Stanford GSB: Stanford Business November 2000

Stanford Business

November 2000, Volume 69, Number 1

Health Care Economics
The Chronic Search for a Health Care Cure

With managed care, when you've seen one, you've seen one.

FOR NEARLY THREE DECADES, Professor Alain Enthoven has blazed a trail of research and real-world analysis in the pressing field of health economics. He and his colleagues have shaped the excruciating debate over health care and the role of managed care.
In 1969, Americans spent $27 billion, or 5.1 percent of gross domestic product, on health care. By 1980, new medical technologies pushed spending to nearly 9 percent of GDP. Insurance premiums skyrocketed, doubling over a five-year period in some cases. By 1993, Americans were pouring 13.7 percent of GDP into health care. As managed care took hold, premiums began to stabilize. Today there are signs they are creeping up again.

Why is this happening? "We look first at the incentives," says Enthoven, who is the Marriner S. Eccles Professor of Public and Private Management, Emeritus. Insurance paid for more hospital services, even if they weren't necessary. Health insurance was also tax free, so employers paid the whole thing. "Patients were cost unconscious, so they had no incentive to sort out value for money," says Enthoven.

Expensive procedures surged at fantastic growth rates. A study by Stanford economist Victor Fuchs found that the per capita rate of angioplasty among 75-year-old men grew 20 percent a year over the seven years to 1995. Bypass surgery grew 9 percent annually; hip replacement was up 18 percent annually among the same group. More people were on Medicare and living longer. "Nobody in the system was responsible for costs," says Enthoven. That strains public finances and crowds out other spending. It also lowers real wages. When employers pay more for health care, that's money that would otherwise go to wages.

When managed care came to the fore, its form varied. The prototype was Kaiser Permanente, which cares for 8 million people. Then arose preferred provider networks, in which the insurer negotiates fees with doctors selectively outside a single group. "We've been in a tremendous phase of experimentation, innovation, and trial and error," says Enthoven. "With managed care, when you've seen one, you've seen one."

Some kind of health care management is here to stay, says Enthoven. In the eighties, a few employers tried "managed competition," in which the employer offers employees a range of plan choices and makes a fixed contribution, usually at or below the cost of the low-cost plan so workers have a financial incentive to make an economical choice. Managed competition avoided scenarios in which some employers who paid the whole premium stuck all employees in a single health maintenance organization (HMO). In that model, outraged workers could not find their chosen physicians in the network. "That's how HMOs went from being the consumer's friend to being the enemy," says Enthoven. Employers also pressured HMOs to include all providers in the state, which destroyed the HMOs' selectivity.

Health care spending as a percent of GDP had been flat since 1993. Although real wages have been growing, there are discouraging signs now that premiums are resuming their double-digit growth. Rates for 2001 at the California Public Employees Retirement System, which is one of the most effective purchasers of health insurance in America because it buys for about 1 million people, are up an average of 11.2 percent. Powerful cost-increasing forces remain. Prescription drug costs are rising 18 percent yearly. Anti-managed care legislation is stacking up as people refuse any limits to health care. Many practice groups are losing money, which cannot be sustained forever, warns Enthoven. Providers are pushing back: Hospitals have joined into a few big chains, telling insurers they can't have one without all.

That raises questions about health care competition. "The fundamental problem is that, in theory, competition in markets for health care can be either good or bad," says Daniel Kessler, associate professor of economics, law, and policy. In one analysis of elderly Medicare patients who suffered heart attacks, Kessler found that competition among hospitals in the 1990s led to both lower costs and higher quality of care, and that the influence of managed care enhanced competition's beneficial effects. This research has implications for antitrust policy, such as how mergers among doctors and hospitals should be treated.

Another Business School faculty member, Stefanos Zenios, associate professor of operations, information, and technology, has taken a different tactic in his research. Working with physicians, he is designing a more efficient system for distributing kidneys to transplant patients. So far, Zenios figures his proposal would make at least 884 more kidneys available yearly.

— BARBARA BUELL