Consumers driving change: consumer-directed health plans are here to stay and are growing into a major force in the industry. Insurers must act now to capitalize on the wave of change.

Within an otherwise confusing and overcompromised law, the new Medicare bill--which includes provisions for health savings accounts--has set the scene for a reasonably predictable near-term future for the health-care industry, in terms of the proliferation of consumer-directed health plans and certain first-order structural changes. Long-term issues are unlikely to be faced in earnest until the baby boomers' den]and bulge is felt. With luck, consumer-directed health plans will help the system prepare for a more rational future mediated more directly by consumers.

We see strong demand for consumer-directed health plans. On a practical level, consumer-directed health plans have performed well so far and growth will be spurred by the new regulations for health savings accounts that will almost certainly be extended to health reimbursement arrangements. While there may never be a broad consensus on larger issues, pieces of consumer-directed health plans can help solve some problems. For example, consumer-directed health plans give employers and employees another option against the alarming rate of cost increases. Higher deductibles and copays have run their course and about the only option--without consumer-directed health plans--is a return to restrictive health maintenance organizations.

We believe consumer-directed health plans are here to stay and will be a major force for at least five to 10 years. The question is, what needs to be done to capitalize on the next wave of change?

The health insurance sector faces major change. First, it seems likely that 2004 will start to feel the downward pull of the underwriting cycle. Second, structural change is coming. Adding new products is necessary, but not sufficient. Industry players will need bold-stroke structural moves and should push structural change throughout the operating levels of the enterprise. Lessons from the transition to managed care should not be forgotten, including:

* Find a coherent position in the consumer-directed health plan marketplace. Decide what space to play in and make strategic moves (merger/acquisition/alliance) to build and defend that space.

* In the coming wave of consolidation, potential acquirers/mergers should push for integration, not just consolidation.

* The value proposition will de-emphasize underwriting, overseeing and processing, moving focus toward retail buyers and away from wholesale buyers. For some, this will be uncomfortable.

* Product proliferation makes managing complexity an imperative. Lessons learned by "smart customizers"--companies who align cost-of-complexity with value-of variety--should be applied.

* Cannibalization will continue, but players are better prepared after the transition to managed care and the ebb-and-flow between HMOs, preferred provider organizations and point-of-service plans.

* Providers should have another good year, with their pricing power baked into 2004 already via contracts with large insurers. Providers' greatest challenges are longer term. Although the capital and capacity crises of the boomer bulge are at least 10 years away, leading provider systems will start to plan their strategies now--despite the urgent pressures of various issues du jour.

Government is likely to feel the boomer bulge pain first, because the big bills will start coming in before capacity hits the wall. The problem is so big (socially and economically) that it may be a rare opportunity for public policy to precede a crisis rather than follow it.

For financial services providers, 2004 could trigger quick and decisive action. Debit cards are now fairly common in consumer-directed health-plan design and will continue to be so. But once the new health savings accounts and health reimbursement arrangements are fully portable, a 401(k)-like industry will be created almost overnight, creating large numbers of consumers with tax-advantaged "health-care nest eggs." We expect consumer-owned health reimbursement arrangements to be a fact of life within two or three years.

By 2030, overall demand for hospital beds could rise by as much as 35%--a profound shock indeed, particularly since it will ripple through the long-term-care, homecare, pharmaceutical and insurance sectors of the industry. Within five years, this will be the story in health care, meaning the time is rapidly approaching for leading industry players to start considering their opportunities--while building winning positions in the new world of consumer-directed health plans.

Gary Ahlquist is a senior vice president in the Chicago office of Booz Allen Hamilton. David Knott is a vice president in Booz Allen's New York office. Joni Bessler is a vice president in Booz Allen's San Francisco office. They can be reached at [e-mail].