The Congressional Budget Office forecasts the federal deficit to decline from about $1.5 trillion in 2009 to $608 billion in 2014, then rise to nearly $800 billion in 2020. This is a hefty deficit, particularly when you consider that we had a surplus as recently as 2000. Then consider that the cumulative public debt, which currently stands at $7.5 trillion, is expected to nearly double by 2020 to $14 trillion.

Years ago, as a young economics professor, I was rather sanguine about the debt. “We owe it to ourselves,” I’d say. No longer. In 2009, nearly half of our debt was held by foreign interests—with China and Japan as our largest creditors at 11% and 10% of our total debt, respectively. Foreign ownership increases the risk that debt poses to our economy.

How can we live within our means? In November, The Economist summarized some of the available options. I found the list rather depressing. Does raising the retirement age under Social Security to age 70 seem a bit draconian? Sad to say, it only cuts the deficit by $4 billion. Same for raising the Medicare age to 67. That only pulls in about $3 billion.

We gain more by eliminating some deductions. Do you like deducting state and local taxes on your 1040? Or the interest on your home mortgage? The deficit falls by $65 billion for the first and $147 billion for the second. Eliminating the favored tax status of employer-provided health insurance would raise a good bit more cash—$215 billion (no wonder it has been a topic of discussion in the context of health reform).

And, of course, we can add new taxes. A 50-cent per gallon gas tax would pull in about $62 billion. A value-added tax (VAT), effectively a national tax on consumption (a kind of national sales tax), would bring in some real money. If set, for example, at 5%, a VAT would raise about $324 billion.

We face similar struggles in New York State. If spending continues on its current trajectory, the Division of the Budget projects a cumulative deficit of $61 billion over the next four years. Even after the changes proposed in Governor Paterson’s 2010-11 budget, the four-year deficit is only cut in half. That may sound like chump change compared to the federal deficit, but remember we don’t have the right to print money here in New York.

How to cut the state deficit? Remember that 53% of the budget is either Medicaid or K-12 education. You can bet that the hospitals are lobbying hard to roll back the $500 million cut recommended by the governor. Nursing homes and home care agencies are fighting the potential loss of another $600 million. Despite the fact that aid to K-12 education is up 42% since 2003-04, the public schools are lobbying aggressively to reverse Paterson’s modest $423 million cut from being imposed.

With the entire Legislature up for re-election in November and political control of the Senate within reach of both parties, candidates will be under pressure to find money for popular projects and avoid unpopular cuts, while still being able to claim to be fiscally responsible.

Is there a solution? Just as the problem is a tangled knot of politics and economics, so must the solution address both spheres. The political solution must provide cover for incumbents running for re-election, some kind of “plausible deniability” to shield them from the anger of special interests and the attack ads of challengers and their proxies. After a recent Supreme Court ruling eviscerated restrictions on campaign spending by businesses and unions, the need for political cover has never been greater.

Republican Senator Judd Gregg and Democratic Senator Kent Conrad are trying to establish a bi-partisan commission that would make recommendations to Congress that could only be voted up or down by members – modeled after the successful military base-closing commissions. This allows the “plausible deniability” incumbents seek—“Hey, you know I support your cause. But the cut to you, Mr. Special Interest, was part of the package. I just couldn’t vote down the whole thing.” Columnist George Will dubs this the “hold-hands-and-jump-off-the-cliff-together” school of government. It may be an inelegant, even cowardly, approach to balancing our budgets, but we don’t live in a perfect world.

Might a similar approach work in New York? We managed to close a number of hospitals and nursing homes using a similar model. The Berger Commission “took the heat” for legislators, letting sensible cutbacks become law without forcing state legislators to take a stand on individual facilities.

Yet we need an economic solution, too. Every one percent increase in the growth rate of the U.S. economy adds about $250 billion in revenue. It works both ways—if the growth rate falls by one percent, the deficit goes up by $250 billion instead. And the same principle applies to New York State. Whatever we do to fix the budget, remember the dictum from medicine: First, do no harm. For if, in our attempt to balance the budget, we chase business from our state or from our shores or we limit the ability of technology to improve productivity, we may fill one hole by digging ourselves another. Only economic growth truly cuts the Gordian knot.

Kent Gardner, Ph.D. President & Chief Economist
Published in the Rochester (NY) Business Journal February 19, 2010

I’m a planning skeptic. Often the process of planning is so exhausting that we declare, “It’s done!” when the ink is dry. We forget that the plan serves only to lay out the course and load the starter pistol. The plan is too-often ignored. We continue going about our tasks as though nothing had changed. To the Superintendent’s credit, many of plan’s strategies codify activities already underway. In fact, the first of the five years was 2008-09. Like all good leaders, Brizard is impatient about his plan.

The threads of empowerment and accountability are woven through the fabric of the plan. We know that the demanding standards of the 21^st century workplace can only be met by students who are empowered by a good education. District and school leaders, teachers, and staff must also be empowered and held accountable to demanding standards.

Goal 1. Brizard’s first goal is to “ensure that each of our students is academically prepared to succeed in college, life, and work in the global economy.” Plans tend to repeat the obvious and aspire to the impossible. No school has the power or the resources to make such an outcome certain—yet if this isn’t our aspiration, what would replace it?

Under Goal 1, the plan seeks to create a district-wide framework that “aligns standards, curriculum and benchmark assessments.” Accountability can only be achieved if it is first defined. But creating the framework isn’t enough—the plan asserts that the framework has to be adopted by schools. Just like the plan itself, the framework is useless if it isn’t adopted.

