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Private Health Purchasing Practices In The Public Sector: A Comparison Of State Employers And The Fortune 500

Abstract

 
State governments are influential purchasers of health benefits but have not been studied extensively. In a recent survey of senior benefit managers, we examine the extent to which states have followed the private-sector approach to purchasing health care. We found that states have adopted "industrial purchasing" practices similar to those of large private employers but offer greater choice of carriers and pay a higher percentage of premiums. Unions continue to influence health care purchasing in both the public and private sectors. Double-digit increases in health costs and the current budget crisis may force states to align their purchasing practices with the private sector to cut costs.

We refer to large private-sector employers’ use of these business practices as an "industrial purchasing" model. Fortune 500 companies use competitive bidding to purchase health coverage as they would other inputs to their production processes. The corporation is the primary decisionmaker that aggressively bids for and selects a smaller number of carriers, to obtain the lowest rate. This differs from consumer models in which responsibility for carrier selection and cost control is placed on the consumer.

In our earlier work, we documented the reliance on the industrial purchasing model among both the Fortune 500 and medium-size manufacturing firms.² However, no study has explicitly examined the spread of these practices to the public sector. The small number of studies have only suggested that public purchasers are more constrained in their purchasing than private purchasers because of strong unions, public procurement regulations, and politics.³

Understanding state employers’ purchasing practices and the degree to which they can adopt private methods is vital because these purchasers shape the choices available to states in responding to today’s budgetary and health care crises. Market-oriented purchasing approaches are being discussed widely in the public sector not only because of the experience of private firms, but also because of recent Medicare reform legislation.

Since state governments are often the largest employers in their respective states and among the largest in the country, the effects of their responses are far-reaching. Our data show that states purchase health care for more than four million employees and retirees and millions more dependents.⁴ They also purchase on behalf of other public agencies such as state universities and municipalities.

In this paper we present the results of our survey of state employee groups in comparison to results from a similar survey of the Fortune 500. We explore the extent to which state employer groups have adopted the key elements of the industrial purchasing model.⁵ We examine the context within which public employers operate and how they have adapted industrial purchasing to suit that environment. We also discuss how unionization and other human-resource issues influence the spread of these purchasing practices.

Study Methods

Top Study Methods Study Results Summary And Concluding Remarks Editor's Notes NOTES

 
Data on state employer groups were collected during spring 2002, using a thirty-minute telephone interview that targeted the state official with the most responsibility and detailed knowledge of health benefits. Pretests were conducted among twelve municipal governments to test and refine the questionnaire. We then surveyed all fifty states and the District of Columbia for a 100 percent response rate.

Comparative data on the Fortune 500 were collected during the winter and spring of 1999–2000. The methods for our study of the Fortune 500 have been described in detail elsewhere.⁶ We surveyed 411 out of 489 companies for an 84 percent response rate. The number of employees in these firms ranged from 1,850 to 204,250.

The number of state employees ranged from 8,200 to 554,558; their average age was forty-four. On average, 25,984 retirees were enrolled in state health insurance programs, with a range of zero to 179,353. Of those retirees, 52 percent on average were over age sixty-five. Altogether, there were 3,523,616 state employees and 1,247,232 enrolled retirees.

Twenty-four states bought health insurance for municipal and county employees. Colleges and universities were the second most common recipients. Five states purchased coverage for children in state-subsidized programs. Together, states purchased for 1,463,717 enrollees from other public agencies or public insurance programs.

Measures. We rely upon many of the same measures in our studies of state governments and the Fortune 500.⁷ Our interviews included questions on health plan types, carrier choice, contribution levels, suppliers’ relations strategies, bidding practices, quality measurement and management, and cost outcomes of purchasing.

We asked about states’ and the Fortune 500’s purchasing of health insurance "carriers" in their largest metropolitan area. Carriers refer to companies such as Aetna, CIGNA, and Kaiser Permanente that offer health maintenance organization (HMO), preferred provider organization (PPO), point-of-service (POS), and other types of plans. We also asked for the average contribution level to individual and family/dependent coverage across carriers.

