When Patients Go To Market: The Workings of managed Competition

After a generation of deadlock, there is finally a broad consensus that the health system is broken, and a rare political opportunity to fix it. The present system manages to be simultaneously inflationalry, arbitrary, cumbersome for providers, and unreliable for consumers. But despite the opportunity for reform, we are on the verge of a disasterous mistake. Increasingly, it appears that the Clinton administration will embrace some variant of "managed competition." The strategy seeks to achieve universal converage and cost containment while simultaneously avoiding either public financing of the entire scheme or a bruising political confrontation with the health-industrial complex.

This logic seems clever, but managed competition is a therapy based on the wrong diagnosis. It doesn't begin to address the deep structural and cultural causes of our health system breakdown. And even though many of managed competition's intellectual creators draw on lessons from failures of past health system reforms, they often don't go far enough in breaking from past orthodoxies.


Managed-competition advocates offer a simple diagnosis of the problem: consumers and providers of health care are not sufficiently cost-conscious, nor have they any reason to be. Since most users of health care pay only a fraction of the cost of their services (in the form of fixed health insurance premiums), they have no reason to shop for the most efficient providers. People who receive health insurance as a tax-free employee benefit don't even feel the true cost of their insurance. And since hospitals and doctors have been the largely unrivaled arbiters of what care is medically necessary, they have every incentive to offer generous, even marginally effective treatments to patients and to stick insurers with the bill. With that diagnosis of the problem, it makes sense to restructure the health care market to create cost-consciousness on both sides. And that's what managed competition aims to do.

The failure of patients and providers to factor cost into their decision making is an old diagnosis. It is precisely the one that led to the expansion of Health Maintenance Organizations (HMOs) with a big boost from the federal government in the 1970s.

HMOs were designed to receive a flat rate per patient-member, known as a capitation fee; with their budget thus essentially fixed, they would have every incentive to avoid unnecessary care and to provide necessary care as efficiently as possible. They would save money, among other ways, by emphasizing preventive care and by using primary care physicians as gatekeepers to hospital and specialist care. Once HMOs got their prices down, competition between them and conventional fee-for-service plans would force the latter to become more efficient and lower their prices as well.

But HMOs failed to cure the disease. The federal government sought to control costs and increase coverage of the poor by stimulating the growth of HMOs and encouraging competition among them and between them and other providers. In 1973, Congress passed a law requiring employers to offer multiple insurance options to their employees if they offered any health insurance at all. The unanticipated effect of this requirement was to divide every employee group into smaller groups for insurance purposes.

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This was the beginning of the erosion of broad risk-pooling in health insurance. Employers, who had been the primary mechanism for aggregating individuals into large insurance risk pools, were now forced to disaggregate their employees, or at least, allow their employees to disaggregate themselves. Once insurers could compete for partial segments of an employer's work force, the competitive strategy of selecting the healthiest risks to insure was greatly intensified. Commercial insurers had already been using medical questionnaires and previous claims records to find firms with healthier-than-average employees, offer them lower prices, and attract them away from Blue Cross-Blue Shield plans. HMOs, while prohibited by the federal HMO law from using these same direct medical underwriting techniques, could still use marketing techniques and benefit design to target healthier groups and could make their services particularly inhospitable to people with expensive chronic illnesses. The one undisputed success of HMOs is that they cut the rate of hospitalization of their members, with no apparent loss of health. It is unclear, though, how much of HMOs' success in controlling costs was achieved by selecting (or being chosen by) healthier groups of patients.

In many ways, managed-competition advocates have simply redesigned the HMO strategy to correct its mistakes, without comprehending the underlying flaw in their premise. Understanding that a lone consumer is never a potent bargainer, they would aggregate consumers into Health Insurance Purchasing Cooperatives (HIPCs) to create a strong countervailing force. They would also extend the HMO idea of packaging physicians together with insurance, so that all physicians would be bundled into "Accountable Health Plans" (of course there had to be a new moniker). Some versions would go so far as to forbid physicians from belonging to multiple plans. A new national Health Standards Board would design a uniform benefit package and set standards for the plans, and the purchasing cooperatives would certify plans, negotiate with them, purchase group contracts on behalf of consumers, and monitor the plans' performance.

