2006-PB-20 December 2006 Consumer Directed Health Care John Goodman Abstract: Consumer driven health care (CDHC) is a potential solution to two perplexing problems: (1) How to choose between health care and other uses of money, and (2) how to allocate resources in an industry where normal market forces have been systemically suppressed. In the consumer-driven model, consumers occupy the primary decision-making role regarding the health care that they receive. From an employee benefits perspective, consumer driven health care in the broadest sense may refer to limited employer contribution or dual option plans featuring high deductible health coverage with tax advantaged savings vehicles such as Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs) and Health Reimbursement Arrangements (HRAs) (Daly, 2005). However, before we consider the solution, we must first investigate why a solution is needed in the first place. About the Author: John C. Goodman, Ph.D. founded the National Center for Policy Analysis in 1983 and has served as President since the center's inception. Dr. Goodman is the author of nine books, including Lives at Risk: Single-Payer National Health Insurance Around the World; Leaving Women Behind: Modern Families, Outdated Laws; Economics of Public Policy, a widely used college textbook, and Patient Power: Solving America's Health Care Crisis. He has authored numerous editorials in The Wall Street Journal, USA Today, Investor's Business Daily, Los Angeles Times, The Dallas Morning News, Houston Chronicle, The San Diego Union-Tribune, and many others. He regularly briefs members of Congress on economic policy issues and frequently testifies before congressional committees.
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Consumer Directed Health Care John Goodman
Consumer driven health care (CDHC) is a potential solution to two perplexing problems:
(1) How to choose between health care and other uses of money, and (2) how to allocate
resources in an industry where normal market forces have been systemically suppressed. In the
consumer-driven model, consumers occupy the primary decision-making role regarding the
health care that they receive. From an employee benefits perspective, consumer driven health
care in the broadest sense may refer to limited employer contribution or dual option plans
featuring high deductible health coverage with tax advantaged savings vehicles such as Health
Savings Accounts (HSAs), Flexible Spending Accounts (FSAs) and Health Reimbursement
Arrangements (HRAs) (Daly, 2005). However, before we consider the solution, we must first
investigate why a solution is needed in the first place.
The Need to Ration Health Care
Busy people are often unaware of how easy it is to spend other people’s money on health
care. Here are a few examples. The Cooper Clinic in Dallas offers an extensive checkup (with a
full body scan) for about $2,000 or more. Similar clinics have sprouted in other large cities. If
everyone in America took advantage of this opportunity every year, we would increase our
nation’s annual health care bill by almost one-third. More than 1,000 diagnostic tests can be
done on blood alone; one doesn’t need too much imagination to justify, say, $7,000 worth of
tests each year. But if everyone did so, we would double the nation’s health care bill.
Americans purchase nonprescription drugs almost 12 billion times a year and almost all of these
are acts of self-medication. Yet if everyone sought professional advice before making such
purchases, we would need 25 times the number of primary care physicians we currently have
(Rottenberg, 1990). Some 1,100 tests can be done on our genes to determine if we have a
predisposition toward one disease or another. At, a conservative estimate of, say, $1,000 a test, it
would cost more than $1 million for a patient to run the full gamut. But if every American did
so, the total cost would run to about 24 times the nation’s annual output of goods and services.
Notice that, in hypothetically spending all of this money, we have not yet cured a single
disease or treated an actual illness. We are simply collecting information. If in the process of
search we actually found something that warranted treatment, we could spend even more.
One of the cardinal beliefs of advocates of single payer health insurance (and one that is
shared by the advocates of the HMO form of health care delivery) is that health care should be
free at the point of consumption, regardless of willingness or ability to pay. But if health care
really were free, people would have an incentive to obtain each and every service so long as it
had any value at all to them. In other words, everybody would have at least an economic
incentive to get the Cooper Clinic annual checkup, order dozens of blood tests, check out all their
genes and consult physicians at the drop of a hat.
In short order, unconstrained patients would attempt to spend the entire gross domestic
product (GDP) on health care even though, as a practical matter, that would be impossible. One
could argue that the current system of third-party payment automatically discourages many of
these expenditures by failing to cover them. But if we continue with the current payment system
indefinitely, we are still on an unsustainable path.
Government at all levels in the United States currently spends about 7.2 percent of GDP
on health care, mainly on Medicare and Medicaid. This is an amount comparable to government
health care spending in other countries. Yet Larry Kotlikoff and his colleagues have shown that,
if benefits expand at the rate of the past 30 years and if the population ages the way
demographers predict, spending will equal one-third of national income by mid-century, when
today’s college students reach the retirement age (Hagist and Kotlikoff, 2006). If that is not
immediately alarming, note that one-third of mid-century GDP is about equal to all government
spending for all purposes today. If private spending on health care keeps up with public
spending, the nation will devote about two-thirds of national income to health care by mid-
century — an amount roughly equal to total consumption of all goods and services today.
