By tying their contributions to the lowest cost of several plans, employers are helping workers become cost effective health care buyers

Employers are experimenting with managed competition: by tying their contributions to the lowest cost of several plans, employers are helping workers become cost effective health care buyers

Pamela Taulbee

Discouraged by unsuccessful attempts to control rising health care costs through managed care, a few employers are experimenting with a new strategy: they’re managing price competition instead of managing care.

The state of Minnesota and Xerox Coop., among others, have adopted a strategy called “managed competition.” As conceived by Alain Enthoven, Marriner S. Eccles professor of management at Stanford University, managed competition attempts to correct marketplace imbalances that encourage escalating health premiums by rewarding HMOs for being low-cost, efficient providers of quality care.

Enthoven explains that most employers actually discourage competition among health plans because they contribute more money when an employee chooses a more expensive health plan. That creates a marketplace imbalance, he says, because employees don’t have sufficient incentive to choose more efficient, lower cost plans. In addition, HMOs or insurance companies offering managed care plans have no incentive to become efficient, cost effective providers. By paying the full price of indemnity, the employer offers no incentive for the HMO to be cost effective.

For example, Enthoven explains that in the Twin Cities, where several HMOs have competed since the early 1970s, employers have continued to pay the full price of plans up to the fee-for-service plan. Thus, the HMOs have raised their prices to levels close to those of the fee-for-service plan, a practice called “shadow pricing.”

“Managed competition requires that the employer assess the HMOs it chooses for quality and cost effectiveness and then hold them accountable for those qualities,” says Michael Sydlaske, principal with benefits consultant William M. Mercer Inc., New York.

The strategy

Not all employers are ready to implement managed competition, however. Managed competition can be complicated; employers have to manage the competing HMOs and adjust their payments to the plans of adverse selection. What’s more, employers have to break in the concept of managed care to employees who are accustomed to indemnity plans and who may not be accustomed to paying part of the premium for their health care benefits.

Employers can institute managed competition, Enthoven says, by making HMOs the center of their health benefits offerings. Employers would tie their contributions to health care premiums to the lowest cost HMO they offer, adjusting for adverse selection. Of course, the employer should set quality and access standards, and plans must meet them to qualify. Employees are required to pay the difference between the lowest cost plan and the plan they choose, and are thus encouraged to choose the lowest cost plan. But because satisfaction with the plan’s providers is also critical, employees choose what they perceive as the higher value for their money. As more employees choose the lowest cost, high value plan, competitors will either become more efficient, customer oriented, and quality driven, or lose market share and drop out of the competition.

The state of Minnesota’s employee health benefits plan has saved more than $20 million since it embraced managed competition three years ago, says Robert Cooley, employee health and benefits manager for the program. It provides benefits to 55,000 employees and 70,000 dependents. Before 1985, Minnesota law required the state plan to offer any HMO that was licensed to operate in the state, and the employer contribution formula was tied to the indemnity plan. It paid 100% of the indemnity plan premium for employees, and 90% for dependents. The indemnity premium, however, doubled in two years. “As a result, the state had run about a $50 million deficit,” Cooley points out.

The law requiring the state to offer any licensed HMO was abolished in 1985, and through collective bargaining with 10 unions that represents its employees, the state changed the basis of its 100/90 formula. Instead of basing its contribution to employees’ health benefits on the indemnity plan, the state could now pay 100% (and 90% for dependents) of the lowest cost provider–be it HMO or indemnity–serving a given county. If employees selected a higher cost plan, they paid the difference.

In 1989, the state offered nine plan options and the lowest rate increase was 15% over 1988; early this year, only six plans were still competing, and the premium increases in all but two were in the single digits. (Studies show that the national average for indemnity plans will be at least 12% higher in 1992 over 1991.) In the first few years after the change, the indemnity plan remained the lowest cost provider, but by 1989, seven HMOs were lowest cost carriers in their counties, according to a University of Minnesota study of the state health plan conducted for the Health Care Financing Administration (see “Annual premium for family health coverage for Minnesota state workers,” above).

