Health Care Cost Control: Getting on the Right Track

Converging forces are an economic train wreck waiting to happen. Avoiding a disaster requires an understanding of the interconnection of health care’s stakeholders and the global consequences of their actions.
Mick L. Diede, FSA, MAAA
Richard Liliedahl, MD

The cost of our health care system is spinning out of control and no one is applying the brakes. While many “solutions” are being offered, they typically address only part of the health care equation, and most often are grounded in a perspective that favors one sector over others. A real solution will, of necessity, involve pain for all players in health care: employers, government, providers, insurers, pharmaceutical and medical technology companies, and consumers.

From our perspective, the best way to regain control is for purchasers and consumers, who have the most to lose in the short term, to join in demanding a resolution that requires the sacrifices that will reduce the rate of increase in health care costs. The alternative — unwanted by most parties — is for the government to step in and mandate its own “solutions.”

Red signal ahead

There is justifiable cause for alarm. Using public data provided by the federal Office of the Actuary, Milliman USA created a model that predicts health care cost increases based on the interdependencies of the key participants in the U.S. health care system. This model integrates the federal data with those collected for Milliman USA’s 2001 HMO Intercompany Rate Survey and with more informal surveys of Milliman health care consultants and emerging plan experience to develop assumptions for resource use. Under this model, which also incorporates data from the Milliman USA Health Cost Index, we estimate that per-capita health care costs for all payers — government, insurance carrier, and consumer — will increase 44 percent by 2006, 13 percent higher than what the Office of the Actuary predicts.

By either estimate, the impact will be dramatic and is likely to be felt by consumers first. With premium increases already on the rise, many employers are forcing employees to shoulder more health care costs. As employee premium payments and out-of-pocket spending for noncovered services continue to grow, our models show consumers bearing the brunt of projected increases, with their health care tabs set to increase by 55 percent from 2001 through 2006. This translates into a $2,500 increase in annual household medical spending (premium share and out-of-pocket combined) for a family of four by the end of that period.

More sobering, these estimates, which assume that current trends continue, may be low and could be adversely affected by a variety of factors. One that has been much discussed but is difficult to pin down is the rise in health care costs associated with acts of terrorism. While there will be increased costs in the short term — especially in some geographic areas — it is unclear how costs five years out will change. Here too, costs are most likely to fall on employers and — eventually — consumers. While insurance companies and HMOs might fail to reach profit objectives in the near term, it’s likely they eventually would recover cost increases through higher premiums. Also, job losses increase the number of consumers who must rely on COBRA for health coverage or do without it altogether.

Other forces may come into play. If, for example, more employers begin to adopt strategies such as defined contribution plans, the increase for consumers could be decidedly higher. In a defined contribution scenario, an employer offers employees a set amount of nontaxable benefit dollars to “spend” as they choose. Increasingly, this is a hot topic among employers, and many experts say these plans are gaining in popularity.

When one steps back to look at the entire picture, the first major challenge will be to manage the rate of cost increase, while working to improve quality and access. Keeping costs under control should not mean reduced quality, but this is no easy task.

Reducing the increase in health care spending — or just keeping it at the same level as the growth of the nonhealth care portion of the gross domestic product (GDP) — will require the health care delivery system to spend about 4 percent per year less than projected through 2006, achieving an aggregate saving of 18 percent. This means that all recipients of health care dollars — hospitals, doctors, pharmaceutical and medical equipment companies, long-term care facilities, and home-health providers — will have to find ways to cut back.

Comparing today’s situation with that of the early 1990s underscores the difficulties ahead. In the ’90s, everyone thought managed care would reduce health care inflation dramatically, and the early results appeared to validate that assumption. Managed care companies did significantly reduce health care inflation by negotiating lower payment levels to providers and promoting improved quality and efficiency for many health care services. Over time, however, many patients and providers have expressed their disillusionment with managed care’s cost-cutting measures, access limitations, and bureaucratic red tape. With market share no longer growing, the pendulum is now swinging back: Many hospitals and physicians are successfully negotiating fee increases well in excess of general inflation to make up for low compensation in recent years. Managed care organizations alone couldn’t keep costs down, nor can any other player.

What’s happening today is that cost pressures are being passed around the system like a hot potato. In addition to hospital and physician increases, HMO expenditures on prescription drugs are rising dramatically (more than 18 percent in the past year). The HMOs, in turn, as Milliman’s 2001 HMO Intercompany Rate Survey reports, are raising their rates an average of 13 percent to 19 percent, and other insurers are raising rates similarly. Employers, socked with higher premiums, are passing more of the cost along to consumers. The players need to stop the game and figure out a way to play together.

Fragile balance

In an ideal world, everyone in the system has a role to play in reducing costs, but in a pragmatic one, not everyone is equally motivated to do so. With consumers, employers, and the government likely to bear the cost increases already in the pipeline, these groups will have the strongest early incentive to push for reductions in health care spending. The operative question is whether they can, together, structure a way to do so.