So in the public sphere, health care is on a course to crowd out every other government
program — from education and roads and bridges to Social Security and national defense. And
for the economy as a whole, health care is on a course to crowd out every other form of
consumption, including food, clothing, housing, etc.
We need not endure an inordinate wait in order to see what the future has in store for us.
Currently, well over half the consumption of people age 85 years of age and older is on health
care.1 By 2025, the same will be true of the entire senior population (everyone age 65 and over)
(Fuchs, 2001). To say that the government path we are on is unsustainable is trivial. To ask how
we are going to get off that path is a serious question which urgently needs to be answered.
At the federal level, the Social Security trustees’ reports implicitly show how health care
will crowd out all other government spending. Only two years ago, Social Security and
1 In 1997, the elderly spent slightly more than one-third of their “full income” on health care. Seniors older than 84 spent about three time more per capita on health care than seniors between the ages of 65 and 74. See Fuchs (1999, 2001)
Medicare combined took in more revenue than was spent, thus contributing a small surplus to the
general budget. But this year, we will need 7 percent of general income tax revenues to cover
the shortfall in these programs. By 2020, we will need one in four income tax dollars to pay for
the deficit in Social Security and Medicare, implying that the government will have to stop doing
one out of every four things it does today. By 2030, we will need one of every two income tax
dollars (and these estimates do not even include the cost of Medicaid!) (OASDI Trustees, 2005).
In order to avoid this disastrous scenario, someone must be forced to choose between health care
and other uses of money. The question is: who will that someone be?
Patients as Choosers. Critics of CDHC are fond of pointing out that there are times
when patient choice is not desirable or appropriate. They are, of course, correct. We don’t want
a parent to choose not to have her child vaccinated, or an at-risk expectant mother to avoid
prenatal care, or a heart patient to eschew aspirin or beta blockers. The reason: there is
overwhelming evidence that the social benefits of the care exceed the social cost (Tengs et al.,
1995 and Eddy, 1991). Yet instances where we can be absolutely sure that we know which
alternative is the right choice are rarer than one might suppose. At the other extreme, there are
literally thousands of cases where only the patient can make the right choice.
Take patients with arthritic pain. Vioxx and Bextra (before they were taken from the
market) and Celebrex cost about $800 more over the course of a year than such over-the-counter
remedies as ibuprofen (Herrick, 2004, Table 3). Let us concede that, for some patients, the brand
name drug is superior. Are the extra benefits of a brand drug worth $800 a year in addition to
the risks of side effects? Patients must weigh this individually.
Drugs affect different people differently. Moreover, different people have different
attitudes toward risk. So it is virtually impossible for one person to make such a choice for
another. When people are spending their own money, presumably they will reveal their
preferences through their actions. But most of the patients who were taking Vioxx (and should
not have been) were not spending their own money. Third-party payers were paying the bill.
And most of those insurance plans probably did not cover the cost of ibuprofen.
Another example is the prescription drug Clarinex, used by allergy sufferers. Some
scientists claim that the over-the-counter drug Claritin is chemically the same (Schieber, 2004).
Yet a year’s supply of the former costs about $949, compared to only $280 for the latter and less
than $15 for an OTC generic equivalent.2 As in the case of arthritic pain relief, many insurers
will cover the cost of a brand name drug but not the OTC alternatives – inducing patients to opt
for the drug with the highest social cost.
The problem with the current system is that all too often patients have no opportunity to
make such choices. The reason: most of the time they are buying health care with someone
else’s money. Ironically, most of the people who were taking Vioxx should not have been taking
it; and the best predictor of whether a patient was taking it was whether a third-party was paying
the bill.3 This example is far from unique. For the health care system as a whole, patients pay
only 15 cents out of pocket every time they spend a dollar, on the average. So the economic
incentive is to spend on health care until its value to the patient is only 15 cents on the dollar.
It’s hard to imagine a more wasteful incentive structure.
