Finding "Truth" about Managed Care
Regina E. Herzlinger
The Pipe Dreams of Patient Protection Legislation
Americans are mad as hell at managed care (Herzlinger 1999). Even the exhausted flyers on my cross-country plane trip spontaneously applauded Helen Hunt's Academy Award-winning tirade against the HMO that denied care to her sick son (Tokarski 1998).
My analysis of health care consumers caused me, long ago, to predict a managed care backlash (Herzlinger 1991, 1994); but, now that everybody knows that managed care is in trouble, our elected representatives rush to the rescue with patient protection remedies.
Many bills contain a shopping bag full of mandated benefits, such as easy access to specialists and hospitals. The consumer activists who induce the mandates present perfectly reasonable evidence for each (Annas 1995). Take Mary Jo Sadosky's complaint when, exhausted and in pain, she was asked to leave a hospital twelve hours after giving birth to twins. Small wonder she fought for a ban against "drive-through deliveries" (Miller 1995).
Well intentioned? Sure. But away from the glow of C-SPAN cameras, reality strikes: regulation is no sure-fire problem solver.
While one cannot argue with the individual complaints, a one-size-fits-all medical care strategy is unlikely to prove effective. Mother Nature designed us in infinite variety; we hurt ourselves in many different ways; and worse yet, mandated benefits may suppress the innovations that offer [End Page 1077] the best hope for improving health-care cost effectiveness. For example, a fifteen-year study found that a program of frequent, at-home nurse visits lowered the rates of substance abuse and welfare dependency of low-income mothers and the abuse rates of their children (Kitzman et al. 1997) and, elsewhere, improved pregnancy outcomes and injury rates (Olds et al. 1997). Will a health insurer forced to follow a one-size-fits-all mandate for a hospital maternity stay invested in such innovative programs to supplant it? Do not count on it.
Dick Fosbury, the 1968 Olympic gold medalist in the running high jump, illustrates the impact of mandates on innovation. Unlike other jumpers who faced the bar, Fosbury innovatively backed into it and flopped 7 feet and 4 1/4 inches over it. His Fosbury Flop is now routinely used. But, imagine if well-intended Olympic officials had mandated forward-facing high jumps because backward jumps increase the chances of injury, or are aesthetically unpleasing, or many other seemingly plausible reasons. But their bottom--or more correctly top--line would have been: no Fosbury flopping, no innovation.
As Robert Waller, CEO of the Mayo Foundation noted, "Regulations put a stake in the ground that says, 'You have to meet that standard.' But what's quality on Monday is not what's quality on Tuesday" (Aston 1998).
Back to Basics
If current public policy initiatives carry deadly consequences, we must go back to basics: What lies at the core of consumers' complaints about managed care?
To my mind, the answer is clear. Today's well-educated, assertive consumers want choice and control. The rest of the U.S. economy understands these desires. As one retailer ruefully noted, today's consumers say, "I want it the way I want it and when I want it" (Lorie 1994). Managed care takes choice and control away from them; for example, all the top-rated responses in one consumer survey favored overturning managed care's powers to select providers, require permission, and approve specialists' care (Gorman 1998).
The Internet vividly illustrates consumers' power. The intermediary, on-line markets that enable consumers to obtain convenient, intelligent, comparative information, such as Amazon.com, succeed because of their "allegiance to buyers rather than products" (Hof 1999). Their focus on [End Page 1078] the customer has propelled estimated Internet retail revenues by 69 percent annually. Health care purchases are already among the leading-edge Internet purchases. For example, experts predict that current Internet purchases of drugs and similar items will triple to $19 billion in 2000 (Forrester Research 1998).
Today's consumers even control items once considered the province of experts. For example, while most pension assets were once controlled by employers in defined benefit plans, by 1998, up to 80 percent were controlled by individuals (Shoven and Wise 1998). Roughly one-third of 1993 personal savings were in self-directed 401(k) retirement accounts, approximately half of them invested in equities (Poterba, Venti, and Wise 1998). Consumers are so self-confident that individual trading on the New York Stock Exchange and the NASDAQ has grown 31 percent annually since 1994 (Franco and Klein 1998: 4).
Yet, despite consumers' manifest desires for the choice and control they find elsewhere, some argue that in managed care these wishes should be ignored. As one Beltway consultant observed: "The approach of trying to give people the power to operate in the current insurance market assumes too much about individual purchasing abilities" (NYBGHC 1992: 61).