Goal 2. Students are not empowered to learn without a social environment that nurtures achievement. Goal 2 articulates the need for reliable security and consistent discipline. Moreover, the school must confront the social context that often impedes student success and recognize the need for comprehensive coordination with social services.

Goal 3. Schools cannot succeed without effective school leaders and leaders cannot be effective without qualified and engaged teachers. Goal 3 articulates steps to recruit, develop and empower gifted leaders; and equip and nurture outstanding teachers. Support and training is critical to the empowerment side of the equation.

Goal 4 addresses the physical environment. Great buildings cannot overcome disengaged teachers and an uncoordinated curriculum. Nor does a deficient physical infrastructure make learning impossible. Nonetheless, efficient and responsive management of buildings, transportation, and food services removes obstacles to achievement, empowering students, teachers and school leaders to focus their attention on teaching and learning.

Goal 5 articulates a strategy to create a culture of accountability. The District must be accountable to all of its “customers”—students, schools, parents, employees, taxpayers, and citizens.

Under Goal 5, Objective II, the district intends to “build [a] District dashboard to capture formative data, including benchmark assessment results, to monitor student learning in real time.” Teachers and administrators can only be held accountable if they are empowered through access to accurate and timely information. They rightly complain about assessments that are either unconnected to the curriculum or scored months too late. I’m not sure how “real time” will be defined, but it is “unreal” when the results of state assessments are available only at the end of the school year.

Accountability at the school level will be built on a budgeting system that empowers school leaders. Significant effort is going into creating a system that will allocate money according to the needs of the students attending each school. This “weighted student funding” system is a critical prerequisite to establishing the “Autonomous” schools, schools that are empowered to use funds creatively, adapting staffing and resource use to the particular needs of the school. Without a clear and fair funding formula, money is allocated directly from Central Office, not always in response to need and opportunity.

Goal 5, Objective IV addresses “Performance Management.” When expectations are clear and timely information on achievement is available, then leaders and teachers—at the district and school levels—can manage for performance. Empowerment appears again, however—the plan notes that the District must invest in building the capacity of managers, particularly principals, to manage for performance.

The plan also recognizes that the community can help. We can empower the District leadership and staff to make what may be unpopular decisions. And we can hold them accountable. We are all stakeholders in the future of Rochester’s children. Dramatic improvement will not come easily or quickly. I urge you to read the plan (see http://bit.ly/6VHeIp) to understand the scale of the work. Both the devil—and the angels—are in the details, the specific actions and initiatives laid out under each goal and objective. Improved student outcomes can only be achieved through many small, sometimes mundane, achievements.

The goal is not to plan but to do. Our role at CGR will be to support the creation of benchmarks and metrics for individual elements of the Strategic Plan, to help identify bottlenecks in the rollout, and to report to the District’s leadership and the larger community on what we see and hear. We are honored by Superintendent Brizard’s trust and openness, and we are challenged by the responsibility.

Kent Gardner, Ph.D. President & Chief Economist
Published in the Rochester (NY) Business Journal January 8, 2010

Five of us at CGR signed up for the HDHP and HSA combination. With our experience as background, nearly the entire staff selected this option for the coming year. Why?

Family A and Family B. Family A is a relatively heavy user of health care services. Over the 9 month period ending in October (CGR’s enrollment began Feb 1), this family chalked up 16 office visits (4 to specialists), 30 prescription drugs, 6 trips to the lab, 4 diagnostic imaging visits and 2 outpatient surgeries. Total payments for care came to $21,955; the family’s share was $4,758. Excellus paid $17,197. As CGR spent $4,649 on premium (again, only 9 months), the net cost to Excellus was $12,548.

Family B experienced ordinary, minor ailments. Between office visits and meds, they spent $1,215 out-of-pocket and never reached either the individual or family deductibles. Excellus spent nothing on their care and kept the entire $4,649 in premium from CGR. See Table 1 for a summary.

Compared to what? Let’s see what our families’ costs would have been under the other plan. CGR pays 70% of the cost of the “base plan.” For 2009, the base plan was a “preferred provider organization (PPO)” health insurance plan (Healthy Blue 15/25) with a 9 month cost of $8,937 ($993 per month). CGR pays $6,256 ($695 per month) and the employee pays $2,681 ($298 per month).

Ignore the health savings account and assume that CGR captured all of the savings from the cheaper plan (and paid the entire premium). If Family B had stayed in the more traditional PPO plan, it would have spent $3,041 (in premiums plus copayments).

High cost Family A would have spent $3,521 (after premium and copays) under the PPO plan.  See Table 2 for a summary.

Don’t forget the HSA. CGR’s spending for a family policy is the same, regardless of which plan is selected by the employee. The monthly premium spent on the PPO is $695, $178 more than the premium owed on the HDHP. CGR deposits the $178 per month in the employee’s HSA. Over the nine month period, both families received HSA deposits of $1,606.

With HSA contributions included, our high cost Family A spent $3,152 in the HDHP, saving $369 over the traditional plan. Family B ended up the nine month period with an HSA balance of $391, a saving over the PPO of $3,433.

Don’t forget the tax advantage. We’re almost finished. The HSA is funded with pre-tax dollars. The $1,606 HSA reduces both families’ tax liability by that total. Assuming marginal tax rates of 25% federal and 6.185% state, this is worth an additional $512. Moreover, if the families choose, they can self-fund their HSA (just as you would a flexible spending account) up to a total employer plus employee contribution of $5,950 (plus an additional $1,000 for individuals 55 and over). While you can secure the same tax benefit for out-of-pocket expenses through an FSA, any funds deposited in an FSA that aren’t spent within the year will disappear. Funds deposited in an HSA are yours and can be kept indefinitely. Family A ended the 9 month period with a total cost of $2,640 while Family B ended with a combined HSA balance and tax credit worth $903 (see Table 3).

