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Taming health care costs now.

Decades of rising health care costs and failing cost-control efforts have created major headaches for many U.S. businesses and for the country at large. Unchecked increases in health care outlays are diverting resources from other investments--ranging from education and highways to technological development and industrial modernization--that are needed to foster long-term economic growth. Health care accounted for only 5 percent of the gross domestic product (GDP) in the 1960s, but today the figure stands at approximately 14 percent and according to projections by the Congressional Budget Office will reach 18 percent of GDP by the turn of the century. We are thus redirecting resources to health care from other vital activities at the rate of 1 percent of GDP every 20 months.

Business is bearing an especially large share of this rising health care burden. Employers are the most significant payers in the nation's mixed private/public system of finance--designing, purchasing, and operating health plans covering 64 percent of the population. Corporate responsibility has been growing as employers have assumed more of the health care expenses for the families of their employees. An even larger part of the added cost, however, comes from the markup on medical bills by hospitals, physicians, and other health care providers to offset their losses from low government payments for services, bad debts, and charity care. In 1990, for example, corporate health plans paid to hospitals an average of 27 percent more than the actual cost of the care provided, according to the Prospective Payment Assessment Commission, an independent body that reports to Congress. These and other pressures have increased business's share of total health care expenditures from 19 percent in 1967 (when Medicare was established) to more than 30 percent today. The average company now pays as much to provide health benefits as it realizes in after-tax profits.

Until now, efforts to control health care costs have been blocked by a standoff between advocates of free-market strategies and advocates of tight government regulation. Since U.S. policy typically develops from a consensus rather than an outright victory for one side or the other, what health care needs is some recipe that will blend ingredients of both ideologies into a single politically acceptable approach. The recent presidential election suggests that the opposing sides may at last be coming together. What began as a contest between unfettered competition and federal controls has evolved into a middle ground of what might be termed "regulated competition." The challenge now facing president-elect Clinton and his advisors is to craft a health care plan that can reconcile uniquely American values of self-reliance and local control with the type of immediate concerted action necessary to slow the growth in national health care expenditures during this decade.

Problems in Wonderland

For many in the business community, the health care market resembles the world that greeted Alice on the other side of the looking glass. The basic rules of economics--that prices are determined by the intersection of supply and demand and that competition forces a reduction in costs and profits to efficient levels--simply do not apply.

Health care "buyers," the individuals and groups that use and pay for medical services, are essentially left out of the economic loop. Instead, physicians act as both buyers and sellers in the same transaction, making decisions on behalf of patients about the use of their services, with little reference to price. They are motivated by training to provide optimal treatment, maximizing care rather than minimizing costs. Consumers generally concur and often are insulated from the economics of their decisions by third-party reimbursement. This means that health care providers dominate the market, and normal competition is eliminated.

Another major market imperfection is that some parties--too often businesses--are made to pay for medical costs incurred by people over whom they have no control. This "cost-shifting" stems from the diversity of payers in the current system. Four of every seven Americans have insurance provided by their employers or purchased individually, and nearly two out of seven are insured through Medicare, Medicaid, or some other government program. One out of every seven Americans has no health insurance and either pays personally for services or does not pay at all. The result is a patchwork of health care payers, each operating in competition with all other payers.

In a normal market, the purchasing decisions of thousands of individual payers would help to lower costs. But health care providers, given their dual role as buyers and sellers, can exploit this diversity to insulate themselves from economic pressures from any payer by raising revenues from other payers. A particular problem arises from the segmentation of public and private payers. The government sets deliberately low prices, which providers are forced to accept. The providers make up their losses by setting higher prices for payers operating in the private sector. Some private payers with sufficient market power can negotiate discounted prices with providers in order to deflect at least part of the cost-shift. As a result, the remaining private payers--often small businesses and individuals that are among those least able to shoulder higher costs--can face payments up to twice the cost of the medical services rendered.

The "competition" we have relied on to control costs has actually made matters worse. Consider hospitals, for example. Hospital utilization declined between 1980 and 1988--measured by a drop in admissions from 37.6 million to 33.5 million patients, a shortening of average length of stay from 7.2 to 6.6 days, and an increase in the proportion of empty beds to all beds from one-fourth to one-third. During the same period, hospitals continued to expand their capacity, increasing staffs by 10 percent and spending more on building construction ($1.5 billion more in 1989 than in 1985, adjusted for inflation). Reduced utilization in the face of expanding capacity should have caused prices to drop and even some hospitals to fail. Instead, hospitals achieved annual profit margins that were consistently 3 percent higher than in the previous decade--largely by their ability to raise charges for private patients.

