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MARKETWATCHStanford University’s Experience With Managed Competition
Stanford University has a "managed competition" model of health insurance. Stanford contributes the cost of the low-cost plan, and employees are responsible for premium differences between this plan and other offerings. Each employee gets what he or she wants and is willing to pay for, and everyone has low-cost access to health insurance. Stanford risk-adjusts the premiums based on age and sex and plans soon to adjust including prescription drug data. In the past five years, premiums have risen rapidly, in line with the rest of the market. For competition to transform the delivery system, most employers in the region must adopt managed competition.
In 1991, after several years of double-digit health insurance premium increases and a doubling over five years, Stanford University adopted a "managed competition" model for employees’ health care and health insurance, effective for plan year 1992.1 This meant that the university would offer employees a choice of several different health insurance plans or delivery systems and would contribute a fixed-dollar amount set at or below the price of the low-price plan. The employees could make their choice among the plans and pay the difference in price with pretax dollars. The reasons for the adoption of this type of program were to create incentives for employees to make economical choices and to introduce price competition among insurance carriers/delivery systems. (A key part of the managed competition idea is that insurance plans select or partner with providers and divide the provider community into competing economic units, to create competition at the delivery system level, where most of the value is added. Managed competition thus focuses on comprehensive care networks and encourages delivery system integration.) In managed competition, the consumer pays the full difference in premiums between the low-price plan and the plan of his or her choice, thus directing the consumer toward low-cost delivery systems. In consumer-directed health plans, by contrast, consumers are not directed to less costly delivery systems, because they do not pay the full cost differences generated by their choice of providers once costs exceed their deductibles. Thus, consumer-directed health plans focus on individual acts of care with weak economic incentives to make economical choices. Under its previous policy, Stanford paid the cost of the low-price plan for individual coverage and also contributed a fixed-dollar amount that the employee could use either to pay the full price of the most costly fee-for-service (FFS) coverage for him/herself or as a contribution toward dependent coverage. There were two problems with this policy. First, it made half of the employee group (those not purchasing dependent coverage) cost-unconscious in their choices. Second, it left the university with a large employee contribution to dependent coverage that could induce adverse selection and that did not provide a benefit competitive with those of other employers. In conjunction with adopting the managed competition model, Stanford standardized the coverage contracts, requiring health maintenance organization (HMO) contracts to be virtually identical, while non-HMO contracts could and did offer more cost sharing. The purpose of this was to make comparisons and plan switching easier. Also, some of the nonstandard plan provisions were likely to select risks and segment the market, thus attenuating the price elasticity of demand. In 1994 Stanford implemented a flexible benefits program in which employees could apply pretax savings in health benefit choices to other benefits, including dental care, child care, life insurance, and disability insurance.2
Under the 1992 plan, the university now pays 100 percent of the premium of the low-price plan for individual coverage and 82 percent of the premium of the low-price plan for dependent coverage. The 82 percent represents a balancing of several factors, including maintaining the "take-up rate" for dependent coverage to avoid adverse selection, incentives for economical choice, concern over equity between singles and families, and meeting the market for employees with dependents. In the first few years after the introduction of managed competition, some of Stanford’s premiums actually went down, as aggressive competition among managed care organizations intensified in the mid-1990s. Stanford’s top management at the time understood that this was just the tip of the iceberg. The prize of a reformed health care system seriously competing to improve value for money would elude the university until it could get most of the employers in its market area to do the same thing. Stanford now offers five health care financing and delivery plans. The most costly is a self-funded preferred provider organization (PPO) administered by Blue Shield of California. The main local provider for the PPO is Stanford Health Service (SHS), the university’s academic medical center (AMC). Since SHS withdrew from all per capita prepayment arrangements a few years ago, the PPO has become the only insured route for Stanford faculty and staff to get their primary care from SHS. The cost of the PPO has been pricing SHS out of the university’s market. In response to the competition, SHS has proposed and the benefits office has agreed to offer employees a new exclusive provider organization (EPO), based on SHS, which will be much more affordable than the PPO. (The leadership of Stanford faces competing interests between those of SHS and those of the rest of the faculty and staff. However, they have chosen not to seek to mitigate SHS’ financial problems at the expense of the rest of the faculty and staff.) The next most costly alternative is the point-of-service (POS) plan, also administered by Blue Shield. The basic premise of a POS plan is that there are multiple levels of coverage. The first level, or tier I, resembles an HMO. Tiers II and III are in-network and out-of-network PPO plans, respectively. Originally, tier I at Stanford was a capitated HMO benefit with the Palo Alto Medical Foundation (PAMF) and with SHS, while tiers II and III were a Blue Shield PPO. The PAMF is a 500-doctor multispecialty group practice just across El Camino Real from the Stanford campus. Its predecessor, Palo Alto Clinic, was founded in 1930 and has always had close relationships with Stanford, including a prepaid plan for students in the 1940s, and a similar plan for Stanford faculty and staff in the 1960s.3 When SHS ceased to accept capitated arrangements, it dropped out of tiers I and II of the POS plan. In addition, about two years ago the PAMF decided that it no longer wanted to participate in tier I on a risk-bearing basis in an HMO format. The problem was that patients could demand diagnostic tests with no personal financial cost. In 2005 Stanford will be replacing the POS plan with a PAMF-focused PPO, in which PAMF providers are tier I, and tier II is a nationwide Blue Shield PPO that includes SHS. In tier I, patients will pay substantial coinsurance for all services. Stanford is likely also to offer a consumer-directed health plan. Like the EPO, these products will be self-insured by Stanford. The next two offerings are HealthNet and PacifiCare, two "California delegated model" HMOs whose main local provider is the PAMF, on a capitated basis. Both plans also have provider networks around the San Francisco Bay Area. Finally, and usually least costly, Stanford offers Kaiser Permanente, the prototypical prepaid multispecialty group practice with about 3,600 physicians in Northern California. The nearest Kaiser facilities are about a fifteen-minute drive north and south of the campus. Stanford risk-adjusts the premium differences presented to employees on the basis of age and sex. The university is now securing the data to permit implementation of risk adjustment based on prescription drug data, probably using the DxCG drugs model.4 Stanford employees can access comparative quality information on the HMOs and their contracting medical groups through the Web site of the Pacific Business Group on Health (PBGH, www.pbgh.org), an active and effective leader in quality reporting. Information on quality can make it easier for people to switch to lower-price plans if their measured quality is as good as or better than that of higher-price plans. The PPO is not an accountable delivery system.
