CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

S T U D Y

DECEMBER 2006

Consumer-Directed

Health Plans:

Potential Effects on

Health Care

Spending and

Outcomes

CBO

© Royalty-free/BXP35466/Brand X Pictures
Pub. No. 2585
The Congress of the United States O Congressional Budget Office

CBO

Consumer-Directed Health Plans:

Potential Effects on Health Care

Spending and Outcomes

December 2006

A

STUDY
Note

Numbers in the text, tables, and figures of this report may not add up to totals because of 

rounding.

For ease of exposition, most dollar figures have been converted to 2004 dollars.
Preface

During the past few years, new options for “consumer-directed” health plans have 

attracted considerable interest and debate and have enrolled several million participants. Such 

plans generally combine a high-deductible health insurance policy with a tax-sheltered 

account that enrollees may use to finance their out-of-pocket costs for health care services. 

The central idea behind such designs is that policyholders will remain insured against catastrophic expenses but will be more careful about their use of services than they would be 

under a conventional health insurance plan that provides greater coverage of their initial 

health care costs. Yet at the same time, concerns have been raised that such plans will have 

only a small impact on total health care spending and could adversely affect individuals who 

have high levels of health care costs. 

This Congressional Budget Office (CBO) study—prepared at the request of the Chairman of 

the House Budget Committee—examines in detail the potential effects of consumer-directed 

plan designs, analyzing the impact they might have on the use of health care, the prices and 

quality of health care services, and the health of enrollees. The report also explores the incentives for enrollment in consumer-directed plans and the potential effect of that enrollment on 

markets for health insurance. Because the plans’ designs are so new, there is little empirical evidence about their effects; thus, much uncertainty about their impact remains to be resolved as 

more data about them become available. In keeping with CBO’s mandate to provide objective, impartial analysis, this report contains no recommendations.

Philip Ellis of CBO’s Health and Human Resources Division prepared the study under the 

supervision of Bruce Vavrichek and James Baumgardner, with contributions from Chapin 

White. The analysis benefited from comments by Colin Baker, Matthew Goldberg, Larry 

Ozanne, and Sven Sinclair of CBO; and by Joseph Antos of the American Enterprise Institute, 

Paul Ginsburg of the Center for Studying Health System Change, and Len Nichols of the 

New America Foundation. (The assistance of external reviewers implies no responsibility for 

the final product, which rests solely with CBO.)

Leah Mazade edited the study, and Christine Bogusz proofread it. Maureen Costantino 

designed the cover and prepared the report for publication. Lenny Skutnik printed the initial 

copies, Linda Schimmel handled the report’s distribution, and Simone Thomas produced the 

electronic version for CBO’s Web site (www.cbo.gov). 

Donald B. Marron

Acting Director

December 2006

Contents

Summary ix

1 Introduction and Overview of Consumer-Directed Health Plans 1

Key Features of the U.S. Health Insurance System 2

Designs of Consumer-Directed Health Plans 6

2 Effects of Consumer-Directed Health Plan Designs on 

Incentives to Use Care 15

Comparing Consumer-Directed Designs with a Simple 

High-Deductible Plan 15

Comparing Consumer-Directed Plans with a Conventional 

Insurance Plan 19

Comparing Consumer-Directed Plans with Conventionally

 Designed Managed Care Plans 27

3 Evidence About the Impact of Consumer-Directed Designs on Health 

Care Spending 31

Evidence from the RAND Health Insurance Experiment 31

Estimated Effects of Adding a Tax-Favored Account 38

4 Effects of Consumer-Directed Designs on the Prices, Quality, and 

Outcomes of Health Care 45

Price Setting and Provider Networks 45

The Quality of Health Care 48

Impact of Consumer-Directed Designs on Enrollees’ Health 52
VI CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

5 The Potential for Favorable Selection and Its Effects on Spending and 

Insurance Markets 59

Incentives for Enrolling in a Consumer-Directed Health Plan 59

Impact on Health Care Costs and Insurance Markets 67

6 Preliminary Evidence from Consumer-Directed Health Plans 73

Surveys of Insurers and Enrollees 73

Studies Published in Academic Journals 78
CONTENTS VII

Tables

1-1. Types and Characteristics of Consumer-Directed Health Plans 8

3-1. Basic Results of the RAND Health Insurance Experiment Reflecting 2004

Levels of Spending 33

3-2. Estimated Effect of Cost Sharing on Inpatient Spending 37

5-1. Sources of Health Insurance Coverage and Prevalence of High-Deductible 

Plans Among the Nonelderly Population in 2004 60

5-2. Persistence of Health Care Spending 66

Figures

1-1. Distribution of Employees by Type of Health Plan, Selected Years from

1988 to 2005 4

1-2. U.S. Health Care Spending as a Share of Gross Domestic Product 5

1-3. Share of Personal Health Care Spending Paid Out of Pocket 6

2-1. Comparison of Enrollees’ Annual Out-of-Pocket Costs Under Illustrative 

Plans of Equal Actuarial Value 21

2-2. Distribution of Individuals in Each Range of Health Care Spending, 2004 23

2-3. Distribution of Annual Health Care Spending, 2004 26

2-4. Distribution of Health Care Spending by Spending Range, 2004 27

5-1. Distribution of Deductibles for Enrollees in Preferred Provider

Organization Plans, 2005 63

Boxes

2-1. Could Tax-Free Out-of-Pocket Costs Reduce Health Care Spending? 18

4-1. Administrative Costs 46

4-2. What Is Health Care Quality? 50

Summary

In the past few years, new health insurance options 

known as consumer-directed health plans have attracted 

considerable interest and debate and have enrolled several 

million participants. Such plans generally combine a 

high-deductible health insurance policy with a tax-sheltered account that enrollees can use to finance their 

“out-of-pocket” health care costs (those not covered by 

the policy). The central idea behind such designs is that 

policyholders will remain insured against catastrophic expenses—but will also be more careful about using health 

care services because they will have to pay a much larger 

share of their initial costs. (Conventional health insurance plans, by contrast, have much lower deductibles and 

thus cover a larger percentage of enrollees’ initial expenses.) Depending on how enrollees in consumerdirected plans responded to those incentives, the end result could be a lower level of spending to achieve the same 

improvements in health or possibly better health at the 

same level of spending. Either outcome would represent 

an increase in the efficiency of the health care sector. 

This Congressional Budget Office (CBO) study examines 

in detail the key features of consumer-directed health 

plans, analyzing the impact they might have on the use of 

health care, assessing their potential effects on the prices 

and quality of health care services, and exploring the incentives for enrollment in consumer-directed plans. Critics of such plans have argued that they will be most attractive to healthy individuals and that they can influence 

only a small share of the nation’s overall spending for 

health care. Those critics also raise the concern that 

consumer-directed plans will leave people who have 

higher health care costs worse off financially and could 

even result in adverse effects on their health. This study 

considers those arguments as well, reviewing both the 

principles involved and the available evidence. 

Key Features of the U.S. Health 

Insurance System and ConsumerDirected Plans

Two features of the U.S. health care system—rapidly rising costs and the favorable tax treatment of health insurance policies that are purchased through an employer—

have shaped the development and design of consumerdirected health plans.

Rising Health Care Costs

Consumer-directed plans represent the latest step in efforts to restructure health insurance coverage to help control spending for health care services in the United States. 

In the late 1980s and early 1990s, health care costs grew 

rapidly; in response, private insurance coverage shifted 

from “indemnity” policies—which had largely reimbursed enrollees for the costs of whatever services 

they and their doctors chose to use—toward various 

forms of managed care. Those forms included: 

B Preferred provider organization (PPO) plans, which 

encourage enrollees to use a particular network of doctors and hospitals by offering lower levels of cost sharing for network services (and which negotiate lower 

payment rates with those providers in return); and 

B More stringently managed plans, such as health maintenance organizations (HMOs), which offer relatively 

low levels of cost sharing within their network of providers but little or no coverage outside of it and which 

use various other measures to limit the provision of 

services. 

The spread of managed care plans played a large role in 

controlling health care costs in the United States during 

the 1990s: total spending for health care between 1993 

and 2000 held nearly constant at about 13.8 percent of 

the nation’s gross domestic product (GDP).
X CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

By the end of the 1990s, however, many consumers and 

providers had come to oppose the restrictions imposed by 

HMOs, and the plans began to relax those restrictions as 

enrollment in more loosely managed PPO plans grew. 

(PPO plans now enroll about 60 percent of individuals 

who receive health care coverage through their employer.) 

At the same time, private health care spending also increased: between 2000 and 2004, that spending rose at an 

average annual rate of 8.4 percent, and health care’s overall share of GDP grew to 16 percent. That share is now 

projected to reach 20 percent by 2015. Not surprisingly, 

purchasers of health insurance have looked for new ways 

to help control those costs.

Favorable Tax Treatment

The other feature of the U.S. health care system that lies 

behind the development of consumer-directed health 

plan designs is the tax advantage provided for insurance 

that is purchased through an employer. Employersponsored coverage is the primary source of health insurance in the United States; in 2004, it insured about 

165 million lives, or about two-thirds of the people who 

were not enrolled in Medicare. Like wages and salaries, 

the costs of providing that coverage are a form of compensation for employees and thus a tax-deductible business expense for employers. But unlike most other forms 

of compensation, the costs of health insurance are excluded from policyholders’ taxable income—and therefore avoid all income and payroll taxes.

For a typical worker, that difference in tax treatment 

amounts to a subsidy for insured costs of more than 

30 percent (which reflects both income taxes and the employer’s and employee’s portions of payroll taxes). By contrast, out-of-pocket payments for health care have generally not received favorable tax treatment. The result has 

been to encourage firms to provide more-extensive health 

insurance policies for their workers—increasing the share 

of costs that are covered and decreasing the share that employees must pay for services—trends that in turn have 

driven up total health care spending. Estimates of the response vary by the type of service that is involved—and 

largely reflect the experience of indemnity insurance 

plans—but overall, a reduction of 10 percent in the share 

of costs that enrollees must pay would tend to increase 

their total spending by 1 percent to 2 percent.

To offset that tendency, consumer-directed plans incorporate a key innovation: the accounts that they include, 

which can be used to pay some out-of-pocket health care 

costs with tax-free funds. That new tax advantage goes a 

long way toward “leveling the playing field” between insured and out-of-pocket costs. The option of combining 

a tax-free account with a high-deductible health plan first 

became available in the mid-1990s, when policymakers 

authorized so-called medical savings accounts for purchase by small employers, self-employed individuals, and 

Medicare enrollees. But few people enrolled in those 

plans, in part because the legislation limited the total 

number of policies that could be purchased and because 

the authorization to sell new policies was temporary.

Current Plan Designs

Consumer-directed health plans now come in two basic 

forms: health savings accounts (HSAs) and health reimbursement arrangements (HRAs). HSAs, which were 

authorized by legislation enacted in late 2003, may be established by an individual or an employer as long as they 

are paired with a high-deductible health insurance policy. 

They have the following key features.

B In 2006, the minimum deductible such a policy must 

have is $1,050 for individual coverage or $2,100 for 

family coverage. 

B Contributions to the accounts may come from policyholders, their employers, or both; however, they are 

subject to an overall annual limit—in 2006, generally 

the lesser of the policy’s deductible or $2,700 for individuals or $5,450 for families. The recently passed Tax 

Relief and Health Care Act of 2006 allows contributions to HSAs to exceed the deductible beginning in 

2007.

B Money contributed to the accounts is not subject to 

income taxes and may avoid payroll taxes; funds withdrawn to pay for health care expenses are never taxed. 

Elderly and disabled individuals who have an account 

and who enroll in Medicare may withdraw funds from 

their account but may not make further contributions 

to it. 

B Policyholders may withdraw funds from their account 

to pay for items and services that are unrelated to 

health care, but they incur income taxes on that 

money and must pay an early-withdrawal penalty of 

10 percent if they are under the age of 65.
SUMMARY XI

B Any contributions that an account holder does not use 

in a particular year may be rolled over indefinitely, and 

account balances are portable from job to job and into 

retirement.

Health reimbursement arrangements were formally authorized by the Internal Revenue Service in 2002 and are 

similar to HSAs in many respects. They typically feature a 

high-deductible health insurance policy as well as an account that may be used to pay out-of-pocket costs with 

untaxed funds. However, they impose fewer constraints 

on the design of the insurance policy and more restrictions on the use of funds in the account. In particular, 

only employers may establish and contribute to the accounts, and policyholders may withdraw funds only to 

pay for health care. Moreover, some rollovers of account 

balances are capped, and employees generally forfeit any 

balance they have built up if they change jobs. (Flexible 

spending accounts are similar to HRAs in some respects—and are more commonly held—but the annual 

contributions are set by employees, come directly out of 

their salaries, and do not roll over if they remain unspent.)

Because consumer-directed plans have arisen fairly recently, information about enrollment in them and about 

the specific features of the policies that enrollees have 

chosen is somewhat limited. The number of individuals 

who are covered by high-deductible policies that meet the 

requirements for HSA plans exceeded 1 million in March 

2005 and by January 2006 had grown to more than 

3 million, but it is not clear how many of those policyholders have established an account as well. Enrollment 

in HRAs in January 2006 was estimated at 2.9 million. 

Among all types of consumer-directed plans offered by 

employers in 2006, deductibles were estimated to average 

about $1,750 for individuals and $3,500 for families (deductibles for HSAs purchased in the individual insurance 

market were higher); contributions to the accounts by 

employers were estimated to average about $750 and 

$1,350 per year, respectively. Surveys of private employers 

indicate that more of them intend to offer consumerdirected health plans in the future, and in early 2006, the 

Department of the Treasury projected (on the basis of 

prevailing law) that total enrollment in HSAs would 

reach 14 million by 2010.

Questions for the Study

The fact that consumer-directed designs are so new also 

means that little direct evidence is available about their 

actual effects, and it is unclear how popular they will ultimately become. Nevertheless, their potential impact on 

health care utilization and spending has evoked interest 

in many quarters. This study reviews that evidence as well 

as studies of similar insurance plans in an effort to answer 

three broad questions. 

B First, how do consumer-directed designs affect enrollees’ incentives to use health care, and what impact 

would those incentives have on health care spending if 

enrollment in consumer-directed plans was representative of the nonelderly population as a whole (that is, 

if the same mix of healthier and sicker individuals enrolled in those plans)? 

B Second, what impact might consumer-directed plans 

have on the prices of health care services, the availability and use of information about the benefits and 

quality of the care provided, and the health of their 

enrollees? 

B Third, to what extent is initial enrollment in 

consumer-directed plans likely to be concentrated 

among lower-cost, generally healthier individuals, and 

what would the short- and long-term implications be 

in that case for insurance markets and overall health 

care spending? 

Effects of Consumer-Directed Plans on 

Incentives to Use Health Care

How consumer-directed plans affected their enrollees’ use 

of health care would depend primarily on how those enrollees responded to the two key features of such plans: 

the high-deductible insurance policy and the tax-free 

account funds. The decades-old RAND Health Insurance 

Experiment provides the best available evidence about 

how a high-deductible design would reduce total spending for a broadly representative set of enrollees. But the 

effects of switching from a conventional plan to a comparable consumer-directed design may be smaller—in part 

because some of the savings seen in the RAND experiment have probably been captured by features of current 

managed care plans. 

Incentives to Limit Spending

Both HSAs and HRAs provide incentives for enrollees to 

limit their health care spending. The high deductibles 

and rollovers of unused account balances that those plans 

feature are designed to encourage enrollees to be more 
XII CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

careful about their use of health care. If enrollees use 

fewer services (or less expensive ones) before they reach 

their deductible, they get to keep most if not all of the resulting savings. Compared with deductibles in consumerdirected plans, those in conventional health care plans—

the types of private health plans in which most people are 

currently enrolled—are generally much lower; in 2005, 

for example, they averaged about $300 for individual 

coverage and $700 for family coverage under PPO plans. 

Enrollees in consumer-directed plans must thus consider 

whether the benefits of the services they receive exceed 

the total cost of those services—that is, whether the care 

is cost-effective—over a much larger range of spending. 

(The greater role envisioned for policyholders in deciding 

what care to get and where to get it is the primary basis 

for calling such plans consumer directed.) 

At the same time, the provisions for tax-free accounts and 

for contributions by employers to those accounts make it 

easier for enrollees to cover their out-of-pocket costs. Indeed, the contributions to the accounts could be set so 

that consumer-directed plans had the same value on average as current conventional health plans—that is, costs 

would be the same under both designs for covering a representative set of medical claims. (Whether that equivalence is being maintained in practice when employers offer consumer-directed plans is not clear.) Yet those 

provisions might also encourage enrollees to be less careful about their spending, at least in comparison to a highdeductible health plan by itself, because they would tend 

to reduce the costs of services to enrollees. The net effect 

that consumer-directed designs will have on the use of 

health care thus depends on the strength of those competing pressures—the incentives to limit spending that 

arise from the high-deductible design versus the inducement to spend tax-free funds and employers’ contributions to the accounts. 

To analyze those effects, it is most useful to compare 

consumer-directed and conventional health plans that 

have equal overall value. Otherwise, some of the difference in spending will simply reflect the difference in the 

values of the plans. Comparing plans of equal value also 

creates a trade-off: if both types of plan included annual 

limits on out-of-pocket costs, enrollees in consumerdirected plans would reach those limits more quickly because they would pay a larger share of their initial costs, 

whereas enrollees in conventional plans would generally 

continue to face some cost sharing at higher levels of total 

spending. That difference could affect the comparison of 

spending because most health care costs are incurred by a 

relatively small percentage of individuals who use the 

most expensive services.

Results of the RAND Health Insurance Experiment 

and Other Evidence

A primary source of information about the impact of cost 

sharing on the use of health care services remains the 

RAND Health Insurance Experiment, whose findings indicated that shifting from a plan with a conventional indemnity design to one with a high deductible would decrease enrollees’ use of services and spending by about 

5 percent. That study, which was conducted from 1974 

to 1982, randomly assigned many nonelderly individuals 

and families to different insurance plan designs—including one under which all care was free to participants and 

one that mimicked a high-deductible plan. The results 

thus reflect what would happen if enrollment in each design was representative of the nonelderly population. The 

RAND experiment found that the largest impact on total 

costs, compared with those under the free-care plan, 

came from simply introducing a relatively modest 

deductible or coinsurance payment. But the study also 

showed that a high-deductible design could reduce 

spending further—and indicated that part of the likely 

savings stemmed from avoiding some expensive hospitalizations whose costs would have exceeded the deductible. 

Moreover, a high-deductible design could reduce total 

spending even though its enrollees would reach the limit 

on out-of-pocket costs at a lower level of total spending 

than would be the case in a conventional plan.

Yet representative enrollment in consumer-directed 

health plans might have a smaller net effect on enrollees’ 

health care expenditures than the results of the RAND 

study would suggest—at least in the short run—for several reasons.