Pegging the contribution to the low-priced plan in each of Minnesota’s 87 counties rewards the most efficient providers in each county. (HMOs are chosen to compete by county so employees have access to a plan that is fully paid in their county.) Changing the employer contribution formula as the state did allows the health plans to compete on price, and employees vote accordingly.

“The changes we saw were exactly what one would expect from economic theory,”

notes Cooley. “The staff-model HMO competing for the state’s employee enrollment had the lowest cost increase and gained more in enrollment, 40% over the prior year. The IPA (individual practice association) model HMOs’ premiums increased in the 20% to 28% range,” Cooley says. Both types of HMOs neither gained nor lost a substantial number of enrollees. The indemnity plan, however, lost 19% in enrollment. The only reason it didn’t lose more, Cooley notes, is because the state is mostly rural; in half the counties the indemnity plan has no competition.

Measuring quality

While pricing is key to a managed competition strategy, quality is equally important. Last year, the state conducted a satisfaction poll among its employees using a survey provided by the Group Health Association of America, the HMO trade association based in Washington. The results were published so each employee could evaluate plans to choose for 1992. The state chose patient satisfaction as its first quality measure because Cooley and the others involved were convinced that research done by the Rand Corp., a health care policy research institute based in Santa Monica, Calif., and other investigators shows a high correlation between patient satisfaction and quality of clinical care delivered.

Cooley says the state plans to do a follow-up survey to determine what impact the results of the satisfaction survey had on employees’ choice of health care plans. The next step for Minnesota, Cooley says, is to provide its employees with information on treatment outcomes, adjusted for severity and other factors, so that they can compare plans using clinical quality measures as well. But that will take a few years, Cooley says. The state is working with the Minnesota Health Care Coalition to develop an outcomes comparison project.

The state of Minnesota has identified several areas in which to review clinical outomes–Cesarean sections, flu immunizations in high-risk populations, and the extent to which mammograms are being used as a preventive tool for women aged 50 to 74. The state is hoping to compile results that it can publish within a year to help its employees make informed plan comparisons.

In addition, the state intends to use the data to review results with its health care vendors. “We will be holding discussions with them on what they would be doing to improve their plan offerings and improve patient satisfaction, for example,” says Cooley. The state will also ask certain vendors to submit plans on what they’re doing to improve their perceptions of employee satisfaction or clinical outcomes data. “Their responses will be the basis for deciding whether we’re going to contract with them further,” says Cooley.

While the state has saved more than $20 million through managed competition since 1989, it has spent a “relatively small amount” to implement the strategy. The most expensive element was the patient satisfaction survey, which cost about $80,000, Cooley says. “That’s less than one-tenth of one percent of what we spend on health care in a year,” he points out. The rest of the cost was in staff time spent with providers to communicate the changes and with the legislature to change the law that blocked managed competition.

The state’s move into managed competition was not without problems. For one, “When we moved to a new employer contribution policy, it caused some employee contributions to increase from zero to $75 per month, for employee plus dependent [depending on the plan the employee chose],” explains Cooley. The increase in employee contributions resulted in employees becoming more sensitive to cost.

Other than employees not being pleased with the cost increase of their contribution, there were other concerns. Approximately 95% of Minnesota’s doctors participated in the state’s self-insured plan. But when the state switched to a PPO-type network in which only about 60% of the state’s doctors participated, “the state had to work together with unions [to communicate the changes to workers and] to get people to understand that in order for them to continue to get salary increases, we had to gain control over associated health care costs. One of the reasons the program stood as well as it has is because of the strong labor/management commitment to it,” he adds.

Xerox’s experience

Xerox Corp., a manufacturer of electronic printing and copying equipment in Stamford, Conn., has also introduced the concept of managed competition. Xerox began managed competition in 1990, when it started HealthLink, its program of HMO offerings. Previously, Xerox, which provides health benefits to 103,000 employees and their dependents, had been dealing with more than 100 HMOs across the country.