Cash flow. Here’s the final wrinkle: Clearly, both families saved money in the HDHP. The high cost Family A, however, had to pay some substantial expenses before reaching the plan deductible. Between February 1 and March 4, Family A had spent $1,745 (largely due to an expensive drug for a single family member). The family’s $2,600 deductible was met by the end of March. At this point, the “coinsurance” period began and the family was obligated for 20% of the cost of care—which was typically at or below the copayments of the traditional plan. The HSA contributions did not keep up with actual cost. Moreover, the family can expect the same beginning-of-the-year cost burden in 2010.

Both families confirmed that paying “first dollar” for care changes your perspective. Knowing that Family B was paying the entire bill, one physician said, “Instead of ordering the whole battery of lab tests, let’s just get the three most important.” Both families report shopping for the best price on drugs. And it is more confusing. Providers are accustomed to applying a copayment and don’t know what you must pay (FYI, it works like this: The physician “bills” Excellus, which sends out a benefit statement that applies Excellus’ negotiated rate and informs the provider what he or she can charge. Then you pay the bill.) Excellus keeps track of progress toward individual and family deductibles and reports this information on each benefit statement.

The transition isn’t painless; you are now responsible for worrying about pricing as well as other considerations. But the savings are considerable and providers are becoming more accustomed to the new model.

Kent Gardner, Ph.D. President & Chief Economist
Published in the Rochester (NY) Business Journal December 11, 2009

In 2006, state law was changed to improve the auditing and budgeting of fire districts.  As a result, expenditure information for each district is now available on the Office of State Comptroller web site. For 23 reporting fire districts in Monroe County, total expenditures rose from $44.8 million in 2006 to $53 million in 2008, an increase of 18.3%, which was more than double the northeast regional Consumer Price Index of 7.2% for the same period.

Can anything be done to slow down this relentless growth in costs without compromising the quality of our fire services?  Studies done by CGR and other organizations across the country have demonstrated that having too many individual governments (there are 867 fire districts in New York) leads to fragmented decision making, which leads to unnecessary and inefficient duplication of resources.  For example, one study comparing northern Virginia (where fire services are managed at a county level) with Long Island (where fire services are fragmented) found four times more equipment on Long Island, even though response times and insurance ratings were comparable.  With fire trucks now ranging in cost from $250,000 to over $750,000, unnecessary duplication quickly adds significant increases to property taxes.

Individual citizens do have the power to change the system.  First, citizens can affect the election of fire district commissioners, although this could take several election cycles.  Second, they can initiate dissolution and consolidation of fire districts through a citizen petition.  There are ways to reduce the costs of fire services in communities, but citizens need to become directly involved in the process.

Charles Zettek, Jr. Vice President and Director of Government Management Services
Published in the Rochester (NY) Democrat & Chronicle December 7, 2009

Public Option. If private insurance plans are part of the problem, then one solution may be to offer another option, a health insurance plan that is run by the government. At this writing, a “public option” seems likely to survive and become part of the final legislation. The debate over the public option has highlighted a fundamental social tension between those who fear too much government and those who fear too little (discussed in the first column in this series). Like Goldilocks, each of us wants the balance to be “just right.”

The public option began as an expansion of Medicare to the nonelderly, an approach that would broadly challenge insurers and providers. National in scope and open to all comers, the federal government would manage the program and dictate provider prices. What seems to have survived will be limited to individuals without employer plans, allows states to “opt out,” and negotiates provider rates like private insurers. Where monopoly insurers keep rates high, the public option may provide a competitive alternative. Where monopoly providers control pricing, however, the negotiated rates are likely to be the same as those paid by private insurers.

The Congressional Budget Office assumes that this version of a public option will attract a less-healthy subscriber. Like Medicare, CBO expects that the public option plan will spend less on administration than private insurers, but that it will have fewer controls on health care service demand among subscribers. The administrative cost savings are offset by the cost of higher utilization. On balance, CBO expects that premiums for the public plan would be higher than for private plans offered through the exchange.

Whether implementing a less-robust version of a public option is a good outcome depends on your perspective. Those who believe that FEMA’s performance after Hurricane Katrina is typical of government will find no public option to their liking. Fans of Michael Moore, suspicious of private enterprise and less concerned about overreaching government, find a weak public option bitterly disappointing.

Coverage does not equal access. The recent debate focused on access to health insurance, not access to health care services. Harvard Medical School professor Marcia Angell (former editor of the New England Journal of Medicine) worries that we may have “coverage without care.” In the wake of its insurance reform, Massachusetts has experienced a shortage of primary care providers. The ability to pay the bill is meaningless if you can’t find a doctor who will see you when you are sick.

Nor does improving access assure improved health status. Our goal in health care reform should be to make us a healthier nation. Individuals and providers alike should have an incentive to improve health outcomes, not simply the quantity (or even quality) of active health care.

Bend the cost curve—next time. Making health insurance affordable is not the same as slowing the rate of health care spending growth. In pending legislation, affordability is achieved through subsidies and new market rules granting individuals access to group rates (through the health exchanges). There is a promise of lower costs—and this will be true for some individuals. But in the aggregate, health care spending will continue its steady rise.

Even the forecasters don’t trust the forecasts. If Medicare and Medicaid have taught us anything, it is that entitlement benefits expand over time and cost projections nearly always fall short. Much attention has been focused on the cost estimate “scoring” of the Congressional Budget Office. The CBO itself notes that these estimates are rough and based on assumptions that are somewhat unrealistic, assumptions it is bound to honor according to the rules governing its work.