In the past five years Stanford’s health insurance premiums have risen rapidly again, pretty much in line with the market in the region. The university’s annual family health insurance premiums and growth are shown in Exhibit 1
HMO penetration at Stanford has always been high, but it increased noticeably in 2004 as the other plans’ relative prices rose substantially. Exhibit 2  shows the market shares for four plans since 2000 and for the PPO since its introduction in 2002, among Stanford employees electing coverage. Typically, 87–88 percent of Stanford employees take up coverage through the university. Those declining coverage are required to state, in their online enrollment, the source of their alternative coverage (for example, spouse’s employer, military, or some other source). These employees then receive an additional $50 taxable benefit each month.
Stanford’s top management likes the managed competition model for several reasons. First, each employee gets what he or she wants and is willing to pay for. Second, this arrangement maximizes competition to provide value for money. As can be seen in Exhibit 2  , 87 percent of Stanford’s group does not value the PPO at what it costs, even in pretax dollars, so it would be a great waste of money if Stanford were to follow the widespread practice of offering only a PPO. In fact, if Stanford were to offer only the PPO, with the same employer contribution policy, health insurance would cost the university an additional $44 million per year, or 74 percent more than it does now. Finally, in this model the university’s contribution is tied to the lowest-cost, least inflationary component of the health care system. At the same time, everyone has low-cost access to health insurance, although the 18 percent employee-paid portion of dependent coverage is beginning to cause some concern among low-paid employees. In general, Stanford’s policy creates strong incentives for economical choices without shifting costs to employees. The continued double-digit growth in the premiums of even the lowest-price plans is a major burden and cause for concern, creating pressure to look for less costly alternatives. It is clear that continuation on the present path is unsustainable. Stanford’s problem is that even the low-price plan faces price-inelastic demand because so many employers pay much more on behalf of more costly than less costly plans. In the Stanford area some employers pay a flat 80 percent, 90 percent, or even 100 percent of the premium of the plan of the employee’s choice. If the employer pays 80 percent of the premium, it is, in effect, imposing an 80 percent tax on efficiency. That is, if a health plan cuts its premium by $100, the employee making the choice will only get $20 of savings before tax and roughly $13 after tax—a greatly attenuated reward for accepting what would probably be a more limited network. Put alternatively, the health plan that makes that price reduction loses $100 of revenue but only gets $13–$20 worth of new customers. Some other employers in the region have adopted managed competition: the University of California, Wells Fargo Bank, Hewlett-Packard, and, of course, the federal and state governments.5 Stanford does not have a good local database on this aspect of employers’ behavior. A national study of the Fortune 500 found that only 9.6 percent of these employers offer choice of carriers and a fixed-dollar contribution to 85 percent or more of their employees.6 It does not appear that California is much better. Thus, these managed competition employers are quite different from most U.S. employers.7 Elsewhere, the conventional wisdom is that consumers don’t want HMOs, that HMOs are not cheaper than PPOs, that integrated delivery does not add value, and that what people want is à la carte consumerism. However, selective HMOs based on group practices do very well in managed competition models even outside California, they do cost less than nonselective PPOs, and integration does add value.8 It remains to be seen whether many Americans will prefer à la carte consumerism if it is offered in competition on a level playing field. Stanford could achieve price-elastic demand for health insurance/delivery plans if all employers in the region adopted the choice of carriers/delivery systems and a fixed-dollar contribution policy. However, the pace of change is so slow, it does not appear likely that there will be enough employer participation in the foreseeable future to create price-elastic demand and to force the plans to compete on value for money, at least not without some unexpected and very decisive intervention by the government. If Congress were to pass a law requiring employers in tax-favored health insurance arrangements to offer employees a choice of selective health insurance/delivery organizations and to make their contribution in the form of a fixed-dollar amount, this situation could improve rapidly.
Stanford’s experience with managed competition has, on the whole, been positive. The university has seen an increased level of competition among our insurance carriers and have seen our employees make cost-conscious health care decisions. Stanford’s management stands firmly behind managed competition going forward as well. However, Stanford will not realize the full value of managed competition until most employers in the area adopt a similar program. As long as many employers continue to offer only a PPO plan or to contribute in a manner that favors the more costly versus the less costly plans, price-elastic demand and true competition among providers will remain elusive.
Alain Enthoven (enthoven{at}stanford.edu) is the Marriner S. Eccles Professor of Public and Private Management (Emeritus), Graduate School of Business, Stanford University, in Stanford, California. Brian Talbott is finance manager, Human Resources, at Stanford.
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