Because its advocates understand all too well how unrestrained market competition in health care can destroy the medical commons, managed competition seeks to use the authority and clout of government to harness the efficiency-producing potential of the market and to curb its community-destroying potential. Health Insurance Purchasing Cooperatives, despite the populist-sounding name, are in fact government agencies, akin to a regulatory agency. They are modeled after the German Bodies of Public Law, a form of quasi-public agency that is chartered by government and invested with the power to implement government programs and regulate relevant parties as necessary to fulfill their public purposes. HIPCs are the "managed" part of managed competition; indeed, many conservatives and insurance company executives oppose managed competition because they understand that the term "managed" is an appropriation of corporate-speak for what is really "regulation."

The target of all this countervailing pressure is no longer just the providers, but also insurers, and with good reason. Under the competitive reforms begun in the 1970s, insurers turned competition into a game of avoiding the sick instead of--as economic theory promised--a game of winning market share by producing health services more efficiently and comprehensively. Managed competition in any of its variants is designed, among other things, to thwart the ability of insurers to "cherry pick." All proposals have some limitations on risk selection, such as a ban on pre-existing condition clauses, on discriminatory pricing according to individual health risks and on selective enrollment. To avoid the common practice of repelling high-risk consumers by clever design of benefits, most proposals would set a standard benefit package and require that health plans offer it, and then vary the HIPC payment to the plan according to the risk-profile of its members.


Like the HMO strategy, managed competition is an effort by people who view health care as a marketplace to make health function more like a textbook market. In a textbook market, consumer demand drives the system. But a sphere where citizens receive services according to need rather than ability to pay cannot be understood as just another marketplace. Medical care, moreover, is not an area where consumers typically are able to make well-informed choices ("Say, Doc, I think I have a touch of amyotrophic lateral sclerosis") or are guided by what economists delicately call "tastes" ("I feel like having an appendectomy today"). It is hard to credit the claim that soaring medical costs and plummeting access to care are being driven by a consumer failure to choose wisely.

Health care costs are "pulled" by capital and labor, not "pushed" by consumers. A famous law of health economics, coined by Milton Roemer in the late 1960s, holds that the demand for hospital beds expands to fill the supply. In today's cost-conscious, cost-shifting environment, where hospital CEOs scramble to boost occupancy rates, the law seems archaic. But it contains a deeper wisdom: give a boy a hammer and he'll find things that need pounding.

Medical technology is the great hammer of the health care system. Technology broadly defined--not only MRIs and lithotriptors but also expensive drugs, organ and tissue transplants, expensive diagnostic tests, and experimental treatments such as genetic therapies--is where physicians and hospitals get their financial, psychological, and status rewards. Much medical research will lead to lower health care costs by preventing disease or inventing simple and cheap cures. But there is much research that leads only to expensive diagnostic tests for diseases we can't treat anyway, or to what Lewis Thomas calls halfway technologies--ones that don't cure but require months or years of extremely expensive life-prolonging therapies. Trying to hold down medical costs while massively funding this kind of medical research is like trying to curb smoking while subsidizing tobacco production. We would do better to choose research projects more carefully, thus enabling us to redistribute the effective technologies we already have.

Another key to curbing medical costs is controlling capital investment in medical equipment. A government agency could do a lot more fiscal good by using its expertise and muscle to guide capital planning than by generating reams of information to set payment levels and inform individuals about health plans. Restrictions on physician ownership of capital equipment are important too. Physicians who own their own equipment refer patients more frequently for procedures using just that equipment than do non-owning physicians. And until very recently, as Marc Rodwin reports in his new book, Medicine, Money and Morals, much financing of physician-owned medical facilities was structured to ensure that participating physician-investors referred certain quotas of patients. Under these circumstances, expecting consumers to police and discipline medical markets is naive to say the least. Rather than relying on price signals to consumers, we should restrain incentives to the makers and users of medical technology.

