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Health care in America:
Can managed care manage it?

This is the third in a series of articles on the health care system. The first two focused on this state: 'Health care in rural Illinois'' (April 1991) and 'Illinois' urban health care dilemma'' (May 1991). This article focuses on the U.S. health care system.

The United States is haunted by the failure of its success in health care policy. Continued improvement in our already excellent health care services through technological and medical advances has been accompanied by rising prices that block more and more people from access to health care. According to the May 1991 issue of the Journal of the American Medical Association (JAMA), the number of people who do not have health insurance has increased by 24 percent in the last decade, while the number of uninsured children has increased by 47 percent. A hospital room that cost $16 per day in 1946 now costs over $300 a day.

By the late '70s it was clear that the United States was not rich enough to pay for all the health care its citizens wanted

Historically, the U.S. health care system has been very strong in physicians, nurses, technicians, technology and hospitals, but weak on organization, discipline and control. During the Second World War U.S. businesses started buying health care for their employees and dependents as part of a total compensation package. In the early post-war years Americans felt they were rich enough to invest in whatever level of manpower, hospitals and technology was needed to give them all the health care they needed, or wanted. Instead there evolved a socially destructive divergence between the availability of health care and the capability of people to pay for health care. The shop windows were full of health care that many people could not afford to buy.

In the historic compromise of 1965, the federal government stepped in when U.S. Rep. Wilbur Mills (D-Ark.) orchestrated legislation to overcome the price/availability dilemma through the creation of Medicaid and Medicare, bringing government-purchased health care to the poor and elderly. This additional government financing caused demand for care to increase much faster than supply, resulting in health care inflation.

By the late '70s it was clear that the United States was not rich enough to pay for all the health care its citizens wanted. Two decades of half-hearted governmental regulation had ended in failure to control prices; need and availability moved farther and farther apart as prices kept increasing America chose the American way, turning to free enterprise. President Carter was rebuffed by Congress when he tried to place price controls on hospitals, so he urged the government to step back and let the free market manage and control the nation's inflation-prone health care system. President Reagan followed in the same direction, and the '80s saw the United States place the private portion, about one-half, of its entire health care system under free market management. It was not so much that the United States actively chose the free market system but that there were no other choices left; full governmental regulation was out of the question.

Simultaneously, much stricter government controls were brought to bear on the other half of the system, the Medicare and Medicaid portion, through a fee schedule imposed on hospitals. Based on a method of categorizing illness called Diagnosis Related Group or DRG, this fee schedule system pays hospitals a set price per Medicare illness, no matter how long the patient stays in the hospital.

Placing the main portion of our health care system (nonelderly and nonpoor) in the hands of employers was an audacious step by the United States. No country has ever trusted the health care of so many of its people to free market management. Most countries have viewed health care as akin to education and have insisted on government control and oversight. Free markets are oblivious to the needs of individuals without purchasing power. The free market works by treating health care like any other commodity, letting consumers compete against each other with their dollars to see who gets what care. But health care is not like other commodities. Consumers do not have the knowledge to choose the best care for the least price. Quality is often hard to discern, even when one is well.

For this free market approach to work three conditions must

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Citizen satisfaction with health care: Lou Harris poll of four nations

Satisfied with country's health care system


Very satisfied with own care

United States






Great Britain



West Germany



Source: Journal of American Medical Association, May 15, 1991.

exist. Everyone must have enough money to buy health care. Health care providers must not waste resources by giving unnecessary care. Buyers must demand the top quality at the least cost, forcing efficiency or bankruptcy on those who cannot measure up. How the health care system functions nationally in terms of these three requisites of free enterprise — consumer purchasing power, producer efficiency and cost-conscious buyers — is crucial to its future success or failure.

Free enterprise markets serve those who can pay. Minimum wage workers bringing home $8,000 to $12,000 per year cannot afford to pay $2,000 to $4,000 to buy health insurance when it is not covered by their employers. According to the Employee Benefits Research Institute in July 1990, although 89 percent of Americans have health insurance, there are approximately 33 million people who are too poor to buy health coverage and who do not qualify for governmental assistance. Strikingly, 26 million, or 85 percent, of all the uninsured persons were members of a worker's family, and 67 per-

Beyond the 33 million people . . . without coverage, Medicaid serves an additional 26 million people, though often with low quality or episodic care

cent were members of a family with a person employed full time. Surprisingly, 25 percent of the uninsured were in families with incomes of $30,000 or more. Beyond the 33 million people in the United States without coverage, Medicaid serves an additional 26 million people, though often with low quality and episodic care. But the percentage of persons served by Medicaid has declined from 67 percent in 1970 to only 40 percent today, according to Eli Ginsberg in JAMA'S May 15 issue.