B Tax-Favored Expenditures. The first reason that the effect might be smaller is that participants in the RAND 

experiment paid their out-of-pocket costs with aftertax dollars, whereas enrollees in consumer-directed 

plans (particularly those in HSAs) may use untaxed 

funds from their account. The tax subsidy that those 

funds receive lowers the effective prices that enrollees 

face for their health care services (compared with the 

prices they would face under a high-deductible plan 

by itself) and thus reduces their incentive to spend 

their account funds carefully—because they must balance the benefits of their care against only a portion of 
SUMMARY XIII

its costs. For a typical worker, the effective subsidy 

would be as much as 25 percent (reflecting income 

taxes and the employee’s portion of payroll taxes but 

not the employer’s portion). In the longer term, an 

offsetting pressure would emerge: giving advantageous 

tax treatment to out-of-pocket spending would encourage enrollees in consumer-directed plans to shift 

toward policies with even higher deductibles (and 

lower premiums). Whether the reduction in total 

spending that resulted from that shift would ultimately be large enough to offset the initial impact of 

the tax subsidy for out-of-pocket costs is uncertain.

B Employers’ Contributions. The second reason relates to 

the way that employers’ contributions are treated. The 

health plans being compared in the RAND experiment were not of equal value. Adding employers’ account contributions to the high-deductible plan 

would bring its value up to the level of the conventional plan’s, but it might also reduce the design’s impact on the use of services. In the case of HSAs, 

enrollees would still have a strong financial incentive 

to treat those funds like cash and thus limit their 

spending. In the case of HRAs, however, the limitations on the use and portability of balances in the accounts would probably lead some enrollees to treat 

those funds less like cash and more like a free 

resource—particularly if they did not expect to exhaust their account. As a result, the impact of a highdeductible policy on enrollees’ financial incentives 

would be muted. 

B Plan Management. Third, the RAND study showed 

how a high deductible in an indemnity insurance policy could reduce health care spending, but some of 

those savings have already been captured by more 

tightly managed health care plans. The American 

Academy of Actuaries estimated that a consumerdirected plan would reduce enrollees’ health care 

spending by 2 percent to 5 percent relative to spending under a conventional PPO plan of equal value. 

The RAND study itself also found that an HMO plan 

that offered free care to enrollees was about as effective 

as a high-deductible design in controlling total health 

care costs. And in other work, CBO estimated that an 

HMO plan’s costs would, on average, be about 10 percent lower than a PPO plan’s to deliver a comparable 

package of benefits. Taken together, those findings 

imply that representative enrollment in consumerdirected plans might ultimately lower health care 

spending under the plans by about 5 percent relative 

to spending under conventionally designed PPO 

plans—but it might not lower spending relative to 

HMOs, and could raise it.

The preliminary evidence available about how actual 

consumer-directed plans affect health care costs is of limited use in resolving those areas of uncertainty—and 

given the limitations of that evidence, it should be treated 

cautiously. Some studies have reported large cost savings 

from consumer-directed plans, but those results may represent reduced costs for the insurer and not the impact on 

total health care spending for enrollees. Even when the 

focus is on total expenditures, the savings that are reported may still reflect the impact of reducing the overall 

value of the coverage (or other factors) and not just 

the effect of changing its design. In particular, comparisons of expenditures under actual consumer-directed and 

conventional plans need to account for potential differences between their enrollees that could affect the results 

(as discussed later). More data about the impact of 

consumer-directed plans on the use of health care services 

should become available over time, as experience with 

them grows. 

Effects of Consumer-Directed 

Plans on Health Care Prices, 

Quality, and Outcomes

In addition to affecting the quantity of health care services that are used, consumer-directed plans could have 

an impact on the prices of those services, on the quality of 

the care that is delivered, and on the health of their enrollees. Some proponents argue that the heightened focus 

on the costs and benefits of care under consumer-directed 

designs will transform the health care system, yielding not 

only lower prices—either through direct negotiations between enrollees and providers or competitive pressures on 

providers—but also substantial improvements in quality. 

A key question, though, is how effective the collective efforts of individual enrollees would be in achieving those 

objectives relative to the actions of health insurers. Meanwhile, critics charge that consumer-directed plans will 

discourage enrollees from getting needed care and thus 

will adversely affect their health—but there appears to be 

little empirical evidence to support that view. 
XIV CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Price Competition and Assessment of Quality

Some advocates of consumer-directed plans maintain that 

enrollees should bargain directly with doctors and hospitals over the prices of the services they receive. Yet even if 

they took the prices as a given, enrollees in consumerdirected plans would have an incentive to “shop around” 

for the best value, which might encourage more price 

competition among providers. Proponents of consumerdirected plans concede that such efforts might not be feasible for some services (such as emergency care) but believe they could play a useful role in less urgent or more 

discretionary cases. The participants in the RAND experiment who faced substantial cost sharing also had a reason to seek out lower-priced providers. But the study involved only a few thousand enrollees, so it would have 

been unable to capture any systematic pressure to compare or reduce prices. If such pressures arose, the impact 

of consumer-directed plans on health care spending 

might thus be greater than the RAND study’s estimates 

have indicated. 

Whether consumer-directed designs could generate savings by reducing prices depends in part on how effective 

the current efforts of conventional insurers are. Reimbursement of costs by third parties (that is, insurers) 

weakens the incentives for enrollees to bargain over prices 

or seek out lower-cost providers. However, those thirdparty payers have correspondingly strong incentives to do 

both—so as to control their own costs and remain competitive in the insurance market—and might also be better positioned than individuals would be to negotiate 

price discounts from doctors and hospitals. As a result, 

enrollees will probably prefer to contract out those tasks 

to their health insurance plan. Consistent with that assessment, it appears that nearly all consumer-directed 

health plans that are currently being offered feature preferred provider networks and plan-negotiated payment 

rates, so they may not differ substantially from conventional PPO plans on that dimension. 

In choosing what care to get and where to get it, individuals consider more than just the costs involved, and both 

advocates and critics of consumer-directed health plans 

generally agree that enrollees will need better information 

about the benefits of different treatments and the quality 

of different providers. The limited information currently 

available on both the prices and quality of health care services represents a substantial obstacle to encouraging 

more cost-effective use of services, regardless of the nature 

of an insurance plan’s design. Broader changes in the 

health care system that might facilitate the assessment of 

providers’ quality could make it easier for enrollees in 

consumer-directed plans to evaluate their treatment options (although some enrollees might still find that task 

difficult). At the same time, such changes would also help 

conventional health plans determine which treatments to 

cover, which providers to include in their networks, and 

how to reward them for delivering better care. It is thus 

difficult to predict how improved information about the 

quality of health care services might affect the comparison of total spending under consumer-directed and conventional insurance plans. 

Health Outcomes

A common concern about attempts to control health care 

costs—whether through higher levels of cost sharing to 

discourage demand or the efforts of managed care plans 

to limit the supply of services—is that lower spending 

might mean worse health for enrollees. On that issue as 

well, the RAND study remains the best source of empirical evidence. It directly measured participants’ health in a 

number of ways and in general found no statistically significant differences between those who received free care 

and those who faced cost sharing. The only substantial 

discrepancy between the two occurred among lowincome enrollees who were in the poorest health to 

begin with; within that subgroup, enrollees who received 

free care controlled their blood pressure more effectively 

than those who faced cost sharing, resulting in a small 

but statistically meaningful difference in their estimated 

probabilities of dying. That finding has been central to 

critiques of plans with consumer-directed designs. 

The possibility that consumer-directed plans will have 

adverse effects on the health of their enrollees cannot be 

ruled out entirely, but for two reasons, that finding from 

the RAND study may not apply.

B When the RAND researchers compared results only 

from plans that required cost sharing—which are 

more relevant than the results from the free-care plan 

to the comparison of consumer-directed and conventional designs—they found no differences in health 

for any group.
SUMMARY XV

B They also estimated that most of the gains that free 

care yielded in the treatment of hypertension could 

be reaped from a one-time screening exam—the kind 

of preventive service that consumer-directed plans 

are permitted to cover before enrollees meet their 

deductible. 

Whether reductions in the use of services have adverse 

effects on health is also difficult to determine.The RAND 

analysts found that cost sharing led participants to forgo 

some treatments that would have had positive medical 

benefits, but they also concluded that cost sharing discouraged the use of some services that were actually 

harmful. Recent surveys indicate that enrollees in 

consumer-directed health plans are more likely than enrollees in conventional plans to avoid or delay getting 

treatments, which raises the concern that their health 

could be adversely affected. If the services that were forgone had benefits that did not exceed their costs, however, any adverse impact on health would be relatively 

small—smaller than the change in their spending for 

health care. 

The Potential for Favorable Selection 

and Its Effects on Spending and 

Insurance Markets

The impact of consumer-directed health plans on enrollees’ incentives to use services and on their spending for 

health care depends to a great degree on who actually 

chooses to enroll in those plans. If the initial enrollees 

had lower health care costs to begin with or were healthier than the average person—that is, if consumer-directed 

plans experienced “favorable selection”—then the change 

in those enrollees’ incentives would be modest, and 

health care spending might remain largely unaffected. 

The same would be true if enrollees in consumer-directed 

plans had previously held high-deductible health insurance policies. Over time, however, favorable selection in 

consumer-directed plans might have broader effects on 

insurance markets. If enrollment in such plans became 

more representative of the population as a result, the reduction in health care spending would be greater (along 

the lines outlined above). But the extent to which such 

selection is occurring in the first place is not yet clear. 

Initial Enrollees

A key determinant of enrollment in consumer-directed 

health plans will be whether individuals would gain or 

lose financially—compared with their current situation—

under those plans. That calculation depends partly on the 

extent of their existing insurance coverage and partly on 

their expected health care costs. Those factors will also 

affect whether employers decide to offer a consumerdirected plan and whether they add it as an option for 

employees or instead convert all of their coverage to that 

design. 

Among individuals who had conventional coverage 

through their employer, those whose health care spending 

was low would generally save money by switching to a 

comparable consumer-directed plan because they could 

use their employer’s contribution to their account to 

cover their medical costs and then save any balance that 

remained. Individuals whose health care spending was 

moderately high, however, would probably see their outof-pocket costs increase under a consumer-directed plan 

because of its higher deductible. Thus, the same features 

of consumer-directed plans that encourage enrollees to be 

prudent in their use of services—the high-deductible and 

control over account funds—also generate pressures for 

favorable selection in those plans, raising a potential 

trade-off. For enrollees who had the highest levels of 

health care spending, the impact of switching plans is not 

clear. (It would depend on the out-of-pocket limit in each 

plan and the extent to which enrollees in a consumerdirected plan could use employers’ contributions and 

other untaxed funds to cover their costs.) Even so, if individuals could predict their future health care costs with 

certainty, the extent of favorable selection in consumerdirected plans might be substantial. 

Individuals who were choosing a health insurance plan 

could not be certain about their future health care costs, 

of course, but the available data indicate a correlation 

between past and future spending that could inform their 

decision. That is, people who have low levels of health 

care costs in one year tend to have similarly low costs the 

next year; high levels of costs also tend to persist. For example, about 50 percent of the insured nonelderly population had total spending for health care that was below 

$1,000 in 2003, and their median spending in the following year (2004) was about $300. Conversely, about 

35 percent of the insured nonelderly population had total 

health care costs that were between $1,000 and $5,000 in 

2003, and median spending for those individuals in 2004 

was about $1,300. Although expected health care spending may differ among individuals for a number of reasons 

(including their preferences about receiving care and the 
XVI CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

practice styles of local providers), as a group, individuals 

who have lower costs tend to be healthier than those who 

have higher costs.

Other considerations that would affect whether individuals with employer-based coverage opted to enroll in a 

consumer-directed or a conventional plan include the following factors. 

B Access to Providers. People who had more problems 

with their health would find it easier to pay for outof-network care (or uncovered services) under a 

consumer-directed plan than under a conventional 

plan because they could use the funds in their policy’s 

associated account to do so. However, they would 

have to balance that gain against the higher out-ofpocket costs that they would face for the care they received within the plan’s network.

B Premium Subsidies. If an employer did not offer a 

consumer-directed plan, employees could still purchase an HSA in the individual market. In that case, 

however, they would forgo any subsidy from their employer for their health insurance premiums; moreover, 

under current law, their HSA premiums would not receive favorable tax treatment, and any contributions 

they made to their accounts would still be subject to 

payroll taxes.

Interest in consumer-directed plans would also vary 

among individuals who did not have employer-based coverage. Among those who purchased their primary insurance policies in the individual market—about 10 million 

people in 2004, CBO estimates—about half have deductibles that are high enough to meet the legal requirements 

for an HSA and thus would find it attractive to convert 

their coverage (to take advantage of the favorable new tax 

treatment for out-of-pocket costs). People who are uninsured may find their interest in consumer-directed 

health plans limited by the same factors that have made 

them unwilling or unable to purchase coverage previously—even when lower-cost, high-deductible plans were 

available to them. Preliminary data suggest that about 

one-third of people who purchase HSAs in the individual 

market were previously uninsured, and those policies represent about 10 percent of all HSAs held. However, the 

net effect on the uninsured population of making HSAs 

available is uncertain, in part because some of those purchasers would probably have obtained other coverage in 

the absence of an HSA option.

Overall, some degree of favorable selection in consumerdirected plans seems likely—because the financial incentives to choose that design are much clearer for lowercost, generally healthier individuals—but the available evidence about whether and to what extent such selection is 

occurring is mixed or ambiguous. For example, some reports have compared the age of enrollees in consumerdirected versus conventional plans. Given the wide variation in health care spending within age groups, however, 

such data may reveal little about differences in their 

underlying health. Academic studies of actual consumerdirected plans and surveys of their enrollees have yielded 

conflicting evidence: the results of some investigations 

show favorable selection, and the results of others indicate that the health status of enrollees in consumerdirected and in conventional plans is comparable. But 

the academic studies have limitations, and the respondents to enrollee surveys may themselves not be representative of the population of enrollees in those plans. Consequently, that evidence should be treated cautiously. 

Dynamics of Health Insurance Markets

Over the longer term, a tendency for lower-cost, healthier 

individuals to enroll in consumer-directed plans would 

leave more-expensive enrollees in conventional health 

plans, putting upward pressure on those plans’ premiums. 

By itself, that development would not have a large impact 

on health care spending, although it would probably 

leave enrollees in those conventional plans moderately 

worse off financially. But rising premiums would also 

reinforce the incentive to switch to consumer-directed 

plans—which, some analysts argue, could induce a selection spiral that would eventually drive loosely managed 

conventional plans out of the market. If such a spiral 

occurred, it would yield the kind of broad enrollment in 

consumer-directed plans necessary to reduce overall levels 

of health care spending, but it would probably also mean 

that individuals who were sicker and who had higher 

costs would have to pay somewhat more for their care. In 

part, the increased financial burden would fall on individuals who chose a more expensive treatment for their condition. The extent to which those individuals would be 

worse off financially would depend on several other factors as well, including how persistent their health care 

spending was over a long period. 

At this point, it is too early to tell whether total enrollment in consumer-directed health plans—and the extent 

of any favorable selection in those plans—will be large 

enough to have substantial effects on insurance markets. 
SUMMARY XVII

If enrollment in the plans grows, employers that offer a 

choice of plan designs may take steps to counter selection 

pressures—for example, by restricting the variation in enrollees’ premiums or by limiting the firms’ contributions 

to employees’ associated accounts. (Employers would 

have financial incentives to take such steps because favorable selection in consumer-directed plans could raise their 

costs, at least initially.) The fact that indemnity insurance 

plans were largely forced out of the market by HMOs 

and PPOs indicates that selection spirals can occur. At the 

same time, the continued presence of HMOs—which 

also tend to attract lower-cost, healthier enrollees—and 

PPOs in the same markets suggests that some form of coexistence between consumer-directed and conventional 

plans will also be feasible.

CHAPTER

1

Introduction and Overview of 

Consumer-Directed Health Plans

In the past few years, new health insurance options 

known as consumer-directed health plans have provoked 

substantial interest and debate. Such plans generally combine a health insurance policy that has a high deductible 

with a tax-sheltered account that enrollees may use to 

finance at least a portion of their out-of-pocket costs. By 

contrast, conventional health plans—the type that most 

people with private insurance currently have—cover 

more of their enrollees’ initial spending. Advocates of 

consumer-directed plans see them as a broadly attractive 

option that both protects policyholders from catastrophic 

losses and gives them stronger incentives to balance the 

benefits of health care services against their total costs. 

Depending on people’s responses to those incentives, it is 

argued, widespread adoption of consumer-directed plans 

could yield either the same improvements in health that 

conventional plans provide but at a lower level of health 

care spending—or better health at the same level of 

spending. Either outcome would represent an increase in 

the efficiency of the health sector.

Some observers, however, have raised concerns about 

consumer-directed health plans. They maintain that such 

arrangements will be most attractive to healthier individuals, whose health care costs are usually low, and that the 

plans’ design will have little effect on the incentives that 

face individuals with high health care costs—because 

their total spending will exceed even a very high deductible. Either way, critics argue, the impact of the plans on 

total U.S. health care spending would probably be small. 

At the same time, critics charge that consumer-directed 

plan designs will leave sicker, higher-cost individuals 

worse off financially and could have an adverse effect on 

their health. Advocates of consumer-directed plans see 

them as giving enrollees greater control over their own 

health care, but critics caution that many individuals may 

have difficulty weighing the costs and benefits of their 

treatment options. 

This Congressional Budget Office (CBO) study seeks to 

examine those propositions. A major challenge, however, 

in assessing how consumer-directed designs might affect 

spending for health care or the health of enrollees is that 

little empirical evidence is available—simply because 

those types of plans are so new. As a result, this study 

focuses first on the principles involved in their design 

and the key differences between the two main types of 

consumer-directed plans: health reimbursement arrangements and health savings accounts. It then compares 

those plans with more-conventional policy designs and 

reviews the available evidence—drawn largely from older 

studies—about the likely impact that widespread conversion to consumer-directed plans would have on health 

care spending and health outcomes. The study also considers whether individuals who have low health care costs 

will be more likely than people who have higher costs to 

switch their coverage and the implications for health 

spending and insurance markets in that case. In addition, the study examines other ways in which consumerdirected designs might alter spending for health care and 

its efficiency, whether by affecting the prices that are paid 

for services or by focusing more attention on the benefits 

and quality of care.

Finally, the study reviews the limited data available on the 

experience of actual consumer-directed plans. Substantial 

caution is warranted, however, in drawing conclusions 

based on such preliminary data about the impact of those 

plans on health care spending or other measures. CBO’s 

analysis does not address other aspects of consumerdirected health plans, such as their effect on tax revenues 

or the impact that their associated accounts might have 

on savings for retirement.
2 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Key Features of the U.S. Health 

Insurance System

To see how the introduction of consumer-directed plan 

designs could affect enrollees’ incentives and outcomes, it 

is useful to review the basic role of health insurance and 

the key features of the U.S. system.

Factors That Affect the Choice of Health Insurance

Most individuals face some uncertainty about the future 

state of their health—and in particular run a relatively 

small risk that they will need very expensive care. To protect themselves against that financial risk, they usually 

seek health insurance. Typically, they pay a premium for 

it, either directly or through a reduction in their wages, 

and thus accept lower but certain net income in exchange 

for less variability in their well-being.1 The extent of the 

coverage they choose will reflect a trade-off between the 

risk of pecuniary loss that they face (which generally 

declines as the share of costs paid by their insurance policy increases) and the premium they must pay (which 

rises as that coverage becomes more comprehensive). 

Indeed, individuals might like to be completely 

insured—that is, share none of the costs for the health 

services they receive—but the fact that they have coverage 

gives rise to what economists call moral hazard. That 

term seeks to capture the phenomenon that in deciding 

whether to seek treatment or how much care to get, people who are insured are apt to use more of those services 

than they would if they had to pay the services’ full costs. 

