How Will Increased Competition Affect the Costs of Health Care?

In an effort to slow escalating health care costs, several legislative proposals that rely on competition among insurers and alternative delivery systems have been introduced into the Congress. One type of "competition" bill would offer vouchers to individuals enrolled in Medicare and Medicaid that they could use to purchase qualified private health plans.

Thrust of Major Competition Bills

The common denominator of the major competition bills, including those that provide for vouchers for individuals enrolled in Medicare and Medicaid, is that insurer-based competition--that is, among third-party insurers, alternative delivery systems, limited-provider groups, and health maintenance organizations (HMOs) --is the most viable, if not the only, form of competition in health care. Currently, the advocates of insured-based competition argue, the market for health services is flawed because of excessive insurance, which allows the patient to demand services when the real societal costs are greater than the benefits. In addition, the market for health services is imperfect even without the presence of insurance, since an asymmetry of information exists between the patient and physician, which may lead to overutilization.

A choice of health care plans is expected to result in a greater growth of the more cost-effective plans, presumably the HMOs. It has been suggested that costs might decline between 10 percent and 40 percent for those enrolled in HMOs. The competition bills have not contained any estimates of how the escalation in costs might be affected by increased HMO enrollment.

Quality, access, and availability of care are apparently not affected adversely in this competitive environment. It has not been suggested that costs will be curtailed under the competition bills; it is presumed, however, that utilization will be curtailed when expected benefits are zero.
Incentives for the formation of cost-conscious health insurance plans would stem, first, from a change in the tax laws requiring that employer contributions above a certain amount be taxable to the employee just as ordinary income is taxable. Second, the employer would be required to offer a multiple choice of plans and to contribute the same amount to each of the plans; if the chosen plan's premium was less than the employer contribution, the employee would receive a tax-free rebate for the difference.

The bills directed toward Medicare and Medicaid recipients differ, in general, from those directed toward employer groups insofar as the employer plays no role in the offering of plans; rather, competing health plans are offered directly to the individual. One variation of the bills directed toward Medicare beneficiaries would "prospectively reimburse HMOs enrolling Medicare beneficiaries at a rate equal to 95 percent of the amount spent by Medicare for the average beneficiary in the area (the average area per capita cost or AAPCC)."

Toward Economic Efficiency

My assumption is that the insurer-based competition bills are intended to create a more efficient market for health insurance as well as for health services, and thereby to reduce the escalation in health care costs. In this section, first, I briefly comment on the efficiency of the market for private health insurance by stressing the importance of information in choosing among plans. Second, in the health services market, I suggest that the most important advantage of increased competition among insurers, alternative delivery systems, and HMOs is the increased incentive to utilize information that can be gathered from the health services industry to contain costs. Third, I suggest that, as a result of information in the health services market, the increased incentives to exert leverage over providers would also be a product of the insurer-based competition bills.