Wednesday, September 8, 2010

Misconceptions About Consumer-Driven Health Care

Cross-posted from The Agenda on National Review Online.

Consumer-driven health plans, or CDHPs, are a relatively new concept. In the United States, they were basically nonexistent until 2003, when the Medicare Modernization Act—the one that added the prescription drug benefit to Medicare—legalized them (with significant constraints).

Since 2003, the growth of CDHPs has been explosive. Prior to the passage of the Medicare Modernization Act, several hundred thousand people were on such plans. In 2009, over 10 million people were enrolled in consumer-driven health plans. Barring a PPACA-driven regulatory strangle, the rising cost of health care will continue to drive both employers and individuals into these popular, cost-effective plans.

The novelty of CDHPs has led to many misconceptions about their qualities and flaws. One is that CDHPs place a greater burden on individuals for the cost of their medical care (i.e., increased cost-sharing). Here’s Austin Frakt on the topic:
Many suggest that the solution to our health care system’s problems is to be found in a more market-based approach. Consumer-directed health plans are at the center of this concept. If you make people spend more of their own money, they’ll be more prudent users of care and seek better value at lower prices…About now you’re thinking I disagree with the notions I just expressed. Actually I don’t. They have merit, which I recognize, accept, and support. Where I take issue is that they are not solutions to all the problems in our system.
Certainly Austin is right that CDHPs are no cure-all. And it is true that many free-market types, myself included, advocate more cost-sharing, especially in situations where the government is subsidizing health care (e.g., Medicare and Medicaid).

But it is important to understand that CDHPs do not increase the cost burden to the individual. Rather, they increase the degree to which individuals control their own health care spending.

Take your plain-vanilla, everyday, traditional employer-sponsored health insurance plan. Such a plan might be designed so that of every $100 that the insurer spends on the beneficiary’s health care, the beneficiary has to spend $18, through a combination of deductibles (i.e., dollars spent before the insurance kicks in), co-payments (dollars spent on an individual service before the insurance kicks in), and co-insurance (dollars spent, on a percentage basis, for a particular claim).

What CDHPs do is transfer control of much of that $100 to the beneficiary. Instead of the individual paying $18 and the insurer paying $82, in a CDHP, the individual (by way of lower premiums) or his employer (by way of a direct contribution) puts a portion of that $82—say $30—in a tax-free health savings account. The degree of actual cost-sharing, at $18, can remain the same. So in a CDHP that is actuarially identical to our traditional plan, there might be $18 of cost-sharing, $30 in a health-savings account, and $52 paid out directly by the insurer.

There are three critical differences, in our example, between a traditional plan and the consumer-driven one. First, that $30 is controlled by the individual, giving him an incentive to shop for high-value, low-cost care. Second, if the beneficiary remains healthy over the course of the year, he gets to keep that $30 and roll it over to the next year. (In traditional insurance, those savings are simply handed to the insurance company.) Third, individuals can invest the savings they accumulate in their health savings accounts, harnessing the power of compound interest.

A plan that seeks to increase cost-sharing, whether a traditional plan or a new-age CDHP one, would increase that $18 to a higher amount, say $25. But there is nothing inherent in CDHPs that requires increased cost-sharing. Indeed, because CDHPs save money even with equivalent cost-sharing to traditional plans, one could in theory offer more generous insurance through the CDHP approach for the same expense.

There are other misconceptions about CDHPs, e.g., they will motivate people to forego necessary care in order to save money. The actual experience of insurers who administer CDHPs rebuts these fears. What we see instead is substantial increases in preventive care (by 4 to 23 percent), increased prescription drug use (especially of generic drugs), and better compliance with evidence-based medicine (i.e., medicine’s best practices as established by the largest, best-run clinical trials).

My praise for CDHPs should not be taken to mean that such plans are perfect. As with any innovation, technical issues have arisen with some plans (read these blog posts by John Graham and the gentlemen at InsureBlog for more detail). The market, if allowed to function, can help shake these issues out over time. More problematic is the fact that the Medicare Modernization Act, the very law that legalized CDHPs, places significant restrictions on the way these plans can be designed, constraining the degree to which insurers can tweak plans and increase their efficiency. By law, a consumer-driven plan must have a deductible floor ($1,200 for an individual in 2010), a cap on annual out-of-pocket expenditures ($5,950), and a limit on HSA contributions per year ($3,050). In effect, these rules constrain the degree to which health savings accounts can drive value-oriented health care consumption.