Keep in mind, however, that they will not be the only constituencies affected by the rise in costs. The U.S. health care system relies on an imperfect balance of stakeholders and their interests. Inflation will affect every party in what is a fragile balance. If the current scenario is allowed to play out unchallenged, everyone stands to lose something:

Employers, who already pay high premiums, will face staggering cost increases. Small employers, many of which already struggle to provide benefits, may be priced out of the market and drop coverage altogether. Those that decide to scale back coverage will lose the competitive recruiting edge that benefits often provide, and risk employee dissatisfaction as well. High health insurance costs also will make it more difficult for U.S. companies to meet shareholder expectations and compete in the global economy.

Consumers, probably, will be the biggest losers. Some will be forced to drop coverage altogether. Those who retain it will bear a substantially larger financial burden and may see their benefits reduced. Either way, consumers will be more likely to forgo care because of its expense, which may result in poorer health and a lower quality of life.

The government, which plays many roles, from regulator to purchaser, will feel the heaviest impact of cost increases when funding coverage for employees and Medicare and Medicaid beneficiaries. As the largest purchaser of health care, the government will shoulder a huge proportion of additional costs, which it will undoubtedly pass on to government employees, taxpayers, and providers of care. At the same time, the government as regulator will come under mounting pressure to take steps to mitigate the rapid cost increases.

Providers, especially institutional facilities, will ultimately experience increased financial pressures, particularly as government reimbursement shrinks. Some, unable to bear the financial burden, will close. Individual providers, whose bargaining power will erode, will be pressured to do more for less.

Managed care organizations and other insurers will be under greater pressure from purchasers to keep costs down. At the same time, they will face demands for higher fees from providers, such as hospitals and physician networks. Some will lose market share as employers self-insure, contract directly with providers, and join purchasing coalitions.

Pharmaceutical and medical technology companies may initially benefit from increased spending but will undoubtedly suffer in the court of public opinion — something we see already — if costs continue to spiral upward and drugs and devices become increasingly unaffordable. Public pressure on lawmakers to create affordable access to drugs and devices will grow, particularly as the population ages. If lawmakers attempt to limit profits, however, drug and technology companies may respond by reducing their investment in research and development.

For those who remain skeptical about any permanent solution requiring everyone’s involvement, consider two hypothetical — and highly unrealistic — scenarios in which only one group shoulders the burden of keeping cost increases in line with nonhealth GDP growth:

  • If all of the cost reductions necessary to control health care inflation through 2006 were made in the hospital sector, hospital spending would have to be slashed by nearly 50 percent. Something this drastic could not be achieved without some combination of staff and service reductions, reduced reimbursement, and hospital closures.
  • If required savings were wrung solely from the physician sector, doctors’ revenues would drop by about 65 percent.

Of course, these scenarios are neither desirable nor viable, but they illustrate the magnitude of the problem. Where, then, does the answer lie? While it would be naïve to expect each sector to drop its own agenda and magically join other sectors around shared goals, the only practical way to achieve balanced cost control is to find ways to drive change in each sector. That will not happen easily or at once. It is most likely to occur over time, as relative power shifts among health care stakeholders and as public and legislative pressure for change builds.

Pragmatism reduces sacrifice

The irony, despite the practical, economic, and political obstacles to initiating meaningful change, is that all of the system’s participants can play several roles in lowering costs without great sacrifice.

The overarching need is for better coordination and more collaboration among participants. One example: Employers need to work with health plans and providers to improve access and quality while controlling costs. Already, we are seeing this happen in some parts of the country, where new types of provider networks are working under quality-driven payment arrangements. Health plans are integral to this type of scheme because they can provide relatively complete data on provider performance and clinical outcomes.

More specifically, one can go sector by sector and find obvious and not-so-obvious practices that can be implemented with relative ease — all of which would dramatically reduce some of the unnecessary expense in health care.

In the consumer sector, for example, the steps are straightforward, much discussed and, at best, ineffectively acted upon. Consumers, sheltered from the true cost of health care by employers who pay the lion’s share of the premium and by low copayments, need to become more cost-conscious. In the same vein, they have to be educated to adjust their expectations and to find the right balance between demanding the latest drugs and treatments and first using less-expensive, appropriate tests, procedures, and medications. They also must be taught to recognize the value of healthy lifestyles on a personal level and in terms of lessening demands on the health care system.

Similarly, the employer/purchaser agenda runs along very pragmatic lines. In addition to helping employees understand their role in keeping health care inflation under control, employers should encourage the design of benefit plans that provide incentives to consumers to use health care resources in a responsible and cost-efficient way. Such vehicles include lower copayments for generic drugs, and incentives to use cost-effective, high-quality providers. The importance of carefully planned preventive care in reducing the need for more costly treatments down the road — as well as in improving the quality of life — also needs to be stressed.

Joining forces with other purchasers has proven to be an effective way to bring about change. Coalitions with clout, such as the Midwest Business Group on Health and the Leapfrog Group, have brought about significant change, successfully pushing for higher quality in health care, lower rates, and greater access to services. Also, purchasers must recognize that it is in their interest to support the gathering of statistically meaningful data about quality across employee groups, working with other employers to standardize requests and to limit demands for costly customized data.