Such sentiments erroneously assume that every market participant must be equally well-informed. The fundamental lesson of Economics 101 is that equilibrium is determined by marginal participants, not the average ones. The importance of marginal consumers is illustrated by the success of markets for complex goods, such as computers, automobiles, and securities. Further, the sentiments are misplaced: the acclaimed consumer-controlled Federal Employees Health Benefits Program provides but one example of the savviness of U.S. consumers (Herzlinger 1997: 264-268, chaps. 1-4).
But, even if these opinions were more persuasive, they ignore the power of the American people to shape the public policy they want. For example, the 1988 Medicare Catastrophic Coverage Act was a Beltway star. The act's expanded benefits, protection against catastrophic medical expenses, and modest incremental costs pleased Democrats and Republicans alike. Only the elderly failed to join the lovefest. Angered by extra costs for unwanted benefits, they forced Congress to repeal this vastly unpopular legislation (Dahl 1989). The debacle demonstrated that Beltway mavens cannot persuade the public to accept health care it does not want. And it wants choice and control. [End Page 1079]
What Works: Information Disclosure
Fundamentally, consumers complain that in managed care they cannot control what they buy. One reason is their limited choice. Currently, only 15 percent of employees in small firms and 50 percent of those in firms with 500 to 999 workers have more than one option (Managed Care Helped Employers 1998). With so little choice, health insurers can allegedly offer too little health care for the money; spend too much on executive salaries, such as Oxford Health Care's CEO whose 1996 compensation topped $29 million (Pollack and Slass 1998), while Oxford's providers were left languishing for payment (Freudenheim 1998); use too little for customer service (Rundle 1998; Woolhandler and Himmelstein 1991); return too much to investors (McKinsey and Co. 1995: 270-273); and, paradoxically, return too little to capital, such as the inadequate $39 million 1992 capital balance of New York's mammoth $7 billion Empire Blue Cross-Blue Shield (Hilgenkamp and Herzlinger 1995).
Theoretically, greater consumer choice in the purchase of health insurance would better line up the interests of the buyers and insurers. Consumers could then reward insurers who give them a good value for the money and punish those who do not. Both Democrats and Republicans agree with this reasoning. A plethora of bills expands consumers' choice, from the proposal by Senator John Breaux (D-La) to enlarge the choice of Medicare plans to those who would use the tax code to subsidize individual purchase of health plans (Kilborn 1999).
There is only one problem: none of the consumer choice bills has a chance of passage in the current Congress (Pear 1999).
If managed care consumers cannot obtain the choice they want, where do we go from here?
We can give them control. The key is information.
With access to good information and freedom to choose health care plans,
consumers respond in classic Economics 101 fashion. For example, the
satisfaction data collected by the Twin Cities' employer coalition,
the Buyers Health Care Action Group, caused a nearly 20 percent drop
in high-cost/low-satisfaction plans and a 50 percent increase in
low-cost/
high-satisfaction plans (Wetzell 1999). Information exerts powerful
effects even in the absence of consumer control. When New York
provided standardized measures of the open-heart surgery performance
of hospitals and surgeons, for instance, statewide death rates dropped
(Chassin and Galvin 1998). Low-performance providers exited and others
improved. High-risk cases did not need to leave the state to obtain
[End Page 1080]
care (Peterson et al. 1998). Market share growth was inversely related
to the mortality statistics (Mukamel and Mushlin 1998).
The trouble is, much of the needed information does not currently exist. Despite exemplary organizations such as the Foundation for Accountability, the Picker Institute, the California Public Employees Retirement System (CalPERS), the federal government's own Office of Personnel Management, and the National Committee for Quality Assurance (Burroughs and Herzlinger 1998), consumers presently lack the consistent, comprehensive, relevant, timely, comparable information they need to reshape the health insurance market.
Indeed, there is widespread agreement that health care quality measurement is in its infancy (Chassin and Galvin 1998). What to measure, how to measure and disseminate it, how to adjust for individual characteristics--these are but a few of the unresolved issues (Isaacs 1996). Small wonder then that consumers simply ignore presently available data. They suspect its validity, from the perspectives of statistical reliability and data integrity (Edgman-Levitan and Cleary 1996). They may find some data irrelevant: for example, data that pool us all into a vast sea neglect the significant differences among us (Tumlinson et al. 1997) and quality measures that focus exclusively on clinical dimensions ignore the busy U.S. consumer's overwhelming interest in convenience (Herzlinger 1997; Edgman-Levitan and Cleary 1996: 45, 52-53). Moreover, consumers want specific, timely information so they can readily identify the health professionals who can best treat them or a sick loved one.
The paucity of such information prevents an effective response to the managed care backlash.