In other words, the presence of insurance protection 

makes it more likely that the services covered by insurance will be used and that they will be used to a greater 

extent.

To offset that tendency toward increased use, health 

insurance policies typically feature some degree of cost 

sharing by enrollees—in the form of deductibles, coinsurance, or copayments—at least for more routine or discretionary health care services.2

 Even then, some moral hazard will be evident because enrollees will continue to seek 

care as long as its benefits exceed the portion of the costs 

that they have to pay. Estimates of the response vary by 

the type of service that is involved—and largely reflect 

the experience of older insurance designs—but overall, a 

reduction of 10 percent in the share of costs that enrollees 

must pay would tend to increase their total spending by 

1 percent to 2 percent. (Enrollees would also take into 

account such costs as the time involved in getting treatment.) The optimal policy design for any given individual must thus balance the gains in reduced risk from 

insurance protection against the costs induced by moral 

hazard. 

An additional consideration in the U.S. health care system has long been that insurance purchased through an 

employer receives favorable treatment under the tax code. 

Employer-sponsored policies are the primary source of 

health insurance in the United States, covering about 

165 million people (including dependents) in 2004, or 

about two-thirds of those not enrolled in Medicare. 

Employers may deduct the costs of providing that coverage as a business expense (just as they deduct employees’ 

wages and other forms of compensation), and thus those 

payments avoid corporate taxes on profits. But unlike 

wages, the costs that employers pay for health insurance 

are excluded from the taxable income of the policyholders. As a result, that portion of employees’ compensation avoids individual income and payroll taxes as well. 1. Employers that offer health insurance coverage may nominally pay 

most or all of its costs, but those costs are ultimately borne by 

workers as a group through reduced wages. Firms generally compete for workers on the basis of the total compensation that they 

offer—wages plus fringe benefits—and the preferences of workers 

largely determine how that compensation is divided between cash 

and other forms. All else being equal, workers at firms that do not 

offer subsidized health insurance coverage must be paid higher 

cash wages (or given other offsetting benefits) compared with similar workers who receive such a subsidy. 

2. A deductible is an amount of spending that enrollees must incur 

before their insurance policy begins to pay for services; coinsurance is the share of charges (for example, 20 percent) that enrollees must pay for the services they receive after the policy’s 

deductible has been met; and a copayment is a fixed dollar 

amount that enrollees must pay for a given type of service (for 

example, $50 for any emergency room visit), which does not vary 

with the service’s actual cost. 
CHAPTER ONE INTRODUCTION AND OVERVIEW OF CONSUMER-DIRECTED HEALTH PLANS 3

By contrast, the payments for deductibles and coinsurance that individuals incur themselves—their “outof-pocket” costs—have generally not received favorable 

tax treatment.3

The cumulative effects of those tax provisions are relatively large. In 2006, the federal government’s “tax expenditure” for employer-sponsored health insurance reduced 

income tax revenues by about $94 billion; in 2004, the 

total loss in revenues for both federal and state governments, including both income and payroll taxes, was estimated at about $200 billion.4

 For a typical worker, the 

favorable tax treatment that those sums represent 

amounts to a subsidy from the government of more than 

30 percent toward the costs of health care services that are 

covered by employer-sponsored insurance.5 By reducing 

the price of that insurance, the tax subsidy has effectively 

encouraged workers to secure richer health insurance policies through their employer, increasing the share of costs 

that is covered and decreasing the share that is paid out of 

pocket. At the same time, some observers say, the tax subsidy has helped encourage individuals who are healthier 

than the average and less likely to incur substantial costs 

for care to purchase employer-sponsored insurance—

which in turn lowers the premium for those policies. 

(Employment-based policies are purchased in the “group” 

insurance market; such policies tend to have lower 

administrative costs per enrollee, compared with policies 

purchased in the individual insurance market.) 

Recent Trends in the U.S. Health Insurance Sector 

Up through the 1980s, private health insurance coverage in the United States typically took the form of an 

“indemnity” policy, which reimbursed enrollees for their 

incurred costs, left it to them and their doctors to determine what care to provide—and largely allowed doctors 

and hospitals to set prices for those services. As health 

care costs grew rapidly in the late 1980s, however, private 

insurance coverage began to shift from indemnity policies 

toward various forms of more managed care. 

B One form was preferred provider organization (PPO) 

plans, which established lists or networks of preferred 

doctors and hospitals and encouraged enrollees to use 

those providers by charging more for care received 

outside the plan’s network. Those preferred providers 

thus gained a higher (or at least more certain) volume 

of patients and usually accepted lower negotiated payment rates from the health plan in return. 

B At the same time, more-stringent forms of managed 

care, such as health maintenance organizations 

(HMOs), also grew in prominence. Like PPOs, those 

plans established networks of providers; unlike PPOs, 

they offered no coverage for services received outside 

of those networks (except for emergencies). HMOs 

also instituted various measures that were aimed at 

limiting the supply of services, such as requiring 

another doctor’s referral or the plan’s prior authorization before some types of specialty care were covered.

B “Point-of-service” (POS) plans emerged as a kind of 

middle ground. Like PPOs, they allowed enrollees to 

go outside a plan’s network for care (albeit at a higher 

charge), but like HMOs, they required enrollees to 

secure referrals for specialty care from a primary care 

physician within the plan’s network. 

3. One exception is that health care costs in excess of 7.5 percent of 

taxable income—including both out-of-pocket costs and insurance premiums—are deductible for taxpayers who itemize their 

deductions. That deduction was claimed by about 9 million filers 

in 2003 representing 7 percent of all tax returns, with deductible 

expenses totaling $56 billion (of which $22 billion was claimed by 

filers under the age of 65). Deductible expenses include some services that are not typically covered by health insurance (for example, nursing home costs). 

4. For the impact on federal income taxes, see Joint Committee on 

Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 

2006–2010, JCS-2-06 (April 25, 2006). The Department of the 

Treasury has a higher estimate of the federal income tax loss for 

2006—$137 billion; the difference may reflect different assumptions about interactions with other health-care-related tax provisions. For an estimate of the total tax expenditure, see John Sheils 

and Randall Haught, “The Cost of Tax-Exempt Health Benefits 

in 2004,” Health Affairs Web Exclusive (February 25, 2004), 

available at http://content.healthaffairs.org/cgi/content/full/

hlthaff.w4.106v1/DC1.

5. CBO estimates that among tax returns that report earnings from 

labor, the median marginal tax rate—the rate that applies to the 

last dollar of earnings in a typical case—is 31.6 percent. That figure reflects effective tax rates of 13.9 percent for federal income 

taxes, 14.2 percent for federal payroll taxes, and an average of 

3.5 percent for state income taxes. Effective tax rates are generally 

somewhat lower than statutory tax rates because the employer’s 

share of payroll taxes is included in an employee’s total compensation. For example, the combined statutory payroll tax rate for 

employers and employees (15.3 percent, split equally) must be 

divided by one plus the employer’s share (1.0765) to get the effective payroll tax rate (15.3/1.0765 = 14.2). See Congressional 

Budget Office, Effective Marginal Tax Rates on Labor Income

(November 2005).
4 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Figure 1-1.

Distribution of Employees by Type of Health Plan, Selected Years from

1988 to 2005

(Percent)

Source: Congressional Budget Office based on Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2005 Annual Survey (Washington, D.C.: Henry J. Kaiser Family Foundation, September 2005). 

Notes: An indemnity health plan, the typical private health insurance coverage in the United States in the 1980s, reimbursed enrollees for 

their incurred costs without imposing constraints on the number and type of services that could be used.

PPO = preferred provider organization; POS = point of service; HMO = health maintenance organization. 

To varying degrees, those approaches all sought to offset 

moral hazard. Collectively, their adoption played a large 

role in controlling the level of U.S. health care costs during the 1990s. Private payments for health care, which 

include both out-of-pocket costs and insurance premiums and account for just over half of all national health 

expenditures, grew at the same rate as the overall economy between 1992 and 2000, and total spending for 

health care as a share of gross domestic product (GDP) 

also remained constant at about 13.8 percent between 

1993 and 2000.6

 Over that same seven-year period, the 

share of workers enrolled in some kind of managed care 

plan rose from 54 percent to 92 percent, and the share 

enrolled in an unmanaged indemnity plan (which had 

been 73 percent in 1988) fell correspondingly, from 46 

percent to 8 percent (see Figure 1-1).7

By the end of the 1990s, however, the increasing objections of enrollees and providers to the constraints of managed care led health plans to adopt less aggressive forms of 

management and produced shifts in enrollment toward 

more loosely managed plans. In particular, enrollment in 

PPO plans has grown rapidly since 2000, and such plans 

now cover about 60 percent of people who get their 

health insurance coverage through their employer. At 

the same time, the share of workers enrolled in HMO 

plans has declined from a peak of about 30 percent to 

about 20 percent; between 2000 and 2005, the share of 

1988 1993 1996 1998 1999 2000 2001 2002 2003 2004 2005

0

20

40

60

80

100

Indemnity PPO POS HMO

6. See Christine Borger and others, “Health Spending Projections 

Through 2015: Changes on the Horizon,” Health Affairs Web 

Exclusive (February 22, 2006), available at http://content.

healthaffairs.org/cgi/content/full/25/2/w61; and underlying data 

on national health expenditures, available at www.cms.hhs.gov/

NationalHealthExpendData. Because of a recent change in the 

methodology used to estimate spending for construction and 

equipment purchases, current estimates of the share of GDP 

attributable to health care spending in a given year are higher than 

prior estimates (for example, by 0.5 percentage points for 2003). 

7. See Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2006 Annual Survey (Washington, D.C.: Henry J. Kaiser Family Foundation, September 

2006). 
CHAPTER ONE INTRODUCTION AND OVERVIEW OF CONSUMER-DIRECTED HEALTH PLANS 5

Figure 1-2.

U.S. Health Care Spending as a Share of Gross Domestic Product

(Percent)

Source: Congressional Budget Office based on National Health Expenditure data compiled by the Department of Health and Human Services.

Note: In addition to out-of-pocket payments by consumers and insurance premiums, private spending includes revenues received by providers for which no direct patient care services are rendered—primarily philanthropy. Those revenues account for about 1 percent of GDP.

employees in HMO and POS plans combined fell from 

50 percent to 36 percent. 

Accompanying those shifts in health plan enrollment, 

health care costs have grown rapidly in recent years, with 

total expenditures rising at an average annual rate of 

8.4 percent between 2000 and 2004. As a result, by 

2004, health care’s share of GDP had risen to 16 percent 

(in part reflecting slower economic growth overall); it is 

projected to reach 20 percent by 2015 (see Figure 1-2). 

Private health care costs have increased at about the same 

rate as total expenditures. Those payments accounted 

for 7.7 percent of GDP in 2000 but grew at an average 

annual rate of 8 percent between 2000 and 2004—

bringing their share of GDP to 8.8 percent.8 That share 

is projected to reach 10.5 percent by 2015. In the light of 

those trends, it is not surprising that purchasers of health 

insurance have looked for new approaches that might 

help control health care spending—including consumerdirected plans. (Although employers serve as the purchasers of most private insurance, their employees would also 

have an interest in limiting health insurance premiums.)

Another factor that has stimulated interest in consumerdirected designs is the declining proportion of health care 

costs paid out of pocket and the correlation between that 

decline and the rise in spending for personal health care 

services—including hospitalizations, visits to physicians, 

and other types of care.9 Out-of-pocket payments 

accounted for 33 percent of all personal health care 

expenditures in 1975 and 57 percent of private spending 

for personal health care services, but by 2004, those 

shares had fallen to 15 percent and 29 percent, respectively (see Figure 1-3). By 2015, they are projected to 

shrink a little more, to 13 percent and 26 percent. 

A declining share of costs paid out of pocket has 

undoubtedly contributed to the growth of health care 

spending, but other factors complicate that relationship. 

Indeed, the reverse is also likely to be true, at least to 

1975 1980 1985 1990 1995 2000 2005 2010 2015

0

5

10

15

20

25

Total Spending

Private Spending

Actual Projected

8. In addition to out-of-pocket payments by consumers and insurance premiums, private payments include revenues received by 

providers for which no direct patient care services are rendered—

primarily philanthropy. Those revenues currently account for 

about 1 percent of GDP. 

9. Spending for personal health care accounts for about 85 percent 

of total health expenditures; it excludes administrative costs for 

health insurance, public and private spending for medical 

research and construction of facilities, and government spending 

for public health agencies such as the Centers for Disease Control and Prevention and state health departments.
6 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Figure 1-3.

Share of Personal Health Care Spending Paid Out of Pocket

(Percent)

Source: Congressional Budget Office based on National Health Expenditure data compiled by the Department of Health and Human 

Services.

Notes: Spending on personal health care excludes administrative costs for health insurance, public and private spending for medical research 

and construction of facilities, and government spending for public health agencies, such as the Centers for Disease Control and Prevention and state health departments.

Private spending on personal health care consists of out-of-pocket payments and insured costs; other payments (such as philanthropy) 

are excluded.

some extent: rising health care costs (as a share of income) 

have probably led individuals to seek more-extensive 

insurance to keep the variability of their out-of-pocket 

expenses from increasing. In addition, some of the past 

decline in cost sharing can be attributed to the spread of 

HMOs, because those plans have typically imposed relatively low copayments for care. But those plans have 

sought to use other methods besides cost sharing to limit 

health care spending, and on balance, the decline in the 

share of costs paid out of pocket that was associated with 

the growth in HMO enrollment may not have fueled 

increases in health care spending. Even so, concerns 

about reinstating managed care methods of controlling 

costs have stimulated interest in using consumer-directed 

designs as an alternative. 

Designs of Consumer-Directed

Health Plans

Although a wide variety of health plan designs might be 

considered “consumer-directed,” that term has come to 

mean a plan with two key attributes: a high-deductible 

health insurance policy and an account that can be used 

to pay out-of-pocket health care costs with funds that 

have not been taxed. The two main types of consumerdirected designs that have arisen are health reimbursement arrangements (HRAs) and health savings accounts 

(HSAs). (In each case, the high-deductible health plan 

and its associated account are formally distinct. However, 

this study will follow common practice and, unless otherwise indicated, use HRA and HSA to mean both the 

account and the insurance policy that goes with it.)

Those two plan types have many other features in common but differ along several important dimensions, 

including: 

B Whether they are available to those purchasing coverage in the individual insurance market or are limited 

to the employer-based group coverage market;

B Whether individuals may contribute directly to their 

account; 

1975 1980 1985 1990 1995 2000 2005 2010 2015

0

20

40

60

80

100

Share of Private Spending

Share of All Spending

Actual Projected
CHAPTER ONE INTRODUCTION AND OVERVIEW OF CONSUMER-DIRECTED HEALTH PLANS 7

B Whether unused funds in the accounts are portable 

from job to job; and 

B Whether funds may be withdrawn and spent only to 

cover health care costs. 

In addition to HRAs and HSAs, two related options have 

received favorable treatment under the tax code: flexible 

spending accounts (FSAs), which are offered by some 

employers; and medical savings account (MSA) health 

plans—the forerunners of consumer-directed plans—

which became available in the mid-1990s, on a limited 

basis, to employees of small firms and to self-employed 

individuals.10 (Table 1-1 compares those four options.) 

Medicare beneficiaries may also be offered a plan that has 

an MSA design, but the requirements in that case are different, and to date, no insurers have stepped forward to 

offer an MSA in Medicare (see the later discussion). 

Health Reimbursement Arrangements

Health reimbursement arrangements may be offered only 

by employers. They may be provided in conjunction with 

any type of health insurance plan—that is, there is no 

requirement that they be linked to a high-deductible 

plan; however, such a linkage is typical. Thus, this study 

focuses on HRAs with high-deductible policies. The 

other key feature of an HRA is a notional account that 

employers establish and that workers (or, in some cases, 

retirees) can use to pay for their out-of-pocket health care 

costs. For example, an employer might offer a health 

insurance plan that had an annual deductible of 

$2,000—but then also credit $1,000 a year to each 

employee’s account. Employees would draw on the 

account to pay their first $1,000 in health care costs; if 

they had exhausted their account’s balance but had not 

yet met the annual deductible, they would have to cover 

their health care costs out of their own pocket until they 

did. If they did not spend all of their employer’s contribution, at least a portion of the remaining funds could “roll 

over” and be available to cover future medical bills. 

A principal attraction of paying for health care costs 

through an HRA is that those expenditures are tax 

deductible for the employer but—unlike cash compensation—are not counted as income for the policyholder. 

The expenditures are thus exempt from corporate taxes 

and from individual income and payroll taxes, receiving 

the same favorable tax treatment as health insurance premiums made by or through an employer. Employers have 

no limit on the amounts they may contribute to HRAs, 

although they must generally make the same contributions for all comparable enrollees. Funds credited to the 

account are not treated as an expense by employers until 

the money is actually used to pay for health care, and 

account balances generally do not accumulate interest—

features that are consistent with the view that those balances are notional until they are spent. 

Several restrictions apply to contributions to and withdrawals from HRAs. Contributions may come only from 

an employer; individuals may not make additional deposits. As a result, once enrollees exhaust the balance in their 

account, the remaining out-of-pocket payments they 

make do not receive favorable tax treatment. In addition, 

balances in the accounts have limited portability—that is, 

they may not be “cashed out” when an employee leaves 

the firm, although they may be carried over into retirement (as determined by the employer). A related restriction is that enrollees may withdraw funds only to pay for 

health care, not to purchase other types of items and services. In addition, according to a recent report, employers 

generally limit the total balance that employees can build 

up in the account.11

HRAs have grown in popularity over the past few years, 

after the Internal Revenue Service (IRS) clarified their 

status and the rules governing them through regulations 

issued in 2002. On the basis of data from the insurance 

industry, the Government Accountability Office (GAO) 

reported in a recent study that by January 2006, the total 

number of enrollees and dependents covered by HRAs 

had reached 2.9 million.12 A separate study, using data 

from a survey of employers that was conducted by the 

Henry J. Kaiser Family Foundation in 2005, found that 

about “2 percent of all firms offering health benefits 

10. For another description of those options, see the Internal Revenue 

Service’s Publication 969, “Health Savings Accounts and Other 

Tax-Favored Health Plans.” 

11. Bob Lyke, Chris Peterson, and Neela Ranade, Health Savings 

Accounts, CRS Report for Congress RL32467 (Congressional 

Research Service, updated March 23, 2005), p. 13, available at 

www.law.umaryland.edu/marshall/crsreports/crsdocuments/

RL3246703232005.pdf. Some employers may allow former workers to use their remaining HRA account balances to cover health 

care costs after they leave the firm. 

12. Government Accountability Office, Consumer-Directed Health 

Plans: Small But Growing Enrollment Fueled by Rising Cost of 

Health Care Coverage, GAO-06-514 (April 2006). 
8 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Table 1-1.

Types and Characteristics of Consumer-Directed Health Plans

Source: Congressional Budget Office.

Notes: When two numbers are separated by a slash, the first is for an individual policy, the second for a family policy.

HSA = health savings account; OOP = out of pocket.

a. In general, contributions from employers are subject to nondiscrimination rules.

b. As a result of the recently passed Tax Relief and Health Care Act of 2006, contributions from employers may exceed plans’ deductibles 

beginning in 2007.

c. The figure reflects enrollment in HSA-compatible plans, which meet the requirements of an HSA and were marketed as such—although 

policyholders may not have established an associated account.

