Achieving Value in Healthcare

March 1, 2005
Michael E. Chernew, PhD
Michael E. Chernew, PhD

Volume 11, Issue 3

In the United States, almost half of healthcare spendingis paid for by public funds, mostly by theMedicare, Medicaid, and State Children's HealthInsurance programs. Since the 1960s, these programshave become a crucial component of the social safetynet and an increasing burden on state and federal budgets.Medicare spending is already approaching 2% of USGross Domestic Product (GDP), which is more than 10%of federal outlays. By the end of 2080, Medicare spendingis projected to rise, under current law, to almost 14%of GDP. Increased Medicaid spending has provoked evenmore immediate financing concerns, as increased spendinggrowth contributes to state budgetary woes.


There are no easy solutions to the challenges posedby rising public healthcare spending. Advances in medicaltechnology and the aging of the population will continueto put financial pressure on Medicare andMedicaid. Appropriate policy will balance program costswith the benefits gained. This balancing act is complexbecause the individuals paying (taxpayers) are generallynot the direct beneficiaries of the care. Ideally, we wouldlike to create a system that promotes value for each dollarspent. To this end, the articles in this issue of thepresent research that informs managers ofinterventions to improve the value of care and informspolicy makers of issues that may lead to more effectivebenefit design for public programs.

In most economic sectors, we trust the market toyield economically efficient outcomes (ie, ensure value).Consumers are assumed to make purchasing decisionsthat reflect the benefits of consumption, relative to costs,and competition among producers is relied on to holdprices to appropriate levels. Yet we've known at leastsince Arrow's seminal 1963 study that healthcare marketsare different.1 Information problems and the prevalenceof insurance weaken, if not sever, the connectionbetween consumers'valuation of medical services andthe provision of care. These issues, as well other institutionaldetails such as consolidated provider networks insome markets, also dampen the extent to which competitionconstrains prices.

Healthcare policy has largely attempted to mitigatethese problems while still fundamentally relying on asystem of markets (for medical services and insurance)to allocate resources. Even our public system has movedto incorporate market features. Yet considerable disagreementexists regarding how best to make healthcaremarkets work. One school of thought emphasizes competingplans. The Medicare Modernization Act hasrevamped and renamed the Medicare+Choice program(now Medicare Advantage) and touts new choices forconsumers. Similarly, the new Medicare prescriptiondrug benefit relies on competition among Part D plans toconstrain costs. These systems require consumers to beinformed about health plans (or prescription drug plans)and make their plan choice prior to making their specificdecisions regarding care. In these models, the planshave at least some influence regarding the care deliveryprocess, and enrollees are at least to some extent lockedinto the systems they have chosen. Once the plan choiceis made, consumers are constrained in their behavior.

Another model of competition relies on greater consumercost-sharing at the point of service delivery withfewer nonfinancial constraints on their behavior. Thismodel relies on products such as consumer-driven plansand health savings accounts. In some cases these productsrely on organized systems (eg, preferred providerorganizations), to bargain with providers for low prices,but the systems have a considerably reduced role relativeto traditional models of managed care plans. Mostimportant decisions are made by patients, with whateveradvice they receive from their provider. In theory,such a model could lead to more efficient outcomesbecause consumers are not constrained by plans at thetime they consume care, and they can weigh the costsand benefits of different treatment options or healthcareproviders themselves without distortions that plans maygenerate. This model more closely resembles the functioningof markets in other economic sectors.

Although we cannot be sure exactly which benefitpackages consumers will favor, a successful healthcaresystem will promote care in cases when it yields sufficientvalue to justify the expense and limit care in caseswhen the costs outweigh the benefits. Systems that relyon consumers to make choices assume that patients canappropriately weigh costs and benefits of different careoptions and different providers if faced with the full priceof care. Existing evidence gives us cause to doubt suchclaims. When faced with cost-sharing, patients cut backequally on care deemed appropriate and on care deemedinappropriate.2-4 They are less likely to take critical preventivemedications.5 Essentially, when left on theirown, healthcare consumers do not ration well, at least inthe opinion of outside observers. Can these consumersbe informed? Will they make better decisions? The evidenceis not yet in.