Consider that the CBO’s net cost estimate for the House plan assumes cuts in provider payments in Medicare of $229 billion and cuts to Medicare Advantage of an additional $170 billion. Congress has a habit of announcing, then withdrawing, Medicare cuts. In fact, a 21% reduction in Medicare fees (worth a quarter of a trillion dollars annually) is still scheduled for 2010, yet seems likely to be rescinded yet again. Moreover, payment provisions in the House bill require the CBO to assume that Medicare cost per beneficiary will grow at 4% per year, well below the 7% we’ve experienced in the past two decades (excluding Part D, coverage for prescription drugs).[1]

The CBO is skeptical about its own estimates, which it notes are based on assumptions that cost savings initially enacted remain unchanged over the long term, something the Office notes wryly “is often not the case for major legislation.” We, too, should be skeptical.

They’ll be back. Most health care experts believe we can improve the quality of health care, achieve better health outcomes AND truly bend that cost curve. The health insurance overhaul likely to pass in the next few weeks leaves this task largely untouched. With expanded coverage adding fuel to the fire, Congress will one day be forced to return to the task of health care reform. The sooner lawmakers create incentives for consumers and providers to seek high quality, cost-effective solutions, the better.

Kent Gardner, Ph.D., President & Chief Economist with Guest Columnist James Fatula, Ph.D., Chair & Assoc. Prof., Dept. of Public Administration, SUNY Brockport

Published in the Rochester (NY) Business Journal November 6, 2009

Employer-based system leaves many without insurance. Sixty percent of the nonelderly population in America has health insurance through employers. Of the remainder, 18% are covered by Medicaid; 5% buy insurance individually; and 17% go without (despite the fact that 80% of the uninsured have a full time or part time worker in the family)[1].

Dependence on employer plans can be traced to a 1950s-era decision to exempt the value of health insurance from taxable income. As a result, a worker will prefer $1 in health insurance to an additional dollar in income and health insurance coverage became a popular benefit.[2]

Yet not all businesses generate enough profit to pay the cost of health insurance. Health insurance is a modest additional expense for a firm employing engineers earning $80,000. It is far more expensive in relative terms for a firm, perhaps a retailer, employing workers earning $7-10 per hour. CGR’s family plan costs about $4 per hour for a full time worker, over half the minimum wage. A Kaiser Family Foundation survey of employers reveals that 36% of firms with a high proportion of low wage workers offer coverage v. 67% of the remainder. This distinction is revealed by sector, too. Retailers tend to have lots of lower-paid workers—as a consequence, manufacturers offer coverage at twice the rate as retailers[3].

Certainly some businesses can afford to offer coverage and choose not to. Requiring employers to offer insurance coverage (or pay a penalty) is intended to close the insurance gap. Still, exemptions or tax credits for small firms and lower “take up rates” among low wage workers (because of cost) ensure that there will still be gaps, even among the employed. One caution:  Health care insurance is a form of compensation. An employer mandate would function much like an increase in the minimum wage. Some unskilled and semi-skilled workers would likely lose their jobs if employers were required to pay them substantially more.

Individual insurance market needs overhaul. Workers without employer-based coverage, are unemployed or self-employed must turn to the individual market. Suppose you decide to quit a job—with health insurance—and start your own business. You discover that it will cost more to buy coverage on your own than you and your employer were paying together before you quit your job.

How come? Insurance is about sharing risk. When Excellus or MVP sells a policy to a group, they get a mix of low cost and high cost customers—some young singles who are cheap and some older people who aren’t. The premium is calculated to cover everyone, on average. Insurers know that people who choose to buy individual health insurance probably need it more than people who don’t. A young couple may go without coverage until they decide to start a family. Individuals with a family history of heart disease are more likely to buy coverage than those from healthy families. And the insurers price accordingly.

Proposals making the purchase of insurance mandatory for individuals aim at this problem of “adverse selection.” They intend to re-create the “spread the risk” effect of employer groups for those individuals who are currently uninsured. Requiring more individuals to purchase health insurance (or pay a penalty), would reduce the likelihood that individuals seeking insurance are poorer risks than those who do not.

It seems likely that the individual market and Medicaid will both be expanded until they meet someplace in the middle. Individuals will be able to purchase health insurance at group rates through “health exchanges” that are intended to drive down cost by increasing competition. Medicaid eligibility will be extended to higher levels of income. Individuals who don’t qualify for Medicaid will be offered a sliding scale subsidy, perhaps up to 400% of the federal poverty level ($88,200 for a family of four).

Several proposals pending before Congress will also tighten the rules for individual health insurance coverage, including prohibiting denial of coverage for pre-existing conditions, restricting the ability of insurers to drop coverage, and regulating annual and lifetime caps. Such changes would increase labor mobility, which is certainly a worthy goal, but will also force insurers to increase premiums for individuals who are eligible for coverage under the current rules.

Paying for changing in health care system. Increasing health insurance coverage will not be cheap. This is why cost control is critically important. An expansion of coverage without action on cost will postpone more fundamental reform. Unfortunately, expansion of coverage is much easier politically. Nearly every proposal aimed at cost has been weakened or removed from pending legislation.

Nor is there any willingness in Congress to pay for increased coverage through an explicit increase in general taxation. Much of the increase in cost from expanded coverage is financed through reducing spending in part of the system and increasing taxes, fees and insurance premiums in another.

With car insurance, you spread risk across lots of people who share your “risk profile.” What you pay for collision coverage depends on your accident history, how much your car is worth, how much it costs to repair and where you drive it. The premium is set to equal what a member of your risk group expects to receive, on average, plus what the insurer gets for administration and profit.