Health

Reimbursement 

Arrangement

Health Savings 

Account 

Flexible Spending 

Account

Archer Medical

Savings Account

Eligibility Depends on employer Anyone not enrolled in 

Medicare

Depends on employer Self-employed individuals 

and employees of small 

firms 

Requirements for 

Associated Health 

Plan

None Minimum deductible 

(2006): $1,050/$2,100;

maximum OOP limit 

(2006): $5,250/$10,500

None Deductibles (2006):

minimum, $1,800/$3,650;

maximum, $2,700/$5,450; 

maximum OOP limits 

(2006): $3,650/$6,650

Contribution 

Sources and 

Annual Limitsa

Employer only Employer or individual; 

combined maximum is 

the lesser of the 

deductible or $2,700/

$5,450 in 2006b

Individual specifies salary 

reduction at the beginning 

of the year (the employer 

may set an upper limit)

In any year, the employer 

or employee may 

contribute—but not both; 

contributions are capped 

at 65%/75% of the 

deductible

Tax Treatment of 

Contributions 

Employer’s contribution: 

free of all income and 

payroll taxes and 

deducted as a business 

expense as OOP costs 

are incurred;

individual’s contribution: 

not applicable

Employer’s contribution: 

free of all income and 

payroll taxes and 

deducted as a business 

expense;

individual’s contribution: 

may be taken as an 

above-the-line income 

tax deduction

Employer’s contribution: 

permitted but unusual; 

individual’s contribution: 

free of all income and 

payroll taxes

Same as that for HSAs 

Limits on and Tax 

Treatment of 

Withdrawals

Funds may be used for 

any health care costs 

tax-free but may not be 

used for other purposes

Funds may be used for 

any health care costs 

tax-free; funds used for 

other purposes are taxed 

as income (and assessed 

an early-withdrawal 

penalty)

Funds may be used for any 

health care costs tax-free 

but may not be used for 

other purposes

Similar to those for HSAs 

Annual Rollover 

and Portability

Unused funds may be 

rolled over but generally 

are not portable

Unused funds may be 

rolled over and are 

portable

At the end of the year 

(plus a grace period), 

unused funds are forfeited

Unused funds may be 

rolled over and belong to 

the enrollee 

Year Authorized 2002 2003 1978 1996

Most Recent 

Estimate of 

Enrollment

In January 2006, 2.9 

million policyholders and 

dependents 

In January 2006, 3.2 

million policyholders and 

dependentsc

In 2004, about 10 million 

to 12 million accounts 

(estimates vary widely) 

In 2001, about 130,000 

households maintained 

such a policy
CHAPTER ONE INTRODUCTION AND OVERVIEW OF CONSUMER-DIRECTED HEALTH PLANS 9

reported offering . . . an HRA [design]. In firms that offer 

this type of arrangement, about 25 percent of employees 

on average participate in the plan.”13 That study estimated that in the first half of 2005, about 1.6 million 

employees had HRAs, a figure that does not include 

spouses and dependents covered by those policies. 

According to the most recent survey of employers by Kaiser, which was conducted in 2006, HRA enrollees currently face average annual deductibles of about $1,450 

for single coverage and about $3,000 for family coverage, 

and contributions by employers average about $800 and 

$1,600, respectively.14 Limits on enrollees’ annual out-ofpocket costs average about $2,700 for single coverage and 

$5,200 for family coverage—meaning that policies typically include a range of spending above the deductible 

in which enrollees face some cost sharing. About onequarter of firms that did not offer an HRA option in 

2006 said that they were either very or somewhat likely 

to do so in 2007.

Health Savings Accounts

The other main type of consumer-directed health plan is 

called a health savings account, which has also become 

available only in the past few years. The option to establish that type of plan was created as part of the Medicare 

Prescription Drug, Improvement, and Modernization Act 

of 2003 (the Medicare Modernization Act). The law permits individuals and families to contribute to an HSA if 

they purchase and maintain a qualifying high-deductible 

health insurance policy. With minor exceptions, the highdeductible policy must be the only form of health insurance that enrollees hold; that is, the law does not permit 

them to purchase a supplemental policy that would cover 

their costs until the deductible was reached.

As with an HRA, funds contributed to an HSA are untaxed dollars that may be used to pay medical expenses 

that are not covered by insurance. Specifically, individuals 

who contribute directly to such an account are eligible for 

a limited “above the line” deduction on their income tax 

returns, whereas individuals who contribute through 

their employer have those funds excluded from their taxable income.15 In many ways, the account that is linked 

to an HSA is like an individual retirement account (IRA), 

but the rules governing withdrawals differ. Funds may be 

withdrawn from HSAs to pay for allowable medical costs 

at any time without penalty—and in that case, those 

funds are never taxed. By contrast, IRA funds are generally subject to income taxation when they are deposited 

or withdrawn. HSA balances, like those of IRAs, may also 

be invested and may accumulate interest or capital gains 

tax-free. In general, little is known about the investment 

options available to HSA enrollees, but two of the HSA 

plans that are currently available to federal workers provide fixed rates of interest for smaller account balances 

and various options for investing in the stock market for 

larger balances.

In addition, HSAs include the following key features.

B Health savings accounts may be offered by employers—but unlike HRAs, HSAs are also available for 

purchase in the individual insurance market. HSAs 

that are purchased and funded through an employer 

still have a financial advantage, however: contributions 

from employers and employees avoid all income and 

payroll taxes, whereas purchasers of HSAs in the individual market receive only the income tax deduction 

for their contributions.16 In addition, premium payments for an employment-based HSA avoid income 

and payroll taxes, whereas premium payments for 

individually purchased policies (except policies purchased by people who are self-employed) are not tax 

favored. 

13. Gary Claxton and others, “What High-Deductible Plans Look 

Like: Findings from a National Survey of Employers, 2005,” 

Health Affairs Web Exclusive (September 14, 2005), available at 

http://content.healthaffairs.org/cgi/content/full/hlthaff.w5.434/

DC1. For the overall results of the survey on which that study was 

based, see Kaiser Family Foundation and Health Research and 

Educational Trust, Employer Health Benefits: 2005 Annual Survey

(Washington, D.C.: Henry J. Kaiser Family Foundation, September 2005). 

14. See Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2006 Annual Survey. The 

average deductibles for 2006 that Kaiser reported were somewhat 

lower than those for 2005, although the differences were not statistically significant. For family deductibles, that difference could 

partly reflect a change in the survey’s methodology. In addition, a 

substantial minority of HRA enrollees “work in firms who report 

that the deductible is not included in the out-of-pocket maximum,” but it is not clear whether the out-of-pocket limits were 

adjusted to include the deductible in those cases. The 2006 survey 

did not report the share of employees who chose an HRA when it 

was offered. 

15. An “above the line” deduction is one that is available to all tax 

filers, regardless of whether they itemize other deductions or take 

the standard deduction. 

16. Even if their employer does not contribute to their HSA, employees might be able to contribute funds to their account through a 

salary-reduction mechanism, which would allow them to avoid 

payroll taxes on those funds as well.
10 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

B Another difference between HRAs and HSAs is that 

funds from HSAs may be withdrawn and used for 

purposes other than health care. Such withdrawals are 

subject to income taxation, however, and to an earlywithdrawal penalty of 10 percent for people under the 

age of 65. Correspondingly, contributions to HSAs by 

employers are treated as a business expense at the time 

of the contribution—because at that point the funds 

come under the employee’s control (a concept known 

as “constructive receipt”). 

B Both HSA and HRA policyholders may accumulate 

funds in their accounts, but balances in HSAs roll over 

from year to year without restriction, and HSA participants retain any unused balances if they change 

jobs—that is, the funds are portable. If at some point 

an individual is no longer enrolled in a qualifying 

high-deductible health plan, he or she may not make 

additional HSA contributions but may use any remaining balances to pay for qualified medical expenses 

and still avoid taxation of that money.17 A similar 

restriction is that Medicare enrollees may not contribute to HSAs, although they may use any existing balances to cover their out-of-pocket medical expenses 

without owing income tax on those withdrawals. 

B Contributions to HSAs may be made “just in time” 

for the medical expenses they are to cover or even after 

incurring those expenses, so individuals do not need 

to save in advance to get favorable tax treatment but 

instead can channel funds through their HSA on an 

as-needed basis (subject to an annual limit on contributions). However, those who did not contribute the 

maximum amount each year would be forgoing an 

opportunity to save for future medical costs—and to 

have interest and investment gains accumulate on 

those savings—on a tax-favored basis. Individuals over 

the age of 54 are allowed to make additional “catchup” contributions (above the standard limits).

Compared with HRAs, HSAs are subject to fewer restrictions on the use of their funds but have much more specific requirements regarding contributions and policy 

designs.

B In 2006, the annual deductible for a qualifying HSA 

policy must be at least $1,050 for single coverage or 

$2,100 for family coverage, and the maximum annual 

amount to be paid out of pocket may be no greater 

than $5,250 or $10,500, respectively. Each year, those 

limits rise at the rate of general inflation (as measured 

by the consumer price index).18

B The statute that established HSAs specifies one set of 

exceptions to the requirement that a qualifying plan 

must have a high deductible: it allows—but does not 

require—those policies to cover certain preventivecare benefits (such as screening tests, annual physicals, 

prenatal and well-child care, and immunizations) 

before the deductible has been met. At the same time, 

the IRS has affirmed that health plans that cover the 

costs of prescription drugs before a person has satisfied 

the general deductible will not qualify as HSAs.19

B Both policyholders and their employers may contribute to HSAs, but total annual contributions have not 

been allowed to exceed the lesser of the policy’s 

deductible or the limits specified in law. In 2006, the 

statutory limits on contributions are $2,700 for a single policy or $5,450 for a family policy (and those limits are also indexed to general inflation).20 With the 

recent passage of the Tax Relief and Health Care Act 

of 2006, contributions to HSAs may exceed a plan’s 

deductible beginning in 2007.

As is the case with HRAs, information on HSAs’ enrollment and on the specific features of the policies that 

have been purchased is limited. A census of insurers con17. Individuals who have an employer-sponsored HSA and then 

change jobs and who want to continue contributing to their 

account would have to either obtain a qualified high-deductible 

plan through their new employer or purchase one on the individual insurance market—because unlike the funds in the account, 

the insurance policy itself is not portable. 

18. For 2007, the minimum deductible will be $1,100 for single 

coverage and $2,200 for family coverage, and the limit on outof-pocket costs will not be allowed to exceed $5,500 for single 

policies and $11,000 for family policies. For plans that have a network of health care providers but also cover services received outside that network, the limits on out-of-pocket costs apply only to 

services from providers within the network.

19. See Internal Revenue Service, “Revenue Ruling 2004-38,” Internal 

Revenue Bulletin 2004-15 (April 12, 2004), p. 717. As a transition 

measure, the IRS allowed plans that provided drug coverage below 

the general deductible to qualify as HSAs during 2004 and 2005.

20. For 2007, the respective contribution limits will be $2,850 and 

$5,650. 
CHAPTER ONE INTRODUCTION AND OVERVIEW OF CONSUMER-DIRECTED HEALTH PLANS 11

ducted by an industry trade group tracked sales of highdeductible policies that had been marketed as “HSA 

compatible” (which means the policies have a qualifying 

deductible) but was unable to determine how many of 

those policyholders established an associated account.21

According to the trade group, the total number of enrollees in HSA-compatible plans surpassed 1 million in 

March 2005 and had grown to 3.2 million by January 

2006.22 Of that total, about 0.9 million people were covered by individually purchased (nongroup) policies; 

about 1.4 million, by employment-based group policies; 

and about 0.9 million, by policies that could not be allocated between the two markets. Insurers also provided 

information about their best-selling HSA-compatible 

plans in the nongroup market: the average deductible was 

about $2,400 for single policies and $4,800 for family 

policies, and out-of-pocket limits averaged about $3,400 

and $6,800, respectively.

Other sources have provided differing estimates about the 

establishment and use of the accounts associated with 

HSAs. The recent GAO report cited insurance industry 

officials as estimating that 50 percent to 60 percent of all 

enrollees in HSA-compatible plans had opened and contributed to such an account.23 That figure would indicate 

that roughly 900,000 accounts had been established as of 

January 2006 (under the assumption that there were 

about two covered enrollees per account). But a more 

recent report from a market-research firm indicated that 

the total number of HSA accounts would reach about 3.6 

million by the end of 2006—up from 1.1 million at the 

end of 2005.24 If that estimate is correct, it indicates that 

the total number of HSA enrollees and the share of 

enrollees who have established an account have both 

increased sharply over the past year. The latter report also 

estimated that HSA accounts would hold about $5 billion in combined deposits by the end of 2006, for an 

average account balance of about $1,400. Another area of 

uncertainty concerns the share of individual contributions to HSAs that are being made through salary reduction (which avoids both income and payroll taxes).25

Additional information about HSAs offered in the 

employment-based group market is available from the 

Henry J. Kaiser Family Foundation surveys of employers 

mentioned earlier.26

B According to the 2005 Kaiser survey, about 2 percent 

of firms that offered health benefits offered an HSAcompatible plan, and about 15 percent of workers participated when an HSA was offered. The “take-up,” or 

participation, rate was higher in smaller firms and 

lower in larger firms.

B In 2006, the overall share of firms that offered an HSA 

increased to 6 percent, and the share of firms with 

more than 1,000 workers that offered such plans grew 

from 4 percent to 12 percent.

B Enrollees in employment-based HSAs currently face 

an average deductible of about $2,000 for single coverage and about $4,000 for family coverage; average 

contributions by employers are about $700 and 

$1,150, respectively.

B Thirty percent of workers who have single coverage 

and 16 percent of workers who have family coverage 

are in plans whose deductibles are close to the mini- 21. See AHIP Center for Policy and Research, January 2006 

Census Shows 3.2 Million People Covered by HSA Plans

(Washington, D.C.: America’s Health Insurance Plans, 

March 9, 2006), available at www.ahipresearch.org/pdfs/

HSAHDHPReportJanuary2006.pdf.

22. AHIP Center for Policy and Research, January 2006 Census Shows 

3.2 Million People Covered by HSA Plans. Those figures include 

spouses and dependents covered by the policies. The Government 

Accountability Office (Consumer-Directed Health Plans, p. 12) 

cited a different survey of insurers that reported a lower total 

number of enrollees and dependents in HSA-compatible plans—

2 million as of January 2006.

23. Government Accountability Office, Consumer-Directed Health 

Plans, p. 17. 

24. Ann Carrns, “Banks Pile Into Health Savings Accounts,” Wall 

Street Journal (November 14, 2006). 

25. Another recent report from GAO estimated, on the basis of IRS 

data for 2004, that about 55 percent of enrollees in HSA-eligible 

plans reported tax-deductible account contributions. But those 

figures did not include contributions that individuals made 

through their employer (through salary reduction), which are 

excluded from taxable income. About half of those who made 

contributions to HSAs in 2004 also reported that they made withdrawals from their account. See Government Accountability 

Office, Consumer-Directed Health Plans: Early Experience with 

Health Savings Accounts and Eligible Health Plans, GAO-06-798 

(August 2006). 

26. Claxton and others, “What High-Deductible Plans Look Like”; 

and Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2005 Annual Survey and

2006 Annual Survey.
12 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

mum statutory levels. As for the limits on annual outof-pocket costs, they currently average about $3,200 

for single policies and $6,000 for family policies.27

Looking ahead, the most recent Kaiser survey also found 

that among firms that did not offer an HSA in 2006, 

4 percent reported that they were very likely to do so in 

2007, and 19 percent said they were somewhat likely to 

do so.28 Among larger firms (which account for about 

half of all workers), about 10 percent indicated that they 

were very likely to start offering an HSA. Enrollment in 

employer-sponsored HSAs thus seems likely to grow. In 

early 2006, the Department of the Treasury projected (on 

the basis of prevailing law) that total enrollment in HSAs 

would reach 14 million by 2010.

Flexible Spending Accounts 

Flexible spending accounts share several of the characteristics of consumer-directed health plans but also have 

some unique features that highlight some of the issues 

that surround those plans. FSAs, like HRAs, are offered 

only through employers. They are typically used to supplement a conventional health insurance policy and allow 

individuals to pay for a wide variety of health care services 

with pretax dollars. (In this case, however, the term “flexible spending account” refers only to the account and not 

to the accompanying insurance policy.) 

For employees who choose to establish an FSA, the contributions to it usually come directly from their salary; 

the law allows contributions by employers, but such 

arrangements appear to be rare. Although each enrollee 

may choose his or her level of annual contributions, the 

amount must be specified at the beginning of each calendar year and (with certain exceptions) may not subsequently be increased or decreased. The IRS does not limit 

the level of the contributions, but employers generally 

specify a maximum annual amount that employees may 

deposit.29

FSA funds, like those contributed to consumer-directed 

health plans, are not subject to income or payroll taxes 

when they are deposited or when they are withdrawn to 

pay for health care services. Funds in FSAs may be used 

to cover out-of-pocket costs under an enrollee’s health 

plan and to pay for services that are not normally covered 

by health insurance, such as laser vision correction surgery or certain types of dental care. As is the case with 

HRAs, however, withdrawals from FSAs are allowed only 

for qualified medical expenditures. 

An important difference between FSAs and the other 

types of accounts discussed earlier is that any balance 

remaining in an FSA at the end of the year is ultimately 

forfeited to the employer.30 That provision—when combined with the requirement that consumers must specify 

their contribution at the beginning of the year—leads 

account holders to contribute only enough to cover medical costs that they are quite likely to incur. Account holders may also feel compelled to spend any remaining balance at the end of the year, given that they must “use it or 

lose it.” To mitigate those pressures, the Treasury Department recently established a “grace period” during which 

balances that remain in FSAs at the end of a calendar year 

may be used to pay for health care services provided 

through March 15th of the following year (at which time 

any remaining balances would be forfeited).31

27. The census of insurers by the AHIP Center for Policy and Research also reported average deductibles and out-of-pocket limits 

for their best-selling policies in the employment-based group market, and the results were similar to those of the Kaiser surveys. On 

average, the AHIP survey also found that HSAs offered by smaller 

employers had slightly higher deductibles and out-of-pocket limits 

than HSAs offered by larger employers. 

28. Kaiser Family Foundation and Health Research and Educational 

Trust, Employer Health Benefits: 2006 Annual Survey.

29. See Chris L. Peterson and Bob Lyke, Health Care Flexible Spending 

Accounts, CRS Report for Congress RL32656 (Congressional 

Research Service, updated February 7, 2005), p. 7, available at 

www.law.umaryland.edu/marshall/crsreports/crsdocuments/

RL3265602072005.pdf. 

30. The recently passed Tax Relief and Health Care Act of 2006 gives 

individuals one opportunity to move certain unused FSA funds 

into an HSA before 2012.

