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The challenge of containing health care costs.

There are a number of techniques to contain health care costs and discourage unnecessary services. But, to be effective, they must be well managed.

New issues confronting the nation and its businesses are as perplexing as the growing cost and complexity of health benefits programs for employees. Business spending on health benefits has become so great that corporate financial officers today are frequent -if often reluctant-participants in the key decisions associated with health care coverage for their companies' employees.


Total health care spending in the United States in 1990 was $666.2 billion, accounting for 12.2 percent of Gross National Product (GNP) and, according to varying estimates, from 40 percent to 60 percent of business spending as a percent of corporate profits. The trajectory these numbers are following is even more alarming. Informed estimates now project the nation's total health expenditures by the year 2000 will account for 17 percent of GNP and 70 percent of business spending as a percent of profits if present trends persist. Despite this massive expenditure, which dwarfs that of any other developed nation, some 35 million Americans are without health insurance coverage.


By 1989, the cost of health benefits accounted for 5.6 percent of wages, surpassing that of retirement (4.7 percent). In the face of manifest public anxiety over the growing cost of health services, employees value their health coverage highest among their benefits. In a 1990 survey conducted by Gallup and the Employee Benefits Research Institute, fully 61 percent of employees rate their health benefits as the single most important one. (Pensions were rated first by 17 percent, and disability programs by five percent.) This fact has been dramatized in recent years by a series of bitter labor strikes in which management efforts to alter health benefits was the key issue.

It is particularly frustrating to managers that, despite rapidly growing corporate expenditures on behalf of employees' health care coverage I satisfaction with employer-provided benefits has dropped precipitously. A multi-year, longitudinal study of 112,000 employees was compiled by International Survey Research Corporation and reported by the Alexander Consulting Group and ISR earlier this year. The study, covering employees in a broad range of work settings and economic strata, revealed that employee satisfaction with their benefits reached a high in 1984. That year 88 percent of those questioned rated their benefits as "good" or very good," up from 86 percent in 1982/83. That percentage had dropped to 77 percent in 1986/87 and had plummeted to 42 percent by 1989/90.

This sharp drop in benefits satisfaction corresponds to a similar decline in employee morale. The authors of the study attribute the steep decline to several factors, most notably the "historic restructuring of medical benefits during the past decade." Employees have viewed these changes as restricting free choice and altering the doctor-patient relationship.

In short, we're spending more and we're liking it less.


It's instructive to look at what is driving health care benefits costs for Corporate America. By understanding these forces and how they apply to your organization, you can formulate a reasonable and effective approach to managing costs.

Medical inflation-Medical inflation, pure pricing, drives fully 39 percent of the cost increases experienced by private-sector purchasers of health insurance. in some ways, this is good news. Prices can be negotiated.

Cost shifting-Twenty-three percent can be attributed to cost shifting. This has several aspects:

* Medicare accounts for 17 percent of total national health expenditures. But, because Medicare policies have the effect of law, when Medicare sets prices for services, they stick, whether or not they cover the full costs a provider incurs. The unfunded costs will be charged somewhere. The same may be said of Medicaid, which accounts for another 10 percent of total national health care payments. Parenthetically, some state Medicaid programs have been so unreasonable in their pricing efforts that providers are fighting back and winning in the courts.

* The 35 million uninsured are another major source of cost shifting. The cost of providing care to those who can't pay becomes part of the provider's "bad debt" load, which is spread to other payers.

* Finally, costs are shifted by canny health care providers from those private-sector payers who have protected themselves with cost containment programs to those who haven't. Dollars lost on the care of uninsured patients, or on patients covered by such programs, are reflected in higher charges to those paying full freight. It should be pointed out here that cost shifting can occur with regard both to price and to utilization of services. Providers that have excess capacity will work to find ways to use it. The fact that 35 percent of American hospital beds are empty at any given time demonstrates the extent to which this type of cost shifting is possible.

Utilization-Growing utilization of health services accounts for 14 percent of the cost increase. Our aging population, the growing perception of the desirability and utility of health care, and demands generated by modern day epidemics such as AIDS, substance abuse, and now treatable low-birth-weight infants are all contributing to this cost increase. The fact that some of this utilization-as much as 25 percent to 35 percent by some estimates-is unnecessary, resulting from system inefficiencies and just plain unnecessary and inappropriate care, is a subject all its own.