Empirical Results. How do patients react when they are asked to manage their own
health care dollars? We actually have far more experience with consumer directed health care
2 Prices for Clarinex and Claratin are for 30 doses from Walgreens.com. The price for the generic version of Claritin (Loratadine) is for Costco.com. All prices surveyed October 7, 2005. 3 A recent study found that two-thirds of patients on Cox-2 inhibitors were not at risk for gastrointestinal conditions like ulcers or bleeding, and most of them had not tried cheaper alternatives. See Cox et Al. (2003) A separate study found that seniors with generous drug coverage but moderate risk of gastrointestinal problems were more likely to be on a COX-2 inhibitor than seniors with high gastrointestinal risk but no drug coverage. See Doshi, Brandt and Stuart (2004).
than many scholars realize. For example, we have more than a decade of experience with
Medical Savings Accounts (MSAs) in South Africa, and, in this country, seven years of
experience with the MSA pilot program, four years of experience with Health Reimbursement
Arrangements (HRAs) and a year and a half with HSAs. The problem is, the data mainly resides
with insurers who regard it as proprietary and, therefore, the results are reported by entities with
a financial self-interest in the outcomes. Even so, reported results of MSAs in South Africa
(Discovery Health) and HRAs in the United States (Aetna, 2006) are consistent with common
sense (Matisonn, 2000, 2002). Patients cut back in areas where there is presumed to be a lot of
waste and substitute less expensive treatment options for more expensive ones. That is, there are
fewer trips to primary care physicians, brand-name drug purchases are down, generic purchases
A McKinsey study found that CDHC patients were twice as likely as patients in
traditional plans to ask about cost and three times as likely to choose a less expensive treatment
option.4 Further, chronic patients were 20 percent more likely to follow treatment regimes very
carefully (McKinsey, 2005). A South African study suggests that CDHC patients can control
drug costs as well as managed care, but without the cost of managed care (Matisonn, 2002).
What about preventive care? McKinsey, Aetna, National Center for Policy Analysis (Discovery
Health) and Humana (2005) all report an increase in preventive care – even as they report other,
significant cost-reducing changes in patient behavior. Note, however, that many CDHC plans
contain extra incentives to seek and obtain preventive care. Discovery Health tried to determine
4 Observations are of CDHC participants enrolled at least one year in plan. Due to an inadequate length of time since HSAs have existed, most of the CDHC participants in the McKinsey study (2005) were enrolled in HRAs rather than HSAs.
whether skimping on care in the short run caused higher costs in later years and found no
The Need to Allocate Resources
Many people assume that a system of national health insurance would be radically
different from the American health care system. In fact, the U.S. system is far more similar to
national health insurance than it is different. The reason: in our country, as in other developed
countries, people primarily pay for care with their time rather than with money. In fact, as far as
financial outlays are concerned, health care is almost as free in this country as it is in Canada and
On the average, every time Americans spend a dollar on physicians’ services, only 10
cents is paid out-of-pocket; the remainder is paid by a third party – an employer, insurance
company or government (Smith et al., 2005). From a purely economic perspective, then, our
incentive is to consume these services until their value to us is only 10 cents on the dollar.
Moreover, millions of Americans do not even pay the 10 cents. Medicaid enrollees, Medicare
enrollees who have Medigap insurance, and people who get free care from community health
centers and hospital emergency rooms pay nothing at the points of service. Most members of
HMOs and PPOs make only a modest co-payment for primary care services. Clearly, we are not
rationing health care on the basis of prices.
But if not price rationing, how do we ration physicians’ services? We ration the same
way other developed countries ration care. We ration by waiting. In both the United States and
in Canada, the price of physicians’ services is mainly set by large, impersonal bureaucracies, and
the physician’s time is rationed to patients based on their willingness and ability to pay for care 5 Apparently MSA holders are not healthier as a group. A comparison of catastrophic claims under the two different health plans did not show more catastrophic claims under the MSA plan than under the non-MSA plan. See Matisonn (2000)
with time rather than money. Both countries have largely achieved what has been a goal of the
political left for almost 100 years. Yet the suppression of the price system has been bad for
Nonprice Barriers to Care. Whereas lawyers and other professionals routinely
communicate with their clients by phone and by email, it is very rare for physicians to
communicate that way – even for routine prescriptions (Health on the Net Foundation, 2001).6
Why is that? Why do doctors avoid telephone and email consultations? The short answer is,
they do not get paid for these types of consultations (Wiebe, 2001).7 Medicare does not pay for
them, nor does Medicaid or most private insurance. In general, doctors only get paid to see
patients in their offices. Doctors paid under capitation arrangement would seem to have different
incentives, but HMO doctors ration their time by waiting as well.