31. Allowing such a grace period is very similar to permitting a limited rollover of unused FSA balances, because enrollees who ended 

a given calendar year with funds in their FSA could reduce their 

contribution for the next calendar year accordingly. Specifically, 

they could reduce their new contributions by the amount of their 

end-of-year balance or by their expected out-of-pocket medical 

costs through March 15th—whichever was less. Then, during the 

grace period, they could cover their incurred costs by using their 

leftover balance instead of tapping into their new contributions.
CHAPTER ONE INTRODUCTION AND OVERVIEW OF CONSUMER-DIRECTED HEALTH PLANS 13

Some information is available about eligibility for health 

care FSAs, but reliable figures on actual enrollment are 

lacking. According to some recent press reports, anywhere from 7 million to 18 million workers have such 

accounts.32 The best available data come from an annual 

survey of employers conducted by Mercer Human Resource Consulting. According to the 2004 survey, among 

employers that had 10 to 499 workers, 24 percent offered 

FSAs, and 38 percent of eligible workers actually participated.33 Among larger firms (500 or more employees), 

81 percent offered a health care FSA in 2004, and an 

average of 20 percent of eligible employees participated. 

The Mercer survey also indicated that annual contributions to FSAs averaged about $1,300 per participant; 

smaller firms saw slightly larger average contributions.

Converting those figures into estimates of FSA enrollment that are comparable to other published reports presents several challenges. The results of the Mercer survey 

suggest that about 60 million workers are employed by 

private-sector firms that offer an FSA and that roughly 

10 million of those workers have such an account.34

Those figures include neither spouses and dependent 

children nor government employees with FSAs; thus, the 

total number of people covered by such accounts is probably much larger. At the same time, published figures for 

FSA enrollment sometimes include the number of individuals in so-called premium conversion plans, which 

allow employees to pay their share of their insurance premiums on the same tax-favored basis that is given to 

employers’ payments. That option was created by the 

same section of the tax code that authorized FSAs, but 

strictly speaking, FSA funds may not be used to pay 

health insurance premiums.35

Medical Savings Accounts

Starting in 1996, legislation was enacted to permit sales 

of two types of health insurance policies that incorporated medical savings accounts, the precursors to HSAs. 

One type, which came to be known as Archer MSAs, was 

available only to self-employed individuals and employees 

of small businesses. The other type was an option established for enrollees in Medicare. Although specific features of the two types of plans differed, the approach in 

both cases combined a high-deductible health insurance 

policy with a tax-favored account that belonged to the 

enrollee and whose contributions could be used to cover 

out-of-pocket health care costs. At least initially, each 

type of MSA was subject to specific limits on its total 

enrollment, and the law’s authorizations to sell new policies were temporary. Both of those factors probably contributed to low levels of enrollment in MSAs.

Archer MSAs. Although Archer MSAs were similar to 

HSAs in many respects, they were subject to several additional restrictions.

B For contributions to and withdrawals from the MSA 

to receive tax-favored treatment, the deductible on the 

accompanying health plan had to fall between specified minimum and maximum levels.

B Contributions to MSAs, like those to HSAs, could 

come from policyholders or their employers—but 

both could not contribute in the same year, and 

annual contributions were limited to 65 percent of the 

deductible for single coverage and 75 percent of the 

deductible for family coverage.

B Unlike HSAs, Archer MSAs were not available for 

purchase in the individual insurance market or by 

larger employers. 

B The authorization for employers to establish a new 

Archer MSA option was temporary, and after several 

extensions, it expired at the end of 2005. However, the 

Tax Relief and Health Care Act of 2006 extended that 

deadline through 2007.

32. Stephanie Armor, “Workers Forfeit Millions in Health Spending 

Accounts,” USA Today (December 20, 2004); and Tom Herman, 

“A Setback for a Popular Health Benefit,” Wall Street Journal

(January 5, 2005).

33. Mercer Human Resource Consulting, National Survey of 

Employer-Sponsored Health Plans (New York: Mercer Human 

Resource Consulting, 2005); and Herman, “A Setback for a Popular Health Benefit.” 

34. The Medical Expenditure Panel Survey, conducted by the Department of Health and Human Services’ Agency for Healthcare 

Research and Quality, collects data on employers’ offers of FSAs. 

It yields figures similar to those from the Mercer survey but does 

not track the number of accounts that are established. 35. See the Internal Revenue Service’s Publication 969, “Health Savings Accounts and Other Tax-Favored Health Plans,” p. 13.
14 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

B Total enrollment in MSAs was generally capped at 

750,000 taxpayers; the total number of households 

that had Archer MSAs in 2001 was estimated, on the 

basis of Treasury Department data, to be about 

130,000.36

Although the option of selling new Archer MSAs expired, 

existing enrollees were allowed to retain their policies. 

They would probably find it advantageous, however, to 

switch to an HSA, and balances in Archer MSAs may be 

rolled over into HSAs with no penalty. 

Medicare MSAs. Medicare enrollees are barred from participating in HSAs or Archer MSAs, but insurers may 

offer them a plan with an MSA design through Medicare. 

Although no insurers have chosen to offer a Medicare 

MSA, a new demonstration project may soon allow 

Medicare enrollees to select an HSA-like plan.

Under a Medicare MSA, the insurer would provide a 

high-deductible policy that covered Medicare’s benefits. 

The difference between the average cost of providing that 

policy and the standard Medicare payment rate for private health insurance plans in the enrollee’s geographic 

area would then be deposited in the enrollee’s medical 

savings account.37 (Enrollees would not be allowed to 

make additional contributions.) Funds that were withdrawn to pay for medical expenses would not be taxed; 

funds that were withdrawn and used for nonmedical purposes (a practice permitted under the option) would be 

taxed as income but would not incur an additional penalty—provided that the withdrawals did not reduce the 

balance in the account below 60 percent of the plan’s 

deductible. 

The Medicare MSA program was initially a temporary 

demonstration project with a time limit on sales of new 

policies and a cap on total enrollment. Whether as a 

result of those restrictions or because the option was not 

considered likely to be attractive to Medicare enrollees, 

no private insurers have offered a Medicare MSA plan.38

The legislation that created HSAs in 2003 also removed 

the restrictions on enrollment in Medicare MSAs, but it 

is unclear whether private insurers will now offer such 

plans or whether beneficiaries will participate in them if 

given the chance to do so.

Recently, the Department of Health and Human Services 

announced that it would undertake a demonstration 

project to allow insurers to offer Medicare beneficiaries 

health plans that have certain HSA-type features. For 

example, plans could offer partial coverage of health care 

costs once a specified deductible was met (Medicare 

MSAs are required to provide full coverage above the 

deductible) and provide coverage below the deductible 

for certain preventive services. The rules under this 

option regarding payments to insurers and deposits to 

accounts would be the same as those for Medicare MSAs.

36. Alexandra Minicozzi, “Medical Savings Accounts: What Story Do 

the Data Tell?” Health Affairs (January/February 2006).

37. The payment to the insurer would be adjusted to reflect the 

expected health care costs of any enrollees; that is, the payment 

would be larger for enrollees who were expected to have higher 

costs and lower for enrollees who were expected to incur fewer 

costs.

38. For further analysis, see Medicare Payment Advisory Commission,

Medical Savings Accounts and the Medicare Program (November 

2000), available at http://permanent.access.gpo.gov/lps21043/

nov2000medsav.pdf.
CHAPTER

2

Effects of Consumer-Directed Health Plan 

Designs on Incentives to Use Care

One of the key concepts behind consumerdirected health plans is that—in the face of a higher 

annual deductible—enrollees will have stronger incentives to consider the costs of the care they seek and to balance those costs against the health benefits they expect to 

receive. If a broad cross section of individuals switched to 

consumer-directed plans, the nature and extent of the 

change in their incentives would strongly depend on the 

form of their previous insurance. For example, the new 

tax-favored treatment for out-of-pocket costs might lead 

enrollees who had previously held a high-deductible 

health insurance policy by itself to increase their health 

care spending, at least initially. Moreover, the relative 

incentives to limit spending would depend on whether 

the consumer-directed plan was a health reimbursement 

arrangement or a health savings account, because of the 

different rules that govern the linked accounts. 

After comparing the incentives created by different highdeductible plans, this chapter focuses primarily on the 

contrast between consumer-directed and conventional 

health plan designs—the type of coverage that most individuals get through an employer. Conventional designs 

typically feature much lower deductibles, but they also 

tend to have broader ranges of spending over which 

enrollees pay some portion of their health care costs. A 

comparison of the incentives to use health care services 

that are inherent in those two designs—both overall and 

with regard to the use of preventive care, prescription 

drugs, and very expensive services, such as hospitalizations—helps clarify the potential effects of consumerdirected plans on health care spending.

In addition to considering how enrollees’ cost sharing 

affects their spending, this analysis also accounts for 

efforts by health plans to manage care. To the extent that 

insurers who offer conventional plan designs already take 

steps to discourage the use of care that is not costeffective, then the scope for further reductions in spending or improvements in efficiency from enrolling a 

broadly representative group of people in consumerdirected plans will be smaller. In other words, if moreprudent management of care by an enrollee in a 

consumer-directed plan primarily substitutes for management by the health plan, the net effect on health care 

spending may be limited. (Subsequent chapters consider 

whether consumer-directed designs might have broader, 

transformative effects on health care prices or delivery 

and whether enrollment in such plans is likely to be representative of the population or concentrated among 

those with lower health care costs.) 

Comparing Consumer-Directed 

Designs with a Simple High-Deductible 

Plan 

For an enrollee in a health savings account, the incentives 

to weigh the costs and benefits of using health care are 

similar to—but generally not quite as strong as—those 

that would exist under a comparably structured highdeductible health insurance policy alone. For expenditures below the deductible, an individual who decided to 

use HSA funds to pay for care would initially be liable for 

the full costs of those services—just as someone with a 

high-deductible policy and no such account would be. 

The difference is that the tax subsidy for using HSA 

funds makes it less costly on a net basis to purchase health 

care than to buy other items. In other words, when HSA 

funds are used, the relative price of health care is reduced 

in proportion to the enrollee’s marginal tax rate (the rate 

that applies to the last dollar of income). 

For a typical worker who faces a marginal tax rate of 

25 percent (including federal and state income taxes and 
16 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

the employee’s share of payroll taxes), deciding to pay for 

$100 worth of medical care by using HSA funds implies 

giving up $75 worth of other goods and services.1 More 

precisely, those are the financial incentives that face someone who is deciding whether to cover that expense by 

making a deposit to her HSA through her employer. 

Given those incentives, that individual would presumably 

purchase that care if she judged its expected benefits to be 

worth more than $75. If, instead, she was considering 

whether to use funds that had already been contributed 

to her HSA—and if those funds were subject to the 

10 percent penalty on early account withdrawals—then 

she would face a trade-off between buying $100 in medical services and $65 in other goods.2

 By contrast, an 

enrollee who had only a high-deductible policy and who 

decided to buy $100 worth of health care would give up 

$100 in other purchases—so the expected benefits of the 

care would have to exceed that larger amount for the 

enrollee to opt for it. 

HSA enrollees could face stronger incentives to limit their 

health care spending if their insurance policy’s deductible 

was above the limit on contributions to their health savings account. Between those two points, enrollees would 

have to cover the full costs of their care by using either 

previously accumulated balances in their accounts or 

after-tax dollars—and in the latter case, their net costs for 

health care services would be the same as those for people 

who had only a high-deductible policy. Whether HSA 

enrollees in that situation would have an account balance 

on which to draw would depend on their contributions 

and withdrawals in prior years, which would vary both 

among individuals and over time; currently, little is 

known about the distribution of balances in health savings accounts. Nevertheless, the available information on 

deductibles for HSAs indicates that on average, they are 

below the limits on annual contributions.3

 Thus, it 

appears that most HSA enrollees could cover all of their 

health care costs up to their deductible with tax-favored 

funds. (Starting in 2007, contributions to HSAs may 

exceed the policy deductible.)

For some enrollees, the incentives to limit spending 

under a health reimbursement arrangement could be 

comparable to the incentives under a simple highdeductible policy; for other enrollees, those incentives 

would be weaker under an HRA. HRA enrollees who 

were trying to decide whether to purchase an additional 

health care service and who had already exhausted the 

balance in their account but not yet met their health 

plan’s deductible would have to pay for that service with 

after-tax dollars—and thus would face clear financial 

incentives. But enrollees who were trying to decide 

whether to use the funds in their account might find it 

more difficult to determine the economic cost of that 

additional service, for several reasons. The fact that HRA 

funds may be used only for health care and are generally 

not portable from job to job would tend to make some 

enrollees treat them less like cash and more like a “free” 

resource. Unused funds in an HRA may be rolled over 

from one year to the next; enrollees thus have an incentive to limit their expenditures—so that they can use 

those funds to cover future health care costs instead of 

paying cash. But those rollovers may be limited, either on 

an annual basis or overall, which weakens the inducement 

for enrollees to build up their account balances. 

Even if an HRA’s design included unlimited rollovers, the 

financial incentives for enrollees to limit their spending 

below the deductible would depend on several other factors, including their expectations about their future 

health care costs and contributions by their employer, the 

1. If HSA enrollees’ employers allowed them to contribute to the 

account through a reduction in salary, those funds would avoid 

both income and payroll taxes. (Such an arrangement would be 

similar to the current system for deposits to flexible spending 

accounts but would have to allow the amount of the contribution 

to be adjusted at the enrollee’s discretion.) If, instead, enrollees 

contributed directly to the account, the funds would avoid 

income taxes but not payroll taxes—in which case, the typical tax 

rate would be about 17 percent. The share of individual contributions made in each manner is not known.

2. Enrollees also have the option of leaving the funds in their 

account, an approach whose attractiveness depends partly on the 

future tax rates they expect to face. Note also that unlike the tax 

subsidy for employment-based health insurance premiums, the tax 

subsidy for paying out-of-pocket costs from an HSA does not 

include the employer’s portion of payroll taxes. That portion of 

the tax savings that result when an individual makes a deposit to 

an HSA accrues to the employer (at least initially) and will not 

affect the individual’s decision about whether or not to use health 

care. 

3. The 2006 survey of employers by the Kaiser Family Foundation 

and Health Research and Educational Trust (Employer Health Benefits: 2006 Annual Survey, Washington, D.C., Henry J. Kaiser 

Family Foundation, September 2006) found that 6 percent of 

individual HSA policies had deductibles of $3,000 or more and 

that 38 percent of family policies had deductibles of $5,000 or 

more. The respective contribution limits for 2006 are $2,700 and 

$5,450, making it difficult to determine exactly what share of 

HSAs have deductibles that exceed the contribution limits. 
CHAPTER TWO EFFECTS OF CONSUMER-DIRECTED HEALTH PLAN DESIGNS ON INCENTIVES TO USE CARE 17

current balance in their account, and how long they 

expected to remain at that firm. (Enrollees will also vary 

in the extent to which they are forward-looking and in 

the predictability of their health care costs.)

B If enrollees expected their future costs for health care 

to be less than their employer’s cumulative contributions to their HRA, they would anticipate leaving the 

firm with a positive HRA balance—which they would 

have to forfeit. In that case, any additional health care 

spending they incurred now would simply reduce the 

amount they would ultimately expect to forfeit. Under 

those circumstances, an individual would be likely to 

use care as long as it provided some expected medical 

benefits—because from the individual’s perspective, 

the care is free. That incentive is particularly clear for 

someone who expects to leave his or her job soon and 

has an ample HRA balance; the pressures to “use or 

lose” those funds resemble those that operate under a 

flexible spending account. 

B If, instead, enrollees expected that their health care 

costs in the future would exceed their employer’s contributions—or in the face of uncertainty about their 

future needs for health care, they wanted to maintain a 

higher balance as a form of self-insurance—then they 

would have a stronger incentive to forgo current medical services whose benefits were limited. HRA enrollees may spend the money they retain in their account 

only to cover health care costs, not on other kinds of 

items and services. In practice, however, that distinction is not meaningful: keeping up the balance in their 

account by forgoing a treatment now will reduce—on 

a dollar-for-dollar basis—the level of future out-ofpocket health care costs that they will have to cover 

from their after-tax income. In turn, that will leave 

them with more after-tax funds available for other 

purchases. In that case, the incentives to limit health 

care spending are essentially the same as those associated with a simple high-deductible policy, and enrollees will treat their HRA balances as being equivalent 

to cash.

The incentives that would face HSA and HRA enrollees 

in plans with similar designs could also differ depending 

on the level and predictability of their health care spending. For people who expected their costs for health care to 

be low, the tax advantages of HRAs and HSAs would be 

similar, but HSAs would provide a stronger inducement 

to limit the use of health care services because enrollees 

would always get to keep the resulting savings and thus 

would tend to treat the funds in their accounts like cash. 

But for enrollees who expected their health care costs to 

be higher, the incentives to limit the use of care under an 

HRA might be modestly stronger than those under an 

HSA. Employers typically contribute amounts to HRAs 

that are much smaller than the overall limits on contributions to HSAs, so (other factors being held constant) 

individuals with higher health care costs would be more 

likely to spend after-tax dollars for their care if they were 

enrolled in an HRA than if they were enrolled in an 

HSA. For such enrollees in HRAs, then, the limited portability of those funds and their tax-favored status would 

have less effect on the use of care—because those enrollees would anticipate that eventually they would need the 

funds to pay for highly valued health care services. However, to the extent that individuals were uncertain about 

their future costs for health care, the incentives they faced 

would reflect an average of the possible outcomes. In that 

case, it becomes more difficult to determine whether the 

net costs of their care would be higher under an HRA or 

an HSA. 

Another challenge that arises in comparing consumerdirected plans and a simple high-deductible policy with 

the same design is that those designs might evolve over 

time. In particular, making some out-of-pocket spending 

tax-free might encourage enrollees to move toward health 

plans that had higher cost-sharing requirements, at least 

to some degree—because enrollees could reduce their 

policy premiums while using the new tax subsidy to limit 

their risk of bearing higher costs. Indeed, if other factors 

were held constant, making all health insurance cost sharing tax-free should eventually yield increases in cost sharing that would be large enough to offset the effects of the 

new tax subsidy (see Box 2-1). The end result would be 

somewhat lower total health expenditures—although 

how long it would take to reach that new equilibrium and 

what the ultimate magnitude of the impact on health care 

spending would be are unclear.

Determining how that finding applies to an analysis of 

consumer-directed health plans is also a complex matter. 

Although those plans allow enrollees to pay some out-ofpocket costs with untaxed funds, they do not provide 

favorable tax treatment for all out-of-pocket spending. 

For health reimbursement arrangements, any ripple effect 

on levels of cost sharing would probably be small because 

tax-favored contributions under those plans are generally 

less than their deductibles. For health savings accounts, 
18 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Box 2-1.

Could Tax-Free Out-of-Pocket Costs Reduce Health Care Spending?

Currently, the premiums that are paid for employersponsored health insurance policies receive favorable 

treatment under the tax code. Those costs are deductible for employers as a business expense, and (unlike 

other forms of compensation) they are not included 

in the taxable income of employees. By contrast, 

employees must generally finance the portion of their 

health care costs that is not covered by insurance—

the cost-sharing amounts that they must pay “out-ofpocket”—by using after-tax dollars. That difference 

makes insured costs less expensive than out-of-pocket 

costs on a net basis and thus encourages employees to 

seek more-comprehensive insurance coverage; morecomprehensive coverage in turn increases total spending for health care. From time to time, economists 

and others have proposed that lawmakers repeal the 

tax advantage given to employer-sponsored insurance—so that health insurance premiums are taxed as 

income to employees.

