The New Consumerism

By Greg Scandlen

Winston Churchill is reported to have said, “America can always be counted upon to do the right thing, after all other possibilities have been exhausted.” Nowhere is that more true than in health care.

For decades we have tried everything else. We have diced it and sliced it, put it in the blender and poured it out. We’ve tried wage and price controls, centralized planning, government programs of every stripe, uncountable rules and regulations, all to deliver to Americans the health care services they need and want at an affordable price.

Only now are we getting around to the idea that works so well in every other part of our economy – allowing individual consumers to spend their money on the services they value most.

The most recent detour was the embrace of managed care as the Great Solution to our health care problems. Managed care was based on the premise that we had to get away from “fee-for-service” medicine and move to a capitated system. That is, if we pay doctors and hospitals a fee every time they provide a service, they will keep providing services until we are bankrupt. Managed care proposed paying providers for the number of patients they saw, not by the number of services they provided. It was argued that this would remove the incentive to over-provide services. Physicians would be responsible for a certain number of patients and give whatever care those patients needed. The managed care company would make sure the physicians were doing the right thing.

This idea was eagerly embraced by employers and government programs as the answer to all our problems. Unfortunately, doctors and patients weren’t so crazy about it. Doctors didn’t like having bureaucrats second-guessing their medical decisions and patients didn’t like being denied services and access to specialists. The approach has been reviled in the press and, as it turns out, it didn’t actually save much money.

This shouldn’t be surprising. Managed care was based on a faulty premise. The essential problem in health care has never been fee-for-service payment. The problem is third-party payment.

Most of what we buy in our lives is done on a fee-for-service basis – haircuts, plumbers’ services, baby-sitting – and none of it is excessively inflationary. The provider of the service may want to induce us to buy more than we really want or need, but because we are reluctant to part with our money, we resist their inducements. There is a healthy tension that results in an equilibrium of interests. The barber wants our money and we want a haircut. We would like to talk the barber into cutting our hair for free, but that isn’t going to happen. And the barber would like to talk us into getting a haircut every day, but that won’t happen, either.  Somehow we manage to come to an agreement that increases the wellbeing of both of us. The barber gets the money he would like to have and we get the haircut we would like to have and we both walk away happy. In fact, we usually each say “thank you” to the other. The barber thanks us for the money, and we thank him for the haircut. Both are winners.

Health care used to be like that, too. The doctor would perform a service for a sum of money. The patient would receive the service and pay the money. Both parties gained. Both parties were happy. Costs were rational and services were plentiful. Then came third-party payment and everything changed.

As with any service, once someone else is paying the bill, the reasons to be cautious with spending are removed. People traveling on expense accounts stay in better hotels than people who spend their own money. College freshman with new credit cards from their parents are notorious for splurging money. And people with health insurance say, “I don’t care what it costs, doc. I’m covered!”

Some people will argue that health care is “inelastic,” that is, health care services are so important that cost doesn’t matter. Someone who has been hit by a truck isn’t going to quibble over the cost of treatment. That may be true, but relatively few health care services are of the immediate life-and-death variety. Most are planned well in advance while the patient is entirely capable of making cost/benefit calculations.

The empirical evidence of consumer discretion in health care is plentiful, starting with the famous Rand Health Insurance Experiment that was completed in the early 1980s. This study tested a variety of cost-sharing options over an eight-year period, from one that paid 100 percent of the cost of services to one that paid only 5 percent with a stop-loss limit. Project director and Harvard University professor Joseph Newhouse concluded, “Use of medical services responds unequivocally to changes in the amount paid out-of-pocket. … Per capita expenses on the free plan are 45 percent higher than those on the plan with a 95 percent coinsurance rate.” [1] He adds, “The more families had to pay out of pocket, the fewer medical services they used.” [2] Importantly, the lower use of services did not have a negative effect on health outcomes.

Both logic and experience tells us that third-party payment will lead to excessive demand for health care services. But what happens then? Third-party payers are not going to just blindly pay for everything consumers feel like getting. They will not write a blank check to be filled out by the physician and the patient. They will try to limit the use and cost of services.