The securities market demonstrates the impact of information on performance. In it, prices of publicly traded securities are fair, in the sense that they fully reflect the impact of the ample publicly available information. (Eugene Fama first proposed three definitions or standards to test the efficient market hypothesis: weak, semistrong, and strong. The strongest form of the hypothesis asserts that all information known by market participants is fully reflected in market prices so it is impossible for insiders who trade on private information to earn abnormal profits [Joy 1987; Fama 1970]. While it is not impossible for insiders to profit from information, for the most part, the stock market comes very close to meeting the strongest standard for efficiency [Jensen 1968, 1969]. The interpretation of the efficient market hypothesis has evolved to mean that if a market is efficient with respect to information, an investor is playing a fair game, meaning that prices behave as though everyone had access to [End Page 1081] the same information [Fama 1970; Beaver 1989: 191, 130-163; Malkiel 1996: 3, 443-444].) The information reflected in these prices effectively redirects capital from ineffective firms to effective ones. (This is not to say that the market is always right, but rather that it reflects all the information publicly available at that time.) If health insurance markets resembled the "efficient" securities markets, consumers would use complete, reliable information to reward effective health insurers.
There goes the backlash.
"Efficient" Markets and How They Got That Way
How can securities prices reflect the impact of all the complex, publicly available information about the performance of the firm when many individual owners of securities cannot fully evaluate it?
There are at least two possible explanations. First, a group's consensus estimate is generally better than the average level of knowledge of the individuals within it; as one example, the consensus forecast for the outcomes of football games consistently beats the estimates of individual forecasters (Beaver 1989). Additionally, expert analysts help investors to evaluate prices, through information freely available in the mass media and to clients of brokerage houses. The experts are rated in publications such as the Wall Street Journal's "All-Star Analysts" (1998) list and the mutual funds reviews in Forbes and Consumer Reports. Investors use these assessments to reward recent good performers by allocating more money to them (Ippolito 1972; Jensen 1968; Malkiel 1996).
The growth in information retrieval services (U.S. Department of Labor 1998)--especially in its electronic component (U.S. Industry and Trade Outlook 1998: 26-28)--supports the market's continued efficiency.
The SEC: The "Truth" Agency
Many knowledgeable observers contend that the U.S. Securities and Exchange Commission (SEC) is a critical element of the efficiency of the securities markets (Seligman 1995: 43-48, 54-55, 561-568).
The SEC was created in 1934 by President Franklin Delano Roosevelt to protect small investors. The regulation of securities was nothing new. As early as 1285, King Edward I required licensure of London brokers [End Page 1082] (Skousen 1991: 2, 118, 125, 128). But FDR's SEC differed from traditional regulation that relied on authorities to evaluate the worthiness of a security. As he noted, "The Federal Government cannot and should not take any action that might be construed as approving or guaranteeing that . . . securities are sound." Rather, his SEC was a "truth" agency to insure full disclosure of all material facts. In Roosevelt's words, "It puts the burden of telling the truth on the seller" (Seligman 1995).
As in health care, there was plenty of truth waiting to be told. There were minimal requirements for listing of securities on the stock exchange, no source of generally accepted accounting principles, and, in 1923, only 25 percent of the firms traded on the New York Stock Exchange provided shareholder reports (ibid.). To put teeth in its mission, the SEC was given the power to enforce "truth in securities" and to regulate the trading of securities in markets through brokers and exchanges.
The Private Sector Sources of Information
Surprisingly, much of the information that lies at the heart of the efficiency of the markets wells not from the SEC but from three private sector groups: the firms, the Financial Accounting Standards Board (FASB), and the accounting profession (see the appendix for a fuller description). The interaction among these groups promotes fuller consideration of diverse points of view. Unlike a government agency, they do not sing out of one hymnal. And their private-sector nature requires the political and financial backing of supporters for their continued existence.
In abdicating some of its authority to set accounting standards to the private sector, the SEC recognized the following advantages: (1) practicing accountants were closer to the firms and thus could more accurately identify emerging issues; (2) private sector involvement encouraged greater compliance than government mandates; and (3) the SEC could more readily audit the work of the private sector information disclosers than its own, thus resolving a conflict of interest (Baker 1976).
Is Government Needed for an Efficient Market?
In a classic 1964 article, the great economist George Stigler (1981) determined that government regulation of information disclosure is not essential [End Page 1083] to the efficiency of markets. In this view, if information is beneficial to the firm, its managers will advertise it; if it is detrimental, the firm's competitors will trumpet it; and, if it exists, whether good or bad, analysts will ferret it out. No need for government.
As is usual in works of such significance, Stigler's analysis and similar research were widely criticized (Benston 1973; Dopuch 1976; Deakin 1976). Yet despite the unusually abundant presence of intelligent research, this debate cannot be settled solely on the basis of empirical analyses.