Through competitive bidding, Xerox selected six system managers, all HMOs, to coordinate the HMO offerings in various areas (see “Xerox’s new health plan: an idea worth copying,” B&H, March 1990). In many cases, the system manager HMOs are not managing their competitors, explains Patricia Nazemetz, director of benefits at Xerox. They are coordinating the HMO offerings for Xerox and selecting plans to compete based on their ability to meet Xerox’s performance standards and administrative requirements.

“Because we have 250 locations throughout the United States and are a relatively small employer in places where we do business, we needed a system that allows us to focus our administrative efforts and not give up on managed competition,” Nazemetz says.

As a result of its strategies, Xerox has increased the percentage of employees enrolled in HMOs from 40% at the beginning of 1990 to 65% today. The company’s goal is to enroll 80% of its employees in HMOs by 1995, says Nazemetz. She estimates the company saves about $1,000 a year for every employee enrolled in an HMO, rather than in an indemnity plan.

Under the managed competition theory, Xerox would not pay more for employees in the indemnity plan than it would for employees in HMOs. But Nazemetz says the cost differential is significant enough between the indemnity plan and HMOs that Xerox still pays for a higher percentage of the indemnity cost for employees in that plan. Rather than eliminate the indemnity plan altogether, Xerox has continued to add more managed elements in its fee-for-service plan to moderate the costs for those who feel it’s their only option. “We may not get rid of fee for service entirely,” says Nazemetz, “but it will look like more of a managed arrangement.” Meanwhile, as fee for service becomes more expensive, more of the workers who generally tend to stay in indemnity plans are choosing HMOs.

Cost is not the only concern of Xerox. The company has long been committed to continuous quality improvement, which includes reducing the number of vendors used and working with the remainder to develop standards of quality and long-term relationships, says Nazemetz. The company built its health plan around HMOs because “we believe HMOs do a better job of controlling costs,” Nazemetz explains.

Making qualified HMOs the cornerstone of its health plan was the first step in its managed competition strategy, Nazemetz says. The second step, begun this year, is to institute a low-cost provider formula, similar to Minnesota’s. “We changed our whole pricing structure to base the company contribution on the most efficient HMO,” says Nazemetz. For example, in one service area, an employee would pay $12 a month for the low-cost plan, but $101 a month for the indemnity plan.

“We want to identify those systems that are efficient and effective and–without sacrificing quality in any way–encourage our people through financial incentives to participate in those plans,” Nazemetz explains. The next step, says Nazemetz, is to refine the HealthLink system of six system managers. This year, the company will emphasize the importance of choosing a plan by its performance measurements and communicating to employees how each of the plans is doing. For example, Xerox plans to review track records for access, waiting times for appointments, referrals, immunizations, and screenings to ensure that the


HMOs are practicing preventive care. Nazemetz emphasized that Xerox plans to use its findings to help HMOs improve their performance rather than to penalize them.

Adopting managed competition does not have to be difficult. However, doing it right requires managing the competition and refining the system, consultants and employers agree. Says Sydlaske, of William M. Mercer, “The best HMOs offer good care at a savings that average 20% or more over indemity plans.” Yet many employers believe that HMOs simply add expense by skimming off the best risks. HMOs can contain costs better than any other type of managed care if employers’ health benefits are designed with incentives for plans to compete against each other, he adds.

Where to start

The key step in putting managed competition into place is pegging the employer’s contribution to the lowest cost plan, which is generally an HMO, he says. The employer example above (see “Family coverage contribution comparison”) lists prices for the indemnity plan and the lowest cost HMO the employer offers. Under its current strategy, the company pays 68% of the indemnity cost. Because the total cost of the HMO is lower, the company is paying for 94% of the HMO cost to the employee. But if the employer puts its 68% contribution to the lowest cost plan–the HMO–it would save $107.10 per month per employee ($382.50-$278.40). Of course, telling employees in HMOs that they’ll have to pay $129.60 a month instead of $22.50 may present a communications nightmare. But the employer could introduce the strategy by contributing a larger percentage initially, Sydlaske says.