Health “insurance” begins to look less like insurance if insurers are prohibited from charging premium differentials that track actual expected costs. Requiring more people to purchase insurance expands the risk pool, which is a good thing. Yet if new entrants are charged substantially more than the expected value to them as individuals, the effect is to broaden the scope of the cross-subsidies already endemic in health care.

These cross-subsidies are formalized in most of the proposals before Congress. The Senate Finance bill, for example, prohibits insurers from charging a differential of more than 4 to 1 by age, although the true variation in cost is probably much higher. Thus the young subsidize the old. The employer mandate will increase costs in some sectors more than in others, another implicit subsidy.

Next week we’ll bring this series to a close with a summary of issues and some thoughts on pending legislation.

[2] Yet the inequities of such an exemption are legion—it is worth more to people in a higher tax bracket, nothing to employees covered by a spouse’s plan, encourages more spending on health care than without the plan, etc. For a good discussion of this issue, see an article by Ezekiel Emanuel (Rahm’s oncologist brother) in the New York Times: http://campaignstops.blogs.nytimes.com/2008/10/10/the-problem-with-tax-exempt-health-insurance/

[3] Kaiser Family Foundation http://www.kff.org/insurance/7672/exhibits/index.cfm

Kent Gardner, Ph.D., President & Chief Economist with Guest Columnist James Fatula, Ph.D., Chair & Assoc. Prof., Dept. of Public Administration, SUNY Brockport

Published in the Rochester (NY) Business Journal October 30, 2009

Traditional health insurance insulates us from the visit-by-visit, script-by-script cost of care. That’s a problem. Facing only a fixed co-pay (or not even that), we don’t look at the “right side of the menu.” In our health care “restaurant,” the menu doesn’t tell us that the Lobster Thermidor costs twice as much as the Chicken Piccata. And we don’t care, because “insurance” will pay for it.

Last week we explored regulatory approaches to slowing health care spending growth. Today we discuss changing the incentives for consumers, providers and insurance markets.

Consumers. Over our lives, most of us will pay ALL the cost of our own health care (if you include what your employer spends on your behalf). There is no “someone else” to foot the bill. There are exceptions, of course—some of us experience catastrophic events that cost more than our lifetime contribution to health coverage. But health cost inflation is OUR problem. We have to help with the solution.

A consumer-directed health plan (CDHP) gets consumers involved by putting pocketbook pain back into health care through a high deductible. Polly Patient pays “first dollar” for her care, forcing her to think twice about getting care and to ask about prices: “So, Doc. How much is this going to hurt (my checkbook)?” With traditional plans, prices are hidden—we don’t know that the same procedure can cost twice as much in one setting as another or that a 90-day supply of a drug costs only slightly more than a 30-day supply. (See http://www.policy-wonk.org/kent-gardner/making-sense-of-health-savings-accounts-2/ for a longer discussion of CDHPs.) But who likes pain? Take-up rates for CDHPs have been disappointing. Yet CDHPs save money (when they are the only option—Kent will explain why in a later column).

Graduated co-payments also change behavior. A generic drug may be cheap or free; an expensive drug (like a biologic) has a higher co-pay. A primary care visit is cheaper than a specialist visit.

Providers. Provider incentives affect behavior. Since 1983, Medicare has paid hospitals a fixed sum based on the patient’s condition, the “diagnosis-related group” or DRG. Paid the same amount whether the patient is in the hospital for one night or five, these “bundled rates” reward hospitals for efficiency. Still, hospital readmission rates among Medicare patients are high. DRGs may encourage hospitals to push patients out the door too quickly.

Physicians, however, are paid by Medicare according to a complex schedule of fees with over 7,000 billing codes. Some version of a “bundled” payment system—like hospital DRGs—could be applied to physicians. For chronic disease, for example, physicians could be paid a single fee for all of a patient’s needs for a period of time. Under a fee-for-service system, physicians do better financially when chronic disease is not well controlled. Instead, they should profit from keeping patients healthy rather than for treating them when they get sick. We are a long way from being able to put such a complex reform in place. Instead, Congress attempts to cut Medicare costs by promising to cut physician fees—then changes its mind under pressure. Cutting fees encourages physicians to do more and “game” the fee schedule.

Managed care organizations slowed cost growth in the 1990s by use of “capitation.” Provider groups and physician “gatekeepers” are paid a fixed sum per member per month, instead of getting paid each time the patient member receives a service. Backlash from consumers forced a retrenchment. Insurers replaced many of these plans with models that are based, again, on fee-for-service payments and place fewer limits on accessing specialists.

Capitation (and the gatekeeper) may be back. Massachusetts is exploring the use of “Accountable Care Organizations” that sounds remarkably like the unpopular HMO. Provider groups would receive a fixed fee per enrollee, thus would be encouraged to keep the member healthy and receiving fewer, not more, services.

Insurers. One group we’re freely permitted to blame in this discussion is the health insurers. They are certainly caught in the middle. Employers cry foul when they raise premiums. Consumers complain whenever coverage is denied. Providers criticize them for playing God (providers only, please).

Some insurers take advantage of a dominant market share and are highly profitable. Yet according to Hoover’s, the sector earned net profit of 3.3% in the most recent quarter (as reported at http://biz.yahoo.com/p/522mktd.html). Of the five largest firms, Cigna did the best at 9.7% and Humana was #5 at 3.7%. The smaller firms were less profitable.

That they are not fabulously profitable does not mean that they are as efficient as they could be. Competition—through the creation of health insurance exchanges—could improve their effectiveness. One hope for the “health insurance exchange” that is likely to emerge from Congress would be the de facto creation of national standards and a national market for health insurance, weakening the Balkanized system of state regulation the industry now confronts and promoting competition across state lines. Standardization would be welcome and likely reduce cost. The task of comparing the cost of health insurance policies within states is difficult; across states it is nearly impossible.

