Bringing Health Care Back to the Free Market

By Brenda Fitzgerald, M.D.

THE PROBLEM

Two factors are central to developing a good public health care policy for Georgia. Health care costs are enormous, and the federal portion of the indigent health care burden is likely to be shifted to the states.

The government pays 45 percent of America’s health care costs. This burden has far exceeded anyone’s expectations.  When Medicare was created in 1965, it was estimated that its budget would reach $9 billion to $12 billion by 1990. The real cost in 1990 was $107 billion. Medicaid was predicted to cost some $1 billion by 1991. The actual cost was $56 billion.

For Georgia, health care is the second largest budget item, with only education receiving more state tax dollars. For 1996, the Department of Medical Assistance received total funding of $3.8 billion.  Of that total, $1.35 billion came from Georgia taxpayers alone and the rest came from all U.S.  taxpayers.  The agency request for 1997 is even more.

Both the number of people who are eligible for Medicaid and the total funds spent have increased significantly in recent years. Since 1984, the number of individuals covered has increased by 155 percent, due largely to federally mandated eligibility requirements.

For the federal government, Medicare costs have increased by about 10.5 percent per year, despite numerous price controls. The baby boomers have just started reaching age 50 and a large influx of people eligible for Medicare is rapidly approaching.  Medicare Trustees report that the current hospital fund is sufficient to insure payments for only the next six years.

According to Martin A. Regalia, the chief economist for the U.S.  Chamber of Commerce, if current Medicare funding is not restructured, the Medicare payroll tax will have to be raised from the current level of 2.9 percent to 6.42 percent.  For the typical worker earning $30,000, the tax would be $1,928 instead of the current $876.  Regalia predicts that this additional tax would lower the Gross Domestic Product by $179.4 billion within two years and threaten the national economy with a recession.

Given this cost crisis and the increasing cost of matching Medicaid funds, there is a formidable incentive for the federal government to control its share of medical costs by converting to a block grant system for states. In addition, the current philosophical leaning of the Congress is for more local control.  From both a theoretical and practical perspective, the State of Georgia will probably play a much larger role in the future in health care.  State legislative leaders must have a thorough understanding of what to do about health care or else we will face recession, increased taxes — and disaster. Wise policies will dramatically improve the state’s bottom line.

WHAT WENT WRONG
For legislators to avoid making a bad situation worse, they must understand government’s role in creating the current situation of high federal and state spending for medical care, the problems with providing coverage for pre-existing conditions, and the facts behind the large number of uninsured people.

Essentially, a quirk of war caused us, as a nation, to pay for health care differently than we pay for other necessities of life, like food and shelter. Before the second World War, most health care was purchased out of pocket and costs were in line with general inflation. With the outbreak of war,  President Franklin D. Roosevelt and the Congress put the national economy on a war footing and imposed wage and price controls. Labor could not bargain for higher wages and businesses could not compete with higher salaries for employees.

With the intention of softening these restraints, the IRS established the principle that health benefits would be tax-free and exempt from price guidelines. As a result, the United States developed a unique system of tax-supported, employer-based health insurance.  Employers bought health insurance tax free and employees consumed health insurance tax free.

Since health costs were relatively inexpensive and in line with inflation, insurance policies with first dollar coverage became common. For consumers, there was no reason to shop for low-priced care. And since employers now paid, providers saw no reason to keep care affordable for the average worker. For each 10 percent decrease in the portion of the health care bill paid out-of-pocket by the consumer, the percent of the Gross Domestic Product spent for health care went up 2.4 percent. When the nation’s elderly in the mid-1960s were brought under the new Medicare program, which is also a first-dollar, no consequences employer-type plan, health costs started to climb exponentially.

In addition, since the plans were employer-based, not individual-based, when employees left a company, they also left their health insurance coverage behind, triggering all of the problems of lost coverage and preexisting conditions. This became especially significant when we moved, concurrently, from a job market where people routinely received a watch for 25 years of faithful service to the current environment where people routinely have several jobs throughout a career, and corporate downsizing is common.

The largest sector of the uninsured, over 50 percent, are individuals (and their dependents) who are self-employed or work for small companies. Since the cost of health care coverage is generally based on the number of people employed in a group, in a small company, with its small risk group, one individual’s illness will have a major impact on the plan’s cost. Therefore, the cost of coverage for small groups is much higher than in large groups.

