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 / Fall 2005 / Issue 40(originally published by Booz & Company)


Prescription for Change

Medicare and Medicaid responded with several unsuccessful mechanisms to control the growth in costs — first by capping costs and then by linking payments to diagnostic codes and severity of illness. The crisis crossed a threshold of public awareness when Lee Iacocca told Congress in 1988 that there was more money for health care than for steel in the cost of a new car. (This is still true, only more so.)

In the 1990s, about the only idea on the table to address the crisis came from the insurance sector. Health maintenance organizations (HMOs) and other variants of managed care, long a staple of the unionized work force in the Northwest and Upper Midwest, moved front and center as “the answer,” promising to cut costs by encouraging prevention and eliminating unnecessary measures via “gatekeepers” and third-party review. There was just one problem: Many consumers and even more providers resented employer/insurer intrusion into their choices of doctors, treatments, specialists, and facilities.

We are currently emerging from the “managed care as the answer” era. Employers backed away from these mandated programs as the economy grew rapidly and labor markets tightened. In addition, providers got smarter about how to gain and use oligopoly-like market strength to regain pricing power. Although HMOs and their kin briefly slowed the rate of health-care cost increases, we were soon back on the same growth curve for health-care costs, as technological advances combined with weakened utilization controls. This is where we stand today, and there are only two ideas on the table to rein in costs: National health insurance and consumer-directed health plans.

Turbocharged Incentives
Until the introduction of CDHPs, most people made few choices about health care beyond selecting their physician and their health plan — and even those choices were restricted by the paternalistic policies of the employers or membership groups through which most people obtained health-care coverage. CDHPs, by contrast, put individuals “in the driver’s seat” by allowing them to design and select their own health plans in a more open market with a range of choices at every stage for treatment and prevention — with innate, turbocharged incentives for making economical, high-quality choices. Just as defined-contribution pension plans placed individuals at center stage in the 401(k) world, CDHPs establish individual choice as the core of systemic improvement.

In a typical CDHP, an employer places a sum of money each year (perhaps $2,000 for an individual or $4,000 for a family) into a health savings account (HSA) that can be used only to pay medical expenses. The employer will also typically provide a high-deductible major medical policy for expenses over, say, $5,000 in any given year. To encourage proper preventive care, many such plans also cover screenings such as mammograms on a first-dollar basis. What sets CDHPs apart from traditional coverage is the rollover: Under many plans since 2004, the employee may carry over any unused cash balance, to which the employer will then typically add the following year’s contribution of $2,000/$4,000. This rollover feature is crucial to changing behavior. If unused funds disappear every year, consumers rationally view them as an evaporating asset they had better spend, thereby driving up costs. But if the unused funds accumulate, then consumers learn to spend the money judiciously, balancing the costs of preventive measures in the short run with long-term savings for possible crises. This also lowers the odds of incurring larger expenses in the long run.

The second key feature of these new CDHPs with health savings accounts that permit rollover and accumulation of unused balances is portability. Individuals can take their accumulated balances with them when they change employers, withdraw from the work force, or retire. This feature transforms health benefits from an annually evaporating asset into a lifelong savings scheme for almost any approved health-care expense. Under new regulations, HSA balances can even be part of an individual’s estate at death.

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