We use descriptive statistics to compare key purchasing practices between state employers and the Fortune 500. Because the survey response rate was 84 percent for the Fortune 500 and 100 percent for state employers, the samples are nearly complete representations of the study populations. We use chi-square tests in an exploratory analysis to examine the association of unions with contribution levels for individual and family coverage.

Study Results

Top Study Methods Study Results Summary And Concluding Remarks Editor's Notes NOTES

 
Rising health care costs. The rise in health care costs during the past few years amounts to a cost crisis for state employers. Forty-five percent of state employers faced per capita health care cost increases of greater than 12 percent in the past year (2001), compared with 25 percent who saw such a rise over the past five years (1997–2001).⁸ States expect double-digit increases to be the rule rather than the exception in the coming years. Among states, the average annual per capita premium cost for individual coverage in the preceding year was $4,469, contributing to states’ cost pressures.

Drug costs are a key factor in the rise in overall health care costs. In the past decade, the demand for prescription drugs has been driven by extensive advertising, the proliferation of new drugs, and an aging workforce that requires maintenance drugs for illnesses such as asthma, diabetes, and heart disease.⁹ Among state employer groups, drug costs increased at a higher rate than overall health care costs, with the majority of states reporting increases of more than 13 percent. More than a third of state employers faced drug cost increases of greater than 19 percent in the past year, compared with only one-fifth during the past five years.

State employers expect these overall increases to continue. Nearly all respondents (98 percent) cited overall costs as the greatest challenge facing state employers in the future. Rising health care costs are particularly important to state governments because they confront these costs in the context of fixed and declining budgets. As health care costs continue to escalate, state revenues are also falling precipitously because of the prolonged economic downturn. According to the National Governors Association, the current state deficit for 2003 is about $30 billion and is projected to be about $82 billion in 2004.¹⁰ Thirty-seven states reduced their fiscal year 2003 budgets by nearly $14.5 billion.¹¹ Unlike the federal government and private employers, state employers are required by law to balance their budgets annually. The combined effects of rising health care costs and state budgetary crises may force states to consider more radical changes in the health benefits they offer.

Purchasing process, carrier selection, and contract period. Almost all state employers rely on request-for-proposals (RFP) bidding, the standard method among private-sector firms, to purchase health benefits for their employees (Exhibit 1). More than two-thirds of state employers and 62 percent of the Fortune 500 are required to regularly rebid all of their health care carrier business. Both states and the Fortune 500 also use bidding to purchase coverage for pharmacy benefits and mental health services and to select administrators for self-insured plans.

We found that states are not as aggressive as the Fortune 500 in selecting or dropping carriers during the bidding process. This is apparent in the greater choice of carriers and longer contract periods among state employer groups than the Fortune 500. In the Fortune 500, the competitive bidding process is often accompanied by short-term contracts, usually one year long, between companies and carriers.¹² Competitive bidding is more effective on premium prices if fewer carriers are selected and are under threat of being dropped.

Seventy percent of state governments offer a choice of two or more health insurance carriers to their employees, compared with 66 percent of Fortune 500 companies. Seventy percent of state employers offer a choice of two or more carriers to more than 80 percent of their workers, compared with only 49 percent of the Fortune 500. State employees continue to have a wide array of choices despite the trend toward market consolidation among carriers.¹³ Sixty-one percent of states reported average contract lengths of three years or more, as opposed to the annual contracts that are the norm among the Fortune 500.

The California Public Employees’ Retirement System (CalPERS), however, is an example of a public purchaser that does use its considerable clout to influence premium prices in a manner similar to the Fortune 500. In response to recent increases in premium prices, CalPERS has reduced the number of carriers offered to its employees and is considering a further reduction.¹⁴ CalPERS’ willingness to drop carriers is a result of its size and its culture of being both a pension manager and a health benefit purchaser.¹⁵ CalPERS has a history of aggressively managing financial assets in its pension funds and frequently switches vendors. Its tactics are also a result of its particular market context that allows it to take advantage of one of the most mature managed care systems in one of the most competitive U.S. markets. CalPERS has capitalized on both of these factors, which are more present in California than in other states.