Employee Distribution by Type of Health Plan

Plan Type Percentage
Point of Service “Managed” Care

21%

Preferred Provider Organization “Managed” Care

13%

Health Maintenance Organization “Managed” Care

32%

Indemnity “Traditional” Care

34%

The current health care payment system that developed in response to this World War II tax law is simply not a true market, and social changes have complicated things even further. When a person consuming a service is not directly paying for it, one does not have a real market.  If we want to control health care costs, reform must be aimed at making health care financing as close to a real market as possible.

WHO HAS CONTROLLED COST INCREASES?
Business has responded much more quickly to the health care cost problem than has government. Unlike the federal government, it could not change the tax law that created the current system, but it could change the way it paid the bill.  In the private sector, newer plans that move away from simple third-party, indemnity-type coverage clearly bring cost increases much closer to general inflation. Several different types have been tried.

PLAN TYPE Cost Per Employee (1994) % of Market Change in Cost (1993-1994)
Traditional Indemnity $3,850 34% Up 10%
Managed Care Preferred Provider $3,386 13% Up 2.1%
Point of Service $3,609 21% Up 10.5%
HMO $3,485 32% Up 6.4%
Medical Savings Accounts $2,900* 1,500 companies No Change
Scheduled Benefits $2,786 1 company No Change

*estimate

Health Maintenance Organizations (HMOs) and other variations of managed care, such as Preferred Provider Organizations and Point of Service options, have been the most frequent.  Today, some 66 percent of all workers are covered by such plans.

Other companies have tried Medical Savings Accounts (MSAs) and a plan called Scheduled Benefits.  In Scheduled Benefit plans, the company gives the employee the rates of all local providers and then pays the median cost of a service in that community.  If the employee chooses a provider at or below the median cost, there is 100 percent coverage, after an annual deductible.  If he chooses a provider above the median, he either negotiates the charge down or pays the difference.  There is a separate arrangement for reimbursement to cover catastrophic events after an employee reaches an annual out-of-pocket maximum.

It is very interesting to compare the actual cost per employee in each of these payment plans.  The data to do this were obtained from information developed by the health care consulting firm A. Foster Higgins and Company, Inc. for 1994, which covered “cost-per-employee,” even though the plans cover employees, dependents and retirees. In addition, the author of this paper personally contacted companies with MSAs and Scheduled Benefits to obtain comparable data.  The Foster Higgins study did not report on these companies since they currently represent a very small percentage of American companies.  During this same time frame, Medicare costs per person were $4,360;  Georgia Medicaid costs per person were $3,094.  Cost per family for these government programs are unavailable since they are individual plans.

Clearly there are different costs for medical care and different rates of increase, depending on the payment plan utilized. The most expensive plans are those like Medicare and Medicaid, based on the traditional indemnity model (meaning traditional health insurance in the sense that the insurance company pays the bills with few questions asked).  The most economical plans are those where individuals have a complete choice of doctors and hospitals and a financial incentive to consider costs in making their choices.

THE ANSWER
The closer a health care system comes to being a free market, the lower the costs of that system. Each of the private companies that have lowered their health care costs has moved that company closer to a free market. A free market has four essential components: choice, information, competition, and consequence. Companies have used one or more of these components to lower their costs.

Choice means the ability to freely choose between different plans or different doctors. In the current system, these choices can be made by either the company or the individual. When a company contracts with an HMO, for example, the company makes the choice of doctors for the employees. In traditional indemnity plans, individuals choose their doctors without constraint.

Information means readily available facts to compare costs and quality of a given product or service. The blue book of automobile prices, or competing automobile ads in the newspaper, are examples of this. Similar comparisons of health care costs have not been readily available until recently.  In fact, under the Traditional Indemnity payment system, there is no incentive to look at cost since the person choosing the service is not the person paying for it. HMOs that contract with companies on a capitated basis (a fixed fee per person) clearly offer the purchasing companies comparative costs. In the Scheduled Benefits plan, individuals are given comparative costs.

