted for a combined total of 3.1 percent of health care costs.[8] The 5 percent who use so much care are the people with major and/or chronic illnesses that require significant medical therapies. Many large employers and health plans have used disease management or intensive case management to provide quality care while trying to control costs for these cases. The data on cost savings are not systematically collected, however.[9]

Reducing Benefits

Many employers have dropped health coverage for retirees who are not already “grandfathered in” by contract, and most other employers are increasing cost sharing for retirees as well as current employees.[10] Since retirees are living longer and using more resources, retiree health coverage has become a significant cost. While eliminating retiree benefits may not lower overall costs of health care to the society, it can lower employer costs. Some employers have negotiated with their unions for different levels of coverage for current and new employees, with new employees receiving fewer benefits and/or less subsidy.[11] Another strategy has been to hire as many part-time workers or independent contractors as possible in order to avoid providing fringe benefits.[12] Some smaller organizations have entirely dropped health coverage as a benefit.

Increased Cost Sharing

Most employers are requiring employees to pay more of the costs by increasing their premiums and/or requiring higher deductibles and co-pays. Deductible amounts have not kept up with general inflation, let alone health care inflation, over the past 30 to 40 years.[13] Tiered prescription drug plans in which co-pays for name brand prescriptions may be double or triple the co-pay for the generic equivalent are now common. Some plans have added an additional tier for so-called “lifestyle drugs” such as Viagra.

A variation on this theme is to require employees to pay a percentage of the actual cost of services or drugs rather than a flat co-pay amount. This practice may encourage employees to choose less expensive options when such are available, at least if they know ahead of time what the costs will be.

In a related vein, Anthony Enthoven[14] has long advocated that employers should provide a single subsidy per employee or family based on some percentage of the least expensive option. The employee who opts for a more expensive plan would have to pay the entire difference between the cost of the plan he or she chooses and the amount of the company payment for the least expensive plan.

“Consumer Driven” Health Plans

Enthoven’s idea is one form of a defined contribution plan rather than a defined benefit plan. Some people are now pinning their hopes for health care cost control on another version of defined contribution health plans variously called consumer driven or consumer directed plans (CDHPs). These plans are similar in concept to the Health Savings Accounts (HSAs) that were authorized by the Medicare Act that was passed in December 2003. In fact, some employers may use HSAs as the vehicle for a CDHP. Both versions of these plans involve combining a high deductible catastrophic insurance policy with a tax advantaged medical savings account that would be used to pay for medical expenses until the deductible amount was expended.

Under both concepts, covered individuals contribute at least half of the amount in the savings account from their own money. These accounts are then used to pay for medical costs until the deductible is met. Unlike current Flexible Spending Accounts, medical savings account money that is not used in one year would remain in the account for future needs, so the individual has an incentive to spend wisely.

Individuals covered under these plans pay the actual cost of their care until the deductible is met—not a co-pay or small percentage. It is thought that market forces will make these individuals more cost conscious consumers who do a cost-benefit analysis when considering health care. That is, if they are spending their own money, individuals should be less likely to opt for medical care that is not really necessary, including some high cost screenings that may not offer much new information or expensive prescription drugs that do little more than over-the-counter medications. Of course, to be able to make this kind of assessment necessitates readily available and accurate real time information on costs and quality. Many people question whether making that information readily available is realistic.

CDHPs

Although relatively new, commercial consumer driven health plan designs for employers already vary considerably. It is therefore risky to generalize very much. As noted above, the plans involve a high deductible insurance policy with a health spending account, widely referred to as a Health Reimbursement Account (HRA). Employers fund the HRA to some level (e.g., half of the deductible amount). Employees fund the remainder with deductions from pre-tax income. The cost of the insurance premiums might be paid by the employee or split between the employer and employee. Some plans include low cost preventive services that are not counted against the deductible. That way employees will not be tempted to save money by skipping preventive care that might keep them from getting ill and needing more care later. Most insurance policies have a Preferred Provider Network of physicians and hospitals that will offer a discounted price if the patient stays within the network.

Some plans allow individuals to use HRA accumulations to pay for retiree health care or COBRA payments if they retire or are laid off. Under other plans, any money left in the account is forfeited when the employee leaves employment. The accumulated HRA normally would be forfeited if one switched back to traditional insurance. Otherwise employees would be tempted to try to “game the system” by going back to traditional insurance when large medical expenses are anticipated. Employers may choose to manage the savings account funds in-house, thereby allowing the accounts to earn the interest or investment income on unspent money.