There are two theoretical bases for government's presence in the information market: first, the public good nature of information disclosure enables free riders. Because disclosers cannot charge these users for the benefits they derive, they lack incentives for full disclosure (Stiglitz, Jaramillo-Vallejo, and Park 1993; Dutt 1997). Absent government regulation, the quantity of publicly available information will be undersupplied. Then too, disclosure may be made selectively, favoring some recipients and excluding others. (Eventually, all investors share information. For example, if you have special knowledge of IBM's rosy future and buy a large amount of its stock, I can learn about your large purchase and judge what circumstances motivated you. But you will have an advantage over me, because you learned this special information before I did.) Such selective discrimination, however temporary, violates our national notions of equity. Regulations that penalize insider activity and require simultaneous dissemination of information level the playing field. (A third frequently voiced justification is less convincing to my mind. Some argue that the government disclosure of public information will cost less than the sum of the costs of many private disclosures of the same information. But if the economies of collective action are so powerful, an industry group could attain them as well as a government organization [Beaver 1989].)
How to Make It Happen: Translating the Lessons of the SEC to Managed Care
The U.S. securities markets have precisely the characteristics that managed care consumers want: (1) prices are fair in the sense that they reflect all publicly available information, (2) buyers use this information to reward productive firms and penalize unproductive ones, and (3) information and competition continually reduce transaction costs. [End Page 1084]
The presence of these characteristics in the health insurance market would achieve two important social goals:
1. They would divert capital from health insurers that offer a bad buy to those that offer a good one. Bad buy insurers would shrink or improve. Good buy insurers would flourish.2. They would reward and punish effective and ineffective purveyors of health insurance.
Currently the magnitude of health insurance transaction costs is unclear. One broker estimates them for a forty-person company at between 2 to 2 1/2 percent. When pressed for more specific data, he said, "Asking about this kind is like asking the military for their nuclear weapons plans. The information is not top secret--or it should not be--but it is treated that way" (Bezmolinovic 1998). Finding comparable health insurance prices is also a major research undertaking.
Contrast this mysterious effluvium with the clarity of the transaction costs of brokers and the prices of securities. Because brokers like E*Trade (1999) openly compare their transaction costs to others, investors can evaluate their services relative to their costs. This information enabled low-price discount brokers to flourish and forced full-price brokers to offer their customers more "free" services, such as proprietary research (Moore and Scott 1986).
Purchasers of health insurance armed with comparable transaction cost and price information could benefit from similar competition. Some brokers would offer low prices and others provide extensive other services that justify their fuller price. Public disclosure of these analyses will eventually lead to a Wall Street Journal's "All-Star Health Insurance Analysts" list.
How to Make It Happen
The key to achieving these desirable characteristics in the health insurance market is legislation that replicates these essential elements of the SEC model:
Registration. The SEC requires firms that trade their securities in interstate markets and all such market-makers to register with the agency. A corresponding health care agency would oversee the integrity and require the public disclosure of information for health insurers, the policies [End Page 1085] they issue, and the interstate markets in which such insurance policies are sold. It would be armed with powerful penalties for undercapitalized and unethical market participants. Private Sector Disclosure and Auditing. The SEC relies heavily on private sector organizations. The new health care agency would delegate the powers to derive measurement principles to an independent, private nonprofit organization that, like the FASB, represents a broad constituency. The agency would require auditing of the information by independent professionals, who would render an opinion of the information and bear legal liability. Private Sector Analysis. The evaluation process is primarily conducted by private sector analysts, who disseminate their frequently divergent ratings. To encourage similar private sector health care analysts, the new agency would require public dissemination of all health insurance prices, related transaction costs, and the characteristics of the policies, such as quality and customer satisfaction.
How Not to Make It Happen
Unfortunately, many of the well-intended patient protection proposals undermine one or more of these essential characteristics. All-too-often, the health care regulator(s) would evaluate and micromanage health insurers and the markets in which they operate. 1
One proposal, for example, blurs the distinctions between information and evaluation, between oversight and micromanagement: its FASB analogue evaluates quality and its SEC analogue evaluates health care benefits and coverage problems (Etheredge 1997). But the real FASB does not assess the quality of the output produced by corporations, nor does the real SEC evaluate whether the markets for the products that corporations sell yield effective, efficient outputs. Instead, they ensure the provision [End Page 1086] of reliable, useful information that investors can use to perform their own analyses (Herzlinger 1996).
The likely result of these proposals? Lack of innovation.
Wave good-bye to the health care Dick Fosburys.