Employer-contribution strategy. To reduce costs, Fortune 500 employers traditionally place pressure primarily on carrier rates through competitive bidding rather than shifting the cost burden onto employees. Only 24 percent of Fortune 500 employers use a fixed-dollar strategy to shift the full cost differential between carriers onto employees. Most private employers pay a fixed percentage of premiums to subsidize the premiums of employees in high-cost carriers. They may do so because of adverse selection and other human-resource concerns.

State employers’ contribution strategy is similar to that of the Fortune 500. Only a third of states have moved to a defined-contribution strategy, in which they pay a fixed-dollar amount regardless of insurance premium. Were state employers to accompany a wide choice of carriers with a financial incentive for employees to choose less costly plans, the competitive bidding process would be a less important instrument of cost control. Yet two-thirds of states that offer three or more carriers to employees do not use a defined-contribution strategy.

The Massachusetts Group Insurance Commission (GIC), which purchases health benefits for active and retired state employees, provides an example of why a state does not use such a strategy. The GIC is required to provide an indemnity plan to employees and contend with adverse selection and retention. Should the GIC introduce a defined-contribution strategy, the high-cost indemnity plan would likely be eliminated. Thus, not only is the GIC required to offer a wide choice of carriers, but it also is unable to steer its employees into more cost-effective carriers because of its inability to pass on the full cost differential between carriers.¹⁶

Employers’ contribution levels and retiree coverage. States and other public employers pay a much higher percentage of premiums for individual coverage than do private firms of similar size: 89 percent of premiums across all health carrier offerings for individual coverage versus 82 percent among the Fortune 500. More than half of states contribute 90 percent or more toward premiums for individual coverage, compared with one-third of the Fortune 500 (Exhibit 2). Since the data were collected two years apart, one might even expect larger differences in contribution levels to individual coverage today. Although states may find it easiest to economize on family coverage, they are still more generous than the private sector. On average, states contribute 77 percent of the premium for family coverage. Other studies of the private sector have indicated a smaller contribution to family coverage than is offered by state employers.¹⁷

View larger version (23K): [in this window] [in a new window]   EXHIBIT 2 Comparison Of Percentage Contribution Levels Toward Individual Coverage Between Fortune 500 And State Employers, 1999 And 2001

Quality management. In quality management, state employers closely resemble their counterparts in the private sector. Nearly all states and Fortune 500 companies routinely collect quality information, from a wide variety of sources (Exhibit 3). They also rely on similar sources for quality information. Fortune 500 companies, however, rely more on consultants than state employer groups do. States are significantly more likely than Fortune 500 employers are to collect information on customer satisfaction. In keeping with the industrial purchasing practice where employers, rather than employees, make many of the choices among health carriers, fewer than half of state employers and one-third of Fortune 500 companies disseminate some quality information to employees. Nearly all state employers (88 percent) and Fortune 500 companies (83 percent) require some form of quality performance in their contracts with carriers, and both clearly emphasize standards for customer service over clinical quality (Exhibit 3).

Unions and other human-resource concerns. Unions and human-resource concerns continue to affect the provision of health benefits. States reported that unions influenced various aspects of health coverage during the collective bargaining process, especially contribution levels (69 percent). Nonunionized states are more likely to have contribution levels for individual coverage of 70 percent or less. Conversely, the presence of unions is associated with much higher levels of employer contribution. More than half of states having more than 20 percent unionization have contribution levels for individual coverage of 90 percent or more. Similarly, non-unionized Fortune 500 companies were more likely to have contribution levels for individual coverage of 70 percent or less (Exhibit 4). We found that unions have a statistically significant effect on contributions toward individual coverage among the Fortune 500 but not among state governments. This may be because of the higher levels of contributions already provided by states. Thirty-three percent of Fortune 500 companies with more than 20 percent unionization had contribution levels of 90 percent or more.