Instituting managed competition also requires employers to adjust for risk selection factors when setting the contribution to employees’ health care costs. Healthier people tend to choose the lower cost HMOs. Employers must determine the degree of risk selection and adjust payments to account for it.

The most practical approach to accounting for risk selection, says Enthoven, is to review the age, sex, and retiree composition of employees in the HMOs and estimate the relative expected costs. Costs for different age and gender variables are readily available from actuarial tables, Enthoven says. If Plan A, for example, enrolled people who would be expected to cost 10% more and Plan B enrolled people who would be expected to cost less, then the employer should adjust its contributions so that the employees’ out-of-pocket premium reflects the relative efficiency of the plan, says Enthoven. In other words, the employee should not pay extra for a plan that has enrolled a “sicker” population.

“There are three reasons to compensate for risk selection,” he continues. “If the employer does not, there is an incentive for the health plan to make itself unattractive to poorer risks. Second, the plan that gets the good risks has an easier time raising price because its competitors that got the worse risks have higher costs. And third, the employees who choose the plans that got the worse risks have higher out-of-pocket costs because they are sicker, not because they chose a less efficient provider.”

Fine-tuning the strategy

Employers should sample their employees to determine whether a larger proportion of diabetics or people with chronic diseases, for example, are enrolled in a particular plan, Enthoven advises.

To prevent imbalances, he suggests that employers standardize the benefits offered by all the competing HMOs. Otherwise, an employer might find one HMO that offers an attractive benefit for people with chronic diseases will enroll a larger proportion of those people. Therefore, the premium would not accurately reflect the relative efficiency of the plan–the basis on which it should compete.

While Enthoven has been an outspoken champion of managed competition, he concedes, there are drawbacks. “It does require a certain amount of sophistication on the part of the employer,” says Enthoven. Managed competition requires that someone manage the competing HMOs, and some employers might not be willing to dedicate the resources to making it work, he says.

Another drawback, he continues, is the paucity of high quality, cost effective HMOs. “It’s important to be selective about doctors,” he says. In addition, one employer’s employees often can’t make a big enough dent in terms of an HMO’s market share to make the HMO change its pricing. An HMO that loses members from one employer because its premiums are too high can merely stop competing with the other HMOs offered by the employer and seek members elsewhere, rather than change its pricing and become more efficient. “An employer needs to find ways to get other employers in the community to follow,” Enthoven says. “There is a need for a certain amount of collective action.”

One big disadvantage of managed competition lies in resistance by employees. Enthoven, who chairs the Stanford benefits committee, says when the university announced last year that it would introduce price competition, “all hell broke loose.”

Late last year, Stanford announced that it would set its contribution level for purchasers of individual coverage at the lowest priced plan minus $25. “To some people, especially single employees, that seemed like a lot of money,” he says. Before this year, Stanford would pay the entire price of the lowest priced health plan for single employees, plus up to $48 a month that employees could use to buy more expensive single or dependent coverage. “The $48 was enough to pay for the extra cost of the high-cost single plan, but not enough to pay for dependent coverage.”

Some employees remain unhappy. “There’s no going back on it,” says Enthoven. However, he adds that employers should expect such problems and make an effort to communicate to employees that there’s a bigger reason for the change, other than saving employer money.

“We felt that everybody should have to contribute something. If the requirement isn’t there, the health plans see that and say there’s no market resistance if they raise the price,” Enthoven says.

Aside from those limitations, the AFL-CIO in Washington, sees another drawback.

Karen Ignagni, the labor organization’s health policy director, says, “From our standpoint, it’s positive to standardize benefits and provide consumer choice among a smaller field of intermediaries. But we want to know more about how the model plan is selected. The lowest cost is not necessarily the best proxy for efficient and high-quality care,” she adds.

COPYRIGHT 1992 A Thomson Healthcare Company

COPYRIGHT 2004 Gale Group