Although individuals do not have the knowledge to act as tough-minded and discriminating purchasers of health care, employers could, but they have so far chosen not to play this important role. The average employer neither has the temperament nor seeks the knowledge to enter the health care marketplace and force quality and efficiency from providers. For years, insurance carriers and others who pay health care providers had a blank check to pay for whatever care the employee wanted from any provider. As a result, inefficiency escalated because buyers did not insist on efficiency.

Long accustomed to sizeable revenues and rising incomes, it was certainly unrealistic to think that hospitals and physicians would, in the name of efficiency, hold down revenues and income, especially if buyers did not so insist. Where free market pressures or governmental price controls curtailed their earnings, they could almost always increase the quantity of services provided to maintain their earnings. This is not necessarily a cynical response. There are always more things that can be done to help a patient: to ensure that the right diagnosis is made, to try a new remedy or to relieve pain and suffering. This ability to escape price and market discipline results in increased prices that all citizens bear. Without the sting of the whip of informed consumer demand forcing efficiency, why should hospitals or physicians decrease their earnings by holding down prices or laying off personnel? Buyers working through the market did not force this and it did not happen.

The requisites for an effective, free-market-driven health care system are not present. Without these prerequisites, the free enterprise market approach is not working with the four following consequences:

• Declining public attitude: A recent Roper poll concluded that never in the last 17 years have American citizen attitudes toward health care been so universally negative as they are today. An 18 percent drop occurred between 1988 and 1990 in those who said they were very satisfied, while 64 percent said that health care costs were unreasonable, and 35 percent said they were very unreasonable. Contrariwise, 70 percent said they felt that the benefits they received from their health insurance were excellent. In a key question in a Health Insurance Institute of America poll, 50 percent said they were not willing to pay more taxes to improve the system. This double finding that people are pleased with their care but displeased with the system (rising prices and lack of care for all people) are shown also in the much quoted, four-country Lou Harris poll (see table 1). Interestingly, a person's satisfaction with his or her own care is highest in the United States and Canada, while satisfaction with the system is lowest in the United States and Great Britain.

• Lack of coverage: According to the Employee Benefit Research Institute, 33 million Americans are without health insurance coverage and are not eligible for governmental programs (see above discussion on consumer purchasing power).

• Continuing price increases: Health care prices continue upward at two and three times the increase of the Consumer Price Index. In The Crisis in Health Care, Dean Coddington notes that health care insurance premiums have been rising from 15 to 30 percent per year. As long as the health care sector of the U.S. economy demands an increasing portion of the nation's

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total productive resources, prices in this sector will continue to rise. And, unfortunately, the demand for resources is still rising. Health care used 5 percent of the U.S. gross national product (GNP) in 1945 and now uses almost 12.5 percent.

• Cost shifting: Governments and large buyers have a peculiar aspect in common. They both use power to gain price concessions from suppliers. Each year Congress and the states brag about the billions of dollars they "save" in the Medicare and Medicaid budgets by paying hospitals fewer dollars than it costs the hospitals to produce health care for the elderly and poor. In the free market sector, aggregations of health care buyers (Preferred Provider Organizations or PPOs, Health Maintenance Organizations or HMOs, and large employers) use their market power to gain price discounts from physicians and hospitals. In addition, no one comes forward to pay for the care given to the destitute who are not covered by Medicaid.

When big business buyers use their market power to coerce price concessions from providers, the hospitals and doctors then find someone else to overcharge by the amount others underpaid them. The only other way out is increased efficiency, but that is usually a last resort. Estimates for cost shifting during 1990 in billions of dollars are shown in table 2.