The much-abused U.S. health care consumer needs, and wants, government protection (Stemberg 1998). We know that the SEC model works. We just need to take advantage of it. [End Page 1087]
Appendix:
The Private Sector Sources
of Information
The Firm
Much of the information emanates from the firm itself using the specific measurement approaches promulgated by the FASB and its predecessors. (The SEC had legal authority to specify these accounting standards but with active oversight, it generally relies on the FASB to do so [Miller, Redding, and Bahnson 1994: 20-21]). Managers must hire an independent accounting firm to audit the financial statements. If the auditor cannot issue a clean opinion, the SEC may well bar the firm from access to the capital markets.
The FASB
As a private nonprofit organization, the FASB must earn sufficient revenues to cover its expenses and the respect of its constituency. Two predecessor organizations folded in part because they could not reach a politically acceptable consensus on specific accounting standards. (The Accounting Principles Board [APB], the FASB's immediate predecessor, collapsed in 1973, in some measure because of disagreement with its proposed accounting treatment for business combinations and an earlier opinion on tax credits. In the latter case, the APB proposed to defer recognition of some of the benefits of the credit. Although the APB's standard conformed with accounting theory, three accounting firms announced they would not comply with the opinion. Even the SEC decided that its registrants need not follow it. Absent the support of business, [End Page 1088] the accounting community, and the SEC, the APB found its authority to set accounting standards severely eroded [Previts and Merino 1979: 204, 290-291]. The FASB's structure was designed to reduce concerns about the APB's excessively close ties to the accounting institute, its sponsor, its large, seventeen-member board, and the continued allegiance of its part-time board members to their employers or clients [Miller, Redding, and Bahnson 1994: 30-58; Armstrong 1976].)
In recognition of the political, consensus-building nature of its mandate, the FASB's structure and process for issuing an accounting standard are designed to elicit broad-based, thoughtful involvement (Miller, Redding and Bahnson 1994; FAF 1998a, 1998b: 24; McEnroe and Martens 1996). The process is completely public and repeated rounds of exposure drafts encourage wide participation. These characteristics are crucial to the FASB's success because, as in health care measurement, there is no widely accepted conceptual basis for accounting. Despite their history--accounting techniques were first codified in 1494 (Previts and Merino 1979)--a conceptual foundation that can clearly adjudicate all accounting disputes does not exist. (Such a conceptual foundation theoretically exists in the form of six concept statements that cover issues such as the Elements of Financial Statements [Reither 1997]. In practice, however, debates about fundamental accounting issues such as current vs. historical costs value or capitalization vs. expensing continue to roil the profession [Miller, Redding, and Bahnson 1994].) As the FASB's first chairman noted, "Accounting . . . is an art whose rules are not susceptible to . . . tests of validity. . . . accounting is rather a convention supported by general acceptance, consensus" (Armstrong 1976).
The Accounting Profession
The independent accountants who audit the financial statements are usually professionals who must pass examinations and fulfill stringent educational requirements. They frequently work in one of the Big Five accounting firms that audited nearly 80 percent of the publicly traded firms (GAO 1996: 2, 89-90). Accounting firms may be held legally liable for negligence, fraud, and breach of contract. One firm was required to pay up to $145 million to the creditors of the bankrupt DeLorean Motor Co. for negligent auditing (Phillips 1998). Accountants have even been found criminally liable (Skousen 1991).
Harvard Business School
Regina E. Herzlinger is an expert in both health care and accounting. Her current events best-seller, Market-Driven Health Care (1997; paperback edition, 1999), won the 1998 Book of the Year Award from the American College of Healthcare Executives. Her latest accounting book is The Four by Four Report: A Practical Guide for Effective Oversight of Nonprofit Organizations (forthcoming).
Notes
1. See, for example, H.R. 216, Access to Quality Care Act of 1999, Rep. Charlie Norwood (R-GA); H.R. 358, Patients' Bill of Rights Act of 1999, Rep. John Dingle (D-MI); S. 240, Patients' Bill of Rights Act of 1999, Sen. Tom Daschle (D-SD); S. 308, Patients' Bill of Rights Plus Act, Sen. Trent Lott (R-MS); S. 326 Patients' Bill of Rights, Sen Jim Jeffords (R-VT); H.R. 448, Patient Protection Act of 1999, Rep. Michael Bilirakis (R-FL); S. 374, The Patients' Responsible Managed Care Act of 1999, Sen. John Chafee (R-RI); S. 719, Managed Care Reform Act of 1999, Rep. Greg Ganske (R-IA); and S. 496, Health Care Consumer Assistance Act, Sen. Jack Reed (D-RI).
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