Would including a public option cut cost further? This question is not easily answered and depends on how such an option is designed. We’ll address it later if a public option emerges from Congress.

The scope for cost reduction through the creation of insurance exchanges is limited. Most of the cost of health care is the care itself, not the administrative cost and profit of health insurers. The simple arithmetic of health care remains: Cost=price X quantity. We must pay less or do less. Nothing less will cost less.

Next week we’ll look at the issues around expanding health insurance coverage.

Kent Gardner, Ph.D., President & Chief Economist with Guest Columnist James Fatula, Ph.D., Chair & Assoc. Prof., Dept. of Public Administration, SUNY Brockport

Published in the Rochester (NY) Business Journal October 23, 2009

To summarize our first two columns: Cost lies at the heart of the health care problem. Health care insurance masks the price signals that guide buyers and sellers. Providers are paid to do more and consumers have little incentive to refuse (go to www.cgr.org and click on the Policy Wonk link to read the first two).

In this column and the next, we look at ways to tame cost growth.

COST=QUANTITY x PRICE. We will only spend less if we do less, pay less, or both. To control health care costs, we must either

• Cut provider reimbursement by reducing fees and/or shifting lower-cost providers (e.g. from hospital ERs to “urgent care” centers or from physicians to nurse practitioners), or
• Cut the volume of services by reducing consumer demand (e.g. increasing co-pays or managing care more aggressively) and/or limiting provider supply (e.g. limiting the number of MRI machines in a market or cutting inpatient beds in hospitals).

The arithmetic is simple. The politics is not. Cutting prices of health care services means cutting the incomes of health care providers. Cutting services means saying “no” to consumers. Shifting care to low cost providers—e.g. from hospitals to urgent care centers—shifts income from one group of providers to another. Nearly every choice we confront is some form of “win-lose,” guaranteed to stir up opposition.

We control cost either through regulation and oversight or by changing the incentives confronting providers and consumers. This week, we discuss regulatory solutions.

Take control. The United Kingdom’s National Health Service (NHS) is the ultimate regulatory approach. Health care professionals are NHS employees. Policies over coverage and utilization are determined centrally. A “single payor” system, nearly all health care spending flows through the NHS. Employing 1.4 million in 2008, the NHS is one of the world’s five largest employers. Parliament imposes a global budget on the NHS, which sets physician salaries, access to care and other cost drivers. Despite well-publicized problems, it remains popular with voters. The federal government in the U.S. provides very little direct care (outside the Veterans Administration). 47% of health care spending is from public sources; 34% is federal.

Cut provider fees. With Medicare responsible for about 20% of total health care spending, provider fees set by the federal Centers for Medicare and Medicaid, typically below the prices paid by private insurance, serve as an industry benchmark. This approach can backfire: Physicians may stop accepting Medicare. Mistakes in pricing distort labor supply—too many medical students may choose to pursue a specialty that gets better fees. Providers may react by billing more procedures or raising prices for other payors. Many feel entitled to “game” the system to offset the cost of complying with an inefficient and unfair payment mechanism.

Politics may intervene. Fee reductions imposed by one Congress can be reversed by the next. The Senate Finance Committee has proposed a Medicare Commission—modeled after the military base closings commission—to control the growth in payments for Medicare providers, although it is meeting stiff resistance.

Manage care. Some health care is unnecessary, counterproductive or simply not cost effective—about 30% of the total, according to Elliott Fisher at Dartmouth. As an example, the effectiveness of spinal fusion is unproven. “The indications for this invasive and expensive procedure remain unclear despite its rapidly expanding use” (New England Journal of Medicine, 2004). Surgeons may not be objective when judging the value of spinal fusion over less costly procedures. And drug companies are often accused of pushing a new drug that is no more effective than an older drug available in a generic—less profitable—form.

Expert panels can be convened to approve or disapprove specific procedures, therapies and drugs. As an example, New York’s Medicaid program adopted a drug “formulary,” a list of approved drugs deemed both cost and medically effective. At the federal level, an expansion of “comparative effectiveness” research is included in several proposals pending in Congress. The House version prohibits the use of findings to make coverage decisions in Medicare, however.

Oversight is itself costly and the decisions of panels can be arbitrary. Experts can disagree on what constitutes evidence of effectiveness. In our last column, we mentioned a patient with glioblastoma (a type of brain tumor) who was treated with Avastin before it was approved for this use by the Food and Drug Administration. An oversight panel might reasonably have prevented its use.

Better management of chronic disease, responsible for up to 75% of health care costs, can both cut the cost of care and improve outcomes. In a fragmented fee-for-service system, coordination of care among health care professionals and patients is a challenge. This is part of what President Obama found appealing at Mayo and Cleveland clinics.

Manage supply. The Dartmouth Atlas of Health Care reports that regional variation in health care is affected by the relative abundance of facilities and medical professionals. Approval processes for new equipment, programs and facilities are common. As of 2008, 36 states required providers to obtain permission for new construction, programs or major equipment. New York’s “certificate of need” (CON) program was the first, established in 1964. Enforcement varies. NY’s program did not prevent the excess capacity that forced creation of a commission to cull surplus facilities. Regional planning entities like the Finger Lakes Health Systems Agency can also contribute, although their role is only advisory under current law.

No panacea. A solution to health cost growth will almost certainly include some regulation, although regulatory solutions add to administrative cost and expose health policy to political influence. Insurance coverage mandates in NYS, for example, are influenced by provider group lobbying, thus increasing total cost. Limitations emerging from oversight panels can be overturned in the political arena.