That is exactly what payers – employers, insurers and the government – have been trying to do for at least 30 years now. The list of laws and programs aimed at constraining health care costs is a very long one, starting with President Nixon’s wage and price controls, to comprehensive health planning, hospital rate-setting commissions, benefit redesign, second surgical opinions, utilization review, preadmission certification quality assurance, and a whole alphabet soup of federal activities – PSRO, DRG, RBRVS, COBRA, ERISA, HIPAA, DEFRA, TEFRA. Most recently, we have enjoyed a 10-year infatuation with managed care. Some of these activities fail miserably. Others seem to work for a while, but only for a couple of years until health care inflation is right back where it was before.

The problem is that none of it deals with the essential issue in health care financing – the growing disconnect between payers and consumers. In 1960, more than 55 percent of total health care spending was paid directly by consumers. That number dropped to 27.8 percent in 1980, and continues to drop, reaching 19.6 percent in 1998, and 15 percent in 2000.[3] Over five out of six health care dollars are now paid by a third-party, and the expenses that consumers pay directly tend to be the least essential ones, such as vision and dental, over-the-counter medications, and in-home nursing care.

Graph 1

(Source: Office of the Actuary, Centers for Medicare & Medicaid Services)

As a result of this growing reliance on third-party payment, we overspend on health care services compared to other parts of our economy. From 1961 through 2000, the growth in National Health Expenditures has been far higher than the increase in Gross Domestic Product in all but five years. In many years the increase in health spending is two or three times the overall Consumer Price Index.

Graph 2

Consumers are exempt from feeling the costs of care, so not only do they over-consume, but they have no idea there is a problem and do not support payers’ efforts to constrain costs. Public opinion surveys have been taken nearly every year since 1973, asking whether the United States spends too much, too little, or just the right amount on health care services.[4] With remarkable consistency over a 30-year period, about two-thirds of the population say the United States doesn’t spend enough on health care. At no time in 30 years has more than 10 percent said we spend too much! 

Graph 3

Since the public thinks we don’t spend enough on health care, it is not surprising Americans don’t support cost-containment efforts. Not only do they fail to support these efforts, but they get angry when someone tries to deprive them of the services they think they need. Since they don’t feel cost containment is justified, any effort to limit the supply of services is taken as a personal affront – mean-spirited insurance companies (or employers) depriving people of needed services just to enhance their profits.

As a result, a large majority of Americans believes the health care system is broken and needs to be rebuilt. But importantly, so do large majorities of Canadians, Britons, Australians and New Zealanders. They all think their own health care system is broken and needs to be rebuilt. Yet these five countries each have different financing systems.[5]

Graph 4

How can so many people in such different systems all believe there is something fundamentally wrong with their own way of financing health care? Because despite superficial differences in whether the government, employers or insurers pay the bills, in every case a third party is paying for the vast majority of care. In every case a promise is made that citizens may have all the care they want for free or nearly so. And in every case, it isn’t true.

Each country has its own method for preventing consumers from getting the care they want. It may be limiting the supply of doctors, using waiting lists for services, rationing by price, using “medical necessity” standards, or outright denial of care. In every case, third party payment is accompanied by third party rationing. Consumers know that care is being withheld, and they don’t like it.

The problem will get worse before it gets better. Every year new drugs and new techniques are introduced to the health care marketplace. Human genomics is only one example; others include nano-technology, molecular level treatments and some 400 new drugs currently in the research pipeline. At the same time we are developing “Star Trek” medicine, we are also rediscovering ancient remedies such as acupuncture and herbal medicines. The universe of what can be considered health care is rapidly expanding. No third party can possibly pay for it all – or even 85 percent of it.

The big question facing us in the next ten years is what gets paid for and what doesn’t. The even bigger question is who decides? Will it be employers, insurers, the government, independent assessment agencies? Or it will it be consumers?