Congress should lighten these constraints; instead, Obamacare added further ones. Worse still, the fracas about medical loss ratios under PPACA is critical to the future of consumer-driven health plans. The Department of Health and Human Services has yet to rule on whether or not health savings accounts will be counted toward the law’s MLR targets. If they are not, consumer-driven health plans will become de facto illegal. We can only hope that Secretary Sebelius takes a sensible approach.


  1. Looks like too short of a time to conclude much. Could just be selection bias. What I have seen at the micro level, is that those who have families that are expecting to see significant medical costs, avoid HSA type plans. Younger, healthier people prefer the HSA plans.


  2. OK steve, what you're saying rather explicitly is that people look to someone else to pay their predictable medical costs. That shouldn't come as any surprise. But if you're expecting an insurance company to pay your predictable medical costs, you're paying for much of those costs yourself through higher premiums, with some additional admin expenses and profit on top.

    Think of it in the context of preventive care: many people think insurers ought to provide routine preventive care free of charge, and indeed PPACA mandates more first-dollar coverage for preventive care. But there is no "free", if everyone is going to get that care they're all going to pay for it in their premiums, except they'll pay even more than it actually costs because the money is being routed through an insurer. Why not pay for that care out of pocket and save on the admin expense and profit, not to mention get a discount on it by paying with tax-free dollars if you're in the individual market?

    You're right that we still have a very limited mount of data to study on CDHP, but if you read the links Avik posted, particularly the one from the American Academy of Actuaries you'll see that the lower costs are apparent even after adjusting for any positive selection.

  3. Hi Steve,

    As AB points out, the AAA study accounts for selection bias. It's really not surprising that CDHPs accomplish what they accomplish -- it's basic economics. How much more do people drink at an open bar vs. a cash bar? CDHPs are basically using the same idea.

    AB: you really know your stuff. I'd love to know who you are. Drop me an email sometime ( and click on the "contact" button on the bottom left corner) -- I'll preserve your anonymity.

  4. Hi Avik,

    While I'm unwaveringly devoted to the free-market and strongly believe in fully privatized healthcare for our beloved United States, I want to play Devil's Advocate for a second regarding a particular financial issue that the left cites in their now classic, "healthcare fails to conform to capitalism" argument. The issue concerns net costs. $250 of every $1000 spent on healthcare in this country goes towards 'Program Administration and Net Cost'--effectively money that is NOT going towards providing care and is, therefore 'lost money' (indeed, we spent nearly $160 billion annually in this regard). The liberal argument goes something like this: Medicare's net cost is 2%, while that of private insurance companies is more like 15%--meaning, that a single payer system would in fact decrease inefficiencies (interestingly, many liberals I've spoken to cite this as one of the primary financial arguments to support a public option for healthcare). My question is, is this the whole picture? And why are the net costs of private insurance so high? Is it (forgive my socialist lingo), the 'evil of the greed' induced by the profit motive?

    Thanks for your time, and I hope you're having a great week!

  5. The assertion that Medicare is more efficient than private insurance rests on faulty comparisons, bad math, and does not account for $60-100 billion of fraud in the Medicare program.

    Here is a good review of the administrative costs issue:

  6. DN,

    It is important to recognize that even if the 2% figure was correct, it only represents the tax payer funded side of the equation. I consulted with dozens of hospitals/health systems on the interface between them and the payors. There remain huge burdens on providers for billing via insurance (gov't or private).

    My POV is most impactful way to slay the healthcare cost beast in the near term is to get health insurance out of the day to day. That is where 80% of your premium goes and it unnecessarily burdens the system with insurance bureaucracy. Long-term the other big cost issue is well documented - Americans not taking care of themselves (obesity, etc.). Other suggestions Avik has made generally make sense but won't have the scale of impact of these two items (which he also spoken to).

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