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Health Care Costs: Why Do They Increase? What Can We Do?

State Policy Options


W. David Helms, Ph.D., President and Chief Executive Officer (CEO), Academy for Health Services Research and Health Policy, Washington, DC.

Richard Figueroa, Deputy Legislative Secretary, Office of the Governor, Sacramento, CA.

The central health policy goal has always been to balance the objectives of containing health care costs, improving health care quality, and assuring access to health care services, according to W. David Helms, Ph.D. Neither regulatory nor competitive strategies have prevailed thus far as a preferential approach to contain health care costs; rather, health policy vacillates along a regulation-competition continuum in attempts to control costs. Helms shared the perspective of Larry Lewin, President and CEO of The Lewin Group, that the goal of health policy should be to balance the forces of regulation, competition, and economic self-discipline.

Helms outlined three major eras of health care reform that generally evolved from a fiscal crisis in the previous era, as described in a recent paper by Lynn Etheredge:

  • The Age of Traditional Health Insurance (1965-1982) was characterized by a fee-for-service system and the enactment of Medicaid and Medicare. Major cost containment strategies during this era included Medicare and Medicaid payment for insurance using usual, customary, and reasonable fees (UCR); national health planning; and implementing certificate of need (CON).
  • The Age of Regulated Prices for Government Programs (1983-1992) was characterized by Medicare and Medicaid costs that increased financial pressures on national and State governments. Major cost containment strategies in this era included government regulated pricing, private sector market approaches, and outcomes and effectiveness research through the Agency for Health Care Policy and Research (AHCPR—the predecessor to AHRQ, the Agency for Healthcare Research and Quality).
  • The Age of Markets, Purchasing, and Managed Care (1993-2000) was ushered in by sharply rising costs for both public and private purchasers. Competitive purchasing strategies, managed care, and evidence-based research and practice guidelines were major cost containment strategies during this era.

According to Helms, it is possible the next era will include successful components of strategies from previous eras, such as diagnosis-related groups (DRGs) and selected capital expenditure controls for long-term care. Helms identified several major strategies States are pursuing to control rising health care costs, including:

  • Assuring appropriate use of pharmaceuticals.
  • Technology assessment.
  • High cost case management.
  • Disease management.
  • Patient safety.
  • Monitoring health care costs.

He also noted several emerging State strategies in health care purchasing, including:

  • Promoting competition among plans and providers.
  • Setting benchmarks for quality and cost.
  • Tying financial incentives to plan performance (e.g., the Leapfrog Group initiative).
  • Providing technical assistance and building strong relationships with State offices and health plans.
  • Providing better information to enrollees and beneficiaries.

To illustrate how California is addressing rising health care costs, Richard Figueroa described a host of factors affecting the State of California's health care expenditures:

  • Aging population.
  • Expensive medical technology.
  • Prescription drug costs.
  • Balanced Budget Act (BBA) Medicare reductions.
  • High uninsured population.
  • Medical group insolvency.
  • Shareholder demands.
  • Individual choice.

Policymakers in California have tended to favor competitive, rather than regulatory approaches to health care cost containment according to Figueroa. The State has embraced managed competition, using health plan bids to leverage reimbursement rates for a number of programs, and not using system-wide cost containment levers such as CON. Figueroa highlighted cost containment strategies in three major health programs: Medi-Cal (Medicaid); Healthy Families (State Children's Health Insurance Program, or SCHIP); and California Public Employee's Retirement System (CalPERS).

Cost containment mechanisms implemented in Medi-Cal include:

  • Managing prescription drug costs, including drug rebates and monthly prescription limits.
  • Selective contracting with hospitals.
  • Home and community-based waivers for in-home care, medical care, and other alternatives to nursing facilities.
  • Case management.
  • Claims processing reviews.

Healthy Families/SCHIP strategies include negotiating premiums with health plans based on the plan's relation to a "Family Value Package" and establishing multi-year contracts. The rate of increase in overall SCHIP costs in the last three years has decreased significantly.

CalPERS negotiates premiums annually based on detailed cost figures, using negotiation practices such as freezing plan membership, rejecting bids, eliminating plans, and publicly discussing direct provider contracting. CalPERS also relies on benchmark pricing.

Figueroa noted that California is continually monitoring and adjusting its programs and offered the following lessons learned from the State's experience with managed competition including:

  • A short-term focus by managed care firms in the current market contradicts the goals of enrollee management over the long term.
  • Requiring enrollees to pay for more of the cost of their care can help offset plan and provider costs.
  • It is more difficult to leverage large discounts.
  • Managed competition assumes some type of defined contribution.

According to Figueroa, California's next steps include:

  • Increasing utilization of disease management.
  • More aggressive drug purchasing.
  • Establishing more multi-year contracts.
  • Offering financial incentives for Long-term improvements in enrollee health outcomes.
  • Increasing purchasing clout, by pushing for better value to justify payment increases.

In addition, CalPERS participates in the Pacific Business Group on Health, which is evaluating how it can cultivate an improved delivery system by engaging consumers, practicing evidence-based medicine, improving patient safety, and utilizing new health care technology.

Additional Resources

Altman SH, Rodwin MR. Halfway Competitive Markets and Ineffective Regulation: The American Health Care System. Journal of Health Politics, Policy, and Law 1988; 13(2):323.

Etheredge L. On the Archeology of Health Care Policy: Periods and Paradigms, 1975-2000. The Robert Wood Johnson Health Policy Fellowships Program. Institute of Medicine. Washington, DC; 2000.

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