Many people in health care are arguing against consumers. The whole movement around “evidence-based medicine” is an attempt to bureaucratize this decision-making process. Stripped bare of all the niceties, the evidence-based medicine movement maintains that neither patients nor clinicians should be making decisions about appropriate care. Panels of researchers and bureaucrats should endorse certain types of treatment and disallow others – regardless of the preferences and values of the person being treated. This is the ultimate destination of third party payment. Patients are just grist in the mill and physicians are mere functionaries. The only values that count are the values of the payer.

And it is indeed the values of the payer that count: “He who pays the piper picks the tune.” Note that we are not talking here about eliminating insurance, but of reducing “third-party” payment, which is a very different thing. Third-party payment means that a patient pays a premium to a carrier, and the carrier pays the doctor or hospital for services delivered to the patient. Insurance is a two-party contract between a consumer and an insurance company. The consumer pays a premium and the insurer pays the consumer when “a loss” occurs. It is not up to the insurer to decide who is a good doctor or what is an appropriate course of treatment. That is between the patient and the doctor. These two-party contracts enable the patient/consumer to know what services cost and to behave accordingly. The consumer may then control how the money gets spent, rewarding those who provide good services and punishing poorer services.

All societies express their values by rewarding some with money and withholding money from others. The party that controls the money is the party that gets to decide who should be rewarded. The principle applies to socialist regimes as well as to capitalist ones.  

But in capitalist societies, we trust consumers to make most of those decisions, based on their own needs, values and priorities. The consumer is the payer, the consumer controls the money and the consumer decides who is rewarded and who is not. We do not ask our employers to make those decisions for us.

Many employers are reaching the conclusion that there is no reason the same system cannot apply to health care as well as it does to every other area of our lives. Americans are as capable of expressing their preferences and choices in health care as they do everywhere else. But they need to understand that resources are limited and trade-offs are required.

Admittedly, this is a leap from where we have been. It is a change from the direction we have taken for half a century. The change will not happen overnight. It will be gradual and incremental. But the beginnings are already in place.

The first significant development was the enactment of Medical Savings Account (MSA) laws, first by 17 states in the early 1990s, and then by Congress in 1996. The essential idea behind MSAs is that people could save premium dollars by raising their deductibles, and put those savings into tax-advantaged accounts to pay directly for routine services. The MSA law passed by Congress was crude and tentative. It included a host of restrictions and limitations.[6] It was aimed at the least innovative part of the benefits market – small employers and the self-employed. As a result, the products that came out of that law had limited acceptance in the market.

The more important consequence of the MSA law is that it forced a rethinking of the role of the consumer in health care spending. Until then, it was nearly unthinkable that health care consumers could be trusted to control some portion of their health resources. People worried that greedy doctors would overcharge naive patients and use up all their funds on worthless treatments, or conversely, that ignorant patients would spend their money on beer instead of getting needed care for their children.

Those attitudes did not last long once they were exposed to the light of day. Economists, insurance company executives, human resource managers, benefits consultants and public policy makers all had to reconsider their views of health care consumers. Paternalism was dealt a fatal blow.

Now, employers, insurers and benefits consulting firms are all looking for ways to replicate MSA-type programs in the rest of the market. They have come up with “personal health accounts,” which allocate a sum of money to each employee. Medical services are paid out of the account, and unspent balances are carried into the next year. The accounts are tax-favored because they are never distributed to the employee. They are funded solely by the employer, available only for health care expenses, and may never be “cashed-out.” Because there is no “constructive receipt” of the funds, there is no taxable event, and the money remains on the employer’s books until it is spent on health care services.

Programs like this are being offered by a number of new entrepreneurial companies, such as Lumenos, Definity Health and MyHealthBank, as well as by some major insurers such as Aetna, Humana and United Healthcare. A number of very large Fortune 200 companies have installed them at least on a pilot basis, and some other firms have bought them on a total replacement basis.

In June, 2002, the Internal Revenue Service approved this approach to health care financing and created a new name for it – Health Reimbursement Arrangements (HRAs).[7]The IRS said HRAs may be for any amount of money and may accompany any sort of insurance plan. The funds may roll over and build up from year to year and even be available after a worker leaves the job. HRAs avoid most of the restrictions of MSAs. The only limitations are that the funds may be contributed solely by the employer and may be spent only on health care services.

