While there is much debate over what to do about healthcare in the United States, few disagree that the system has to change. Since 1990, the annual cost of medical care has skyrocketed from $665 billion to almost $2 trillion.
To pay for this, healthcare premiums are rising sharply. According to the Fall 2005 issue of Strategy+Business,1 a family of four could be paying $25,000 a year by 2010. Ominously, the single leading cause of bankruptcy in this country is already unpaid medical bills. And the rapidly aging Baby Boomers are only going to put more pressure on the system.
But there is reason for optimism. A growing number of employers and individuals are taking advantage of an initiative that promises to revolutionize the way healthcare is delivered in the United States ? and to lower its cost.
We’ll explore that initiative, but first a little background is in order.
Insurance, including public programs like Medicare, can have a paradoxical effect. It can encourage wasteful behavior. The 2004 Economic Report of the President2 uses this example: Suppose you could insure your clothing so that you’d pay only a 20 percent co-payment for all of your clothing purchases.
After your premium, you’d experience an 80 percent discount on all your clothes ? so like most people, you’d naturally buy more clothing, and choose clothes of better quality. The insurance company, naturally, would then have to charge a higher premium to cover the remaining 80 percent.
Eventually, the premiums for such insurance would become so expensive that they’d cease to be cost-effective. This example illustrates why economists say health insurance becomes “inefficient” under certain circumstances.
It also points to the larger problem known as “moral hazard.” The concept of moral hazard has been around a long time, but was first tied to health insurance in 1968 by economist Mark Pauly. It refers to the idea that people will make healthcare decisions differently, depending on whether or not they’re insured ? and, under certain circumstances, they’ll overuse it.
That’s what we’re seeing today on a national scale. And, as expected, this results in insurance costs rising out of control. The fact that insurance policies come with co-insurance rates, co-payments, and deductibles reflects an attempt to mitigate the moral hazard problem.
Unfortunately, those measures haven’t eliminated much of the inefficiency in the system. That’s because of other economic phenomena that are in play here. One such phenomenon is the concept of “adverse selection.” That concept says that if an insurance company sets its premiums for the average individual, but then attracts people who spend more, the price will have to go up over time.
This can result in premiums priced for the most expensive consumer. When that happens, some people won’t purchase insurance at all. Adverse selection occurs because insurance companies can’t distinguish among the different types of consumers. If they could, they could tailor policies to each group according to how much healthcare each consumes.
Another problem is that health insurance has ceased to be genuine “insurance” in the classical sense of the term. Insurance, traditionally, is a means of spreading the risk of an unlikely but catastrophic event over a large number of “premium payers.”
For example, the average motorist is unlikely to have a big auto accident. But when someone does have an accident, there is a common fund, built out of all of the insured drivers’ premiums, to pay the bills for the unlucky driver.
Our health insurance lacks this logic in at least three ways:
First, employers rather than the insured individuals typically pay the bulk of premiums, and the costs for both employer and employee are subsidized by being tax-exempt.
Second, health insurance covers not just unlikely events but also events that are extremely predictable, such as routine exams and vaccinations. If automobiles were insured this way, the policies would cover oil changes and car washes.
Third, health insurance covers events that are neither catastrophic nor very costly, such as taking a child to the doctor for a sore throat or a rash.
The result is a system where the decision maker never feels the direct consequences of his or her own decisions. As expected, this leads to some pretty inefficient decisions.
The reforms provided under recently enacted laws promise to eliminate these inefficiencies and make healthcare more logical and cost-effective. This will happen because there will be direct interaction between consumers and healthcare providers with less reliance on insurance companies.
In other words, the reforms will reintroduce free market economics back into a system that has suffered from poorly designed policies for decades. The centerpiece of these reforms is known as Consumer Directed Health Plans, or CDHPs. CDHPs will allow people to design their own healthcare plans. As reported on the Dow Jones News Service,3 individual choice and market forces are the driving factors in this new system.
The idea behind CDHP is that competition for patient dollars will drive quality up and price down, just as it does in any other consumer marketplace.
Under a CDHP, the employer would typically contribute about $2,000 for an individual or $4,000 for a family to a health savings account, or HSA. Those funds would be used at the patient’s discretion to pay any medical expenses for either prevention or treatment.
In addition, the employer would supply a traditional medical insurance policy, but one with low premiums and a high deductible, up to $5,000 for a given year. This policy would protect the insured party from catastrophic loss due to illness.
At the end of the year, any remaining money in the HSA would roll over, as the next employer contribution is added. This feature encourages people to build the fund up for the possibility of a catastrophic illness or accident by spending wisely and choosing the most effective ? and cost-effective ? preventions and treatments. The CDHP plans can be moved from job to job, or into retirement. The contributions are tax-free whether they are earning interest or being spent.
Since the funds, if not used, can accumulate to significant amounts over time, they will create a secondary industry in financial services that will help people to maximize the return on those funds and perhaps combine them with retirement accounts, life insurance, disability, and even education funds.
Such financial services giants as Mellon, Fidelity, Principal, and JPMorgan Chase have begun to form alliances with big insurance companies to bring this opportunity through to the marketplace.