What would happen if, instead, out-of-pocket costs 

were given the same favorable tax treatment that 

insured costs receive? That is, what if people could 

also pay their out-of-pocket costs with funds that had 

been excluded from their taxable income? The initial 

effect would probably be to further increase health 

care spending by lowering the effective price that 

people paid for their health care services. But two 

recent studies have shown that if all health insurance 

cost sharing was made tax-free, that change would 

eventually yield increases in cost sharing that would 

be large enough to offset the initial effect—so that 

health care spending ultimately would be reduced.1

In other words, people would change their insurance 

coverage over time so that they were paying a larger 

share of their health care costs out of pocket, even 

after taking into account the new tax advantage that 

would apply to that spending. 

Such a result may seem surprising, but it can be illustrated through a simplified case in which individuals 

choose insurance policies that specify only a coinsurance rate (the percentage of the cost of each 

health care service that policyholders must pay). That 

choice requires a trade-off to be made: the lower the 

coinsurance rate that an individual selects, the less 

risk he or she will have of incurring high medical bills 

but the higher will be the policy premium. (The premium will be higher both because the policy will 

cover a larger share of total health care costs and 

because that more-comprehensive coverage will lead 

policyholders to use somewhat more health care.) In 

general, when individuals are deciding which policy 

to purchase, they will move to a lower coinsurance 

rate until the benefits of reducing their risk (by 

decreasing the variability in their out-of-pocket 

costs) just equals the costs of paying a higher policy 

premium. 

Now consider the effects of favorable tax treatment 

for health care costs. Providing a tax subsidy only for 

costs covered by insurance (as is done now) encourages people to choose a policy that has a lower coinsurance rate, other things being equal, because the 

subsidy reduces the net cost of the policy premium. 

But if people could also pay all of their out-of-pocket 

costs with tax-free funds, they could achieve the same 

net coinsurance rate with a cheaper policy—that is, 

one with a higher gross rate—and pocket the savings 

in premiums.2 A numerical example helps clarify that 

case. Suppose that an individual’s initial optimum 

point (when only their premiums are paid with 

untaxed funds) is a policy with a coinsurance rate of 

30 percent and that their marginal tax rate is 25 percent. If all out-of-pocket costs were made tax-free, 

that person could switch to a policy with a gross coinsurance rate of 40 percent and face the same risk 

1. See William Jack and Louise Sheiner, “Welfare-Improving 

Health Expenditure Subsidies,” American Economic Review, 

vol. 87, no. 1 (March 1997), pp. 206–221; and John F. 

Cogan, R. Glenn Hubbard, and Daniel P. Kessler, Healthy, 

Wealthy, and Wise: Five Steps to a Better Health Care System

(Washington, D.C.: AEI Press, 2005). 

2. Two well-founded assumptions underlie that analysis: first, 

that employers offer health insurance policies that reflect the 

collective preferences of their employees; and second, that 

employees will reap the savings from moving to a policy that 

has a lower total premium—either directly, through lower 

payments, or indirectly, through higher wages.
CHAPTER TWO EFFECTS OF CONSUMER-DIRECTED HEALTH PLAN DESIGNS ON INCENTIVES TO USE CARE 19

the impact on cost-sharing levels might be greater because 

more spending can be tax-free. In particular, HSA enrollees who had a deductible that fell below the cap on 

annual contributions would have an incentive to raise 

that deductible—because the increase in their out-ofpocket costs could still be covered by using untaxed 

funds. HSA enrollees would have less of an incentive to 

increase their deductible above the annual cap on contributions, however, and under current law, that cap is 

slated to grow more slowly than average medical costs. 

Moreover, HSA funds can be used to pay for services that 

are not typically covered by insurance (such as infertility 

treatments or chiropractic care). Because there is no scope 

to raise the level of cost sharing for such services, the tax 

subsidy will only tend to increase spending for them.

Comparing Consumer-Directed Plans 

with a Conventional Insurance Plan

To illustrate the difference in enrollees’ incentives under 

HRAs and HSAs, on the one hand, and a health insurance policy with a conventional design, on the other, it is 

Box 2-1.

Continued

that they did before—that is, their coinsurance rate 

net of taxes would still be 30 percent.3 Because that 

insurance policy would be correspondingly cheaper, 

enrollees would prefer it. 

How would those changes affect health care spending? If all enrollees did was to change their insurance 

policies so that they faced the same net coinsurance 

rate that they faced before, there would be no impact 

(the only effect would be a reduction in tax revenues). 

But if that policy was used as a starting point, a small 

increase in the net coinsurance rate would yield larger 

savings in premiums than it would have before—

because it would involve a larger increase in the policy’s gross coinsurance rate.4

 To continue the example, 

enrollees could now increase their net coinsurance 

rate from 30 percent to 33 percent by choosing a policy with a gross coinsurance rate of 44 percent. By 

contrast, if out-of-pocket spending did not receive 

favorable tax treatment, then the same change in the 

risk that enrollees faced would involve a smaller 

increase in their policy’s coinsurance rate (from 

30 percent to 33 percent) and smaller savings in premiums. Because the premium savings that accompany a given increase in risk are larger when out-ofpocket costs are tax-free, enrollees could be expected 

to move in the direction of higher net coinsurance—

at least to some extent. In turn, the higher net coinsurance rate would reduce their total health care 

spending, all other factors being equal. 

Several caveats about that result also need to be considered, however. First, although the direction of the 

effect is clear—spending for health care services covered by insurance would eventually decline—the 

effect’s magnitude is uncertain. Second, it might take 

a considerable amount of time for the designs of 

insurance policies to adjust to the new incentives that 

would arise if out-of-pocket spending was made taxfree; until those adjustments occurred, total health 

care spending would probably increase because of the 

new tax subsidy for out-of-pocket spending. Third, 

the reasoning outlined above applies only to health 

care services that are covered by insurance and not to 

other health-related items and services. In the case of 

the latter, individuals already pay the full cost, so 

there is no scope to increase the coinsurance rate. 

Extending favorable tax treatment to the funds used 

to pay for those other items and services would tend 

to increase spending for them because it would create 

a new tax subsidy but no offsetting reduction in 

coverage. 

3. Under the original insurance policy, the individual would pay 

$30 for a health care service whose overall cost was $100. 

With the new insurance policy, the individual would initially 

owe $40 for that same service but would save 25 percent of 

that amount (or $10) through lower taxes—so his or her net 

cost would also be $30. 

4. The extent of the premium savings would also depend on 

how enrollees’ use of care responded to the higher net coinsurance rate they would face.
20 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

most useful to present an example of plans that provide a 

similar level of coverage overall. Conventional designs—

the type of coverage that most individuals currently 

receive through an employer—have lower deductibles but 

obviously lack an account to which employers can contribute tax-free funds to offset enrollees’ out-of-pocket 

costs.4 Despite those differences, it is possible to specify 

conventional and consumer-directed designs that—for a 

fixed set of medical claims—have the same expected costs 

for providing coverage. In other words, the costs for an 

employer or insurer to cover those claims (including 

the costs of funding the accounts associated with the 

consumer-directed designs) would be the same under 

each plan. Such comparable plans are said to have the 

same actuarial value or to be actuarially equivalent.

Three Illustrative Plans

A recent study by the American Academy of Actuaries 

provided the basis for developing a set of actuarially 

equivalent plans with the following benefit parameters:5

B A conventional policy that has a deductible of $350, 

followed by coinsurance of 10 percent until a yearly 

limit of $1,350 on out-of-pocket costs is reached (after 

which all health care costs are covered by the plan). 

B An HRA policy that has a deductible of $2,000, followed by coinsurance of 20 percent on the next 

$5,000 in spending and a contribution of $800 by the 

employer to the associated account. The annual outof-pocket limit for this plan is $3,000, but because 

$800 of those costs could be paid from the account, 

the enrollee would pay a maximum of $2,200 per year 

out of pocket.

B An HSA that also has a deductible of $2,000, followed 

by coinsurance of 20 percent on the next $5,000 in 

spending, an annual out-of-pocket limit of $3,000, 

and a contribution by the employer of $600 (yielding 

a maximum net liability of $2,400 per year).

Taking a set of medical claims as a given in designing the 

illustrative plans has several implications for an analysis of 

them. First, total premiums would be the same for all 

three policies. And with total health care spending and 

total covered costs held constant, average out-of-pocket 

costs for enrollees—net of account withdrawals and the 

expected value of any remaining balances—would also be 

the same.6 It may seem surprising that the comparison 

does not yet account for any behavioral response by 

enrollees to a change in the design of their plan, which 

could affect both their premiums and their out-of-pocket 

costs. But structuring the three plans in this way allows 

the effects of the enrollees’ response to be clearly identified. By contrast, with plans that varied in actuarial value, 

some of the difference in total spending and out-ofpocket costs under them would stem from the difference 

in the plans’ values. 

Before analyzing the incentives created by the plans’ 

designs, two aspects of their features merit further discussion. One question that may arise about this example is 

why the contribution to the HSA is smaller than the one 

to the HRA, even though the high-deductible health 

insurance policies attached to them are the same. The 

reason is that some of the contribution to the HRA will 

never be used and will revert to the employer—and thus 

will never become a cost to it or to the insurer.7 Although 

some HRA funds will be used in future years, some will 

be forfeited, as a result of enrollees’ leaving the firm or the 

4. This analysis focuses on employment-based health insurance 

because that is the predominant form of private coverage. 

5. See American Academy of Actuaries, The Impact of ConsumerDriven Health Plans on Health Care Costs: A Closer Look at Plans 

with Health Reimbursement Accounts (January 2004), available at 

www.actuary.org/pdf/health/cdhp_jan04.pdf. Although the study 

did not explicitly analyze an HSA plan, the Congressional Budget 

Office imputed the parameters of an actuarially equivalent HSA 

by using the data that the study provided.

6. According to the Academy of Actuaries’ study, average estimated 

medical costs for individual enrollees would be about $2,600. For 

the conventional plan, average covered costs would be about 

$2,100, and average out-of-pocket costs (excluding policy premiums) would be about $500. Costs for providing the catastrophic 

portion of the coverage under the consumer-directed designs 

would be about $1,500; the remaining expenditures of about 

$1,100 would come from the contributions to enrollees’ accounts 

or would be paid out of pocket.

7. Actual withdrawals from HRAs under this design, the Academy of 

Actuaries’ analysis indicates, would average about $500 in the first 

year, leaving an average balance of about $300. For the HRA plan 

to be actuarially equivalent to the other two plans, the present 

value of future spending of those funds would have to be about 

$100. (The present value is a single number that expresses a flow 

of future and current funds in terms of an equivalent lump sum 

received or paid today.) If larger withdrawals occurred in the 

future, employers’ costs for the HRA plan presented here would 

be slightly higher over time than those for the other two plans, 

meaning that the employer’s contribution to the account to maintain actuarial equivalency should be somewhat smaller than $800.
CHAPTER TWO EFFECTS OF CONSUMER-DIRECTED HEALTH PLAN DESIGNS ON INCENTIVES TO USE CARE 21

Figure 2-1.

Comparison of Enrollees’ Annual Out-of-Pocket Costs Under Illustrative Plans of 

Equal Actuarial Value

(Dollars paid out of pocket)

Source: Congressional Budget Office based on American Academy of Actuaries, The Impact of Consumer-Driven Health Plans on Health 

Care Costs: A Closer Look at Plans with Health Reimbursement Accounts (January 2004), available at www.actuary.org/pdf/health/

cdhp_jan04.pdf. 

Notes: Although the American Academy of Actuaries’ study did not explicitly analyze an HSA plan, CBO imputed the parameters of an 

HSA by using the data that the study provided.

Negative out-of-pocket costs in the figure reflect balances in accounts that may be carried over to succeeding years. Enrollees might 

consider account balances under an HRA less valuable than those under an HSA because HRA balances are forfeited if enrollees 

change jobs.

The figure does not reflect the favorable tax treatment of contributions to HRAs and HSAs. 

employer’s deciding to limit the total amount that may 

build up in the account. Thus, employers would be contributing slightly more to HRAs than to comparable 

HSAs, but the HRA funds would be less valuable to 

enrollees (and less costly to employers) because of the 

added restrictions on their use. In particular, enrollees in 

HRAs whose health care costs were generally low might 

value the balance in their account at less that its nominal 

level because they might not expect to use all of it. 

The second noteworthy aspect of the illustrative plans

is that the higher limits on out-of-pocket costs in the 

consumer-directed plans are not an inherent feature of 

those designs. Other features of each plan’s design could 

be changed to equalize their out-of-pocket limits on a net 

basis. (That is, the limits would be equal after factoring in 

the use of account contributions.) For example, the conventional plan’s deductible could be lowered and the 

coinsurance rate in the consumer-directed plans 

increased, and the out-of-pocket limits could then be 

adjusted to maintain the plans’ actuarial values. Those 

changes would yield an increase in the out-of-pocket 

limit in the conventional plan and a reduction in that 

limit in the consumer-directed plans. Indeed, it would 

probably be feasible to revise the two designs so that their 

actuarial value was the same but the conventional plan 

had a higher net limit on out-of-pocket costs. 

Comparing Overall Incentives

Those caveats notwithstanding, a comparison of the 

designs of the three plans highlights the differing financial incentives that enrollees face when they decide 

whether and to what extent to use health care services (see 

Figure 2-1). In the example, enrollees in the HSA or 

0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000

-1,000

-500

0

500

1,000

1,500

2,000

2,500

3,000

Total Annual Health Care Spending (Dollars)

Conventional Plan

Health Savings Account

Health Reimbursement Arrangement
22 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

HRA—to the extent that they treat the funds in their 

accounts as cash—are obliged to balance the expected 

benefits of that care against its full costs for the first 

$2,000 in health care services that they use each year (that 

is, up to the limit of the plan’s deductible). The design of 

the conventional plan encourages that kind of careful 

consideration only for the first $350 worth of care; 

between that point and the limit on out-of-pocket costs, 

the conventional plan enrollee’s decision in financial 

terms is whether the likely benefits of the services exceed 

10 percent of their full cost—the share of the costs that 

the enrollee must pay. (The slopes of the lines in 

Figure 2-1 reflect an enrollee’s initial costs for additional 

services—not including the tax advantage given to 

account funds in the consumer-directed plans—with a 

45-degree angle representing full liability. The effects of 

those tax advantages are considered below.) 

How might enrollees respond to the incentives they 

would face under consumer-directed plans? They would 

have several options, at least in principle. They could seek 

to obtain the same services but at lower prices—possibly 

from a different provider. (The effects that consumerdirected plans’ designs might have on the average prices 

paid for care are discussed in Chapter 4.) They could seek 

a lower-cost treatment for their condition. Or they could 

simply choose not to use some services. Whether those 

options were available as a practical matter would depend 

in large part on the disease or condition in question, its 

severity in an individual case, and the range of treatments 

that exist. Which option enrollees chose—and whether 

they decided to reduce their spending at all—would also 

depend crucially on their assessment of the benefits of the 

treatments involved.

Although the three plans differ in their coverage of initial 

health care costs, Figure 2-1 also shows that once enrollees reach a level of spending that corresponds to the HRA 

and HSA deductible, there is a large range of spending 

under all three designs in which they will pay only a small 

portion of their costs. However, the higher deductibles in 

the consumer-directed plans mean that their limits on 

out-of-pocket costs will be reached at a lower level of total 

health care spending (and that would be true even if all 

three plans had the same net limit on annual out-ofpocket costs). Thus, over some range of spending, enrollees in conventional plans will generally be financing a 

small portion of their own care, but enrollees in HSAs or 

HRAs will have reached the out-of-pocket limit and 

become insensitive to the costs of those health care 

services.

In a comparison of the designs of the plans and their 

potential effects on expenditures, another important consideration is how many enrollees—out of a broadly representative group—will be in each range of spending (see 

Figure 2-2). The Congressional Budget Office estimates 

that among nonelderly individuals who reported having 

health insurance for the entire year in 2004, 32 percent 

had total health care costs of less than $350, 23 percent 

had costs of $350 to $1,000, and 15 percent had costs 

between $1,000 and $2,000. Another 22 percent had 

costs that would have put them between the consumerdirected plans’ deductible ($2,000) and out-of-pocket 

limit, which would be reached at $7,000 in total spending. The remainder of the group of nonelderly individuals had costs above that level. Because the illustrative 

plans were constructed to have equal actuarial value, 

the financial gains and losses for individual enrollees offset one another overall, once the values of the HRA’s 

and HSA’s balances are accounted for. (Chapter 5 discusses how those gains and losses would affect whether 

enrollment in consumer-directed plans was broadly 

representative.) 

A potentially significant limitation of the comparisons of 

out-of-pocket costs is that they do not factor in any tax 

subsidies. Although the subsidies will tend to encourage 

people to use more care (other things being equal), they 

will also reduce the financial burden of cost sharing for 

individual enrollees in proportion to the enrollees’ marginal tax rates. The three health plan designs may have 

different effects on tax revenues as well. 

B For HRA plans, the effect of the tax subsidy applies 

most clearly up to the point at which the employer’s 

contribution or the balance in the account is 

exhausted—because those dollars are the only ones 

that receive favorable tax treatment. Over time, if 

enrollees built up balances in their accounts, the tax 

treatment of those funds would become a more significant factor in their decision about whether or not to 

seek treatment. 
CHAPTER TWO EFFECTS OF CONSUMER-DIRECTED HEALTH PLAN DESIGNS ON INCENTIVES TO USE CARE 23

Figure 2-2.

Distribution of Individuals in Each Range of Health Care Spending, 2004

(Percent)

Source: Congressional Budget Office based on data for 2004 from the Medical Expenditure Panel Survey conducted by the Department of 

Health and Human Services’ Agency for Healthcare Research and Quality.

Note: “Individuals” constitutes a broadly representative group of nonelderly individuals who were privately insured for all of 2004. 

B For enrollees in HSAs, the employer’s contribution to 

the account in the example is well below the annual 

limit on total contributions, so enrollees with higher 

levels of health care costs could arrange to make most 

or all of their remaining out-of-pocket payments 

through the account and so avoid taxation of that 

money. Thus, they would not generally bear the full 

cost of the services they received before they had met 

their annual deductible. 

B Further complicating the comparison, however, is that 

enrollees in conventional plans might also be able to 

pay for some of their out-of-pocket costs with taxfavored funds by using a flexible spending account. 

Although they would probably be reluctant to cover 

more than their predictable medical costs in that manner (because of the use-it-or-lose-it nature of FSA 

deposits), their out-of-pocket costs would also be 

more predictable under a conventional plan than 

under a consumer-directed plan. 

Because consumer-directed designs make out-of-pocket 

costs financed through the account tax-free, they can at 

least match and may exceed the tax advantages provided 

by a conventional plan’s design. HRAs would offer the 

same overall tax advantages as conventional plans would, 

but HSAs would allow more out-of-pocket costs to become tax-deductible (while also reducing tax revenues). 

Thus, enrollees in conventional plans would find 

consumer-directed plans more attractive than highdeductible plans alone. 

At the same time, the example shows that consumerdirected plans can be structured to offer the same average 

value as a conventional health plan while generally providing stronger incentives for enrollees to control their 

initial health care costs—thereby avoiding some of the 

moral hazard problem common with insurance. That is, 

their policy will cover the same share of health care costs 

overall, but the presence of that insurance is less likely to 

stimulate greater use of covered services because enrollees 

get to keep most or all of the savings when they limit 

their spending. That combination is the key innovation 

embodied in consumer-directed designs.