A cost-shift "tax" of $62 billion dollars on mostly small-and medium-size businesses is levied to pay for the "savings" of government and other market-powerful buyers of health care. The government purchases its health care at a subsidized price, paying from 50 to 85 cents on each dollar of care received while indemnity and private pay purchasers of health care pay an "excise tax" as high as 75 cents on each dollar of care they purchase. Indemnity policies are the most common health insurance policies. The insured pays the provider directly, and the insurance company then reimburses the insured in total or in part.

This use of market power by the powerful buyers is perhaps one of the most destructive aspects of the system. Michael Peevey, president of Southern California Edison, has stated that cost shifting "is threatening the integrity of the entire system." Businesses must find substitutes for their indemnity health care policies which are going up in cost at the rate of 30 percent per year, leaving a smaller and smaller base of indemnity holders every year to pay the cost-shift tax. Those who have no place else to go to obtain insurance except to indemnity health policies, such as farmers, employees of small-and medium-size businesses and other individuals, are forced to continue to pay the tax and subsidize the market-powerful who receive their health care at less than cost. Thus, prices of indemnity policies have risen much more rapidly, around 30 percent per year, than the prices of other health coverage policies, which are rising at around 20 percent per year. Not surprisingly, indemnity policies as a percentage of all types of health care policies have fallen from a market share of 52 percent in 1980 to 27 percent today, according to The Crisis in Health Care. The decline in indemnity market share has gone to managed care policies.

The national health care system fails, however, principally because no one feels responsible. We have an unmanaged system. Business looks to the government to fix things.

Table 2
Estimates of cost shifting for 1990 in U.S. health care system
(dollars in billions)

Hospital discounts to Medicaid and Medicare (undercharging)


Hospital free care to destitute



Hospital discounts to PPOs and HMOs (undercharging)


Total discounts (undercharging)


Hospital overcharging to indemnity health care insurees and to people who pay for their care


Source: The Crisis in Health Care, Dean Coddington, et al., Jossey-Bass, San Francisco, 1990, Table 11, p. 106.

Physicians and hospitals are busy finding ways to keep up their earnings as fee ceilings and rules change. The paymasters of the system, insurance carriers, until recently have washed their hands of any responsibility for costs. Our national government chose free enterprise to run our health care system, but it failed to assign management and cost control responsibilities to any player in the system. So, the system runs increasingly without management and out of control.

One obvious way to reform the system is a double-barrelled attack, introducing strong management into the system (Managed Care) and ensuring that all people have at least basic health care coverage (Play or Pay). This approach is designed to make the free market system work. An alternative would be to abandon the employer-based, free enterprise system and adopt a Canadian-style system. It is assumed that a completely government-run and -operated system, as in Great Britain, would not work well for the United States, and thus this alternative is not considered. The fortified free enterprise and the Canadian approaches appear to be the only options for our nation's health care system.

Managed care is based on the idea that the deficiency previously noted, lack of tough-minded price-sensitive buyers, can be turned into an advantage. In this way the defect of lack of responsibility and management would be remedied. The hope of managed care is that it can invigorate the free enterprise approach by putting buyers and cost-effective providers in control in the following way.

An employer says to an HMO or PPO, "I want quality care for my employees, but I want you to hold down our cost increases and I realize that you will impose some restrictions on where and how my employees obtain care." The provider retorts, "Yes, we will assure you a smaller increase in health care costs than you have paid recently. We will assign a gatekeeper physician to each of your employees and dependents to manage his or her care. The gatekeeper physician will determine how much care employees receive. If your employees and

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dependents want to go to hospitals and physicians other than those we suggest, then they must pay 30 percent of the cost themselves." These are called point-of-service plans since employees and their dependents can, at a time of illness, choose whether to receive care from the stipulated gatekeeper provider or from a provider they choose.

Under such arrangements, where only cost effective physicians and hospitals are placed in the service network, the price and quantity of care is managed and controlled. Responsibility is established. Providers are chosen who care about cost as well as quality. Employees are forced to accept a doctor/manager of their health care. In The Crisis in Health Care, Dean Coddington indicates that at least an estimated 30 percent of medical services are unnecessary. For example, in a recent study, Bruce J. Hillman, M.D., reported that of 6,419 doctors treating 65,617 cases of acute upper respiratory symptoms, low back pain, pregnancy and urination problems, the physicians who owned magnetic resonance imaging equipment ordered imaging 4 to 4.5 times more often than physicians who did not own imaging equipment and referred their patients to radiologists.

