Executive Summary of NCPA Policy Report #183

• The unifying objective of all proposals for managed competition is to create an artificial market for health insurance in which individuals choose among competing health plans that are forced to charge the same premium to every applicant, regardless of expected health care costs.
• Among people entering a health plan, a person who has AIDS would pay the same premium as someone who does not, and people in hospital cancer wards would pay the same premiums as people who do not have cancer.
• Because of the one-price-for-all rule, the premiums sick people pay would be well below the expected cost of their treatment, while the premiums of healthy people would be substantially higher.
• As a result, the incentives for the plans to avoid sick people and attract healthy ones would be far worse than under the current system.

On the consumer side, heart patients would tend to choose the health plan with the best cardiologists, while cancer patients would tend to choose the plan with the best cancer specialists. By contrast, healthy people would tend to choose plans with the best primary care services and amenities - secure in the knowledge that they could always switch plans if they became seriously ill.

This would create extremely perverse incentives for the managers of the health plans. For example, no competitor could afford to have a reputation as being the best plan for those with expensive-to-treat illnesses. Indeed, the plans that attracted a disproportionate number of sick people would eventually fail and leave the market. Moreover, each health plan would have an incentive to underprovide services to the sickest people and overprovide services to the healthy. Specifically:

• The natural tendency of managed competition is to compete the amount health plans are willing to spend for the care of the sick down to the level of the premiums sick people pay.
• By contrast, there would be a natural tendency to compete the amount health plans are willing to spend on the healthy up to the level of the premiums healthy people pay.
• As a result, seriously ill people would be progressively denied access to the benefits of modern medical science, while healthy people would have access to services that are medically unnecessary and only tangential to health care.

These conclusions follow from well-known principles of the economics of regulation. In competitive markets, price tends to change until it equals average cost. But if prices are constrained, competition will cause cost to change until it equals price, primarily through changes in quality. For example, when housing rents are kept artificially low by rent control, landlords tend to allow housing quality to deteriorate until housing costs fall to the level of the government-controlled rents. When airfares were kept artificially high under airline regulation, the airlines tended to increase quality by adding more flights and amenities until their costs rose to the level of the government-controlled fares.

A different way of appreciating this result is to consider it in terms of a basic principle taught in all introductory economics courses: when firms are maximizing profits, marginal revenue must equal marginal cost. Under managed competition, marginal revenue (the amount of premium each enrollee brings to a plan) must be the same for every enrollee. That means that marginal cost (the amount the plan spends on health care for a patient) must also be the same for every enrollee.

We do not expect the quality of care delivered to the sick to deteriorate immediately. Nor will all diseases be affected in the same way. Health policy analysts believe the patients at greatest risk initially will be those with chronic conditions - those in need of mental health care, custodial care or long-term care. Where physicians have discretion, as in the treatment of leukemia or in efforts to save premature babies, the tendency will be to save money rather than prolong life. Expect a substantial decrease in the number of CAT and MRI scans and other costly tests that detect brain tumors, cancer and other life-threatening conditions. Where possible, expensive surgery (such as bypass operations) will be delayed - if for no other reason than to take advantage of the chance that the patient might switch health plans and have the surgery performed by a competitor.

Advocates of managed competition like to stress the word "competition." But in order to preclude the disaster just described, policymakers would have to focus on "management" (read: regulation). Various proposals would try to restrain perverse behavior by (a) limiting the freedom of enrollees to change plans to "open enrollment" periods, (b) rigidly insisting that everyone have exactly the same package of health insurance benefits, (c) requiring everyone to have the same deductibles and copayments, (d) transferring income back and forth among insurers under "risk adjustment" schemes and (e) imposing regulations designed to prevent the deterioration in quality of care.

Some of these features would lead us to modify our predictions. For example:

• If the premium income each enrollee brings to a health plan were risk adjusted, then competition would tend to make the cost of care equal to the risk-adjusted premium for every patient.
• If government succeeded in setting a floor under the quality of care for the sick, then competition would tend to compete the quality down to the government-imposed minimum standard.

But because these restrictions do not correct the fundamental problem " incentives distorted by artificial prices " they are unlikely to make managed competition workable. And each new set of regulations is likely to create pressures to enact even more regulations.

Advocates of managed competition point to three operational examples of the reform they propose: the health care program for federal employees and programs for public employees in the states of California and Minnesota. Although all three have confronted some of the problems described above, they have not yet produced the radical changes in health care delivery predicted by economic analysis. The primary reason is that in these programs most people are enrolled in health plans that are primarily selling insurance services to a wider market, rather than medical services to public employees. That makes the public employee plans distant cousins of managed competition, rather than examples of the real thing.

Under pure managed competition, there would be no need for insurance companies. Health plans could just as easily be operated by hospitals or physicians' groups. Indeed, physicians and hospital personnel are likely to have a competitive advantage over insurance companies in a very important respect: their "hands-on" relationships with patients would put them in a much better position to encourage the least profitable enrollees to move to some other plan. Thus the existing plans " both public and private " that allow choice and competition among insurers tell us very little about what would happen if the market for insurance were effectively abolished under managed competition.

Managed competition would make no sense unless most health care were delivered in health maintenance organizations (HMOs), employing the techniques of managed care. That is why most proponents of managed competition oppose traditional insurance and fee-for-service medicine. They want physicians to become agents of bureaucracies rather than agents of their patients, and they want medical practice to be determined more by computer-generated mandates than by the physician's best judgment.

Yet these views reflect the prejudices of a small group of health policy reformers and are not based on the results of academic research.

• Rand Corporation studies show that people spending their own money are more effective at controlling costs than are HMOs.
• The Mayo Clinic, which mainly caters to fee-for-service clients, shows that managed care need not be combined with an HMO.
• Studies show that physicians using their own judgment can outperform computerized protocols.
• And health economists have shown that the problems of the 1 percent of the population that is uninsurable can be adequately solved through risk pools and government subsidies, without regulating the premiums of the other 99 percent.

Managed competition is much more than an untested theory. Its underlying assumptions are contradicted by reality. And its likely outcome would be hazardous to our health.

NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress.

A complete copy of the NCPA study A Primer on Managed Competition is available for $10.
To order this study please contact the NCPA at 972/386-6272.