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The Revived Debate on Managed Competition

A one-time supporter like Hillary Rodham Clinton doesn’t promote managed competition anymore, but there are employers who are standing by their plans.

December 11, 2007
Related Topics: Benefit Design and Communication, Workforce Planning, Compensation
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When the Committee for Economic Development, whose members include IBM, Coca-Cola and MetLife, recently called for an end to employer-based health care, they revived a policy proposal that looked like it had died with the failed health care reforms of the early Clinton administration.

    The approach that’s getting a fresh look is called managed competition. And despite similar names, it is not the same thing as managed care, a term more familiar to employers.

    Managed competition aims to cut health care costs by making the most cost-efficient health plan the cheapest for employees. The idea is that in such a system, health insurers will compete to become the lowest-cost option for plan members. Managed care, on the other hand, is the health insurance system that provoked a backlash from consumers who did not like having an insurance company running both the medical and financial aspects of their care.

    But managed competition has not produced the kinds of savings it promised. Advocates say the problem stems from the fact that not enough employers have embraced it. They say that only by putting everyone in the same pool of potential plan members would insurers have the incentive to become the lowest-cost plan. The easiest way to get everyone in the same pool is to end employment-based health insurance, they say.

    But even an end to employer health insurance may not be enough to break down the other major barrier in the health care marketplace—consolidations in the health insurance and hospital industries. Those consolidations have diminished the leverage employers and other payers have to reduce health care costs.

    The experience of two employers, Stanford University and Wells Fargo Bank, help explain why managed competition has not lived up to its potential.

    Stanford adopted managed competition in 1992. The school offers employees a choice of several health insurance plans and contributes a fixed dollar amount equal to or just below the cost of the least expensive and most efficient plan. Employees can pay more if they want to enroll in the more expensive plans.

    This year, as in most years, the least expensive plan it offered was a health maintenance organization at Kaiser Permanente. For individual employees the plan was free. Family coverage cost $204 a month. PacifiCare, an HMO, was the second cheapest at $284 a month for family coverage. The most expensive plan was a preferred provider organization that cost $820 a month for family coverage.

    The high cost of the premium reflects the cost of the PPO plan, which gives people the most choices in doctors and hospitals. A PPO tends to be more fragmented. Hospitals and doctors in this system get paid on the services they provide and have little economic incentive to coordinate care, which would mean patients get what they need without duplicating care. The price of the premium reflects the inefficiency of PPOs.

    The university covers about 20,000 people; two-thirds of them are in the two low-cost plans.

    "If nothing else, it causes our employees to ask the question: Why does this health plan cost more?" says Leslie Schlaegel, the director of benefits at Stanford. It also ensures that lower-income employees who work at Stanford can afford comprehensive health care benefits. Schlaegel believes that managed competition forces health insurers to better care for their members and to make the quality of their care measurable.

    The model is also easy to explain to employees, say executives who have experience running these plans.

    "The fundamental of managed competition is that you have an enrollee who is making decisions about what health plan they enroll in," says Jim Franklin, the former director of benefits for Stanford University who is now the president of the Pacific Business Group on Health.

    Schlaegel, however, says managed competition as practiced has a rub. In fact, it has several. Depending on their point of view, employers might conclude that the problems of managed competition are rooted in employer-sponsored health care or managed competition—or both.

    If Stanford were more interested in providing the commonly preferred but more expensive PPO network to all its employees, it would do what most employers do: Make it the only health care option and hope that by putting all of its employees in the plan, it would get a discount from the health insurer. By purchasing health care in bulk, employers achieve some savings.

    Schlaegel says most Silicon Valley employers can offer family PPO coverage to employees for around $350 a month, decidedly cheaper than the $820 a month Stanford employees must pay. The cost of the plan makes it harder for the university to compete with other employers for talented prospective employees.

    "When they see our PPO rates, that throws them back on their heels," Schlaegel says. "It does make it more difficult for the hiring manager to sell the health care program when your PPO costs are so high."

    In the end, the university may offer a signing bonus to help employees with health care and housing costs. So what the university saves in health care it loses trying to recruit employees.

    Further, Schlaegel says, offering signing bonuses "gets into the question of being tax-effective. We’re just going around the back door and giving it to them in the form of taxable income."

    The bottom line is that other employers who have not embraced managed competition undercut Stanford’s efforts.

    "One of the problems we have with our managed competition model is that no one around us adopted it," Schlaegel says. "So that puts us at a disadvantage."

    Still, Stanford has no intention of dropping its approach. The university believes managed competition offers employees something that both employers and employees value: choice and care that’s affordable to lower-income workers.

    Employers, though, are not the only ones to blame for managed competition’s limitations.

    Consolidation in the health insurance industry has reduced the number of HMOs to four from about 25 in 1990, Schlaegel says. With less competition, an employer like Stanford has little leverage to get insurers to drop their prices.

    As a result, the university has seen health care cost increases similar to those that are the average in the United States: as high as 13 percent annual increases several years ago, and about 7 percent annual increases more recently.

    This is a problem plaguing Wells Fargo, says Sally Welborn, senior vice president of corporate benefits at the San Francisco-based bank, which has been using a managed competition model to purchase health benefits since 1999.

    Wells Fargo covers about 325,000 people under its health plan. Forty-five percent or employees chose the lowest-cost provider, which last year was an HMO. The switch to managed competition was accompanied by a shift by employees to the least expensive plans. And that’s good, Welborn says.

    "I still think it’s the right approach," Welborn says of managed competition. "I just don’t think it’s driven as much competition between insurance companies. Consolidation has made it so there is not much competition."

    One of the advantages of managed competition is that in theory, it allows employers to fix the amount they will spend on health care. Stanford says it will pay 100 percent of the cheapest plan and the difference will be made up by the employee who wants another plan. In a perfect world, competition would keep the costs low. But with consolidation and rising prices, both Wells Fargo and Stanford have had to subsidize the cost of insurance more than they would have liked to, just to keep health benefits affordable for employees.

    Consolidation has not just occurred in the insurance industry. In Palo Alto, California, hospital consolidation has had an even more pronounced effect on cost, Schlaegel says. As a condition for allowing health insurers and employers to contract with them, hospitals have demanded increases in what they get paid for procedures.

    "So even if you had a lot of health plans, they’d all be going to the few hospitals, and that increases the premium," Schlaegel says.

    Alain Enthoven, who created managed competition in the early 1990s, believes the lessons learned in the years since his ideas were first implemented are clear.

    "You’ve got to get practically everyone into it to get a competitive market to emerge," he says.

    And that, he says, requires ending employer-based health care, something not even presidential candidate Sen. Hillary Rodham Clinton is advocating this time around.

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