In the beginning, health care financing was relatively uncomplicated. Individuals either paid for their health care in cash or they bartered for services — or they went without. It was a simple though not perfect system for simple times, and as far as historians can tell, it lasted from the beginning of man to the early 20th century, when medicine became sophisticated enough to affect clinical outcomes consistently.¹

During World War II, health care financing as we know it began to surface more rapidly when wage and price controls pushed employers into offering health insurance to attract workers.² In 1930, only 2 percent of the U.S. labor force (or 1.2 million workers and their 2 million dependents) had any health insurance. By 1958, 123 million Americans had hospital insurance, and 75 percent obtained it through their employers.³ By the 1960s, employer-based major health care coverage had become commonplace, and in 1965 Medicare was born.

Over the next two decades, health care costs rose substantially, the increase blamed in part on a fee-for-service system that offered little incentive to manage costs and every incentive to overutilize. Looking for new solutions, the health care system began to embrace managed care and the HMO, a term first coined in 1970.

Since that time, managed care has proliferated, and while it has shown some success at stabilizing costs, it has had at least as many failures as successes. As patients and physicians have expressed their dissatisfaction, managed care has had to take a less managed approach. Meanwhile, costs continue to grow, with health care now exceeding 14 percent of the gross national product and growing.⁴

So where does this leave the health care financing system at the start of the 21st century? While many might argue that the United States should move toward a government-financed system or perhaps some improved version of the status quo, another theory is gaining momentum: a consumer-driven health care marketplace.

Forces at work

At some point during the past five years, many physicians may have noticed that their patients became “consumers.” In some ways the change is simply semantic, but it also represents a shift in the larger economy. In other industries, consumers rule. Businesses compete for their dollars by offering better quality, service, price, etc. But in health care, consumers have little or no control over their health care dollars and little or no choice among benefits and providers. In turn, doctors who provide excellent care and service are generally reimbursed at the same rate as all others, making for a health care economy with all the wrong incentives. (See the previous articles in this series, listed below, as well as “The Emergence of Consumer-Driven Health Care,”FPM, January 2000, page 46.)

Baby Boomers and Generation Xers are the most likely players to help usher in a new health care financing system. “They are not tolerant of paternalistic systems and will demand more involvement and decision making,” says Charles M. Kilo, MD, a fellow of the Institute for Healthcare Improvement and president of Greenfield Health System, Portland, Ore. “We have only seen glimpses of this so far because most of them are healthy, but they are aging, and as they do, look out health care. These folks have money, they are more connected, they are great shoppers, and they will change the system whether it wants to change or not.”

The flame of consumerism is also being fanned by the Internet, which has enabled individuals to access more and more personalized information faster than ever before. Consumers can do their banking, shopping and investing online 24 hours a day and will begin to expect the same level of information and service from health care.

“This is a movement that transcends health care,” says Dave Sanders, MD, a family physician and CEO and president of MyHealthBank, an “e-health plan” based in Portland, Ore. “We’re in a very advanced consumer society today, where individuals are in control of things they weren’t previously in control of. Health care is just part of that overall trend toward consumerism. So whether it’s one tactic or the other, the consumer is moving toward the center of the health care economy.”

Consumer-driven health care is getting its push not only from technology but also from those who are looking for new ways to control costs and who believe individuals are better stewards of their own health care dollars. (See “Can patients handle this new responsibility?”) This approach differs greatly from the current system, in which patients have no incentives and no opportunities to be prudent purchasers.

“Patients have been totally removed from the cost of care,” says Lee Newcomer, MD, executive vice president and chief medical officer of Vivius, an e-health plan based in Minneapolis, and former senior vice president of health policy for UnitedHealth Group. “As a result, we’re now in a mentality where we think if we put $10 and an insurance card down, we should have anything we want, regardless of whether it makes sense, and that’s causing a problem.”

Defined contribution plans

Ironically, what may ultimately bring about a consumer-centric health care financing system won’t be consumers themselves. Instead, employers looking to reduce the administrative costs and headaches associated with managing health care benefits may decide to hand over the responsibility to individuals to manage themselves. One way to do that is with a “defined contribution” approach.

Under a defined contribution model, employers would commit to a fixed dollar amount employees could use to pay for health care coverage they select, rather than the current practice of committing to a fixed health benefits package with pre-selected networks for all employees. A similar shift occurred in the 1980s on the retirement benefits front when employers began moving away from “defined benefit” (or pension) plans toward “defined contribution” (or savings) plans.

“Most health plans today are more like defined benefit plans, so it’s kind of an open-ended commitment and obligation for employers, and they would like to be able to change that,” explains Ray Werntz, president of the Consumer Health Education Council. “A defined benefit approach also puts employers in the position of trying to decide which benefits to provide populations of employees based on medical necessity. Now that doesn’t necessarily mean they’re going to pay less or leave their employees hanging out to dry. They just want to have some control over their costs and distance themselves from concerns about liability.”

A defined contribution plan could take several forms. On the more conservative side, employees would simply use the defined contribution to choose among several health plans pre-selected by their employer. Or, on the more radical side, employees could take their defined contribution and head to the open market to purchase their own health insurance or care directly from providers. “While there are some vendors of defined contribution plan services in the market, I don’t know of any employer who does that yet,” says Werntz. While there may be a defined contribution mind-set developing, there is “not yet a willingness on the part of employers to pull away,” he says.