View larger version (25K): [in this window] [in a new window]   EXHIBIT 4 Comparison Of Contributions Toward Individual Coverage Between Fortune 500 And State Employers, By Unionization, 1999 And 2001

While unions in the public and private sectors have similar health benefit goals, their stronger presence in the public sector increases their effect on health benefits. The effects of unions on employers’ premium contributions are consistent with earlier studies of the private sector that show rates of unionization to be strongly associated with higher employer premium contributions and lower copayments.²³

We also collected supplementary information from in-person interviews on other human-resource concerns that affect health benefits. State employers often emphasized a culture of public employment characterized by an inclusive employment policy and a generous benefit package. Yet the current cost crisis puts the generosity of public employers at odds with cost-cutting measures. According to Dolores Mitchell of the Massachusetts GIC, "Traditional wisdom has it that, in comparison to the private sector, lower salaries and richer benefits characterize the culture of public employment. Rising health care costs threaten this prevailing culture."²⁴

Similarly, California’s fiscal crisis is having far-reaching effects in the public sector. California’s public employees are likely to bear the full costs of increasing health insurance premiums in 2004, while their wages remain fixed. This poses a hardship particularly for low-income state workers who have come to depend on a rich health benefit package. These increases may have long-term effects on health benefits and employment policy among state employer groups.²⁵

Study limitations. We recognize that this study has several limitations. One limitation is that the Fortune 500 and state employer groups differ in the geographic characteristics of their workforces. Fortune 500 companies tend to be more national in scope with employees across the country. While state employers can also be dispersed across a state or neighboring states, they usually have a more geographically concentrated workforce. A second limitation is that benefit managers in both sectors have difficulty identifying their overall contribution strategy, leading to sizable amounts of missing data. Other studies have confronted this problem.²⁶ Finally, the data for state employer groups and the Fortune 500 were collected two years apart, although using the same measures. The results nevertheless are consistent with each other and other studies that compare the public to the private sector.²⁷

Summary And Concluding Remarks

Top Study Methods Study Results Summary And Concluding Remarks Editor's Notes NOTES

 
States have moved toward the tough bidding and negotiating tactics associated with large private employers. However, they are not as aggressive in dropping or otherwise disciplining their carriers on price. States also are unable to share costs with their employees as extensively as large private-sector employers can. Similar to past studies, we found that contribution levels tend to be higher among state governments than in the private sector.²⁸ Nearly a third of states still contribute 100 percent to individual coverage, compared with 8 percent of Fortune 500 companies. Strong unions coupled with human-resource concerns have made it difficult to reduce employers’ contributions or increase employees’ copayments.

Unions exert a strong influence on health benefits in both the public and private sectors. The major difference is that while unions remain strong in the public sector, they are in decline in the private sector. The public sector also has a different employment culture than the private sector.²⁹ Many state employees have come to expect long-term job security and rich benefits during their career and retirement, in lieu of the higher compensation that traditionally characterizes the private sector. These constraints on reducing contribution levels affect states’ ability to steer their employees into low-cost carriers.

In the quality arena, the practices of states are more similar to those of the private sector. States have moved rapidly to collect quality information and incorporate it into their contracting practices with health carriers. Similar to large companies, states’ emphasis in contracting has largely been on customer service rather than on clinical quality. States primarily collect quality data for use in their own decision making; they often do not share these data with their employees.

States’ current budget crises may force them to align their purchasing practices with those of the private sector to cut costs. CalPERS’ recent reduction of carriers and its proposal to reduce the number offered to just two is similar to large private employers that offer only one or two carriers to their employees. Gov. Mitt Romney of Massachusetts proposed a reduction from 85 percent to 75 percent in contribution levels for state employees.³⁰ He justified the cutback as bringing state employees in line with the private sector. Only the worst state budget crisis since the Depression could have provoked such a powerful stimulus for change.