Similarly, the oversupply of physicians during the 1980s that was expected to increase competitive pressures and reduce physician income did not. While the concentration of physicians increased from 19 per 10,000 residents in 1980 to 23 per 10,000 residents in 1988, physician income also increased by 25 percent above inflation (from $117,000 to $145,000, in constant dollars). Various studies have shown that the increase in the number of doctors served only to increase the total amount of care provided to patients. Moreover, since most of the new physicians were in specialties, there was a substantial rise in the volume of expensive specialty services provided during this period.

The growth of medical technology has also been rampant. Hospitals in the 1980s vied to acquire the latest equipment in order to attract physicians and patients, and physicians often bought their own equipment or joined in partnership with others to establish independent diagnostic facilities and laboratories. The density of expensive medical equipment in the United States is now far greater than in other countries with high-quality health care systems. For example, three generations of diagnostic imaging machines evolved and proliferated in the past decade--first to hospitals, then to ambulatory clinics, independent imaging centers, and physicians' offices. More than 900 multimillion-dollar magnetic resonance imaging machines are now in operation--compared with 57 MRI machines in Germany and only 12 in Canada. These are often paid for through overuse: Patients of a physician who owns or has financial interest in a machine are three to four times more likely to get a scan than are patients treated by other physicians.

The fundamental solution to health care problems, then, is to create a true marketplace where demand and supply can interact to appropriately value health care services. Various market strategies are being explored, and they show promise of restoring real competition over the long run as they are tested and implemented on a large scale. But we also must begin slowing the growth in health care costs immediately, to stop the current hemorrhaging and give the market systems time to take root and spread. This can be accomplished by some relatively straightforward actions that will concentrate the market power of payers and reduce or do away with cost-shifting. Business leaders do not expect a nation with an increasing appetite for health services and an aging population to eliminate real growth in health care expenditures, but it is vital to make the growth rate both tolerable and reasonably predictable.

Building a better market

Among the market strategies being explored is "managed care"--a broad term that encompasses a variety of cost-containment and quality-control techniques. The most sophisticated managed-care plans negotiate prices and practice standards with a network of providers, develop incentives for patients to limit their use of health care services to these network providers, use payment methods that discourage the provision of unnecessary or inappropriate services, and monitor and seek to improve provider practice patterns.

Some managed-care plans have demonstrated the ability to achieve savings within their segment of the health care market. But this typically comes at the expense of other payers, and there is no evidence yet that managed care has slowed the rise in national health expenditures. The success of managed care in controlling expenditures has been limited by the fact that the dominant payers--Medicare and Medicaid--do not (with few exceptions) participate in managed-care networks. It is also limited by the weakening of incentives and controls on providers that results from multiple competing managed-care networks negotiating separately with the same hospitals and doctors.

The weakened influence that results from this haphazard approach to managed care has led a growing number of health economists and business leaders to advocate a more coordinated approach called "managed competition" that would combine more advanced managed care and coordinated purchasing. Although several versions of managed competition have been advanced, the plans have certain elements in common. They envision a complete restructuring of the delivery system into a limited number of competing, organized, health care delivery systems, similar to but more sophisticated than today's health maintenance organizations (HMOs).

These "one-stop" delivery systems would include hospitals, physicians, and other health professionals and provide a full array of inpatient, outpatient, and long-term health care. They would serve an enrolled group of members who would pay a set annual fee. By bringing providers exclusively into one organization, they would end the potential for cost-shifting. By placing the delivery systems and the providers in them at financial risk, they would encourage a more cost-effective approach to providing necessary health care.

On the demand side, small employers and individuals would join together in groups and be represented by purchasing agents who would negotiate favorable agreements with an array of selected delivery systems. Individuals would select their own delivery system and would be made more sensitive to the premium differences through a federal cap on the amount of tax-free employer-provided benefits they could receive. The systems would be required to offer uniform benefits and to disclose data on price and quality--information hard to obtain today--so that consumers can make informed choices. Competition among the delivery systems for enrollees would place downward pressure on annual membership fees.

Although promising, managed competition remains an untested theory facing a number of significant hurdles. Not least is the continued resistance among the general public and health care providers to these kinds of closed delivery systems, as evidenced by the fact that enrollment in HMOs has remained consistent at about 15 percent of the population in recent years. If managed competition demonstrates the virtues that its proponents expect, from cutting costs to improving the quality of care provided, acceptance will likely grow more widespread. But clearly it will take time, perhaps several decades, to develop a nationwide system based on the principles of managed competition.