The focus of consumer-directed designs is thus on influencing the demand for medical care; managed care plans, 

by contrast, have focused (to a greater or lesser extent) on 

affecting the supply of services by doctors and other 

providers. But before considering how the features of 

Annual Health Care Spending (Dollars)

0 to 1,000 1,000 to 2,000 2,000 to 3,000 3,000 to 4,000 4,000 to 5,000 5,000 to 6,000 6,000 to 7,000 More Than

7,000

0

10

20

30

40

50

60
24 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

consumer-directed designs interact with efforts by health 

plans to manage enrollees’ use of care—efforts that are 

also aimed at limiting moral hazard and health care 

spending—two areas of controversy surrounding those 

designs warrant attention: coverage of preventive care and 

prescription drugs and incentives to control costs that 

exceed a policy’s deductible.

Incentives for Using Preventive Care and 

Prescription Drugs

A concern that has been expressed about health plans’ 

having high deductibles is that they could discourage the 

use of “preventive” care and prescription drugs and 

thereby raise overall costs for health care. In principle, 

preventive care (such as screening for the presence of a 

disease or for risk factors associated with it) can help 

avoid the more costly treatments required after a disease 

has developed further. Likewise, the use of prescription 

drugs may forestall or slow the progression of a disease 

that would be more expensive to treat at a later stage. In 

some cases, however, increased use of preventive care or 

prescription drugs could increase other health care spending—for example, to treat newly discovered diseases or to 

address complications that arise from testing or from 

drug regimens. Indeed, one older study concluded that 

the use of preventive care usually adds to overall medical 

spending, once the costs of screening individuals who are 

found not to have the disease in question are included.8

Even if the use of those services could reduce total spending for health care for an average patient, the evidence is 

mixed about whether providing coverage for them under 

an insurance policy would have the same impact. That 

effect would depend on whether enrollees who would 

otherwise not have used those services increased their 

demand once coverage was provided. It would also 

depend on the effects of preventive care for the specific 

group that received those services—which might differ 

from the effect for average patients.

To the extent that the greater use of preventive care or 

medications reduced other health care spending, insurance plan designs that featured a high deductible could 

lead enrollees to use too little of such care. The reason is 

that they would take into account the costs they would 

bear up front but would discount any savings that 

accrued to the health plan in the future. (Economists 

refer to such a situation in which the person who is making a decision does not reap all of the benefits of their 

actions as a positive “externality.”) Clearly, enrollees 

would have personal and other financial incentives to 

avoid becoming sick, but they might also be dissuaded by 

such factors as the immediate time and effort required to 

get preventive care or to follow a prescription drug regimen. Enrollees in conventional plans would also tend to 

discount the potential savings from avoiding a high-cost 

treatment in the future. But because they would be less 

likely to face the full costs of their initial care, they would 

be more likely to seek preventive services even if they did 

not stand to realize all of the resulting benefits. 

The extent to which those concerns about consumerdirected plans arose in practice would depend on the 

plans’ specific features. HRAs are not required to have a 

high deductible; consequently, even if the basic design of 

a plan featured a high deductible, the employer that 

sponsored the plan would be free to provide exceptions 

for drugs or preventive care. For HSAs, the enabling legislation specifically allowed coverage for preventive care 

before enrollees had met the deductible (probably to 

address concerns about the underutilization of such services). Although the law does not require the coverage, 

health plans would have an incentive to offer it if they 

expected that it would reduce their costs—thus allowing 

the potential externality to be corrected.9 If health plans 

experienced a substantial amount of turnover in their 

membership—and thus would not expect to capture later 

savings from covering preventive care—their incentive to 

cover preventive services would be weakened. However, 

that consideration would apply equally to plans of 

consumer-directed and conventional design. Another reason that insurers might choose to offer coverage of preventive services would be to attract healthier enrollees, 

8. Louise B. Russell, Is Prevention Better Than Cure? (Washington, 

D.C.: Brookings Institution, 1986).

9. The illustrative plans discussed earlier, drawn from the American 

Academy of Actuaries’ study, included full coverage of as much as 

$500 in preventive services under the HRA and HSA designs; 

under the conventional plan’s design, preventive services would be 

covered in the same manner as other services would be. The 

Henry J. Kaiser Family Foundation’s 2006 survey of employers 

reported that 22 percent of enrollees in consumer-directed plans 

could receive coverage for preventive procedures before meeting 

the general deductible and that 57 percent of HRA enrollees 

could get coverage for prescription drugs below the deductible. 

Among conventional plans that had a deductible, about 45 percent exempted preventive procedures from the deductible. 
CHAPTER TWO EFFECTS OF CONSUMER-DIRECTED HEALTH PLAN DESIGNS ON INCENTIVES TO USE CARE 25

who might be more likely to benefit from that coverage 

than from payments to treat incurred illnesses. 

The legislation that established HSAs provided no exception for coverage of prescription drugs below the deductible. In 2004 and 2005, Internal Revenue Service regulations allowed HSAs to provide drug coverage before 

enrollees met the general deductible; starting in 2006, 

however, plans may not provide such coverage if they 

want to continue to qualify as an HSA. Thus, before 

enrollees reach the deductible, they must now weigh the 

full costs of drug regimens against their benefits—that is, 

those therapies will be on a par with visits to the doctor or 

other types of care that enrollees might receive. (The IRS 

has indicated that it will consider permitting coverage 

below the general HSA deductible for specific drugs if 

they can be shown to prevent rather than treat a disease.) 

A related issue is whether those requirements will make it 

more difficult for HSAs to steer enrollees toward the use 

of lower-cost generic drugs or to obtain discounts from 

drug manufacturers on the prices of patented brandname drugs. Conventional health plans generally feature 

lower cost-sharing obligations for generic drugs than for 

brand-name drugs to encourage enrollees to use generic 

products. HSA enrollees will also have strong financial 

incentives to use generic drugs when their spending is 

below their plan’s deductible because they will face the 

full difference in cost between those medications and 

their brand-name competitors.

The situation could be different, however, if the competing brand-name drugs were patented and no generic 

product was available. Conventional health plans are able 

to set up their formularies, or lists of preferred drugs—

and to vary the levels of enrollees’ copayments for preferred and nonpreferred brand-name drugs—to shift 

usage to drugs that are preferred. In turn, the plans secure 

price discounts from the manufacturers of preferred drugs 

(in exchange for the increase in sales of their product and 

in their market share that results). HSA enrollees whose 

spending was below their deductible would see only the 

differences in prices between drugs, which could be larger 

or smaller than the differences in copayments for preferred and nonpreferred drugs under a conventional plan. 

Given that arrangement, providing a price discount for a 

preferred drug might not be enough of an incentive to 

substantially increase the use of that drug—which could 

make it more difficult for the HSA to secure discounts for 

preferred drugs in the first place. Even so, enrollees in 

HSAs generally have strong financial incentives to use the 

least expensive brand-name drug that is available to treat 

their disease. 

Incentives to Control Catastrophic Costs

Relative to health care plans of conventional design, 

consumer-directed plans clearly create stronger incentives 

for enrollees to limit their initial health care spending, 

but comparisons of plans must also account for any 

effects the designs have on spending that occurs after the 

higher deductible has been met. As in the example given 

earlier, many consumer-directed designs include a range 

of spending—one that lies above the deductible but 

below the annual limit on out-of-pocket costs—over 

which enrollees face limited coinsurance.10 If enrollees in 

consumer-directed plans had reached the out-of-pocket 

limit, they would not have a financial incentive to control 

their health care spending—and might prefer to shift the 

timing of their care (if possible) so that it would be fully 

covered rather than wait for the beginning of a new plan 

year, when a new plan deductible had to be satisfied. 

Enrollees in conventional plans would have the same 

motivation once they had reached their out-of-pocket 

limit, but in general, they would reach that limit at a 

higher level of total spending. 

Some observers have argued that consumer-directed plans 

can have only a small effect on health care spending 

because so much of that spending is incurred by enrollees 

who will exceed their deductibles and out-of-pocket limits. Indeed, the vast majority of such spending is generated by the relatively small share of individuals who use 

large amounts of care in a given year (which is why people seek insurance for their health care costs). For example, CBO’s analysis indicates that in 2004, 13 percent of 

nonelderly insured Americans used more than $5,000 

worth of care—but that high-spending subgroup 

accounted for about 68 percent of the health care costs 

10. Contrary to that example, however, the available data on coinsurance rates indicate that they are slightly lower, on average, 

under consumer-directed plans than they are under conventional 

plans. According to the 2006 Kaiser survey of employers, enrollees 

in conventional plans that charge coinsurance typically face rates 

for physicians’ services of 10 percent to 15 percent (28 percent of 

enrollees) or 20 percent to 25 percent (68 percent of enrollees) for 

network doctors; coinsurance rates generally varied from 20 percent to 45 percent for nonnetwork doctors. Under consumerdirected plans, the typical coinsurance rates were 10 percent to 

15 percent (60 percent of enrollees) or 20 percent to 25 percent 

(34 percent of enrollees) for network providers. 
26 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Figure 2-3.

Distribution of Annual Health Care Spending, 2004

(Percent)

Source: Congressional Budget Office based on data from the Medical Expenditure Panel Survey conducted by the Department of Health and 

Human Services’ Agency for Healthcare Research and Quality.

Note: In the figure, individuals are grouped according to their total health care spending for the year, and the associated spending includes 

all health care costs incurred by the group’s members. For example, 17 percent of this population had total spending of at least 

$2,000 but less than $5,000, and their aggregate health care costs (including their first $2,000 in spending) accounted for 19 percent 

of the total.

a. Privately insured individuals who were insured for the full year. 

for that population (see Figure 2-3). If the threshold is 

lowered to $2,000 worth of care, the share of nonelderly 

insured people with higher spending increases to 30 percent, and the share of health care costs attributable to 

those individuals rises to 86 percent. By contrast, the 

share of that population that used less than $1,000 worth 

of care during the year was (as noted previously) about 

55 percent, and their collective spending amounted to 

only 6 percent of the total.11

Although that concentration of health care spending 

tends to limit the impact that consumer-directed designs 

can have on total costs, the initial cost sharing that those 

designs require might nevertheless affect spending above 

the deductible somewhat and could also affect spending 

above the out-of-pocket limit. Enrollees who used substantial amounts of care would eventually exceed their 

out-of-pocket limits, but much of their spending would 

occur below those thresholds. Among nonelderly insured 

people in 2004, for example, about one-third of the 

spending of individuals whose total costs exceeded 

$5,000 occurred before that threshold was reached. (That 

is, about one-third of their spending was incurred before 

their total costs reached $5,000, and the rest was accumulated after that point.) Similarly, much of the spending of 

those who ended up using more than $1,000 but less 

than $5,000 in health care services was actually for their 

first $1,000 of care. Recasting the distribution of costs so 

that it shows spending within each of those dollar intervals suggests less concentration of health care costs (see 

Figure 2-4). 

The key question is how financial considerations will 

affect the choices about health care that enrollees in 

consumer-directed plans make. For some enrollees who 

0 to 1,000 1,000 to 2,000 2,000 to 5,000 More Than 5,000

0

20

40

60

80

100

Share of Nonelderly Insured Peoplea

Share of Total Health Care Spending

Annual Health Care Spending (Dollars)

11. The data that CBO used in its analysis come from the Medical 

Expenditure Panel Survey (conducted by the Department of 

Health and Human Services’ Agency for Healthcare Research and 

Quality), which tends to undercount total health care spending 

and may undercount the costs incurred by people who consume 

the most care—in which case, it would understate the degree to 

which health care spending was concentrated in the highest-cost 

groups.
CHAPTER TWO EFFECTS OF CONSUMER-DIRECTED HEALTH PLAN DESIGNS ON INCENTIVES TO USE CARE 27

Figure 2-4.

Distribution of Health Care Spending by Spending Range, 2004

(Percent)

Source: Congressional Budget Office based on data from the Medical Expenditure Panel Survey conducted by the Department of Health and 

Human Services’ Agency for Health Care Research and Quality.

Note: In the figure, individuals are classified according to whether they had any spending in each dollar range, and the associated spending 

includes only those expenses that were incurred in the range. For example, 45 percent of the sample had total spending of at least 

$1,000—but some of that spending was for their first $1,000 worth of care (which is included in the first spending range); some was 

for services that they used after their total spending had exceeded $2,000 (which is included in the third spending range); and some 

was for care provided after their total spending had reached $5,000 (which is included in the fourth spending range).

a. Privately insured individuals who were insured for the full year. 

have high costs for health care, the exact level of their 

deductible will not affect their use of services because 

their need for care and the benefits they receive from it 

will outweigh any burden created by their cost-sharing 

obligations. Even before they reach their deductible, 

some enrollees may anticipate that they will exceed it 

later; consequently, their choice will be governed by the 

share of costs they expect to pay above the deductible. For 

other enrollees, however, higher initial cost sharing may 

lead them to decide that treatment for their condition is 

not worth its costs. If such decisions ultimately prevented 

some hospitalizations, the result could be to reduce 

higher-end costs—that is, there would be fewer expenditures that exceeded the plans’ deductibles. 

A similar question arises regarding the design of conventional health plans. As noted earlier, a conventional plan 

of comparable value would tend to require some cost 

sharing over a range of spending that would extend 

beyond the point at which a consumer-directed plan’s 

limit on out-of-pocket costs had been reached. (In the 

example given earlier, that range runs from $7,000 in 

total spending to $10,350.) The extent to which cost 

sharing may influence decisions about treatment when 

overall expenditures reach those levels is uncertain. 

Comparing Consumer-Directed 

Plans with Conventionally Designed 

Managed Care Plans

The potential for consumer-directed health plans to 

reduce health care spending is clearest when those designs 

are compared with an unmanaged conventional plan, 

such as an indemnity policy that provides reimbursement 

after the fact for care received. Conventional plans of that 

kind have lower deductibles and cover any care that is 

deemed to be medically necessary—that is, any care that 

has positive medical benefits—so enrollees generally have 

to balance the benefits of that care against only a small 

fraction of its total costs. Enrollees are likely to use more 

health care when faced with those incentives than they 

Annual Health Care Spending (Dollars)

0 to 1,000 1,000 to 2,000 2,000 to 5,000 More Than 5,000

0

20

40

60

80

100

Share of Nonelderly Insured People with Spending in the Rangea

Share of Total Health Care Spending in the Range
28 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

will when they have to pay all or nearly all of the initial 

costs of their care. That logic generally applies even if 

enrollees in a consumer-directed plan are paying for care 

by using funds in their account that were contributed by 

an employer—because most individuals have an incentive 

to treat those contributions like cash. 

The potential for cost savings from widespread enrollment in consumer-directed plans is less evident, however, 

if those plans are being compared with managed care 

approaches—with the impact’s depending on whether the 

comparison involves a preferred provider organization 

plan or a health maintenance organization.12 PPOs generally employ less restrictive management techniques 

than HMOs do; their main source of leverage comes 

from selecting the doctors and hospitals to be included in 

their network of preferred providers.13 In plans that have 

a conventional PPO design, enrollees must pay a higher 

coinsurance rate when they use nonnetwork providers, a 

requirement that gives enrollees a strong financial incentive to seek care within the plan’s network. (And network 

providers usually accept a discounted payment in return 

for the higher or more certain volume of patients they 

get.)14 If PPOs can exclude some high-cost providers 

from their network and enrollees avoid using those providers, the direct result will be lower health care spending. 

The risk of exclusion that providers face may also help 

reduce the use of health care services within the plan’s 

network. Although a PPO plan may actually exclude only 

a small number of doctors, a credible threat of exclusion 

may discourage network doctors from calling for hospital 

admissions in borderline cases or pursuing the most 

expensive treatments for their patients. 

To offset the limited incentives that enrollees have to contain their costs for expensive services (such as hospitalizations), PPOs may take additional steps to limit those 

expenditures. For example, they may pay a fixed fee per 

admission based on the patient’s diagnosis (instead of per 

diem payments) or assign case managers to encourage 

shorter hospital stays. Consumer-directed plans could 

have a similar effect on the use of health care services by 

adopting their own PPO networks and methods for managing costs once enrollees had exceeded their deductible 

(and could also secure lower prices for those services from 

network providers). Even so, some of the savings that 

might be garnered by raising the deductible in an indemnity insurance plan have probably been achieved by 

PPOs’ limited adoption of management techniques.

The potential for reductions in the use of health care services under consumer-directed plans is further limited in 

comparison to HMOs because HMOs generally use 

more aggressive management tools than PPOs do.15 In 

some cases, such as in the Kaiser Permanente health plan, 

the doctors in the HMO work exclusively for that plan, 

and the plan owns the hospitals that provide care to 

enrollees, thus enabling the HMO to exert considerable 

leverage over enrollees’ use of services. (Such plans are 

called staff-model HMOs.) In the more common case, a 

network of independent doctors and hospitals works 

under contract to the health plan, a structure that is more 

like a PPO. But HMOs still tend to be more active than 

PPOs in reviewing the use of health care services and in 

seeking to alter patterns of clinical practice. Because 

HMOs generally do not cover any portion of the cost of 

care received from out-of-network providers, providers 

face a stronger incentive to be included in an HMO’s network. As a result, provider payment rates may be lower 

and compliance with treatment guidelines may be higher 

in HMOs (although the extent of the differences will 

depend on local market conditions and other factors). 

In the past several years, however, consumers and providers have objected to some of the management techniques 

that HMOs use, and as a result, the health plans have 

12. For further discussion of interactions between managed care and 

consumer-directed approaches, see the November/December 

2005 issue of Health Affairs.

13. For a discussion of PPOs, see Robert E. Hurley, Bradley C. 

Strunk, and Justin S. White, “The Puzzling Popularity of the 

PPO,” Health Affairs (March/April 2004).

14. Indeed, the difference in out-of-pocket payments between preferred and nonpreferred doctors may exceed the difference in their 

total charges. For example, if a network provider charged a discounted rate of $100 for an office visit and enrollees faced coinsurance of 20 percent, they would pay $20 for that visit. If a 

nonnetwork provider’s charge was $120 and enrollees faced coinsurance of 40 percent, their obligation would be $48 (or $28 

more). Some PPO plans require enrollees to pay a larger share of 

the discounted charge plus the full difference in charges for outof-network care. 

15. Although HMOs could offer a high-deductible plan that included 

an individual account—and could thus meet the definition of a 

consumer-directed plan—the available evidence (discussed later) 

indicates that such arrangements are rare. Moreover, an aggressive 

management role for the health plan under such an arrangement 

might appear to be inconsistent with a “consumer-directed” 

approach. 
CHAPTER TWO EFFECTS OF CONSUMER-DIRECTED HEALTH PLAN DESIGNS ON INCENTIVES TO USE CARE 29

modified some of those approaches. For example, HMOs 

had typically required enrollees to obtain a referral from 

their primary care physician before seeing a specialist—

thus providing a “gatekeeper” who could assess the need 

for care but who did not have a financial interest in 

whether it was provided. Many HMOs no longer require 

such referrals.16 Even more recently, though, rapidly rising costs have led many HMOs to reinstitute some of the 

procedures they had previously eliminated, such as the 

requirement to obtain prior authorization from the 

health plan before receiving selected services. One study 

found that in so doing, “health plans have targeted those 

services that offer little or no clinical benefit while being 

careful not to reduce access to potentially beneficial 

services.”17

In comparing HMOs and consumer-directed health 

plans, it is also useful to consider a hypothetical plan—a 

very tightly managed HMO—that would deny coverage 

for all services whose costs exceeded their expected benefits. Enrollees in such an HMO would face essentially the 

same financial incentives regarding their use of care as 

would enrollees in consumer-directed plans who expected 

their costs to remain below their deductible. Enrollees in 

the consumer-directed plan would presumably forgo 

treatments whose costs exceeded their likely benefits and, 

conversely, purchase all care whose expected benefits 

exceeded its costs. In the tightly managed HMO, care 

that was not cost-effective would not be covered, so 

enrollees could still avail themselves of it but only if they 

were willing to pay its full cost. (Presumably, they would 

not do so.) However, care that was cost-effective overall 

would be covered by the HMO and available at a relatively small cost to the enrollee—and thus almost certainly would be used. Total health care spending for 

enrollees in both plans would therefore be comparable, at 

least in principle. 