Editor's Notes

Top Study Methods Study Results Summary And Concluding Remarks Editor's Notes NOTES

 
The authors thank Eugenie Coakley for her statistical expertise; Rachel Kohn and Stephen Lemuth for their management of the survey; the dedicated interviewers at JSI, Bob Hickey and Nancy Politzer; and Saminaz Zaman for her contributions to the initial drafts of this paper.

James Maxwell (maxwell{at}jsi.com) is director of Health Policy and Management Research at JSI Research and Training Institute in Boston, Massachusetts. Peter Temin is the Elisha Gray II Professor of Economics at the Massachusetts Institute of Technology in Cambridge. Tanaz Petigara is a research associate at Brigham and Women’s Hospital in Boston.

NOTES

Top Study Methods Study Results Summary And Concluding Remarks Editor's Notes NOTES

 

1. J. Maxwell, P. Temin, and C. Watts, "Corporate Health Care Purchasing among Fortune 500 Firms," Health Affairs (May/June 2001): 181–188.
2. J. Maxwell and P. Temin, "Managed Competition versus Industrial Purchasing among the Fortune 500," Journal of Health Policy, Politics and Law 27, no. 1 (2002): 5–30; and J. Maxwell and S. Zaman, "Health Care at the Crossroads" (Report to the National Association of Manufacturers, September 2002).
3. S.H. Long and M.S. Marquis, "Comparing Employee Health Benefits in the Public and Private Sectors, 1997," Health Affairs (Nov/Dec 1999): 183–193; C. Watts et al., "The Role of Public Employers in a Changing Health Care Market," Health Affairs (Jan/Feb 2003): 173–180; S. O’Laughlin Ward, "What Is Unique about Public Purchasing?" (Washington: National Health Care Purchasing Institute, March 2001); and M. Maciejewski, B. Dowd, and R. Feldman, "How Do States Purchase Health Insurance for Their Own Employees?" Managed Care Quarterly 5, no. 3 (1997): 11–19.[Medline]
4. J. Maxwell et al., "Health Care Purchasing among State Employers" (Report to the Robert Wood Johnson Foundation, March/April 2004).
5. For a complete description of the industrial purchasing model, see Maxwell and Temin, "Managed Competition versus Industrial Purchasing."
6. Maxwell and Zaman, "Health Care at the Crossroads."
7. Maxwell et al., "Corporate Health Care Purchasing among Fortune 500 Firms"; and M.S. Marquis and S.H. Long, 1997 Robert Wood Johnson Foundation Health Insurance Survey/Questionnaire (Washington: RAND, December 1996).
8. B. Strunk, P. Ginsburg, and J. Gabel, "Tracking Health Care Costs: Growth Accelerates Again in 2001," Health Affairs, 25 September 2002, content.healthaffairs.org/cgi/content/abstract/hlthaff.w2.299 (9 December 2003).
9. National Governors Association, "States Face Increased Expenditures for Pharmaceuticals," 3 February 2000, www.nga.org/cda/files/000203PHARM.pdf (16 October 2003).
10. NGA, "The State Fiscal Crisis," 22 February 2003, www.nga.org/nga/legislativeUpdate/1,1169,C_ISSUE_BRIEF^D_5080,00.html (16 October 2003).
11. National Governors Association and National Association of State Budget Officers, The Fiscal Survey of States (Washington: NGA, June 2003).
12. P. Temin and J. Maxwell, "Corporate Contracting for Health Care," Journal of Economic Behavior and Organization 52, no. 3 (2003): 403–420.[CrossRef]
13. Henry J. Kaiser Family Foundation/Health Research and Educational Trust, "Employer Health Benefits: 2002 Annual Survey," 4 September 2002, www.kff.org/insurance/3251.pdf (22 December 2003).
