Four Ways to Improve the Efficiency of U.S. Healthcare Markets
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Healthcare Policy Dec 1, 2017

Four Ways to Improve the Efficiency of U.S. Healthcare Markets

An economist discusses how to ensure the right mix of access, affordability, and quality.

a doctor examines a patient

Yevgenia Nayberg

Based on insights from

Amanda Starc

It is no secret that Americans spend an enormous amount of money, compared to the rest of the world, on healthcare. But what is less clear is whether that spending translates into better care.

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One way to measure that is to look at how efficient the healthcare industry is, meaning that the benefits of healthcare spending exceed its costs, providers and insurers have incentives to participate, there is healthy competition, and consumers are able to make informed decisions about care and coverage.

Current U.S. healthcare markets “present every market failure you’ve ever thought of, plus a few you haven’t thought of yet,” says Amanda Starc, an associate professor of strategy at the Kellogg School.

So how can we ensure that right mix of access, affordability, and quality? The good news is that a growing body of research by Starc and others points to multiple practical routes for achieving this goal.

Starc offers four “rules” for improving an industry whose efficiency we all rely on to feel healthy and protected.

Rule 1: Ensure the Right Kind of Market Competition

You do not have to be a healthcare economist to know that competition—whether it is among insurers or healthcare providers—is a good way to ensure higher-quality, lower-cost care for consumers. Federal and state governments’ heavy involvement in healthcare through programs such as Medicare and Medicaid, as well as legislation such as the Affordable Care Act, means policymakers are uniquely positioned to help ensure that marketplace competition.

One question is just what role the government should play.There are some places where reducing the government’s role could promote competition. Consider how drug expenses are handled by insurers. Currently, Medicaid covers almost 20 percent of drug costs in the U.S., leaving state governments to provide drug coverage to beneficiaries. But a new working paper by Starc and her Kellogg colleagues David Dranove and Christopher Ody suggests that shifting this coverage to private Managed Care Organizations (MCOs) would cut drug spending by more than 22 percent without reducing the number or efficacy of the drugs offered to consumers. The cost savings would come largely from the MCOs’ ability to negotiate for lower drug prices and steer consumers toward less expensive drugs and pharmacies.

But encouraging greater competition is not as straightforward as just removing the government altogether—and sometimes policies that would seem likely to promote competition fall flat.

For example, Starc previously investigated the impact of a 2001 decision to increase a subset of Medicare Advantage reimbursements to private insurers. She found that although the increase was successful in attracting more providers, it provided a lackluster benefit to consumers. Only about one-fifth of the additional reimbursement was passed through in the form of lower premiums, co-pays, or deductibles. The remaining 80 percent went to insurers’ profits and advertising.

“That isn’t going to improve outcomes for consumers,” Starc says. “As in many other markets, the government needs to ensure robust competition.”

Rule 2: Provide Better Information to Consumers

To ensure market competition, policymakers can provide consumers with critical healthcare information, especially about coverage options. They can also help consumers navigate that information effectively.

Take the case of the ACA healthcare exchanges, through which millions of people have chosen coverage plans. These have become a flashpoint for the Trump administration’s efforts to dismantle the ACA, including recently announced limits to exchange-related outreach and enrollment periods.

“How you provide information to consumers is really important in determining what [plan] they’ll ultimately pick.”

In this context, design decisions about the exchange websites—from the density of the information presented to how people are able to navigate the site—can have a profound effect on what plans are chosen. Starc says such websites should be focused on helping people pick the best plans for their needs, an objective that will ultimately deliver better market outcomes.

“How you provide information to consumers is really important in determining what they’ll ultimately pick,” Starc says. Her studies on pre-ACA exchanges show that about 20 percent of enrollees just choose the cheapest plan possible—even if it may not provide ideal coverage for them. This reality makes features like a standardized presentation of insurance products, as well as tools that allow for easier comparisons, critical to providing choice without overloading insurance shoppers.

Rule 3: Give Insurers the Incentive to Design Better Plans

Of course, the best-designed website in the world is not going to increase efficiency unless consumers actually have good options to choose from. So it is important for insurers to design plans that yield better health outcomes.

For example, Starc’s research shows that Medicare Part D plans that cover drug and medical expenditures tend to be designed to keep consumers out of the hospital, as compared to Part D plans that only cover drugs—an inefficiency of about $520 million, by her calculation.

“Part D insurers that choose to cover both types of costs [drug and medical] spend a lot more time doing things like making sure you’re taking your asthma drugs and your blood pressure medication,” Starc says. “Because if you show up in the hospital, that’s their money.” Charging consumers lower copays for preventative medications—which effectively means sending consumers the right price signals—is one way for insurers to encourage healthier behavior.

“There have to be incentives for insurers to treat their beneficiaries holistically,” Starc says.

Rule 4: Mind the Winners and Losers

“You also have to think about the fact that healthcare regulation is going to create winners and losers,” Starc says. “Thinking about those trade-offs in a smart way is really important.”

One of the central tentants of the current ACA exchanges is that premiums for older consumers are capped as a way of distributing costs across the population. Capping older people’s premiums at two to three times that of younger policyholders lowers prices for older consumers but raises prices for younger, generally healthier ones.

In the presence of an effective individual mandate, Starc’s research shows that this regulation is effective. It curbs insurers’ ability to charge older consumers as much as they possibly can (knowing they are likely to pay), and reduces overall insurer profits. However, it also limits insurers’ ability to cut costs for younger consumers, who tend to be more price-sensitive.

In the absence of an individual mandate, her research suggests the possibility of “dramatic premium increases,” as younger consumers flee the market altogether.

Starc suggests increasing federal insurance subsidies for younger consumers as a way to make them more “whole.”

“Ultimately,” Starc says, “there are ways to get markets to deliver healthcare efficiently, as long as they’re regulated carefully. At the moment, that regulation remains a work in progress.”

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Associate Professor of Strategy

About the Writer
Sachin Waikar is a freelance writer based in Evanston, Illinois.
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