Next week we explore “market oriented” tools to “bend the cost curve.”

Kent Gardner, Ph.D., President & Chief Economist with Guest Columnist James Fatula, Ph.D., Chair & Assoc. Prof., Dept. of Public Administration, SUNY Brockport

Published in the Rochester (NY) Business Journal October 16, 2009

In 1960, health care spending was 5% of gross domestic product (GDP). This year it’s expected to reach about 18%. For the past 30 years, health care cost has been rising 2% faster than GDP.

On the one hand, perhaps this doesn’t matter. We are spending more on health care and sometimes we get more for our money. Medical science has discovered new therapies. Pharmaceutical companies have identified fabulously successful new drugs. The survival rate for many dread diseases has increased significantly. For example, many cancer sufferers are living longer and experiencing a higher quality of life. Some diseases that were fatal only a few years ago—AIDS is the most prominent example—are now considered almost chronic illnesses. But these new therapies, these new drugs, these new treatments aren’t cheap. Genentech’s Avastin, currently used for a broad range of cancers, can cost from $4,000 to $9,000 per month.

On the other hand, sometimes we get less for our money. Higher spending on health care does not always mean higher quality or better health. Rising health costs affect us in many ways. If we receive health care insurance from our employers, we may have seen our salaries rise more slowly as our employers struggle to absorb these higher costs. Over the past decade, health insurance premiums have gone up almost four times as fast as wages (119% v. 34%). Health insurance cost is part of GM’s financial troubles—for every car it sells, $1,200 to $1,500 of the sale price goes to pay for health care benefits for workers and retirees, making it even harder to compete in global markets. As taxpayers, we are paying more to support Medicaid and Medicare, crowding out funding for other priorities. Hospitals and other health care providers are absorbing more bad debt. And of course higher health care costs have resulted in continually eroding private insurance coverage, especially affecting middle and low income families.

The rising cost of health care forces us to confront some difficult and serious choices. How much are we willing to pay for our own health care or the health care of our loved ones? More challenging for society, perhaps, is the question of what we are willing to pay to support the health care costs of others.  Is health care a right, regardless? In our society most seem willing to answer a heavily qualified “yes, in part” to that question. But what about personal responsibilities that accompany that right?  Many may be reluctant to see their insurance and tax dollars supporting medical treatment for those who choose to continue to smoke. Or for individuals who don’t take their meds or take other steps to manage their health. And no one wants to pay more than is necessary to achieve our goals.

We know that we’re on an unsustainable trajectory.  The Congressional Budget Office notes that health care will soak up nearly half of GDP by 2082 if nothing changes. That’s certainly unaffordable—some crisis or political miracle will force change upon us before we get to that point.

We also know that simply expanding the system we currently have will only bring that day of reckoning forward in time. Congress is poised to pass a package of changes that primarily addresses gaps in insurance coverage without altering the fundamental incentives now driving health care costs inexorably upward.

So why is the cost of health care going up? Like a stable political system, a well-functioning economic system has “checks and balances.” For a normal product, the buyer and seller work this out between them. Starbucks can sell a grande latte at $4 but sell few at $8. Starbucks’ success prompted Dunkin’ Donuts and McDonalds to offer a similar product at a lower price, putting pressure on Starbucks to cut costs and emphasize its “value proposition.”

This feedback loop is missing in health care. The nature of health care insurance insulates the consumer—you and me—from the cost. If we’re not paying the bill, we may not care whether Starbucks is charging $8 for a grande latte.

In 1965, nearly half of health care costs—43%—was paid by the “consumer,” the person whose health was being cared for. Now the consumer pays only 11% of the cost. Insurers are constantly inventing new ways to encourage consumers to pay attention to cost—that’s what deductibles and co-payments are intended to do. But the full cost of our care is still hidden from the insured.  And it is a simple fact of human nature that we buy more when something costs less. This is why simply providing the uninsured with health insurance without cost controls is a prescription for even more exorbitant cost growth. That is one lesson of the Massachusetts experience with mandating “universal coverage.”

Of course, health care is not bought and sold in a normal market. A relative of Kent’s is fighting a nasty kind of brain cancer, glioblastoma, and is taking Avastin. Despite the fact that there is little hard evidence that Avastin does more than prolong life by a few months, none of us want to be put in the position of concluding that his life isn’t worth $9,000 per month.

Health care providers are also conflicted. As Kent noted in an earlier column, his mother’s doc will continue to try new ways to fix her back pain until she calls a halt. As Medicare pays the freight, she gets to keep hoping and he gets to keep billing. The system rewards the volume of services provided, and if you have insurance, there is no reason not to collude with this system.

If the consumer isn’t in a position to self-ration health care, someone else must. Next week we’ll explore proposals to “bend the cost curve.”

Kent Gardner, Ph.D., President & Chief Economist with Guest Columnist James Fatula, Ph.D., Chair & Assoc. Prof., Dept. of Public Administration, SUNY Brockport

Published in the Rochester (NY) Business Journal October 9, 2009

You, too, can be fluent in Health Care! In only 10 easy audio lessons, you can amaze your friends with your command of phrases like single payer, health co-operative and rescission, plus acronyms like ERISA, LOS, IPA and HIPAA. Available on CD or by MP3 download for 10 easy payments of only $29.95.

Tempted? We’ll be attempting a similar feat over the next four weeks. Jim Fatula and Kent Gardner will be offering a “back to basics” look at the debate over health care reform. Two core issues—health care cost and health insurance coverage—occupy center stage.

