Tackling rising health care costs.

• Author: Barth, Sanford M.

Exploding health care costs are exacerbating the budget difficulties of state and local governments. While there are no quick fixes, governments can pursue a number of strategies to address the systematic causes of health care inflation.

Editor's note: The Government Finance Officers Association takes no position on health care reform. This article is intended to be informational for readers and should not be construed as an endorsement of the author's views.

Personnel costs represent the single largest expenditure category for state and local governments. In 1993-94, for example, wages and salaries accounted for 32.7 percent of state and 51.8 percent of local government operating expenses. (1) Add in the costs of health care benefits--usually the second largest category of personnel costs--and you begin to comprehend just how much public agencies spend on their employees alone. Over the years, health benefits programs have grown exponentially in terms of both scope and cost. The inability of employers to check the growth of health care costs has become a serious problem, especially now that a sluggish economy is taking its toll on government revenues. This article explores some of the strategies governments can pursue to help curb this troubling trend.

Up, Up, and Away

The resurgence of double-digit annual increases in health care costs is threatening the affordability of health care benefits for both employers and employees. According to Hewitt Associates, a global outsourcing and consulting firm, increases in health care costs are averaging 15.4 percent for 2003 renewals, with no foreseeable end in sight. (2) Exhibit 1 illustrates the growth in benefit costs over the last decade. Actuarial projections suggest that costs will actually double by 2007 if nothing is done. That is triple the rate of inflation! As if this weren't enough, a recently released study documenting the causes and effects of health care inflation concluded that there are fundamental flaws in the health care delivery system for which there are no easy answers. (3)

Neither private nor public employers are safe from rising health care costs. No organization can long afford to absorb the cost increases benefit plan sponsors are now confronting. Yet employers can ill afford to shift some or all of the costs of increasing rates to employees. Not only does cost shifting not address the root causes of health care inflation, but it will be met by fierce resistance from beneficiaries.

The last time we experienced a health care cost "crisis" like this, the managed care movement came to the rescue. For a while, health care costs seemed to be under control. But managed care has not proven to be the panacea it was hoped to be. The reasons are many and not the focus of this article. Suffice it to say that the managed care era, as we knew it, is coming to a close. The only question now is, What will take its place?

The dynamics of health care costs are effectively captured in the following equation:

P (hc) = (C(u) x U) + A, where,

P (hc) = Price of health care benefits

C (u)= Cost per unit delivered

U = Number of units consumed

A = Administrative expenses

We have tried controlling administrative expenses via cost sharing and managed care tactics such as price negotiations and access controls, hoping this would leave only value-driven health care providers. No such luck. We have tried controlling the cost per unit delivered via discounts and capitation payment methods. Yet instead of increasing their efficiency, providers took the easier route of increasing the number of units consumed. We have tried controlling the number of units consumed via utilization and provider access controls. This worked to a degree, but we paid a heavy price in terms of employee and provider animosity. What we are left with is the notion that we must add a component to our benefit management strategies that addresses structural inefficiencies and holds...