Instead of trying to teach the middle class the "true" costs of health insurance for everyone, the Clintons and their appointees might have a lot more impact on costs by using their moral authority to change the culture of prolonging life at any cost. This is a touchy subject, and not one that will go down well with the religious right and the anti-abortion crowd. Nevertheless, we are spending so much on health in part because we are approaching the technical capacity, in the words of one observer, to "keep a severed head alive," but we lack the moral capacity to stop ourselves.

Finally, we have to look realistically at the monetization of caring work as a cause of expenditure growth. One big--but unacknowledged--source of cost increases in health care is that we are now paying for labor we used to get for free or for cheap. The costs of home care were not even a category of health expenditure when fewer women were in the work force and more provided full-time family care for free. Hospital costs now include decent salaries for nurses; gone are the days when hospitals ran on the cheap, and frankly exploited, female labor. These are new costs that we cannot and should not suppress.

Our health system creates voracious beasts in the forms of medical technology and medical research. Then we create jobs--and whole industries--to tame the appetites of the beasts: utilization reviewers, case managers, technology assessors, information systems designers and managers, training and accrediting organizations for utilization reviewers and case managers, and all the rest. There is a parallel development in insurance, with its proliferation of occupations in underwriting, product design, sales, claims management, information systems, and training and accrediting organizations for each occupation.

Health care expenditures are eating up our GNP and raising the cost of American goods, but in a perverse way the health sector is the strongest part of the economy. Jobs in health care grew 43 percent between 1988 and 1992, while jobs elsewhere in the private sector inched up a paltry 1 percent. There's a nasty double bind here. Every health expenditure is income to somebody employed in the health sector, or to somebody who makes things or does things for the health sector. We can't restrain health care costs without putting a lot of people out of work.

The good news is that many of the people who would be displaced by genuine health care cost controls--the cost-controllers and the insurance armies, as well as some medical researchers and research administrators--are highly educated and well-positioned to apply their skills in other productive occupations. They are the very "symbolic analysts" Labor Secretary Robert Reich has extolled as the adaptable labor force of the future and the key to global competitiveness.


In theory, consumers shopping around among plans will yield efficiency, cost-control, and quality. But that theory falsely assumes equal buying power; the approach under consideration will give most consumers access only to a stripped-down, basic plan. Supposedly, consumers with "tastes" for enhanced services beyond the basic package will satisfy their "preferences" by shopping among more costly plans.

All it takes is money.

The language of consumer preference is grossly misleading in health care. The whole argument disguises a call for distributing health services according to ability to pay--the very thing we are trying to get away from. To be sure, any health reform, including a Canadian-style single-payer system, would have room for the affluent to buy services not covered in the universal program. But managed-competition schemes would likely have a much larger proportion of health care defined as extras and limited by ability to pay.

Managed-competition proposals envision that everyone will be funded, in one way or another, to purchase the lowest cost plan. Some people, such as the self-employed, might pay the entire sum themselves; some, such as workers in large companies, might have their employer pay a premium on their behalf (which in some views comes out of the workers' wages anyway); and some, such as the poor, might have the government pick up the tab in the form of subsidies or tax credits. Most proposals, whether or not they would require employers to provide at least the standard package, would tax any employer contributions above the level of the lowest cost, standard package plan. Everyone would have the option of purchasing a higher cost plan by paying the added costs themselves, probably in fully taxed dollars. Nominally, all Accountable Health Plans, would be required to offer a uniform benefit package covering medically necessary hospitalization, physician services, and so forth. In practice, the benefit package will vary, because higher cost plans will define "medically necessary" more liberally.