Visiting Washington this summer, Kent watched a session of the Senate and listened to a member’s passionate speech on this subject. Yet he spoke to an empty chamber. Only one other senator was present. Oh, and C-SPAN’s camera, focused only on him. It seemed a metaphor for what has been a sorry debate, filled with speeches but few discussions. Radicals on both ends of the spectrum are driven more by ideology than by thoughtful differences in policy. This is a war between different faiths, a bitter competition between tribes in which winning is the only goal.

At one end of the faith spectrum is a belief that the greed of the private sector is unbounded and cannot be tamed or channeled. These believers advocate moving toward a single payer system, where government would have a central role in the financing and delivery of health care. At the other end of the spectrum are those who hold a similar belief about government, convinced that government is fundamentally incompetent and controlled by special interests. These believers argue for reliance on decentralized markets with government’s role as limited as possible.

The practical reality is somewhere in between these two ends of the spectrum. Markets can fail, spectacularly. Activities directly controlled by government are often influenced by the few against the interests of the many, and performance can be poor. What is the right kind and mix of private/public solutions to meet our health care challenge? This is the heart of the debate.  Moreover, both “camps” have different beliefs about the behavior of citizens/consumers, (who are taxpayers, users of health care, employees with or without health insurance, etc.) affects and is affected by any changes we may make.

The discussion is not about “overhauling the health care system,” desirable as this might be. It is for the most part about changes to health insurance, how individuals finance their health care needs. Health insurance coverage does not guarantee us access to health care nor does it guarantee that the health care we receive will make us healthier.

The two largest publicly-funded health insurance programs—Medicare and Medicaid— have been left largely untouched by most proposals, despite the fact that they are central to health care delivery. Individuals who are 65 and over (plus a few other covered groups) receive care under Medicare. Some of the poor and some of the near-poor qualify for Medicaid, depending on the state.

Medicare’s dire financial circumstance was originally a major impetus for health care reform. The Congressional Budget Office forecasts that the total cost of Medicare will rise from about $500 billion this year to $943 billion (88% growth) in only ten years. And that’s only the beginning—the CBO forecasts that Medicare and Medicaid together will consume 12% of GDP by 2050, up from 4% today.

Yet the fundamentals of Medicare and Medicaid do not change under the proposals with the most traction in Congress. The Baucus proposal, for example, cuts payments to Medicare Advantage plans and some Medicare providers as a way to raise money to finance expanded coverage for the uninsured. Giving provider payments a haircut may change Medicare, but that will be an unintended consequence. Medicaid eligibility will be expanded as a way of covering more of the uninsured near-poor, perhaps also for financial reasons as the cost of Medicaid is shared with the states.

Most of the rest of us rely on a health insurance system that is employer-based. A large proportion of employers, particularly large employers, provide health insurance to their employees, although they are not required to do so. This dependence on employer-based insurance is something of an accident.  There are two principal causes. First, tax law allows individuals to exclude a wide range of noncash compensation from taxable income. Do you get free coffee at work or do you have to pay for it? In a sense, those of us who get free coffee are getting “paid” more than those who don’t. We don’t have to report this kind of thing on our tax returns. Health insurance is also excluded. Fifty years ago health care was less expensive and health insurance, when offered, was largely of the “catastrophic” variety, so the impact of this tax rule was nearly trivial. Today, the difference is anything but. Consider one of CGR’s 2009 health insurance options: The Excellus Healthy Blue 15/25 plan costs $8,227 per year for family coverage. For an employee with family income above $67,900, his or her tax rate on additional income (both state and federal) is 31.85%. For CGR, the cost of either paying family health insurance coverage or granting $8,227 in added salary is the same. The difference for the employee is not. Assuming that the employee could and would purchase the same plan at the same price, the difference in after-tax income is $2,620. Which would you choose?

The nature of insurance explains a second reason for our dependence on employer-based coverage. Insurers know that people who buy insurance of their own free will are more likely to need insurance than those who do not (e.g. if you buy flood insurance, you probably don’t live on a mountaintop). For this reason, insurers are willing to offer a better average rate to cover individuals who are part of a group than to individuals who apply for coverage independently. Adding $8,227 to our employee’s cash compensation will probably not be enough to permit him or her to purchase comparable coverage.

If we could start over, we would not build our health insurance system around a connection to employment. The rapid increase in the cost of health care, thus the cost of health insurance, has demonstrated the flaws of the system we created by accident. For many employers, health insurance coverage is simply unaffordable. The cost of CGR’s family plan is about $4 per hour for a full time, hourly worker. For a firm employing unskilled workers earning the minimum wage, full coverage would add 55% to total employee compensation. It is no surprise that employers have been cutting the share of coverage they are willing to pay or eliminating health insurance benefits entirely. What is not understood by employees is that  wage increases and  health insurance premiums are interchangeable to the employer. As premiums rise, most employers will limit wage increases.

Many of the proposals being considered in Washington are aimed at fixing the problems that arise from our dependence on employer-based coverage. With a market dominated by powerful employer-based plans plus Medicare and Medicaid, the health insurance market for individuals has many flaws. Workers whose employers don’t offer a plan or individuals who are self-employed are disadvantaged under the current system. Not only is it hard to find affordable insurance coverage, individuals who pay for health care without the power of an insurance provider often pay much higher prices for the same services.

Underlying the entire discussion is the question of how society shares the cost of care between the young and the old, the healthy and unhealthy, those with healthy lifestyles and those without, and between the rich and the poor. Finally, how can we design a system of care and payment that is humane, yet does not encourage unnecessary expense?

Kent Gardner, Ph.D., President & Chief Economist with Guest Columnist James Fatula, Ph.D., Chair & Assoc. Prof., Dept. of Public Administration, SUNY Brockport

Published in the Rochester (NY) Business Journal October 2, 2009