Until a mature defined contribution model can emerge, says Werntz, several issues must be resolved. For example, “How do you decide how much money to give everyone?” questions Werntz. “Do you give someone who’s young less money than someone who’s old?” He also raises caution regarding how employers put the defined contribution money into the hands of the individual. For example, if employers were to give individuals their health care dollars directly, it would raise tax issues as well as concerns that some individuals will not use the money to purchase health insurance at all. The best approach, many argue, is to give employees health care vouchers or to deposit the money earmarked for health care directly into employees’ medical savings accounts, which the employees would then be responsible for managing.

Another consideration is how defined contribution plans will affect the uninsured. Some argue that defined contribution plans would exacerbate the problem by making coverage more expensive for the elderly and those with chronic illnesses. Others say it could reduce the number of working uninsured if employers’ contributions can provide at least basic coverage without the employee contributing out of pocket. Additionally, if defined contribution plans create tax advantages that would encourage individuals without employer coverage to participate in similar programs (such as medical savings accounts), the number of uninsured could decrease.

What’s clear, however, is that defined contribution health plans are piquing the interests of employers nationwide. In a survey of employers identified by Fortune magazine as some the country’s best companies to work for, the firm of Booz Allen & Hamilton found that “all but a few of the largest, most paternalistic respondents” anticipate a shift to defined contribution plans.⁵ “Over the next 10 years, employer-sponsored health plans will evolve en masse into defined-contribution formats, finally and irrevocably creating a consumer-driven health care system in the United States,” says Gary D. Ahlquist, a senior vice president and managing partner of the firm’s Health and Insurance group.

Ahlquist and his colleagues describe defined contribution health plans not as a trend but a breaking wave that will emerge rapidly as costs become more of an issue for employers. “Exactly when these forces will meet and propel us forward is impossible to say, but it’s a risky gamble to bet that it is more than three to five years away,” he says.

An emerging alternative

With so many dynamic forces swirling in the market (including consumerism, the Internet, defined contribution plans and continued efforts to control costs), a number of alternative health care financing companies have begun to emerge. Although their tactics vary, what they share is a reliance on the Internet and a belief that individuals should control their health care dollars. Among the many start-ups are Definity, HealthSync.com, Healthmarket.com, MyHealthBank.com, Sageo.com and Vivius.com.

One of the most progressive of these companies is Minneapolis-based Vivius, which is creating a direct contracting arrangement between physicians and patients. The model is currently being pilot tested in Kansas City, Mo., and Minneapolis, with plans to enter more cities in 2001. “Think of us like a supermarket,” explains Newcomer. “We have 22 aisles in our supermarket, and we’re going to ask you, the patient, to go in there and make a choice from each and every aisle. When you get done you’re going to have your own health plan tailored to you and you only.”

In the Vivius model, each “aisle” represents either a specialty or a facility (e.g., primary care, orthopedics, cardiology, hospitals, pharmacy). Patients can either pick from the shelves themselves or can begin with one doctor they trust and build on that doctor’s recommendations. Providers are allowed to set their monthly fees, and upon checkout the consumer knows exactly how much he or she will have to pay each month to receive care from the 22 selected providers. Any additional services that are needed are covered by a traditional indemnity plan, a required purchase.

MyHealthBank, based in Portland, Ore., officially launched its defined contribution approach in October 2000 when it contracted with two Eugene, Ore., employers, representing more than 300 employees and dependents. Like other models, it funds coverage with an employer contribution to the employee’s health care account. From there, an employee elects a level of coverage best suited to his or her tolerance for risk and desired benefit options. For example, a woman in her 50s might choose “gold” level coverage, spending all of her employer’s contribution plus some of her own money, while a young male might opt for “bronze” level coverage, leaving money in his account to pay for health care services not covered by his insurance.

What makes this model so attractive, says Sanders, is that it lets the individual “use the insurance for things that are best covered by insurance — procedures, hospital coverage, and those sorts of needs — and it lets the individual use cash to buy primary, routine, discretionary care directly from providers and suppliers. It’s a very simple approach, very feasible and very attractive to employers.”

MyHealthBank considers its approach a safe but important first step. “Unless you get the dollars, we believe, in the hands of the consumer, there is no other reasonable control vehicle available today,” says Sanders. He believes that ultimately a marketplace will evolve in which providers and consumers interact in a direct one-to-one economic relationship.

How will it all shake out?

Clearly the market is searching for new solutions. Many of the emerging e-health plans have secured partners such as Merrill Lynch, Chase Capital Partners, Hewitt Associates, PricewaterhouseCoopers and even the Mayo Clinic. If their hunches are right, we may now be witnessing the emergence of the next wave of health care financing.

“Traditional HMOs aren’t going to go away. I think it would be naive to say that they will. But it’s a real big market out there,” says Newcomer. “There are hundreds of millions of people who need insurance, and a certain segment of them are getting tired of HMOs and will probably leave. That’s where you’re going to see these new companies taking hold. If one of them really becomes popular, they may in fact some day replace HMOs, but that isn’t going to happen in the next three to five years.”

The financing paradigm does seem to be shifting, however, bringing new challenges but also opportunities to physicians and patients alike. “My sense is that physicians are going through a period of great change. Probably a year and a half ago, a lot of them were quite burnt out and had gone through the collapse of local IPAs, big major physician practice management companies had collapsed, and so on,” says Sanders. “But I think we’re seeing right now a great resurgence of energy and excitement on the part of physicians to look toward the future.”

Although the financing system of the future remains unknown, there are reasons to be optimistic. “In the long run, what we really want are doctors and patients working together to solve problems. All of us want that,” says Werntz. “I think a lot of the hostility patients have toward managed care is this feeling that they’ve lost control. If we can find a way to couple a more open, patient-driven approach with real patient-physician partnering, I think we’ll solve a lot of the problems we’re trying to solve. And I think everyone will be happier with that kind of a system.”