Help closer at hand

In the short term, while managed competition is evolving, payers need to have the ability to concentrate their market power and eliminate cost-shifting. This can best be accomplished by initiating a process for negotiating provider rates at the local level and ensuring that the rates are available to all payers on an equal basis. This type of coordinated "all-payers" system will protect smaller payers, who independently would have little influence in the market, and it will force government to pay the same rates as private payers, thus eliminating the cost-shifting that now creates a substantial indirect tax on private plans. More important, because all-payer rates would provide all of the provider revenues, they help focus the attention of payers on each provider's total costs and revenues and thus on their overall efficiency. The system also will benefit health care providers by simplifying their bookkeeping and administration. In place of the current jumble of alternative price lists, providers will need to maintain a single negotiated rate schedule that compensates them equitably for the cost of direct services, capital expenditures, and any uncompensated care.

To implement this system, the federal government first must establish a council to, among other tasks, set national and state targets for health expenditures. Federal waivers would also be needed to commit Medicare and Medicaid to locally negotiated provider rates. A network of councils would then be developed at state or local levels. Keeping in mind the federally designated cost-containment goals, these councils would negotiate rate schedules with individual physicians and hospitals, which all payers would then follow. All providers within the region would not negotiate the same rates, however. This will allow providers to compete for patients, while at the same time enabling payers to benefit from selecting those who are most cost-effective or in some cases to pay a premium to reward exceptional quality.

This approach has several advantages. First, it can be implemented fairly quickly. There are many local business coalitions and state health commissions that already collect and analyze health care data, making them likely candidates to serve as the local negotiating councils.

The system keeps primary responsibility for health services at the local level, where judgments about resource allocation can best respond to particular needs. Most previous all-payer proposals simply recommended extending current Medicare rates uniformly to private payers nationwide. But by failing to account for local variations in costs and resources, national rates would be unnecessarily high in some areas and unrealistically low in others. National rates would also deprive local communities of their discretion in compensating providers for differences in quality or in maintaining and improving needed but underutilized health care facilities.

In addition, since negotiated all-payer rates limit the total revenues for health care providers, they become the basis for solving a major problem underlying recent rapid cost increases: the escalating acquisition of medical technology. State and local councils would have to review and approve new acquisitions and capital expansions, and would exclude all unapproved capital expenditures from the cost base used in negotiating rates. Putting a lid on what providers can charge will create pressure to reduce excess capacity in the delivery system and to pursue operating efficiencies--for example, by sharing imaging facilities.

Along with controlling the prices that providers can charge, rate negotiations will need to focus on controlling utilization as well, in order to prevent increases in service volume from offsetting progress in reducing total costs. This can be accomplished by structuring the negotiated rates in order to create incentives to reduce utilization, setting limits on total spending, and improving the efficiency of service delivery through use of managed-care techniques such as reviewing how and when various practices are performed.

Although a comprehensive all-payers system has yet to be tested in the United States, four states have experimented with all-payer hospital rates. Each of the states--New York, New Jersey, Massachusetts, and Maryland--achieved some degree of success in holding the line on costs. Maryland has had the best experience with an all-payer system that was established 20 years ago, at the request of the Maryland Hospital Association, and is still operating today. Each hospital's rates are based on an initial agreement with the state council on specific rate schedules, which they then apply to all payers who use that hospital. This system has kept the state's rate of hospital cost increases generally three percentage points below the national average, and has brought per-admission costs down from 24 percent above the national average in 1976 to 10 percent below the average today. Medicare and Medicaid have participated in paying the all-payer rates since 1977, and will continue to as long as Maryland can hold its hospital cost increases below national rates of growth.

Advocates of this approach also point to the experience of Germany, where a negotiated all-payers system has been in use since 1977. Each year, more than 1,100 independent "sickness funds" (equivalent to U.S. health insurers) negotiate with the nation's hospitals and physicians' associations. The negotiations are guided by a federal law stipulating that the average premium costs for employers and employees cannot grow more rapidly than wages. During the past five years, Germany has reduced the proportion of gross domestic product spent on health care from 8.7 to 8.1 percent, at a time when U.S. spending was on the rise.

From such promising evidence, it seems likely that local all-payer negotiation can do much to strengthen the demand side of the health care market. At the same time, the continued evolution of managed-competition techniques will gradually improve the overall quality of American medicine. The effort to control health care costs must start today. And it must use the tools that are in hand to build a more stable platform for a comprehensive restructuring of the delivery system during the next century.

G. Lawrence Atkins is Washington-based director of health legislative affairs for the New York City law firm of Winthrop, Stimson, Putnam & Roberts. John L. Bauer is vice president of the Washington office of Armco Inc., a specialty steel company. Both developed these ideas as part of the Alliance of Business for Cost Containment.
COPYRIGHT 1992 National Academy of Sciences
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Title Annotation:Issues in Focus
Author:Atkins, G. Lawrence; Bauer, John L.
Publication:Issues in Science and Technology
Date:Dec 22, 1992
Words:3004
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