Free Market Index

PLAN Choice Information Competition Consequences Free Mkt. Index Actual Costs
Indemnity

xx

     

2

$3,850

Medicare

xx

     

2

$4,800*

HMO

x

x

x

x

4

$3,485

Preferred Provider

x

x

x

x

4

$3,386

MSA

xx

x

x

x

4

$2,900**

Defined Contribution

xx

x

x

x

5

$2,786

* per individual
** estimate
Note: The author has one x for a system-level decision and 2 xs for individual-level decisions. The cost of all plans except Medicare is cost per employee and covers employees, dependents, and retirees.

Competition means plans or doctors that compete to give high quality service at lower prices, or better service at the same price. Whenever cost is a factor in the choice process, there is automatically competition. Traditional Indemnity plans and Medicare do not in any way encourage patients’ choice of doctors on the basis of cost. In a MSA system, on the other hand, there is a limited amount of money available, so cost comparisons are encouraged. HMOs that bid for a company’s business also clearly compete on both quality and cost.

Consequences mean that the health care choices made will have a financial impact on the individual. If the employee chooses the more expensive doctor, he or she pays more. If the company chooses the more expensive plan, the company pays more.

To quickly and accurately estimate how any health care system will perform financially, or how any change will affect cost, one can use a Free Market Index.  Assign one point for each component of choice, information, competition and consequence that a system has. Choice is the most important component, since without choice the other components are not pertinent variables.

Within the current health care system, choice can occur at two levels. Corporate benefits managers and employers can choose at the systems level, or individuals can make choices at the personal level.  Obviously the scope of market pressures is greater when more detailed and frequent choices occur at the individual level.  To allow for this, count one point for systems choices and two points for individual choices. The highest Free Market Index will be five and the lowest one.

Any health care reform law that may be passed can affect these components and cause an increase or decrease in the Free Market Index. If a law increases choice, information, competition and consequences, costs will go down. If choice, information, competition and consequences are limited by a new law, costs will go up.  The legislator who wants to decrease health care costs will want to increase the Free Market Index.

SPECIFIC LEGISLATION
To control the cost of indigent health care in Georgia, the Department of Medical Assistance has initiated two pilot Medicaid managed care programs. Georgia Better Health Care is a Medicaid primary care management program operating in 32 counties.  Enrollment in this program is mandatory in the target counties except for those in the second pilot, the HMO program. Each recipient is linked to a primary care provider who is given $3.00 per month to coordinate a recipient’s health care. This provider is responsible for primary care services and must also authorize any  specialty care and inpatient services.  When these other services are provided, regular Medicaid reimbursement applies.

In five metro Atlanta counties (Clayton, Cobb, DeKalb, Fulton and Gwinnett), the Department of Medical Assistance contracts with established HMOs to provide total health care to those Medicaid- eligible persons who choose to enroll.  It pays a lump sum per member per month capitated rate that is developed by an actuarial firm. As has been true in the private sector, we can expect costs to decrease under this plan.  Looking at the Foster Higgins data for guidelines, per person costs would be expected to be about 9.3 percent lower than in comparable counties not having a managed care program.

Two cautionary points need to be considered.  While most people do well in HMOs, a study reported in the health care publication Lancet found that individuals who were both low income and in poor health did worse in HMOs than in comparable fee-for-service plans.1  At the end of the study, these patients had more serious symptoms, more bed days due to poor health, and a greater chance of dying if they had been randomly assigned to an HMO.

Moreover, the private sector experience has been that managed care often generates initial savings but does not guarantee long term containment of health care costs.  Paying a third party to control costs does not maximize cost savings.  Nationally, the amount HMOs actually spend on medical care is decreasing, but premiums continue to rise. KPMG has reported that, although the annual growth rate of premiums has been 6 percent to 8 percent, the costs that are directed to actually providing care decreased from 82 percent of premiums in 1990 to 75 percent in 1994. Bernstein Research Associates report that the largest HMOs spend less than 70 percent on actual care.

As more consolidation of managed care companies occurs, the cost savings are likely to decrease. Minnesota COACT (Citizens Organized Acting Together), a watchdog group, reports that just four vertically integrated companies now provide 80 percent of all health care in Minnesota, and costs have now increased to 5 percent above the national average. The lesson is clear: if Medicaid contracts with only a few companies in Georgia, it will encourage similar consolidation here, with the same results.

