Assessment of the effectiveness of supply-side cost-containment measures - Cost-Containment Issues, Methods, and Experiences

Health Care Financing Review, Annual, 1991 by Louis P. Garrison, Jr.

Introduction

As the share of our gross national product (GNP) that is devoted to health care continues to climb, policymakers and consumers alike increasingly question the desirability of this increase. Economists are quick to point out, as a theoretical matter, that the increase in the health share of GNP is not necessarily a bad thing. From the perspective of maximizing consumer welfare, consumers may choose to use more care over time if there are changes in their incomes, preferences, or the prices they face. Price changes can be the result of various changes on the supply side, such as technological change, changes in input prices, or changes in the number of suppliers.

The real problem with the rising share of GNP that is spent on health care is that the benefits of this additional spending do not seem to be commensurate with the costs. Several pieces of evidence support this widely held view. International comparisons across developed nations indicate that the United States is far above the curve that relates the level of real health spending to real income (Schieber and Poullier, 1989). Furthermore, there is little evidence to support the view that his additional spending results in significantly better health outcomes on average (particularly in terms of mortality rates). The evidence of substantial amounts of "inappropriate" or "unnecessary" care also contributes to public misgivings about the benefits of the increasing costs.

The continuing rise in health spending in the United States is, of course, not a new problem. For the past 20 years, we have been inventing and applying various kinds of public and private mechanisms and schemes in an effort to better control these costs. The purpose of this article is to summarize the arguments and evidence regarding selected "supply-side" measures and to assess their likely effectiveness in controlling health care costs.

Definitions and framework

The term "cost containment" itself carries a connotation of an objective that is broad and not very precise. It should be obvious that the objective of containing or controlling costs is not to reduce health care costs without regard to benefits nor simply to be able to predict costs more accurately. Rather, the objective is to achieve the appropriate balance or, at least, a more appropriate balance between the additional costs incurred and the benefits received.

Analysts often cite several characteristics of medical care markets (including informational asymmetry, product complexity, and equity concerns) that cause them to differ from other markets. A good case can be made that the central difference, especially with respect to cost control, is the problem of moral hazard. Once an individual has insurance, the marginal cost of additional services is usually less to the individual than it is to society. The individual consumer who usually has a physician as an advisor will have the incentive to use care to a point where the value of the marginal benefit of an additional service to the individual is less than its cost to society.

Other characteristics of the medical marketplace may also result in other cost-related distortions. Costs may be high or rising because of inefficiency in production, excessive profits paid to providers, or wasteful competition. Some cost-containment strategies also attempt to address these problems.

In thinking about the moral-hazard issue versus other possible motivations for cost containment, it is important to keep in mind distinctions among various types of efficiency - technical, cost, and economic. "Technical efficiency" refers to obtaining the maximum physical output from the physical inputs used. "Cost efficiency" refers to minimizing costs for a given set of input prices and a given output level. "Economic efficiency" assumes that technical and cost efficiency prevail and that markets work to provide the proper levels of outputs and appropriate market prices. Moral hazard is mainly an issue with respect to economic efficiency.

Pauly (1990) has argued persuasively that the central issue for rising costs in the United States is not increases in technical or cost inefficiency or increases in provider profits; rather, it is increases in the intensity of care. Hence, cost-containment strategies that attack cost inefficiencies are likely to achieve, at best, only a one-time savings unless they also address the fundamental forces that increase intensity of care.

Various types of cost-containment devices target different sources of the problem. Deductibles and copayments are the most common demand-side devices used to counter the incentive for overuse because of moral hazard. Prospective price setting for packages of services, such as diagnosis-related groups (DRGs), is a supply-side attempt to encourage providers to produce treatments at less cost per treatment. Health maintenance organizations (HMOs) - i.e., prepaid group practices - force consumers to limit beforehand the package of services to which they have access and encourage suppliers to choose the appropriate package of services to provide. Regulations on the number of suppliers (e.g., hospitals or nursing homes) attempt to reduce the cost of unused capacity or to limit wasteful competition on amenities and the like.