Consumer-Directed Health Plans and the RAND Health Insurance Experiment

Joseph P. Newhouse


Health Affairs. 2004;23(6) 

In This Article

So What Happened in the Interim?

Although the HIE findings are generally supportive of initial cost sharing such as high deductibles, one might ask why, if these results had anything to do with it, a move toward greater cost sharing is only appearing some twenty years after the initial publication of the HIE results.[5] Whatever the explanation, it was not that the HIE results were kept under a rock and have just now been discovered. They were well known to benefit consultants and have been extensively cited by analysts such as the Congressional Budget Office (CBO).[6]

In fact, the results did appear to cause some short-term changes in health insurance policies. For example, initial cost sharing for inpatient services increased in the period immediately after the HIE results were published (more precisely, the number of plans with no cost sharing for inpatient services declined), and hospital admissions declined markedly, although any causal relationship between the changes in cost sharing and publication of the results must remain speculative.[7]

But the increased initial cost sharing for inpatient services caused almost no break in the surge of increasing health care costs. In fact, the real rate of increase in health care costs in the 1980s was the highest of any decade since 1940 save for the 1960s, the decade in which Medicare and Medicaid began. Did this leap in costs mean that the HIE results could not be generalized to the real world and, more importantly, that today's increased cost sharing will have no effect?

Although hospital admission rates fell in the 1980s, consistent with the HIE results, costs per inpatient stay rose by more than the fall in admissions as new medical capabilities came into use. Moreover, the overall changes in cost sharing may have been one cause of this pattern, because there was not only more initial cost sharing, presumably leading to fewer hospital stays, but also a spread of stop-loss features in private insurance.[8] A stop-loss feature meant that the marginal service for those in the hospital was more likely to be fully covered, consistent with the increased cost per stay.[9] Medicare's implementation of the hospital prospective payment system (PPS) probably exacerbated private payers' premium increases by shifting some fixed costs to them.[10]

When the increased initial cost sharing did not stem the tide of increased premiums for employer-based insurance in the 1980s, employers embraced managed care as the antidote to rising costs. Managed care promised to control costs through reductions in the unit prices of care as well as in the actual use of services and to do so without imposing financial risk on patients. If a patient used in-network providers, managed care typically lowered cost sharing relative to prior indemnity insurance arrangements; thus, it used cost sharing principally to steer patients to in-network providers rather than to deter use altogether. Although the lower cost sharing encouraged patients to seek care, managed care sought to control use through financial incentives to physicians as well as command-and-control methods such as utilization review.

And managed care did have some success in reducing costs. The rate of increase in real health care costs fell about two percentage points below its historical trend in the 1993-1997 period, a stretch of low cost-growth years not previously seen in the post-World War II period. As the readers of this journal know, however, a counterrevolution against managed care set in, in part because providers disliked the increased price competition and because neither providers nor consumers liked the command-and-control utilization review methods. The success of the counterrevolution brings us to the present day of benefit buy-downs and high-deductible health plans.

There is, however, an important wrinkle in today's consumer-directed plans relative to old-fashioned, plain-vanilla, high-deductible plans. In the usual consumer-directed health plan, the employer contributes some of the deductible amount to an account that is earmarked for health care. Although economic theory holds that the employer's premium savings from an increased deductible would in any event be passed on in the form of higher cash wages or other fringes, an earmarked account for health care appears to lessen employees' resistance.[11] At a minimum, money in the account mitigates possible cash flow concerns.

In 2002 the Treasury Department issued a notice that an employer's contribution to such an account is not taxable income to the employee and that any unused balance could be carried forward and applied to a subsequent year's expenses. The balances in such health reimbursement arrangements (HRAs), however, typically belong to the employer and thus are not portable if the employee leaves the firm.

Title XII of the Medicare Prescription Drug, Improvement, and Modernization Act (MMA) of 2003, however, contains some provisions that should make high-deductible plans much more popular. Either an employer or employee can now contribute before-tax income to a health savings account (HSA), which functions much like a 401(k) plan in that amounts can be invested and earn tax-free. Moreover, the monies belong to the employee and so are portable.[12] Unlike 401(k) monies, however, funds withdrawn for health care are not taxable.[13] The requirements are that an individual health plan must have a minimum deductible of $1,000 and a maximum stop-loss of $5,000; these amounts are doubled for family plans. These plans should be particularly attractive to healthy people who pay income tax, and they are now beginning to come on to the market.