Through managed care, providers are forced to take medical efficiency seriously, to view waste . . . as hurting their competitive position and market acceptance

In addition, those doctors who owned imaging equipment also charged higher prices than other doctors so that costs due to both price and quantity differences were 4.4 to 7.5 times higher for doctors who owned equipment. Doctors may order extra services for a variety of reasons: defensively hoping to ward off malpractice lawsuits, to help comfort the patient or reduce pain, to keep their income up and/or to cover equipment costs and maintenance.

Under managed care the incentives are reversed. Patients can no longer go to whatever doctor or specialist they wish, unless they pay more of the cost themselves. Hospitals are chosen to participate in the PPO or HMO because they are "good" —that is, cost efficient and of high quality. Physicians are chosen because they practice high quality medicine, do not overuse tests, referrals and hospitalizations and communicate well with their patients, thereby avoiding malpractice suits. The idea is that costs will be contained because cost conscious physicians will practice with one eye on cost and one on quality.

Southern California Edison has instituted such a managed care approach for its employees and has reduced the rate of health care cost increase from 23 percent in 1988 to 12 percent in 1989. Five employers who added PPOs to their indemnity plans were studied by the RAND Corporation. The employees who used PPOs had from two to four fewer doctor visits per year than other employees. Four of the five employers found that PPOs helped them to keep their costs down.

Through managed care, providers are forced to take medical efficiency seriously, to view waste, extra billing and overtreatment as hurting their competitive position and market acceptance. Too frequently in the past, PPOs and HMOs concentrated on selling their wares to the healthiest consumers who would need little care, rather than staffing their networks with the most cost efficient and high quality doctors and hospitals. Managed care does not work to contain costs unless the word "Preferred" in Preferred Provider Organization (PPO) means that only cost effective doctors and hospitals are included in the network. The same is true for HMOs. Preferred means selectivity, the chosen few. Offering employees a health plan that includes all doctors and hospitals in a region will please by providing everyone's favorite doctor, but will punish by causing onerous price increases. Only by choosing the most cost effective hospitals and providers does managed care have a chance to manage costs so that they do not rise so rapidly.

Managed care means selected care and some restriction of employees' choice of doctors, specialists and hospitals. Employees' insistence on the freedom to see whatever doctor they want when they want is the antithesis of both health care cost responsibility and of managed care. In short, reduced freedom to choose health care providers is a necessary price to be paid if Americans want continued freedom to participate in a nongovernmentally run health care system.

The managed care pieces are now being put in place to make the U.S. free enterprise health care system work better. Yet, it must be emphasized that wrenching changes for business, patients and providers must be made for managed care to work to control prices. The stakes are large. Without managed care there is nothing to stop continuing large price increases.

There is a consensus that the managed care reforms will not do their inflation-stopping job without the introduction of some form of universal access, allowing all who are poor or without health insurance to receive medical care. The uncompensated care now provided must be paid for because, as Coddington said, "Uncompensated care is destabilizing the system." As discussed earlier, uncompensated care adds to the cost shirting that is causing business leaders, such as Lee Iaccoca of Chrysler, to call for a governmental health care system.

The most commonly discussed method of adding universal access to the current U.S. free market approach is to ask all businesses to provide health care to their employees and dependents and to expand Medicaid to cover all those who are not employed. Frequently dubbed "play or pay," this approach is designed to force all businesses to provide health care for their employees — to play within the system or to pay for not. Those not providing health care pay an additional payroll tax to finance a government program to provide health care for employees whose employers do not cover them. Such a program was passed in Massachusetts, but has not been funded and has not yet commenced because of increasing costs and state budget fund shortages.

July 1991/Illinois Issues/19

Public opinion supports this approach in that 80 percent of those polled by the Employee Benefits Research Institute in September 1989 said that employers should be required to provide health insurance to full-time employees. This compares with only 54 percent who favor a U.S. government-run or national health care insurance system. This play or pay approach is attractive to Congress because business not government must come up with the financing. However, the estimates of the number of businesses that would fail because of the added health care costs and the number of people thrown out of work through layoffs and business failure are soberingly high. This increased cost to business could be mitigated by requiring only low benefits or basic health care plans. This would reduce somewhat the cost burden on businesses and especially on small businesses, which employ the majority of the workforce. Such a policy might have a high deductible and serve primarily as insurance against catastrophic illness. This would decrease the job-loss cost of providing universal access.