Technology-The rapid development of medical technology is one of the miracles of our age. But there is a price to progress. Care of a low-birth-weight infant commonly ranges upward of $400,000. One injection of a new substance, HAIA, can reverse the grim statistics on the outcome of an often fatal disease, overwhelming Gram-negative sepsis. But HAIA costs $3,750 for a single life-saving injection. Faced with the disease, who would say no to its use for oneself or a loved one?

Deductible erosion-About 8 percent of increasing costs is attributable to the dwindling impact of employee deductibles, which have fallen behind inflation. The $ 1 00 deductible of a decade and a half ago may have accounted for a noticeable share of an employee's weekly take- home pay. Even today's higher deductibles represent a smaller percent of pay and certainly a smaller percent of the enormously higher employer cost.

Employee cost-sharing is not popular, but it's clear that more employers are moving in this direction.


Besides generating a veritable explosion in health care costs, the decade of the 1980s also saw the development of many techniques that, properly applied, can slow the rate of growth in health benefit expenses. Some of these techniques have been around for years, but have come to new prominence in the fight against runaway costs.

Following is a list of some proven cost-containment techniques. The potential for savings with any of these techniques depends on the underlying health care utilization patterns of the affected population. But critical to the success of each of these approaches is the competence and integrity of the organization and individuals managing them. A number of organizations have sprung up in the last decade to provide these services to employers. But frequent and significant gaps occur between what they claim and what they actually do. The time you spend identifying the right vendor and monitoring its performance is an essential investment.

Accurate claims administration-Self evident as this may seem, a poorly performing claims administrator can cost a plan 5 percent or more in excess of what should be paid according to the plan documents and contracts.

Utilization management-Outside health care professionals, generally registered nurses and physicians, review health care provided to a plan beneficiary before or during the care. Based on experience with our own clients, average savings attributable to these efforts are estimated as follows:

* Pre-admission and concurrent review can yield savings of 3 percent to 5 percent of inpatient hospital costs;

* Catastrophic case management can yield savings of 8 percent to 14 percent of inpatient hospital costs;

* Second opinion on surgery, even though much maligned, can be cost effective if the program is well designed and executed, yielding savings of $ 1.00 to $3.00 for every dollar spent.

Because of the sensitivity of interactions with employees, their families, and providers, these services must combine professional rigor with excellent service and "people skills" if they are to succeed. These programs have the added advantage of protecting people from the very real, and often very expensive, risks associated with unnecessary hospital admissions and procedures. These approaches, once applicable only to hospital stays, are now being applied to high-cost outpatient and doctors' office procedures.

Health promotion program-A significant portion of illness is related to matters of lifestyle. Health promotion programs that are properly designed and implemented and that target the requirements of a particular organization consistently yield savings in excess of their cost. Studies of these programs have reported that companies have experienced savings in health care and absenteeism equal to two to five times the cost of the program.

Employee assistance program (EAPs)-Programs that provide counselors to whom employees can go for counseling on a wide variety of problems are becoming full-scale mutual health programs. Once again, savings can be dramatic. One of our clients, a large defense contractor, experienced a four-to-one return on its EAP alone, as a result of reduction in employee claims, an even greater reduction in the claims of dependents, and a decrease in absenteeism.

Carve-out program have been developed to address specialized benefit areas, such as mental health, substance abuse, and prescription drugs. These programs have also produced good-and often dramatic-results.

Managed care-This development is a large enough topic to warrant more extensive exploration.


Managed care arrangements redefine the organization of medical care and the relationships between providers and purchasers of health services. As an organized and contractually determined medical delivery system, managed care has the potential to improve clinical quality, increase customer satisfaction, and manage costs. Although some definitions of "managed care" include utilization management, as described above, the term increasingly is limited to organized systems of care that include contractual relationships with providers of medical services. Most of these systems, in fact, employ the techniques of utilization management in their operation.

Managed care arrangements include health maintenance organizations (HMOs), preferred provider organizations (PPOs), exclusive provider organizations (EPOs), gatekeeper PPOs, point-of-service (POS) PPOS, and a proliferating number of variations.

The original concept of managed care, the original models for health maintenance organizations, was introduced in the 1940s by Kaiser, the Health Insurance Plan of New York, and the Ross-Loos Group in Los Angeles. The organizations provided incentives for efficient care, introduced management principles to medical practice, and included some element of standardization through peer interaction.

Early growth of this approach to health care delivery was slow, however, because it did not coincide with the American demand for freedom of choice. The necessity of limiting one's choice of physician to a defined panel or group of professionals did not have broad appeal, and some people associated it with negative images of clinics and charity care.

