One-time savings is not cost control

Thomas Buchmueller summarizes some famous natural experiments in consumer choice of health plans at the University of California and Harvard (h/t Michael Cannon).

Two notable experiments in “managed competition” took place in the mid-1990s: the University of California (UC) and Harvard University both offered a menu of plans that varied in generosity, but adopted a “fixed dollar contribution” policy. The plans also varied significantly in cost, so employees had a greater incentive to consider price when selecting a health plan. Because out-of-pocket premiums increased for some employees but not for others, these changes provide a natural experiment for estimating the impact of price on employee health insurance decisions. […]

The results for UC and Harvard are strikingly similar. In both cases, employees were quite sensitive to price, and were willing to switch plans to save as little as $5 per month in out-of-pocket premiums. […] At Harvard, the combined effect of employees shifting to lower cost plans and the premium reductions was a 10 percent reduction in total spending in one year. Over a three-year period, total spending in the UC program fell by over 25 percent. This was at a time when increased competition among managed care health plans was causing premiums to decline throughout the country, so these savings cannot be attributed entirely to the adoption of a fixed dollar contribution policy. However, the reduction in premiums charged to Harvard and UC were larger than those observed in the general market, suggesting that the pricing reforms enacted by each university did result in a one-time savings. […]

The most generous indemnity insurance – which covered care from the doctor of your choice – was subject to an “adverse selection death spiral.” Faced with an initial increase in price for this coverage, the healthiest dropped out of indemnity insurance into lower cost plans. Those who remained in the plan were, therefore, sicker on average. To cover their costs, the price of the coverage was raised, which led to more dropouts until, after a few years, no one was covered by the indemnity plan. (Bold mine.)

This all played out as one might expect. Adverse selection played a role, leading to the death of one plan. Also, competition lead to savings, but only of a short-term (one-time) type. The savings was not trivial, but it alone didn’t and couldn’t address the long-term real health care cost problem because it didn’t affect the long-term rate of change of health care costs. Even a 10% one-year reduction, which is more than actually occurred in the natural experiments described once one accounts for secular trends, is wiped out in less than two years at typical health care inflation rates (6.5% per year). The fact that these experiments occurred in the 1990s when health care markets were very different form today’s — at that time insurers had the clear upper hand with respect to market power, relative to providers — makes generalizing from them difficult at best.

This is not to say there is no value in choice and competition. There is! I wouldn’t be a proponent of competitive bidding among health plans (public and private alike) in Medicare if I didn’t think so. But we should not expect such competition alone to bend the cost curve. It will take more than that. One-time savings is not cost control any more than insurance reform is health reform. Without involving providers and the mechanisms by which they are paid in the solution we won’t arrive at one.

Further Reading

T.C. Buchmueller and P.J. Feldstein, “The Effect of Price on Switching Among Health Plans,” Journal of Health Economics, 16(2) (1997), pp. 231-47.

T.C. Buchmueller, “Does a Fixed-Dollar Premium Contribution Lower Spending?” Health Affairs, 17(6) (1998), pp. 228-35.

B.A. Strombom, T.C. Buchmueller, and P.J. Feldstein, “Switching Costs, Price Sensitivity and Health Plan Choice,” Journal of Health Economics, 21(1) (2002), pp. 89-116.

D.M. Cutler and S. J. Reber, “Paying for Health Insurance: The Tradeoff Between Competition and Adverse Selection,” NBER Working Paper No. 5796, October 1996, and Quarterly Journal of Economics, 113(2) (1998), pp. 433-66.


Hidden information below


Email Address*