Testimony before the House Select Committee on State Health Care Expenditures, Subcommittee: Interim Charge 5 (ERS-TRS)

March 24, 2004

by Devon M. Herrick

Madam Chairman and Members of the Subcommittee, thank you for the opportunity to share my thoughts with you about ways to slow the rising cost of health care and increase choice among enrollees. The history of health insurance is that people began receiving coverage as a "non-cash" benefit during World War II because of wage controls. A few years later Congress confirmed that health insurance was exempt from taxable wages. The effect of this regulation meant that coverage received in lieu of wages was more affordable than using after-tax wages to purchase health insurance. The same was true of funds used to pay for incidental medical needs. Thus began the trend of purchasing health coverage through your employer and paying third parties to manage all your health care spending - including data-to-day medical needs.

Unfortunately, this created a whole set of new problems, including rising prices, fewer choices and in some cases wasteful utilization.

From the standpoint of health economists, the essential problem in health care is too much third-party payment. Third parties - government, employers or insurance companies - pay for about 85 percent of all health care received today. The proportion of health care paid directly by consumers has been falling for years. In 1960 consumers paid about 56 percent of health care directly. In 1980 the proportion had fallen to about 28 percent. It stands about 15 percent today. Most of the 15 percent of health care for which consumers pay directly are over-the-counter (OTC) drugs, vision care, dental care and cosmetic surgery such as Lasik.
One problem that occurs when third parties control our health care is that they will always ration care. Third parties also have higher overhead and administrative costs since many of their procedures are designed to ensure that only appropriate care is given and claims are not fraudulent.

Giving more control to third-parties means less for consumers. Moreover, it reduces patients' incentive to be wise consumers of medical services by removing their ability to express preferences and make trade-offs similar to other areas of their lives.

For instance, consumers do not bear the burden for poor life-style decisions they make. People who smoke or lead unhealthy lifestyles generally do not pay more for care which, in turn, doesn't provide them with much incentive change their behavior. Likewise, people with first-dollar health (and drug) coverage are not penalized for wasteful health care spending. Thus, we all have little incentive to be prudent consumers of health care. About a dozen years ago, researchers with the Rand Corporation performed a health insurance experiment where they provided randomized samples of participants with different levels of health care deductibles and cost-sharing. Those with higher co-pays and levels of cost sharing consumed about 30 percent less health care annually with no ill effects on health.

With experiments like this, it became obvious that the key to improving health care and holding down prices is to get consumers involved in decisions regarding their own care. One of the ways employers are attempting to connect employees with decision-making is through defined contribution health insurance. The employer "defines" their contributions while employees choose among the types of policies they purchase. An employee wanting a richer benefit package might have to contribute additional money out-of-pocket to cover the cost. On the other hand, employees choosing less expensive (high-deductible) health plans might have funds left over to deposit into a personal health account, such as a health savings account (HSA). This works because high deductible policies are less expensive than policies offering first-dollar coverage. The funds placed in an HSA would be controlled by the employee, and would be used to pay for incidental health care needs up to the health insurance policy deductible. Employees would also have the ability to contribute additional funds into the HSA tax free to shore up these accounts. Balances not used could be invested in fund of the enrollee's choosing.

Data is just emerging on how well these plans have performed. A study published by the National Center for Policy Analysis on Medical Savings Accounts (MSA) in South Africa found that for those enrolled in MSA plans' discretionary spending (primarily outpatient spending) was 47 percent lower. Individuals with an MSA were also much more likely to purchase a generic equivalent rather than a name-brand drug. By contrast, prescription drug spending by members increased 7.1 percent, and the number of prescriptions filled per month grew by 19.1 percent after the patient reached their policy's deductible and were essentially spending insurance company funds. Once patients were spending insurance company funds use of the more expensive branded drugs jumped 45 percent.

Closer to home, a survey by Aetna of 14,000 members with Health Reimbursement Accounts (HRA) found that members in their HRA (called HealthFund) performed very well compared to a match set of non-HRA enrollees.

HealthFund members only experienced a 1.5 percent increase in medical costs compared to almost 16 percent in populations with similar demographics, and more than 14 percent for Aetna's PPO plans.

HealthFund members decreased the number of overall prescriptions by 6.5 percent and increase the proportion of generic medications they used by almost 13 percent which drove down pharmacy costs driven by an 11 percent.

Half of members had funds left over at the end of the year to roll over into the next calendar year - averaging 31 percent of their funds.

An additional benefit is those enrolled in HSAs tended to participate in more preventative care than a control group. This is probably because any savings accrued from prevention is captured by the enrollee. Traditional health insurers are reluctant to invest in preventative care since benefits might be realized years later - often by another company.

Some of the critics of personal health accounts often argue that they will experience favorable selection by appealing only to the "young healthy" and "wealthy" - leaving the poor and sick in traditional risk pools. However, preliminary data from Aetna (and others) have shown that the age distribution of those enrolling in their plans is similar to a bell-shaped curve. In fact, the average age of HealthFund enrollees was slightly older than other plans, not lower as critics might suggest. Overall, about two-thirds of HealthFund enrollees were between the ages of 35 and 55.

These plans also experienced a very high degree of customer satisfaction. Ninety percent of those enrolled in the plans reportedly were satisfied with their choice and were likely to renew for the following year.

In conclusion, giving employees more choice and control over their health care makes good sense. It leads to lower costs and more control over the kinds of care they prefer.