The steps that HMOs and other insurers can take parallel, in some respects, the concerns of purchasers — the need for appropriate financial incentives in plan design and for more extensive consumer education aimed at fostering more prudent use of health care services. In addition, insurers have to examine carefully their own practices. It’s no secret that administrative complexity increases cost, and carriers should work to streamline routine processes. The Health Insurance Portability and Accountability Act of 1996 promotes standardization of provider-data layouts. Insurers need to capture all the information from a patient encounter, rather than just what is needed to process claims. More complete data sets are the foundation of quality-and-efficiency-improvement studies.

That information, in turn, can be used to create financial incentives for providers, to improve access and quality, and to utilize sensible preventive care and screening tests. Insurers can provide physicians with information about patient compliance with medication and preventive services along with data showing them how they compare to their peers on key quality measures — all of which should serve to improve quality of care.

Of providers and prescriptions

On the provider side of the equation there are four significant issues to address.

First, providers must accept accountability for resource management. Physicians direct about 70 percent of health care spending. They have enormous influence over costs, one patient at a time. Their task is to advance quality and meet demands of employers and purchasers for improved performance while keeping overall costs under control.

Second, they must accept ownership of quality issues. Purchasers believe that better quality can reduce long-term costs, so many have promoted the use of quality standards and have held provider organizations accountable for meeting those standards. Physicians and institutional providers must accept these standards or establish their own, and work to improve access and reduce treatment variation through use of evidence-based practice.

Third, providers can work with insurers to improve appropriate drug use by analyzing claims data to identify patients who do not adhere to medication regimens. To use the example of coronary artery disease, the leading cause of death in the United States, the American Heart Association promotes the use of beta-blocking drugs as the first choice for long-term control of CAD in post–myocardial-infarction patients, yet many heart attack patients do not fill their prescriptions after hospital discharge. Insurers and providers can work together to improve appropriate drug use by identifying, through claims data, patients who do not adhere to medication regimens. Providers can promote use of disease management programs for patients with heart disease. Most of these programs provide education for patients and verify that they receive, fill, and take appropriate prescriptions.

Fourth, providers must practice demand and expectation management. This involves education for physicians and patients. Patients, for instance, bring their doctors articles from the Internet about new treatments or technology they want, or press for an antibiotic when it is not indicated. Physicians need to educate patients about appropriate care and resist the temptation to give in to pressure.

Reining in the spiraling cost of drugs and new technology, two significant contributors to health care inflation, will not be easy. Milliman’s 2001 HMO Intercompany Rate Survey shows spending on pharmaceuticals alone accounted for 26 percent of HMO medical cost increases over the last year.

In this realm, commonly cited “solutions” include pressuring the pharmaceutical industry to curb development of me-too drugs and to demonstrate more responsible marketing to consumers and physicians. Few, however, believe that pharmaceutical and medical technology companies will take it upon themselves to discourage spending on the products they sell. Such governmental interventions as price controls and reduced patent protection are far too controversial, so the best hope is that more cost-effective use of these therapies can be forced through a variety of means:

  • Pressuring pharmaceutical and medical technology companies to provide cost/benefit analyses to improve the chance their treatments will be covered;
  • Facilitating — with government backing — the dissemination of objective cost-benefit information on new therapies;
  • Moving from fixed-dollar copayments to coinsurance on pharmaceuticals;
  • Demanding more accountability from pharmacy benefit managers and insurers;
  • Encouraging physicians to refuse to write prescriptions for a new drug when a lower-cost alternative is effective and available.

Far and away, the most contentious element in the health care equation is the role to be played by government. Controversial practices, such as coverage mandates for expensive treatments, will often increase cost without improving quality of care. As a purchaser and the overseer of Medicare and other programs, the government should design benefit plans that encourage consumers to use resources wisely and develop reimbursement approaches for hospitals and other providers that include incentives to treat patients in the least expensive, most appropriate setting.

Laws designed to protect patients or expand their choices often cost them money, and the right balance must be found between these priorities. At this writing, Congress and the president are debating the merits of patient-rights legislation, which will give enrollees more legal recourse if care is denied, but would, according to Congressional Budget Office estimates, raise premiums about 4 percent.

Moving beyond blame

With pressure for cost containment building and the price of inaction high, the imperative to act is strong. Delay will create pressure for government action — something sure to divide the diverse interests within health care. The struggle for favorable regulatory position — and survival — under a government-mandated solution will not be pretty.

The complexity of our health care landscape and of the relationships among its players does not support simple solutions. As in the past, the debate about controlling health care costs will undoubtedly incline toward blame, when what’s really important is recognizing the critical role of interdependence in this delicate balancing act.

Each entity naturally works to further its self-interest while meeting its customers’ needs. However, the self-interest of each group is also tied to the success of the entire system. Within that fragile balance, each group must find — or must be forced to find, as the more skeptical among us will say — incentives to act responsibly, as we develop an effective approach to curbing health care cost increases.

Mick L. Diede, FSA, MAAA, is a principal and consulting actuary in the Atlanta office of Milliman USA. Richard L. Liliedahl, MD, is a principal in the Seattle office.