The greatest chance for ensuring continued cost control is to increase the Free Market Index for Medicaid even more. The American Legislative Exchange Council (ALEC) has proposed  model legislation that accomplishes this goal.  Their plan is modeled after the Federal Employee Health Benefit Program that is available to members of Congress. This program has 400 plans that compete once a year for the business of federal employees. The employees choose the kind of plan and benefits that meet their needs,  and the government pays a fixed contribution toward the premium. Not surprisingly, there has been solid control of health care costs with this plan. The rates have been essentially flat for three years, and if a plan does not provide the service promised, it is not renewed the following year. Both cost and quality are excellent.

The only recommendation to improve the ALEC bill would be to make sure persons covered are allowed to change plans once a year. And one version of the bill had numerous benefits required. This increases costs and forces individuals to pay for benefits they may not need or want. A 60 year old woman, for example, probably will not need nurse midwife services. It is a good idea to list the benefits that may be included for patient information and reminders, but not require it.

The ALEC bill also provides for MSAs. Clearly, any move in this direction should be encouraged.

EXCEPTIONS
As you move the health care system toward a true free market, some decisions during the transit will have to be based on how close to a true market you are at a given time. Certificate of Need (CON) legislation is a perfect example of this.  In a free market, a monopoly will increase prices. Therefore, two hospitals offering obstetrics, or two MRI machines available for films, should, under normal circumstances, decrease costs to the consumer. But, the current health care system is not a free market and, in reality, two hospitals offering obstetrics or MRIs will likely increase costs. This will continue to be true as long as a majority of the market is controlled by a third party payment system.  As more individuals establish MSAs  and other such personalized systems, market principles will begin to dominate. It therefore makes perfect sense to support some CON laws now but remove them in the future when we are closer to a true market.

Patient protection acts also make sense now because health coverage is often controlled by someone other than the patient. The “drive-by delivery” bill passed in the 1996 session of the Georgia General Assembly is a good example of this.

The most frequent reason for admission to any general hospital is for baby delivery. Unlike other high tech services like cardiac bypass, where different equipment or different drugs can significantly lower costs, obstetric costs are almost totally dependent upon the length of stay.  Insurance companies have a real interest in decreasing inpatient obstetric time. Their interest and the medical interest of the mother and child are at odds.  A legislator, in this instance, has the responsibility to protect the individual since the individual cannot replace the inadequate insurance that is chosen by a third party. As more individually-controlled health plans like MSAs or individual Scheduled Benefit programs enter the marketplace, this type of consumer protection will also no longer be necessary.  An insurance plan that kicks a newborn and its mother out in the snow will quickly lose most family business.

CONCLUSIONS
1)  The most important legislation the 1997 General Assembly could pass would move health care toward a free market. Any law that increases the Free Market Index by increasing choice, information, competition and consequences will decrease health care costs.

2)  There must be a recognition that health care coverage offered by a company is in fact employee compensation. Equalize the tax consequences of all employee compensation at the state level. Congress should do the same on the federal level.

3)  For the private sector, MSAs and Scheduled Benefit plans should be adopted. For Medicaid, the General Assembly should adopt an ALEC-type indigent health care plan that encourages MSAs and choices in various plans.

Each of these steps will not only maintain the best quality care but will put Georgia in the best position to manage its increased role in providing health care to all its citizens.

Endnotes

  1. Cited by John E. Ware Jr., et al., “Health Insurance: Comparison of Health Outcomes at a Health Maintenance Organization With Those of Fee For Service,” Lancet, 8488, pp.1017-1022.

Brenda Fitzgerald is past president of the Georgia Ob-Gyn Society and an assistant clinical professor at Emory University’s School of Medicine. This article also appeared in Agenda `96: A Guide To State Issues, published by the Georgia Public Policy Foundation (GPPF). The GPPF is an independent, nonpartisan organization dedicated to keeping all Georgians informed about their government and to providing practical ideas on key public policy issues. The Foundation believes in and actively supports private enterprise, limited government and personal responsibility.

Nothing written here is to be construed as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.

© Georgia Public Policy Foundation (September 15, 1996) Permission is hereby given to reprint this article, with appropriate credit given.