These Health Reimbursement Arrangements are only one of several consumer-centered approaches being tested in the marketplace today. Other models include:

·     Allowing consumers to build their own HMO by selecting a personal network of providers who are all paid on a capitated basis. (Vivius)

·     Paying patients a fixed indemnity payment to cover all costs associated with a particular illness or condition. (HealthMarket)

·     Providing a network of physicians who charge less to cash-paying patients. (SimpleCare)

·     Providing a similar network of non-physician providers who also charge less for participating patients. (HealthAllies)

·     Enabling employees of smaller companies to choose their own health plan from a wide variety of models. (HighMark and Wellpoint)

Consumerism is also showing up in all sorts of otherwise conventional benefits programs. Employers and insurers are using the Internet to enable employees to make enrollment decisions, develop personal health profiles, shop for physicians by price and style of practice, gather information about treatment alternatives, create support groups for patients with similar conditions, and in some cases actually make appointments on-line.

The new Health Savings Accounts (HSA) provision in the Medicare bill was signed into law by President Bush on Dec. 8, 2003 and went into effect Jan. 1, 2004. All 250 million non-elderly Americans now have access to a Medical Savings Account, and one that is far more attractive than the Archer MSAs enacted in 1996.

Account holders must have a qualified insurance plan, but the insurance requirements have been opened up considerably. Allowable deductibles have been lowered to $1,000 for an individual and $2,000 for a family. The maximum deductible requirement has been replaced by maximum out-of-pocket limits of $5,000 and $10,000 for individuals and families.

Annual contributions to the HSA are limited to 100 percent of the deductible up to a maximum of $2,600 for an individual or $5,150 for a family. From age 55, account holders may make additional contributions of $500 in 2004, increasing by $100 each year up to $1,000 in 2009. Such contributions may be made by any combination of employer and individual. Employer contributions are excludable from income and individual contributions are deductible “above the line.” That is, a taxpayer does not have to itemize deductions in order to take the contribution as a deduction. Employers may offer HSAs as part of a section 125(d) cafeteria plan.

Finally, even without all these programmatic changes, employees are being asked to bear more responsibility as employers raise deductibles, coinsurance and co-payments to offset some of the rate increases they have experienced in recent years.

Perhaps more than anything else, it is health care inflation that is causing a switch to a consumer-based system. Payers will simply not pay without end and, ultimately, the only people truly responsible for our health care needs is are ourselves.

And that is the bottom line. No one else cares as much about our own health as we do. Other parties may help pay for it; other people may offer suggestions and advice. But no one else will suffer our pain for us. No one else will die for us. There is no experience more intimate and personal for each of us than our own life, our own health, and our own death. And there is no one else who can take responsibility for that process. There is no part of our lives that requires consumer empowerment more than health care.

[1] Joseph Newhouse, Free For All?: Lessons From the Rand Health Insurance Experiment, Harvard University Press, Cambridge, Mass., 1991, page 41.

[2] Ibid., page 338.

[3] Health Care Financing Administration, Office of the Actuary, National Health Statistics Group. See year 2000 numbers at

[4] Robert Blendon and John Benson, “Americans’ Views on Health Policy: A Fifty Year Historical Perspective,” Health Affairs, March/April 2001, page 38.

[5] Karen Donelan, et al, “The Cost of Health System Change: Public Discontent in Five Nations,” Health Affairs, May/June, 1999, page 208

[6] Greg Scandlen, “MSAs Can Be a Windfall For All,” NCPA Backgrounder #157, November 2, 2001, pp. 4-5, available at:

[7] IRS Notice 2002-45 and Revenue Ruling 2002-41.

Greg Scandlen, the director of the Center for Consumer Driven Health Care at the Galen Institute, is a Senior Fellow with the Georgia Public Policy Foundation. The Foundation is an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or 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 (May xx, 2004). Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.

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