In Chapter 8, we discussed the general relationship between costs and health outcomes and explored the tension between painful and painless approaches to cost containment. In this chapter, we examine specific methods for controlling costs. Our emphasis is on distinguishing among the different types of cost-control mechanisms and understanding their intent and rationale. We briefly cite evidence about how these mechanisms may affect cost and health outcomes.

Financial transactions under private or public health insurance (see Chapter 2, Figs. 2-2, 2-3, and 2-4) may be divided into two components:

1. 
   

   Financing, the flow of dollars (premiums or taxes) from individuals and employers to the health insurance plan (private health insurance or government programs), and

   
   
2. 
   

   Payment, the flow of dollars from insurance plans to physicians, hospitals, and other providers.

Cost-control strategies can be divided into those that target the financing side versus those that impact the payment side of the funding stream (Fig. 9-1 and Table 9-1).

Cost controls aimed at the financing of health insurance attempt to limit the flow of funds into health insurance plans, with the expectation that the plans will then be forced to modify the outflow of payment. Financing controls come in two basic flavors—regulatory and competitive.

Regulatory Strategies

In nations with tax-financed health insurance, government regulation of taxes serves as a control over public expenditures for health care. This regulatory control is most evident when certain tax funds are earmarked for health insurance, as in the case of the German health insurance plans (see Chapter 14) or Medicare Part A in the United States. Under these types of social insurance systems, an increase in expenditures for health care requires explicit legislation to raise the rate of earmarked health insurance taxes. Public antipathy to tax hikes may serve as a political anchor against health care inflation.

A somewhat different model of financing regulation was offered by President Clinton’s 1994 health care proposal (which never passed). This proposal called for government regulation of premiums paid to private health insurance plans. The Affordable Care Act (ACA) includes a much weaker measure authorizing government “review” of private insurance premium increases of more than 10% per year in the individual and small group market.

Competitive Strategies

An alternative US proposal for containing health costs attempts to control the financing flow through a competitive strategy rather than through regulation. The basic premise of competitive financing strategies is to make employers, employees, and individuals more cost-conscious in their health insurance purchasing decisions. Health insurance plans would be encouraged to compete on the basis of price, with lower-cost plans being rewarded with a greater number of enrollees. Instead of having a government agency regulate financing, the competitive market would pressure plans to restrain their premium prices and overall costs.

When considering competitive strategies that attempt to make purchasers more price sensitive, it is important to consider who the purchaser of health insurance really is. For employment-based health insurance, is the purchaser the employer selecting which health plans to offer employees, or is it the individual employee deciding to enroll in a specific plan? As in the case of Giovanni Costa and GA, the answer is often both: GA selects which plans to offer employees and what portion of the premium to subsidize, and Giovanni chooses a particular plan from those offered by GA.

Historically, several factors have blunted both employers’ and employees’ consideration of price in the purchase of health insurance (Enthoven, 1993). For employees, the fact that employers who provide health benefits usually pay a large share of the premium for their employees’ private health insurance has insulated insured employees from the costs of insurance. Employees view health insurance premiums as an expense to the employer rather than as a cost borne by themselves. In fact, many employees might receive higher wages if the costs of health insurance were lower, but employees do not generally perceive health insurance benefits as foregone wages.

Moreover, the federal policy of treating health care benefits as nontaxable to both employee and employer makes it in the employee’s financial interest to receive generous health care benefits and reduces the burden to the employer of paying for such benefits. A dollar contributed directly by the employer to a health plan goes farther toward the purchase of health insurance than a dollar in wages that is first taxed as income and then spent by the employee for health insurance. This dynamic, which costs the federal government about $250 billion per year in employee tax exemptions (Ray et al., 2014), has shielded employees from the real price of health insurance and given employees less incentive to be cost-conscious consumers when selecting an insurance plan.

For employers, inflation of health insurance premiums in the 1950s and 1960s was an acceptable part of doing business when the economy was booming and health insurance costs consumed only a small portion of overall business expenses. However, as health insurance costs continued to spiral upward and economic growth slowed in recent decades, employers became more active in their approach to health insurance costs (see Chapter 16).

The competitive approach to health insurance financing encourages price-sensitive purchasing by both employer and employee. For employers, the competitive strategy calls for businesses to be more aggressive in their negotiations with health plans over premium rates. Employers bargain actively with health plans and offer employees only plans that keep their rates below a certain level. Moreover, employers make employees more cost aware when selecting a health plan by limiting the amount of the insurance premium that the employer will pay. Rather than paying all or most of the premium, many employers offer a fixed amount of insurance subsidy—often indexed to the cost of the cheapest health plan—and compel employees selecting more costly plans to pay the extra amount. Economist Alain Enthoven, one of the chief proponents of the competitive approach, has called this strategy “managed competition” (Enthoven, 2003). The strategy is also known as the “defined contribution” approach.

Is the evolving competitive approach succeeding at controlling costs? From 2000 to 2010, employer-sponsored health insurance premiums rose by 114%, a major cost-control failure (Claxton et al., 2010). From 2010 to 2014, these premiums grew more slowly, largely due to the severe economic recession (Claxton et al., 2014). However, competition has never been truly instituted in the United States; 94% of metropolitan markets are controlled by one or two large commercial insurance companies that can extract increasing premiums from employers (Arnst, 2009). Moreover, insurance plans find it easier to compete by “gaming” the market through selection of low-cost enrollees rather than by disciplining providers to deliver a lower-cost, higher-quality product. Studies have shown that competing Medicare HMOs have utilized precisely that strategy (Mehrotra et al., 2006).

If competition could succeed at containing costs, would the outcome be painful or painless cost control? A fundamental concern about market-oriented reforms is that whatever pain may be produced would be experienced most acutely by individuals with lower incomes. Under competition, individuals with higher incomes would be the ones most likely to pay the extra premium costs to enroll in more expensive health plans, while individuals of lesser means could not afford the extra premiums and would be relegated to the lower-cost plans. Enrollees in low-cost plans might experience inferior quality of care and health outcomes.

The Weaknesses of Financing Controls

For cost controls—whether regulatory or competitive—on the financing side of the health care equation to be successful, these strategies ultimately must produce reductions in the flow of funds on the payment side. A government may try to limit the level of taxes earmarked for health care. However, if payments to physicians, hospitals, and other providers continue to grow at a rapid clip, the imbalance between the level of financing and level of payment will produce budget deficits and ultimately force the government to raise taxes. Similarly, under competition, health insurers will attempt to hold down premium increases in order to gain more customers, but if these health plans cannot successfully control what they pay to hospitals, physicians, pharmacies, and other providers, then insurers will be forced to raise their premiums, and competitive relief from health care inflation will prove elusive. It is on the payment side of the equation that the rubber meets the road in health care cost containment. Governments in nations with publicly financed insurance programs do not simply regulate health care financing, but are actively involved in controlling provider payment. Competition would place the onus on private health insurance plans—rather than a public agency—to regulate payment costs. We now turn to an examination of the options available to private insurers or government for controlling the flow of funds in the payment transaction.

In Chapter 8, we distinguished between the “Ps” and “Qs” of health care costs: prices and quantities. Cost equals price multiplied by quantity

Strategies to control costs on the payment side can primarily target either prices or quantities (see Table 9-1).

Price Controls