The imagery in managed-competition proposals suggests that medical care can be divided into a core of necessary items--the standard benefit package at the lowest price--and a periphery of incidentals. What is an incidental? The same few examples keep cropping up, and they are very telling. Consumers, we are told, will choose among plans according to their tastes for aggressive or conservative practice styles, freedom of choice of provider, length of waiting time for non-emergency appointments, and level of amenities. On close inspection, very little in this periphery of incidentals is really a matter of taste.

In the managed-competition literature, the term "aggressive practice style" is always contrasted with "conservative" practice style and seems to be a code word for physician disposition to intervene quickly and early when therapies, or even tests, might not be necessary. The very placement of "aggressive practice style" in the implicit category of unessential incidentals defines this kind of style (whatever it is) as non-essential care. In practice, there are many medical situations when an aggressive style is called for--when, if money were no bar, most consumers would want their doctors to run diagnostic tests and be prepared to treat immediately. It is hard to imagine, for example, that any woman would choose to wait a month or two to see how a breast lump develops instead of having a mammogram immediately. It is easy to imagine a health plan, on the other hand, that provides more cost-efficient care by refusing early mammograms, since most lumps are benign. (Far fetched? Lisa Belkin of the New York Times tells of a woman who thought she had Lyme disease--and in fact did--but whose managed care plan refused for many months to authorize the diagnostic test for it. The plan insisted it did not deny testing for financial reasons. The world of managed care is full of such tales.)

Under any version of managed competition, the more money you have to spend, the more likely you are to receive early diagnosis and aggressive treatment when those are appropriate. Of course, all the proposals give lip service to the need for close monitoring, but the incentives in the low-cost plan for "conservative" style and undertreatment are overpowering. And there are so many medical situations requiring nuanced judgment about appropriate care that effective monitoring is unlikely.

The same sort of argument can be made for waiting time for non-emergency appointments. The rub is all in how each plan defines emergency. They will have lots of discretion, and in any case, the triaging will be done, as now, mostly by receptionists, not medical personnel. Ideally, we would like to think that waiting time for an appointment would be determined by medical criteria. In a system where waiting time is defined as a matter of consumer taste, however, if there is a great difference among plans in average waiting times for physician appointments, managed competition will reinforce the ability of people with more money to buy their way to quicker visits. Most people who have to wait for a long time will not harm their health, but the poor will be a disproportionate share of those who are hurt by the cost-saving mechanisms of managed competition.

The danger is that the basic, mandated plan will be a fairly minimal one, and the new world of managed competition will have insurers and other plan sponsors marketing blue-chip supplemental plans to wealthier and more attractive sub-markets--exactly the kind of inequitable and inefficient fragmentation universal health care should eliminate.


Freedom to choose one's doctor is probably the aspect of medical care people care most about, yet managed-competition proposals define it, too, as a luxury to be purchased by those who can afford it. Managed competition offers choice in one very restricted sense--the chance to choose a health plan once a year, assuming one has the disposable income to purchase anything other than the lowest cost plan. Proponents argue that consumers can make much better (well-informed and rational) choices about medical care when they are not sick and when the trade-offs between costs and benefits are presented in the abstract instead of when they are facing a particular disease. Most patients, by contrast, would probably consider their decisions better, more informed, and more comfortable when they are able to decide contextually rather than abstractly, knowing as much as possible about the specifics. In any case, most citizens care much more about being able to choose their doctors and having some say in therapeutic choices when they are ill than about being able to choose their health insurance plan. The freedom of choice that managed competition offers is simply not worth much to most of us.