. . . not to adopt some form of universal access ensures continued cost shifting which . . . will ultimately destroy the free enterprise health care system in the United States

Alternatively, the United States could abandon the free enterprise and insurance-based approach and seek to gain both price control and universal access by adopting a Canadian system. The Canadian system is called a single payor system because the government controls all payments to providers. Virtually all funding for health care in Canada comes from the national or provincial governments, and therefore, from tax revenues. Payments are made to hospitals on the basis of an annual, negotiated budget. Physicians are paid on a fee-for-service basis determined by a federal fee schedule. There is no insurance industry in Canada, and Canadians do not pay for their health care although they do have their choice of physicians.

In a fall 1988 Lou Harris poll, 61 percent of Americans polled said they would prefer a Canadian-style system. Though this statistic speaks to serious dissatisfaction with the U.S. system, other polls, such as the Health Insurance of America poll referred to previously, indicate that people do not want to pay more taxes to pay for their health care.

Creating a Canadian single payor system where all funds for providers come from the government would greatly reduce the large administrative, paperwork and insurance costs associated with the current U.S. system. But, paying for the 33 million people now uninsured and paying the full cost for those who now receive discounts (see table 1) would cause costs and taxes to increase sharply. One study by Aldona and Gary Robbins of the National Center for Policy Analysis estimates an increase in costs of $339 billion per year necessitating a 14 percentage point increase in the U.S. income tax rates.

Canada is increasingly confronted with cost control problems. Kathleen Doherty in Business and Health (July 1989) states that, "The Achilles's heel of Canada's health plan is that there's no imperative or incentive to control costs." Victor Fuchs concluded in the New England Journal of Medicine (September 27, 1990) that "the quantity of services per capita is much higher in Canada than it is in the U.S." And, as reported by the Health Insurance Institute of America, the percentage increase of GNP devoted to health care has increased more rapidly recently (albeit from a lower base) in Canada than in the U.S. From 1977 to 1982, Canada's GNP increased by 4.1 percent compared to a 3.7 percent increase in the United States, and from 1982 to 1987, Canada's GNP rose by 4.5 percent against a 4.2 percent increase in the United States. Moreover, because of the large governmental costs and the large Canadian deficit, there is talk of costs being shifted to Canadian employers, and from employers to employees. According to a Hewitt Associates study in Toronto, over one-half of Canadian employers polled said they plan to introduce co-insurance and increased deductibles during the next 10 years. It is also noteworthy that Canadians travel to the United States for medical care, but Americans do not frequently travel to Canada for care.

Adopting either the Canadian system or the play or pay system alone would bring major dislocations, cost increases and additional difficulties. But, and this is the crunch, not to adopt some form of universal access ensures continued cost shifting which is already destabilizing and will ultimately destroy the current free enterprise health care system in the United States. Faced with these distasteful choices, a requirement that employers provide a basic or minimum health coverage coupled with full throttle on managed care probably represents the best path to maintain excellence in U.S. health care and make it available to all Americans.

Illinois does not have to wait for Washington to act. The prior two articles in Illinois Issues pointed toward major steps Illinois can take. In addition, Illinois can take further steps to make the health care market work, such as Public Act 86-1407 passed last year, which enables small size businesses to provide "bare bones" insurance coverage to their workers without providing all the benefits and coverage required by state law. Illinois could be a national leader in making managed care work for all its citizens.

Leroy S. Wehrle is chief executive officer and Chandra Gravit is marketing director of Health Economics and Market Analysis Inc., a national health care data company located in Springfield. HEMA provides health cost and utilization information to self-insured employers and third-party administrators. Wehrle received his doctorate in economics from Yale University. He served in the U.S. Foreign Service as economic counselor and as a senior economist on the President's Council of Economic Advisors. He is professor emeritus at Sangamon State University. Gravit received her B.A. with honors from Washington University in St. Louis, Mo. She has experience in the field of health care cost-containment analysis.

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