HSAs

Health Savings Accounts authorized under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003[15] are more likely to be of interest to small businesses that do not self-insure and that do not offer the range of insurance products that larger businesses do. They may also be of interest to self-employed individuals, those who do freelance work, those between jobs, or early retirees who do not have company provided health care and are not yet eligible for Medicare.

Perhaps the key points for businesses to consider in thinking about HSAs as a CDHP option is that HSAs are actually trusts and that money contributed to an HSA belongs irrevocably to the individual. The business cannot reclaim unused portions. Second, money in HSA trusts cannot be commingled with other types of funds. Third, the law specifies that these trusts should be invested through banks or insurance companies. While provision is made for exceptions, it might be difficult for a company itself to control and invest these funds. Therefore a business that self insures would not likely find HSAs a useful vehicle.

We turn now to some of the arguments made for and against consumer-driven health plans.

Arguments for CDHPs

1. Proponents argue that these health care plans will help control costs because people have to spend a considerable amount of their own money—once the employer’s contribution to the HRA is used—before insurance coverage begins. This provision will give market forces a chance to influence care decisions.

2. Plans that permit employees to retain unused money in the account when they leave employment provide another incentive for careful spending. Therefore employees will seek care only when it is really necessary and will question the use of expensive services or drugs that promise little additional benefit. Consumers may even change to healthier lifestyles to avoid having to pay for health services with “their” money.

3. Plan participants are not limited in their choice of physicians and hospitals by an HMO, thereby removing a major complaint about managed care. PPO networks generally provide a wide choice of care providers. In addition, patients can self refer to specialists, an option not available to true HMO participants.

4. For employers the big benefit is that the employer’s contribution becomes a defined contribution rather than a defined benefit. That is, the employer contributes a fixed amount of money rather than paying a percentage of whatever the premiums may be. Future payment increases can be controlled by the amount the employer chooses to contribute rather than by increases in policy premiums. If as predicted people are careful about how they spend their savings accounts, catastrophic policies would not be used very often, thus helping to keep the cost of such policies stable. However, if premiums do go up, under CDHP policies that require the employee to buy the insurance, the employer is not necessarily obliged to help cover that increase.

5. CDHPs return to the basic idea of “insurance” rather than pre-paid health coverage, thereby encouraging people to plan for routine health care as a personal expense.

Arguments against CDHPs

1. The most frequent argument against CDHPs is that they will attract the “healthy and wealthy,” while those who expect to use a significant amount of care would choose the traditional plans with their lower deductibles. This latter circumstance could raise costs of traditional insurance to the point that it would be completely unaffordable.

2. The kind of information needed to make valid judgments about quality and cost is not readily available. Quality in health care is difficult to measure, and most laypeople would not invest the time necessary to understand the measurements even if data were readily available. Many medical decisions need to be made quickly when there is not time for research and comparisons. Furthermore, there may be a tendency among laypeople to believe that higher cost equals higher quality.

3. CDHPs may encourage people to skip important preventive care in order to save money.

4. CDHPs may limit the financial exposure of employers, but they do so by increasing the exposure to risk of employees—just as switching from defined pension benefits to defined contributions to 401(k) plans has done.

5. These plans are not likely to hold down overall costs to the economy—and maybe not even to employers—given the disproportionate share of costs consumed by such a small percentage of patients.[16] These major costs would not be controlled by CDHPs. That is, the patient with an expensive illness would reach the catastrophic insurance coverage level very quickly. At that point, insurance would pay in the same way it does now.

Final Thoughts

There are cogent arguments on both sides of the issue. As is true of many situations, the future of consumer driven plans may well depend on the details of plans as they evolve. While some employers have expressed a great deal of interest,[17] others do not see such plans as an attractive option.[18]

The health care insurance industry is at a point in its traditional business cycle in which the rate of inflation should moderate for a time. Even if that is the case, however, it is likely to be a temporary respite in the continuing rise of health care costs unless significant new initiatives emerge. One of those initiatives on the horizon is tiered provider networks, a topic which is beyond the scope of this paper.[19]

If there were a real public discussion about the value of health care versus other uses of resources, Americans might consciously decide that an improved quality of life is worth an increasing share of GDP.  However, that discussion is not often heard. Meanwhile, cost control remains the focus. But until Americans confront the real cost drivers—including an inefficient insurance system and the idea that individuals have the right to every medical intervention they wish to use without concern for cost or likely effectiveness—any reprieve in cost increases is likely to be temporary.