The fact that patients cannot consult with physicians by telephone or email leads to two
bad consequences. First, the unnecessary visitors (say, patients who have a cold) expect at least
a prescription in return for their investment of waiting time, and all too often the drug will be an
antibiotic. For physicians, these prescriptions may be thought of as a convenient way of
maintaining a patient clientele (Soumerai and Lipton, 1995). Were telephone consultations
possible, the physician would more likely recommend an OTC remedy, thus avoiding the cost of
waiting for the patient and the cost of degrading the effectiveness of antibiotics for society as a
6 There are exceptions. It is common for people to get test results by phone and to get refills on prescriptions by phone conservations with doctors and nurses. What is rare is an actual telephone consultation. Only about 14 percent of patients exchange e-mail with their physicians. Of this, slightly less than two percent do so on a frequent basis. Survey results from Health on the Net Foundation (2001).
7 Among health plans that do pay, some will not compensate doctors for e-mail exchanges unless the patient has first been examined in an office. Other insurers reimburse less for e-mail exchanges than for in-person visits. See Freudenheim (2005). An exception is, Blue Shield of California, which pays physicians the same for an e-mail consultation ($25) as it does for an office visit. See Koenig (2003). The American Medical Association has created a reimbursement code for online consultation patients, making it easier for physicians to get paid.
The second bad consequence is that rationing by waiting imposes disproportionate costs
on patients who need more frequent contact with physicians. Because the chronically ill need
more interactions with their doctors, they face above-average waiting costs. This may be on
reason why so many are not getting the one thing they most need from primary physicians and
the thing that is most likely to prevent more serious and costly health problems later on – a
The ability to consult with doctors by telephone or email could be a boon to the
chronically ill. Face-to-face meetings with physicians would be infrequent, especially if patients
learned how to monitor their own conditions and manage their own care. Remote consultations
could be used to change a drug prescription or determine whether an office visit was needed.
Lack of Competition for Patients. One consequence of rationing by waiting is that the
time of the primary care physician is usually fully booked, unless she is starting a new practice or
working in a rural area. This means that almost all the physician’s hours are spent on billable
activities. Further, there is very little incentive to compete for patients the way other
professionals compete for clients. The reason: neither the loss of existing patients nor a gain of
new patients would affect the doctor’s income very much. Loss of existing patients for example,
would tend to reduce the average waiting time for the remaining patients. But with shorter
waiting times, those patients would be encouraged to make more visits. Conversely, a gain of
new patients would tend to lengthen waiting times, causing some patients to reduce their number
of visits. Because time, not money, is the currency we use to pay for care, the physician doesn’t
benefit (very much) from patient-pleasing improvements and is not harmed (very much) by an
This insight may explain why doctors in some areas now refuse to take new Medicare
patients.8 Assuming that retirees have a lower opportunity cost of time, odds are they are willing
to out-wait the nonelderly patients. And since Medicare pays at a lower rate than private
insurance, such crowding out actually lowers the physician’s income. Medicaid typically pays
even less than Medicare and since Medicaid patients also tend to have a lower-than-average
opportunity cost of time, small wonder that many doctors refuse to see any new Medicaid
Rationing by Waiting vs. Rationing by Price
Virtually all of these features of our health care system discussed above are the direct
result of the way in which we pay for health care, especially the way we pay doctors. That is, we
compensate physicians in ways that are different from the way we pay for other professional
services and those differences create problems in the medical marketplace that do not arise in
other markets. The principal payment methods, moreover, are not the natural result of free
market forces. They are instead the product of distortions created by public policies. And in
most cases, mistakes embedded in the public policies and in the payment mechanisms reflect a
failure to understand the economics of time.10
Would physicians practice medicine differently if they were paid differently? There is
ample evidence that the answer is yes. Unlike other forms of surgery, the typical cosmetic
surgery patient can (a) find a package price in advance covering all services and facilities, (b)
compare prices prior to the surgery and (c) pay a price that is lower in real terms than the price
8 According to an American Medical Association survey, about 30 percent of physicians limit the number of new Medicare patients they will accept — or do not accept Medicare patients at all. See Hawryluk (2002).
9 According to a recent survey by the Medicare Payment Advisory Commission more than 30 percent of physicians refuse to access any new Medicaid patients (Hackbarth, 2002).
10 On the general economics of time, see DeVany and Saving (1983).
charged a decade ago for comparable procedures – despite the technological innovations in the
Ironically, many physicians who perform cosmetic surgery also perform other types of
surgery. The difference in behavior is apparently related to how they are paid. A cosmetic
surgery transaction has all the characteristics of a normal market transaction in which the seller
has a financial interest in how all aspects of the transaction affect the buyer. In more typical
doctor-patient interactions, doctors are not paid to be concerned about all aspects of care and
therefore typically ignore the effects on the patient of the cost of time, the cost of drugs, and
other ancillary costs. Note, this holds for HMO doctors as well as fee-for-service doctors. What
is true for U.S. doctors in general is also true of doctors who practice in the government-run
health systems of other developed countries.
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