It may be that cost-sharing provisions can be designedin a more efficient manner such as that advocated inBenefit-Based Copay (BBC) designs.6 In BBC models,copays are kept low for patients who would receive themost benefit from the intervention. Increases in copaymentsfor drugs are common in today's marketplace andthey typically exemplify the distinction between standardmodels of increased copays and value-based models.If copays are raised for all drugs for all patients, somewill undoubtedly opt not to adhere to clinically appropriateprescription regimens, the benefit of which wouldbe deemed by many to justify the cost. A better valuecreation strategy would shield subsets of patients fromhigher copays.


At the same time as these new high deductible planshave been evolving, organized systems of care thatactively intervene to promote delivery of beneficial carehave become much better at targeting care, which inturn contributes to value. Disease management companiestypically stratify consumers based on risk. Interventionssuch as that outlined by Stankaitis et al in thisissue of the involve stratification and managementof a subset of high-risk patients.7 This report illustratesthe potential that intensive use of informationtechnology and intervention can have on improvingcare and generating value. Information systems implementedat a systems level, such as that explored byRask et al, attempt to identify situations in which systemlevel interventions can prevent harm (adverse drugreactions) and create value.8 Coverage policy, discussedby Foote et al, although a blunt tool, can alsohelp target care.9

Organized systems of care can also offer advantagesin terms of price negotiations. If left on their own, healthcareconsumers would likely face much higher pricesthan those received by large care systems. Even manyconsumer-driven plans, in which patients face the cost ofcare at the time of service, rely on systems to negotiateprices. Given the importance of the institutional detailssurrounding payment systems, research that investigatesthe ramifications of different payment systems, such asthat by Danzon and Wilensky, is crucial.10

Ultimately, we will likely end up with a combinationof the high-deductible plans and more traditional managedcare plans. The ideal situation may be one inwhich consumers can choose the approach they prefer,although the institutional details governing choice ofplan types and the spillovers between plan types will beimportant. For example, if consumers can choosebetween different types of plans (or even different plansof similar types), we must worry about adverse selection.If we move away from pooling, some individualswill benefit and others will lose. More generally, becausepatients with different benefit designs or covered by differentmanaged care organizations will be seeking carefrom a similar set of providers, we must also understandbetter how different systems of care affect each other.For example, as Avery et al note in this issue, whenphysicians serve patients from different systems, theactions of one system may affect care delivered toenrollees of another system.11 This may be good or bad,but understanding the extent of spillovers is important.

One strength of competition is the immense creativitythat it allows regarding plan design and product creation.New types of firms, such as disease management companies,will emerge when the need and profit opportunitiesarise. Similarly, new products will be developed that experimentwith how the basic building blocks of the system arecombined. They will determine how risk is apportionedacross individuals and firms, how prices are negotiated,and how care is managed. They will establish how muchautonomy patients and physicians will have and when individualsmust commit to different care networks.

Because new systems of care are likely to have a crucialrole in the future of our healthcare system, we musthave a better understanding of what information consumersneed to make their choices. The Agency forHealthcare Research and Quality has been a leader infunding development of plan performance measures,funding work to examine methods of disseminatinginformation, and funding evaluations of responses toinformation. Support for research is crucial if we are tounderstand how to inform consumers, improve thefunctioning of markets, and promote value.


Given the march of medical progress and an agingpopulation, these issues are only going to become moresalient over time. The clinical, economic, and distributionalconsequences of different choices could be staggering.Hopefully research such as that presented in thisand other issues of the can contribute to betterdecision making at all levels of the healthcare system.

From the School of Public Health, University of Michigan, Ann Arbor, Mich.

Address correspondence to: Michael E. Chernew, PhD, Health Management andPolicy, University of Michigan, 109 South Observatory, Room M3118, Ann Arbor, MI48109-2029. E-mail:

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