14. L. Benko, "Shake-up in California: Pension Fund’s Decision Could Affect Whole Industry," Modern HealthCare 32, no. 19 (2002): 32; and California Public Employees’ Retirement System, "CalPERS Adopts New 2003 Health Rate Package: 25 Percent Rate Hike, Fewer HMOs, No Reduction in Benefit or Service Area," 17 April 2002, www.calpers.ca.gov/whatsnew/press/2002/0417a.htm (6 January 2004).
15. Allen Feezor, former health benefits administrator, CalPERS, personal communication, 22 October 2002.
16. D. Cutler and S. Reber, "Paying for Health Insurance: The Trade-off between Competition and Adverse Selection," Quarterly Journal of Health Economics 113, no. 2 (1998): 433–466; D. Altman, D. Cutler, and R. Zeckhauser, "Adverse Selection and Adverse Retention," American Economic Review 88, no. 2 (1998); B. Strombom, T. Buchmueller, and P. Feldstein, "Switching Costs, Price Sensitivity, and Health Plan Choice," Journal of Health Economics 21, no. 1 (2002): 89–116; [CrossRef][Web of Science][Medline]T. Buchmueller and P. Feldstein, "The Effect of Price on Switching among Health Plans," Journal of Health Economics 16, no. 2 (1997): 231–247[Medline]; and Dolores Mitchell, executive director, Massachusetts Group Insurance Commission, personal communication, November 2002.
17. S.H. Long and M.S. Marquis, "Comparing Employee Health Benefits in the Public and Private Sectors, 1997," Health Affairs (Nov/Dec 1999): 183–193.
18. Workplace Economics Inc., "State Employee Benefits Survey" (Washington: Workplace Economics Inc., January 2003).
19. L.A. McCormack et al., "Trends in Retiree Health Benefits," Health Affairs (Nov/Dec 2002): 169–176.
20. Governmental Accounting Standards Board, "Governmental Accounting Standards Board Issues Exposure Draft on Other Postemployment Benefits to Increase Transparency," News Release, 20 February 2003; and "Accounting and Financial Reporting by Employers for Postemployment Benefits Other than Pensions, GASB Exposure Draft no. E-55, February 2003.
21. The Leapfrog Group, founded by the Business Roundtable, was created to improve safety and reduce preventable mistakes by giving consumers information to make smart health care choices. It supports the adoption of three proven patient-safety practices to help prevent medical mistakes in hospitals: computerized physician order entry (CPOE) systems, evidence-based hospital referral, and intensive care unit (ICU) physician staffing. For more information, see the Leapfrog Group’s home page, www.leapfroggroup.org.
22. Maxwell and Zaman, "Health Care at the Crossroads."
23. T. Buchmueller, J. DiNardo, and R. Valletta, "Union Effects on Health Insurance Provision and Coverage in the United States," Industrial and Labor Relations Review 55, no. 4 (2002): 610; [CrossRef]K.E. Thorpe and C.S. Florence, "Why Are Workers Uninsured? Employer-Sponsored Health Insurance in 1997," Health Affairs (Mar/Apr 1999): 213–218; and R. Freeman, " The Effects of Unionism on Fringe Benefits," Industrial and Labor Relations Review 34, no. 4 (1981): 489–509.[CrossRef]
24. Mitchell, personal communication.
25. J. Rabin and C. Ornstein, "The California Budget: Cuts Will Be Both Deep and Broad," Los Angeles Times, 11 January 2003.
26. See, for example, Long and Marquis, "Comparing Employee Health Benefits."
27. Ibid.
28. Ibid.
29. Watts et al., "The Role of Public Employers"; and O’Laughlin Ward, "What Is Unique about Public Purchasing?"
30. M. Romney, "Governor’s State Address," 29 January 2003, www.nga.org/governors/1,1169,C_SPEECH^D_4981,00.html (8 December 2003).

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