Development of the independent practice association (IPA) model HMO responded to this concern by creating contractual networks of physicians practicing out of their own private offices.

But these, too, have been perceived as a limitation on the patient's freedom of choice. And so new variants on the managed care theme have developed, including open-ended HMOs, opt-out HMOs, and point-of-service programs. Under these arrangements, a contractual provider network is established and patients receive the maximum benefits specified in the plan. if, however, the patient chooses to receive care from a non-network provider (at the "point of service"), the care is reimbursed at a lower amount and the patient is responsible for paying the difference. Extent of in-network service, where presumably the care will be managed more reliably from the point of view of economy and hopefully quality, varies with the spread between in- and out-of-network reimbursement and patient acceptance of the network providers. None of these managed care organizations is easy to manage. They deal with sensitive services provided by highly educated professionals and involve technology at all levels. They are swimming upstream against some of America's most deeply entrenched cultural habits:

* Freedom of choice for the patient

* The independent solo physician practitioner

* Fee-for-service medicine

* The myth that health care and its practitioners are somehow "above" basic business and management principles And organizing physicians has been likened to herding cats.


Nevertheless, managed care does work. The price increase for HMOs over the past six years has averaged about 6 percentage points lower than for the insurance industry as a whole. This has occurred during a period of unprecedented shakeout and consolidation among HMOs, signs of a maturing industry.

Cost containment results bear a direct relationship to the type of management. Our analysis of 400 companies shows the following percentage of increase in premium costs for various types of plans from 1990 to 1991:
Unmanaged Indemnity 22-25%
Indemnity with Utilization 20-22%
PPO 18-20%
Open-ended HMO 14-16%
HMO (IPA) 12-14%
Staff HMO 9-10%

The structure of the Staff Model HMO (where physicians are directly employed by the HMO) offers the most control, and the results show it. But there is great resistance to these types of plans in some parts of the country, and they can be the toughest to sell to employees.

Plan sponsors have been frustrated with managed care organizations for several reasons. HMOs in particular have been unable or unwilling to share health services utilization data, they have employed "shadow pricing" so that plan sponsors do not benefit from their efficiencies, and they have often worked to attract a plan sponsor's healthiest employees, thereby aggravating adverse selection against the sponsor's indemnity offering. Under pressure from plan sponsors, HMOs are beginning to provide the information employers need to negotiate appropriate pricing.

Plan sponsors contemplating a move to managed care have successfully used the newly emerging open-ended HMOs and point-of-service opt-out plans as a way to begin the move to full managed care. These programs are more appealing to employees, but they also demonstrate less significant savings because of their looser organization and relative lack of control.

If you're considering managed care, here are some key things to look at in assessing any managed care organization.

* The caliber and energy of the leadership, both administrative and medical

* The philosophy and practice of quality management/improvement

* The criteria and process used to recruit and accept physicians and other providers into the organization

* The quality of information and processes used to evaluate and influence provider performance

* The approach to assessing and improving patient satisfaction

* Whether or not and how providers have been removed from the organization, which can serve to indicate how carefully the network was created and how closely it is being monitored

* Financial performance and soundness

* Reputation


America is in the midst of a revolution in the way health care is organized, financed, valued, and perceived. The importance of health care in the American psyche was dramatized in the elections this fall by Harris Wofford's stunning defeat of Richard Thornburgh in the Pennsylvania race for the Senate. Mr. Wofford made national health insurance a key feature of his campaign. Significantly, he offered no details about how much it would cost, where the money would come from, or who would have to give up what. This is not unusual when health care and health insurance is the topic.

Because I am not holding my breath for prompt resolution of all our health care problems, I continually look for what is possible. And much is possible. Data available to analyze, understand, and track health care performance are better than ever. The information that can be extracted from the data is, in knowledgeable hands, a powerful tool for planning and management. Useful techniques exist to contain costs and discourage unnecessary services. In spite of the problems it has encountered in the last decade, managed care is a most promising development-but it must be done well, and it must be managed. Finally, the technology for improving the quality of health services is developing rapidly. Each of these capabilities can be applied to the problems facing the corporate purchaser of health benefits. Accurately applied, they can yield good results.

Dr. McGarvey adapted this article for Financial Executive from his presentation before Financial Executives Institute's Committee on Employee Benefits.
COPYRIGHT 1992 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Special Report: Health Care
Author:McGarvey, Michael
Publication:Financial Executive
Date:Jan 1, 1992
Previous Article:How the Fortune 500 are dealing with FAS 106.
Next Article:Health care: where do we go now?

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