Many existing managed care plans restrict patients' choice of doctors more than meets eye. Though they advertise thousands of participating physicians, each patient is limited to a very small network of specialists in the same "referral circle" as his or her primary care physician. That circle may include only 100 doctors out of the thousands of participating physicians in a metropolitan area. Within a referral circle, there are usually only about 5 to 15 doctors per specialty, and in some circles, there are specialties with just one doctor whom the patient is allowed to consult. When families move into managed care plans, all members have to be in the same plan, or even referral circle, so some of them will have to sever links with personal physicians to consolidate their care. Though a plan touts its large network of member hospitals, patients are usually required to receive all their care in one hospital.

When "amenities" truly refers to just incidental niceties--private hospital rooms, gourmet meals--it is reasonable to ask consumers to pay extra. But in a climate of scarcity, we had better all be watching to see what the health policy architects slip into the category of amenities.


Consumer cost-consciousness in a competitive market is supposed to drive down costs, but managed competition isn't even true to its own theory. Instead of separating out the different features of health care and health insurance and truly giving consumers a chance to shop, managed competition bundles everything together in large packages. Consumers will not be able to mix and match different styles of medical care, waiting times, doctors or other personnel, and financing features. All of these will be lumped together in a very few take-it-or-leave-it plans. It is as if we could choose between blue four-door sedans with air conditioning and standard transmissions, or red two-door compacts with power steering and automatic transmissions. With that kind of "stickiness" of the goods, consumers can't possibly send useful information signals to the market about their preferences on individual features.

If we have learned anything from two decades of competition in health care, it is that providers and insurers will compete on everything but better information, better service, and more efficient care. Employers, as payers of health care, have relied chiefly on shifting costs back to employees and cutting benefits. Insurers have relied heavily on selecting healthy customers and using pre-existing condition clauses and other small print to wriggle out of payment. Managed-competition advocates understand this problem but don't make clear just how large a regulatory task is required to prevent it. If we allow insurers to offer different benefit packages, we have to ensure that the benefits don't become marketing strategies to attract only healthy customers. If the purchasing cooperatives will adjust payments to health plans according to the risks of their members, they need much of the same underwriting or claims information that insurance companies collect for their risk assessments. Such risk adjustment will be enormously intrusive; it will require that personal medical information be semi-public, available to a government agency, and permanently attached to each person's record. For all the expensive monitoring, plans will still find ways to select their risks and optimize their payments.


Americans want universal health insurance, and they consistently say they are willing to pay for it. The Clinton administration has so far done a smashingly good job of creating a vision and enlisting both ordinary citizens and business leaders to support it. Offering the country managed competition would wreck that alliance.

Budget concerns ensure that the basic package in managed competition will be stripped down, leaving much of what people consider important to be purchased with tax-eaten dollars. Managed competition will remove the choices people care about. Promised a slightly restricted choice of physicians, they will be furious when they find out how binding the constraints really are. They will have very little choice among specialists once they choose their primary care physician. If managed competition is set up the way most of its proponents advocate, with physicians allowed to belong to only one plan, citizens will find they have no choice among plans if they want to stay with their current physician, and no ability to choose a physician they know if they want a plan with different features from the one their physician is in. They will be even more furious when they are rendered powerless to choose among diagnostic and therapeutic options because of restrictions of their plans. There is already a huge undercurrent of resentment among the existing managed care plans. Imagine the rumble when all but the rich are squeezed into managed care.

The worst political mistake of managed competition is that it will put flashing neon price tags on levels of health care, extending, fine tuning, and making utterly explicit the price rationing we now have and want to escape. Americans want universal coverage. They are asking for a restored sense of community. Although they generally believe money should be able to talk, they think access to the House of Medicine that is our collective creation should not depend very much on wallet size. Managed competition is a grand betrayal. In another decade, medical care and its administration will still be eating up the GNP, leaders will still be blaming the people for their undisciplined shopping habits, and at best we will have nominal universal access with severe price rationing for anything but a place in the cellar. Even if the Clinton Health Reform Task Force is merely using an ambiguous label for tactical advantage, the perverse logic of the underlying model will inexorably hijack health policy.

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