[1] “Major Work Stoppages in 2003,” Bureau of Labor Statistics, U.S. Dept. of Labor, http://www.bls.gov/news.release/wkstp.toc.htm, March 19, 2004.
[2] Health, United States, 2003,” National Center for Health Statistics, U.S. Dept. of Health and Human Services, http://www.cdc.gov/nchs/data/hus/hus03.pdf, pg. 10, September 2003.
[3] “Health, United States, 2003,” National Center for Health Statistics, U.S. Dept. of Health and Human Services, http://www.cdc.gov/nchs/data/hus/hus03.pdf, click through to Table 112, September 2003.
[4] Bradley C. Strunk, James D. Reschovsky, “Trends in U.S. Health Insurance Coverage–2001–2003: Supplementary Tables,” Tracking Report #9, Center for Studying Health System Change, August, 2004. http://www.hschange.com/CONTENT/694/?topic=topic14, click through to Supplementary Table 1.
[5] Kaiser Family Foundation, “Demand Effects of Recent Changes in Prescription Drug Promotion,” Health Care Marketplace Project, Publication Number 6085, June 25, 2003. (http://www.kff.org/rxdrugs/6085-index.cfm); Francesca Lunzer Kritz, “FDA on Drug Ads: Less is More,” The Washington Post, February 10, 2004: F01.
[6] Studies show that approximately one-half of all lifetime health care expenditures occur after age 65. (See Berhanu Alemayehu and Kenneth Warner, “The Lifetime Distribution of Health Care Costs,” Health Services Research, June 2004, vol. 39, no. 3: 627-642.
[7] However, the emphasis on wellness coincided with the introduction of advertising of prescription drugs directly to the retail consumer. For many people the choice of watching their diet and exercising versus taking a pill was easy – take the pills. That does not negate the value of these programs, but depending on them to stem the rise in health care costs is probably not realistic.
[8] Kaiser Family Foundation, “Trends and Indicators in the Changing Health Care Marketplace,” (2004 update), Exhibit 1:11, (page 16 of pdf file). (http://www.kff.org/insurance/7031/loader.cfm?url=/commonspot/security/getfile.cfm&PageID=36091).
[9] Ashley C. Short, Glen P. Mays, and Jessica Mittler, “Disease Management: A Leap of Faith to Lower-Cost, Higher-Quality Health Care,” Issue Brief No. 69, Center for Studying Health System Change, October 2003. (http://www.hschange.com/CONTENT/607).
[10] “Survey Finds Increasing Health Costs for Retirees and Continued Erosion of Benefits,” Kaiser Family Foundation, January 14, 2004, Exhibits 2.7 – 2.12 in PDF. (http://www.kff.org/insurance/7031/loader.cfm?url=/commonspot/security/getfile.cfm&PageID=36092).
[11] A key provision of the agreement that ended the Southern California grocery strike, which idled 67,000 workers for 20 weeks, was a two-tiered benefit system. See Debora Vrana and Ronald White, “The Super Market Strike,” The Los Angeles Times, February 27, 2004: C1.
[12] Such a strategy would not lower overall health costs; indeed, it could increase the number of uninsured, already a social problem. In addition, hiring independent contractors on a long-term basis could be legally questionable if these people are actually in positions in which they are supervised by the company.
[13] Deductibles in the 1960s were approximately $100 annually. If the effects of inflation are taken into account, an equivalent amount in 2003 would be over $500. [14] Dr. Enthoven, a Professor Emeritus from Stanford University, has been one of the country’s leading health care economists and policy analysts for many years.
[15] The Health Savings Accounts are authorized under Title 12, Section 223, beginning on page 405 of the PDF version of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (PL 108-173) which may be found at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=108_cong_public_laws&docid=f:publ173.108.pdf.
[16] Kaiser Family Foundation, Trends and Indicators in the Changing Health Care Marketplace. Op. cit supra.
[17] For example, Bill Brewer, “Cutting Costs: Health Savings Accounts Offer New Tools for Workers, Small Businesses to Control Rising Health-care Costs,” Knoxville News-Sentinel (Tennessee), May 2, 2004.
[18] Sally Trude, Leslie Jackson Conwell, “Rhetoric vs. Reality: Employer Views on Consumer-Driven Health Care,” Center for Studying Health System Change, Issue Brief No. 86, July 2004. (http://www.hschange.org/CONTENT/692/).
[19] “Tiered Networks for Hospital and Physician Health Care Services” EBRI, Issue Brief No. 260, August 2003. (http://www.ebri.org/ibex/ib260.htm)

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