While it hasn’t received the same media attention as the new prescription benefits for seniors, anyone under 65 can now start building an HSA.
As reported in June by The Wall Street Journal,4 the numbers seem to indicate that the CDHP concept is catching on. About 4 million people have signed up for CDHPs in the past two years. In 2004 alone, the number of people enrolled in the plans grew by more than 100 percent.
According to a Kaiser Family Foundation survey conducted in 2004, one-fourth of all companies in the nation were then considering the plans. One recent survey found that 26 percent of large companies would offer CDHPs to their employees by 2006, which will more than double the percentage tallied this year.
According to an article in the Saint Paul Pioneer Press,5 Hewitt Associates, a consulting firm specializing in human resources issues, surveyed nearly 300 companies recently and found that 60 percent planned to offer their employees CDHPs.
At the heart of the CDHP concept is the idea of making wiser, more cost-focused decisions. According to The Los Angeles Times,6 as it stands today, consumers have no idea what healthcare costs. Most would be surprised to learn that a brain scan costs nearly $3,000 at San Dimas Community Hospital in California, while the same test is just $1,650 at Cedars-Sinai Medical Center.
Bringing price into the forefront of the consumer’s mind is seen as the key to bringing healthcare costs down. CDHPs will play a big role in that.
Based on the current demographic and economic realities as well as the ongoing convergence of other powerful trends, we offer the following five forecasts for your consideration:
First, as the numbers make clear, the healthcare system is already under radical renovation. CDHPs and HSAs are spreading. Today, only about 2 percent of the insured population, or 2.7 million people, representing $16 billion worth of premiums, are covered by CDHPs, according to a study done by Forrester Research. However, we forecast CDHPs’ market share will reach 24 percent in 2010, with $413 billion worth of premiums being paid. And from there, the numbers can only be expected to rise. In part, this is because healthcare has operated for too long outside the traditional market forces that make businesses work. The broad changes we are about to see are already underway: Healthcare will become a consumer-driven business with the result that American medical care, already the best in the world, will become even better, and much more cost effective.
Second, these reforms will enable the United States to maintain and expand its preeminence in providing healthcare technology at home and abroad. Since 1975, more Americans have won the Nobel Prize in medicine and physiology than all other nations combined. More than 80 percent of biotech drugs in existence were developed by U.S. companies. Of the top 10 medical innovations in the past 30 years, nine out of 10 were developed in whole or in part by the United States. Bringing rational economics to the healthcare system will ensure continued incentives for American companies and academic institutions to push medical technology into its next phase through genetics, nanotechnology, and stem cell research.
Third, demographics will play a role. As Baby Boomers inherit the wealth of previous generations and enter a period of higher demand for healthcare, they will have both the means and the incentive to find the most cost-effective way of serving those needs while preserving their wealth. Under the CDHP system, this will produce an unprecedented opportunity for the healthcare and financial-services industries. A new industry that marries the two and focuses on the triple tax advantage of HSAs will become one of the hottest new economic areas in the next 10 years.
Fourth, the CDHP model will ultimately be extended to Medicare. If this concept makes sense for younger people, it should be applied to the elderly as well. In an era when a large percentage of people in their 70s will continue to work, this will be an increasingly saleable proposal. When Medicare recipients are given a health savings account to spend wisely, we’ll start seeing a dramatic drop in the rate of cost increases.
Fifth, over the long term, as the quality of healthcare in the U.S. rises with falling costs, the European model will be forced to change. As Michael Porter and others have suggested, the only way to drive down costs is through competition. Voices urging the U.S. to move toward a European healthcare model will disappear as the empirical evidence from market-based healthcare reforms mounts. Ironically, we foresee the day when the European healthcare system, already under severe strain, will have to bend to the reality of market forces.
References List : 1. Strategy + Business, Fall 2005, “Prescription for Change,” by Gary Ahlquist, David Knott, and Philip Lathrop. ⓒ Copyright 2005 by Booz-Allen Hamilton. All rights reserved. 2. To access the Health Insurance chapter of “Economic Report of the President 2004,” visit the Government Printing Office website at:A257.g.akamailtech.net/7/257/2422/17feb20051700/www.gpoaccess.gov/budgets/fy05/pdf/2004_erp.pdf 3. Dow Jones New Service, June 29, 2005, “Savings Accounts for What Ails You,” by Dinah Wisenberg Brin. ⓒ Copyright 2005 by Dow Jones & Company, Inc. All rights reserved. 4. The Wall Street Journal, June 14, 2005, “Patients Give New Insurance Mixed Reviews,” by Vanessa Fuhrmans. ⓒ Copyright 2005 by Dow Jones & Company, Inc. All rights reserved. 5. St. Paul Pioneer Press, July 5, 2005, “Consumers Gain Clout, and Risks, in Healthcare,” by Jeremy Olson. ⓒ Copyright 2005 by St. Paul Pioneer Press, Inc. All rights reserved. 6. The Los Angeles Times, July 2, 2005, “How Much for That Brain Scan?” by Lisa Girion. ⓒ Copyright 2005 by The Los Angeles Times. All rights reserved.