In practice, many challenges would confront that hypothetical HMO in trying to establish coverage rules that 

could distinguish between cases in which care would be 

cost-effective and cases in which it would not be. Even so, 

the hypothetical case illustrates the fact that managed 

care plans can effectively vary cost sharing, depending on 

the extent of the enrollee’s need for care. By contrast, 

consumer-directed designs must (at least in the case of 

HSAs) have a high deductible that applies equally to all 

services, whether they are clearly needed or of marginal 

value. (HRAs could have lower deductibles but would 

then be comparable to conventional plans and would not 

meet the working definition of a consumer-directed 

plan.) Further, individuals who are enrolled in consumerdirected plans also face substantial challenges in determining whether the care their doctor has recommended—or an initial visit to the doctor to begin treatment—is cost-effective. Even by comparison with a less 

tightly managed HMO, therefore, it is not clear whether 

consumer-directed health plans would yield lower health 

care spending for the same set of enrollees. (The role 

that better information about the costs and benefits 

of treatments could play under both conventional and 

consumer-directed plan designs is discussed further in 

Chapter 4.)

16. See Debra A. Draper and others, “The Changing Face of Managed Care,” Health Affairs (January/February 2002). 

17. See Glen P. Mays, Gary Claxton, and Justin White, “Marketwatch: Managed Care Rebound? Recent Changes in Health 

Plans’ Cost Containment Strategies,” Health Affairs Web 

Exclusive (August 11, 2004), p. W4-429, available at http://

content.healthaffairs.org/cgi/content/full/hlthaff.w4.427/DC1. 

CHAPTER

3

Evidence About the Impact of

Consumer-Directed Designs on Health Care Spending

Because health reimbursement arrangements and 

health savings accounts are so new, little direct evidence is 

available about how those designs affect individuals’ 

spending for health care. But a number of insights about 

their potential impact can be gleaned from older studies 

that examined the consequences of increasing deductibles 

and coinsurance rates or simulated the effects of combining a high-deductible health plan with a tax-favored 

account. Those studies have estimated the effects such 

plans would have if their enrollees are broadly representative of the nonelderly population. (Chapter 5 considers 

the issue of whether consumer-directed plans are likely to 

attract individuals with below-average health care costs; 

Chapter 6 reviews the limited evidence that studies of 

actual consumer-directed plans provide about their 

enrollees and their impact on health care spending and 

outcomes—evidence that should be treated cautiously 

because it is preliminary.)

A primary source of information about the impact of cost 

sharing on the use of health care services remains the 

RAND Health Insurance Experiment, which began in 

the 1970s and primarily studied unmanaged plans. On 

the basis of its findings, researchers have estimated that 

shifting a representative group of enrollees from a conventional indemnity plan to a high-deductible design 

could decrease their use of health care services and spending by about 5 percent. Some of those savings appear to 

come from avoiding expensive hospitalizations whose 

costs would have exceeded even a high deductible. Several 

more-recent studies have tried to simulate the effects of 

adding a tax-favored account into the mix; those studies 

have yielded larger or smaller estimates of the reduction 

in spending, depending partly on the levels of the deductibles they modeled and partly on the assumptions they 

used about enrollees’ responses to cost sharing. 

Although those findings are valuable, an important limitation of them is that they did not account for the effects 

of care management, which (as discussed in Chapter 2) 

could reduce the scope for savings from adopting a highdeductible design. The results of a more recent study 

indicate that consumer-directed plans—when compared 

with conventional plans that also use a network of preferred providers—will yield spending reductions of about 

2 percent in the short term and 5 percent in the longer 

term. Combining that finding with comparisons of costs 

for preferred provider organizations and health maintenance organizations, however, indicates that consumerdirected plans will not lower spending and might raise it, 

relative to spending under HMOs.

At the same time, other studies have suggested that over 

the long term, the effects of consumer-directed plans on 

health care spending could be larger, as enrollees adjusted 

to the new incentives that they faced. In particular, they 

might shift to plans with higher deductibles—either because of the new tax advantage given to funds used to pay 

for out-of-pocket costs or because they had accumulated 

larger balances in their consumer-directed accounts—and 

the systemic effects of higher levels of cost sharing could 

be larger than the RAND experiment’s results suggest. 

But questions remain about those findings as well. 

Evidence from the RAND Health 

Insurance Experiment

The basic rationale behind the designs of consumerdirected plans—that individuals will be more prudent in 

their use of care if they are responsible for more of their 

initial health care costs—was tested most rigorously in a 

study by the RAND Corporation. The RAND Health 

Insurance Experiment, conducted from 1974 to 1982, 

sought to measure the effects of health insurance cost 
32 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

sharing on the utilization of services, expenditures, and 

health outcomes by randomly assigning large groups of 

nonelderly individuals and families to insurance plans 

with different designs and tracking their experience for 

several years.1

 A major advantage of random assignment 

is that the study’s results show the effects of the policies’ 

designs for a broadly representative group of people—

which could differ from the effects that are observed 

when individuals sort themselves into different designs. 

Even though the RAND data were gathered several 

decades ago, the study’s findings remain relevant and are 

widely relied on by analysts, owing largely to the study’s 

rigorous design and execution but also to the lack of 

more-recent experimental work.2

Estimated Effects of Cost Sharing on Health Care 

Spending

The RAND study tested several versions of various insurance designs, but the main policies that it analyzed were 

structured as follows: 

B A plan in which all care was free to enrollees (that is, 

with no deductible or coinsurance);

B A plan that had a deductible of $150 per person (but 

no subsequent coinsurance) for outpatient services 

and no cost sharing for inpatient (hospital) services;

B Plans that had no deductible and coinsurance of 

25 percent or 50 percent for all services; and

B A plan that required coinsurance of 95 percent for all 

services. 

The plans that required coinsurance also featured an 

annual limit on enrollees’ out-of-pocket costs, pegged at 

the lesser of $1,000 or a percentage of family income. 

The last plan listed above is thus very similar to a policy 

that has a deductible of $1,000 and full coverage beyond 

that point; it differs only in the fact that it provides a 

small degree of up-front coverage (an approach that was 

taken in large part to ensure that enrollees in the study 

had a reason to report all of the health care costs they had 

incurred).3 None of those plans, however, matches the 

arrangements in current conventional health plans, which 

feature both a deductible and coinsurance payments 

beyond that point. As a result, the direct results of the 

RAND study do not allow a clear comparison of spending under conventional and high-deductible health plans. 

After the RAND study was completed, a team of researchers led by Emmett Keeler (who had worked on the 

original RAND experiment) applied a complex methodology to the RAND data to simulate the effects on health 

care expenditures of a larger set of plan designs, including 

a variety of conventional and high-deductible arrangements.4 The resulting spending levels from their study 

were reported in 1983 dollars, but for ease of comparison, 

the Congressional Budget Office has adjusted those figures to reflect the fourfold increase in health care costs per 

capita between 1983 and 2004 (see Table 3-1). 

1. For a complete discussion, see Robert H. Brook and others, “Does 

Free Care Improve Adults’ Health? Results from a Randomized 

Controlled Trial,” New England Journal of Medicine, vol. 309, 

no. 23 (December 8, 1983); Willard G. Manning and others, 

“Health Insurance and the Demand for Medical Care: Evidence 

from a Randomized Experiment,” American Economic Review, 

vol. 77, no. 3 (June 1987); or Joseph P. Newhouse and the Insurance Experiment Group, Free for All? Lessons from the RAND 

Health Insurance Experiment (Cambridge, Mass.: Harvard University Press, 1993). For a recent and more accessible summary, see 

Jonathan Gruber, “The Role of Consumer Copayments for 

Health Care: Lessons from the RAND Health Insurance Experiment and Beyond” (Washington, D.C.: Henry J. Kaiser Family 

Foundation, October 2006), available at www.kff.org/insurance/

upload/7566.pdf.

2. For a more recent contribution to this literature, see Matthew J. 

Eichner, “The Demand for Medical Care: What People Pay Does 

Matter,” American Economic Review, vol. 88, no. 2 (May 1998). 

Eichner’s study was not a randomized trial but instead used health 

insurance claims data to examine the impact on the use of care 

by other family members if one member incurs an accidental 

injury—a random event that (because of the design of family policies) changes the cost sharing that those other family members 

face. Eichner found that if individuals had perfect foresight about 

their health care spending for the remainder of a calendar year, 

then total spending appeared more responsive to cost sharing than 

the RAND study’s results had indicated. However, in earlier work, 

when he assumed that individuals faced some uncertainty regarding their future health care spending, his results were comparable 

to those of the RAND study.

3. The plan in the RAND study that is shown here as having a 

deductible of $150 also provided 5 percent coverage below that 

point to encourage participants to report all of their claims. 

4. Emmett B. Keeler and others, The Demand for Episodes of Medical 

Treatment in the Health Insurance Experiment (Santa Monica, 

Calif.: RAND Corporation, March 1988). See also Joan L. 

Buchanan and others, “Simulating Health Expenditures Under 

Alternative Insurance Plans,” Management Science, vol. 37, no. 9 

(September 1991). 
CHAPTER THREE EVIDENCE ABOUT THE IMPACT OF CONSUMER-DIRECTED DESIGNS ON HEALTH CARE SPENDING 33

Table 3-1.

Basic Results of the RAND Health Insurance Experiment Reflecting 2004

Levels of Spending

Source: Congressional Budget Office based on Emmett B. Keeler and others, The Demand for Episodes of Medical Treatment in the Health 

Insurance Experiment (Santa Monica, Calif.: Rand Corporation, March 1988); and Joan L. Buchanan and others, “Simulating Health 

Expenditures Under Alternative Insurance Plans,” Management Science, vol. 37, no. 9 (September 1991).

Note: Figures in the studies noted above were reported in 1983 dollars. CBO adjusted those figures to reflect growth in health care spending 

per capita by using the National Health Expenditure estimates compiled by the Department of Health and Human Services.

Consistent with the direct results of the RAND experiment, the Keeler study found that total spending would 

be highest under the plan that offered free care to enrollees. Compared with spending under that plan, a policy 

with a limited deductible but full coverage above that 

point (the “Deductible Only” design in Table 3-1) would 

reduce total spending by about 20 percent, and a policy 

with no deductible but uniform coinsurance of 

25 percent up to a limit on out-of-pocket costs (the 

“Coinsurance Only” design in the table) would reduce 

average health care spending for enrollees by about 

25 percent. At today’s level of spending, the “Deductible 

Only” policy would have a deductible of about $400, 

whereas the “Coinsurance Only” policy would have an 

out-of-pocket limit of roughly $4,000.

Adjusted to reflect current levels of health care spending, 

the Keeler study’s results also indicated that a conventional policy with a deductible of $400 and coinsurance 

of 25 percent up to an out-of-pocket limit of $4,000 

would generate average health care expenditures that were 

about 35 percent lower than those under a free-care plan. 

Similarly, a high-deductible policy—specifically, one that 

had a deductible of $4,000 but full coverage beyond that 

point—would reduce spending by about 38 percent compared with a free-care plan, according to the estimates. 

Compared with spending under the conventional plan, 

total health care spending under that high-deductible 

policy would thus be about 5 percent lower. Although the 

savings expected when moving from free care to a conventional or a high-deductible policy design would be 

substantial, the likely savings when moving from a conventional plan to a high-deductible plan would be more 

modest. At the same time, the results indicate that the 

high-deductible design could reduce total spending even 

though its enrollees would reach their limit on out-ofpocket costs at a lower level of such spending than would 

be the case in the conventional plan.

In dollar terms, average health expenditures—whether 

paid by the plan or the enrollee—would fall to $2,116 

under the high-deductible policy, compared with $2,228 

0 0 0 0 3,440 3,440 100

400 0 400 272 2,512 2,784 81

0 25 4,000 504 2,096 2,600 76

400 25 4,000 616 1,612 2,228 65

Higher deductible 4,000 0 4,000 972 1,144 2,116 62

Lower deductible 2,000 0 2,000 744 1,760 2,504 73

Organization 0 0 0 0 2,475 2,475 72

Memorandum:

Average

Annual Levels of Health Care Spending

Average

Out-of-Pocket

Selected Characteristics of Plans

(Dollars)

Conventional

High Deductible

Deductible

(Dollars)

Designs Estimated on the Basis of the RAND Experiment's Results

Plan Type

Free Care

Coinsurance Only

Costs Relative to

Free Care

(Percent)

Coinsurance

Above Deductible

Out-of-Pocket

Costs

(Dollars)

Costs

Health Maintenance

Limit

Average

Costs

(Dollars)

Covered

(Percent) (Dollars)

Designs Included in the RAND Health Insurance Experiment

Deductible Only
34 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

under the conventional policy. At the same time, for 

people switching from the conventional to the highdeductible plan, average cost-sharing liabilities would rise 

from $616 to $972, an increase of $356.5

 But their covered costs—total expenditures minus out-of-pocket 

costs—would fall by a larger amount ($468 dollars), and 

enrollees would be expected to capture those savings 

through lower health insurance premiums.6 Thus, enrollees as a group would ultimately benefit financially from 

the reduction in their average health care costs under a 

high-deductible plan. Depending on their use of health 

care, however, some enrollees would be worse off in such 

a plan, and some would see a larger-than-average gain—

as discussed later. 

Limitations of the RAND Results for Health Care 

Spending

Several factors make it difficult to translate the results 

from the RAND experiment and estimates based on 

those results into a precise prediction of how health care 

spending would be affected if a broadly representative 

group of enrollees was shifted into plans of consumerdirected design. In addition, one recent study has highlighted the longer-term impact that changes in cost sharing could have on health care spending—an effect that 

might be larger than the RAND estimates suggest. 

Differential Tax Advantages. The above comparison of 

conventional and high-deductible plans does not account 

for the tax-favored treatment that consumer-directed 

plans provide for some out-of-pocket spending. If enrollees typically face a marginal tax rate of 25 percent, that 

tax subsidy effectively lowers the coinsurance rate below 

the deductible from 100 percent to 75 percent. (The 

effect of the tax advantage on spending might be smaller 

for health reimbursement arrangements than for health 

savings accounts because HRAs tend to make less out-ofpocket spending tax-free.) The Keeler study did not simulate the effects of that specific design; nevertheless, its 

results suggested that total health care spending under 

such a “high-coinsurance” plan would probably be similar to the levels seen under the conventional plan that was 

described above.7

As discussed in Chapter 2, a further complication in 

attempting to foresee effects on health care costs is that 

enrollees in conventional plans could also gain favorable 

tax treatment for some of their out-of-pocket spending by 

establishing a flexible spending account. Contributions to 

FSAs would tend to be smaller than contributions to 

accounts associated with consumer-directed plans (in part 

because the use-it-or-lose-it feature of FSAs would 

encourage individuals to use the account to fund only 

their predictable out-of-pocket costs). As a result, the 

impact of the tax subsidy on the use of health care services by enrollees in conventional plans would probably 

be smaller as well. At the same time, the tax-favored 

treatment of out-of-pocket costs might lead enrollees in 

consumer-directed plans to shift toward higher costsharing requirements—which would tend to generate 

some reductions in health care spending. Thus, the net 

impact of tax considerations on the spending comparison 

is potentially important, but its likely magnitude is 

unclear.

Modeling Issues. Another challenge that arises in comparing the policy designs examined by the RAND researchers with current insurance plans is that the RAND 

study assigned both individuals and families to the same 

plan designs (although the limits established for out-ofpocket expenses depended partly on total family income); 

by contrast, the design of insurance policies today typically differs for individual and family coverage. For example, average deductibles for family coverage under such 

plans are in the vicinity of $4,000, but conventional family plans currently have higher deductibles, on average, 

5. The resulting arc elasticity (which uses the average coinsurance 

rates and spending levels between the two cases to calculate the 

percentage changes in each variable) is about 0.1; that is, a 

10 percent increase in cost sharing reduces total expenditures 

by about 1 percent. 

6. Whether they purchased their insurance individually or through 

an employer, enrollees in the high-deductible plan would be 

expected to capture the savings in covered costs in the form of 

lower policy premiums (or, for employees, perhaps a corresponding increase in their wages or in their employer’s contribution to a 

consumer-directed plan account). Note also that the dollar figures 

used here reflect average spending for the types of enrollees that 

were studied in the RAND experiment—nonelderly individuals 

and families—so the spending figures differ from current levels of 

average health care spending for the entire U.S. population.

7. The Keeler study modeled a policy that had a coinsurance rate of 

50 percent up to an out-of-pocket limit of $4,000 (at today’s levels 

of spending) and estimated that total health care costs under that 

policy would be about $2,400. A policy that required coinsurance 

of 75 percent below the deductible could be expected to yield 

total costs that would fall about midway between that level and 

the amount estimated for the full high-deductible design—that is, 

$2,116. In other words, spending under a plan with 75 percent 

coinsurance would probably be on the order of $2,250.
CHAPTER THREE EVIDENCE ABOUT THE IMPACT OF CONSUMER-DIRECTED DESIGNS ON HEALTH CARE SPENDING 35

than the conventional policy described above. Conversely, the deductible of $400 in the conventional plan 

design is comparable to the average deductible for conventional policies for individuals, but a deductible of 

$4,000 is much higher than the average levels seen today 

for individual enrollees in consumer-directed plans. 

Further complicating the comparison is the way that the 

Keeler study modeled the deductibles and out-of-pocket 

limits. In that study, those amounts applied separately to 

each individual in a family; in practice, deductibles and 

out-of-pocket limits usually encompass spending by all of 

a family’s members. Thus, both the conventional and 

consumer-directed designs in the above comparison 

offered less coverage than the average plans that are 

currently held. Using a family-level limit on out-ofpocket costs would tend to raise health care spending 

under both designs (because a greater share of health 

care costs would be covered by the insurance policies), 

but here, too, the impact of those modeling assumptions 

on the comparison of spending under conventional and 

consumer-directed plans is difficult to determine. 

Differential Actuarial Values. In comparing total health 

care costs under two different plan designs, analysts 

should distinguish between differences that reflect enrollees’ responses to varying designs of the same overall actuarial value and differences that are due to varying levels of 

richness in the designs. However, in the comparison of 

spending under conventional and high-deductible 

designs that is shown in Table 3-1, the actuarial value of 

the conventional plan design appears to be greater than 

that of the high-deductible design—because at any given 

level of medical claims, an enrollee’s cost-sharing liabilities under the conventional plan will be less than or equal 

to those under the high-deductible plan’s design.

The actuarial values of the plans could be equalized in 

several ways. One approach would be to lower the 

deductible in the high-deductible plan design. A plan 

that had a deductible of $2,000 would appear to have 

about the same actuarial value as the conventional plan, 

but according to the RAND estimates, such a policy 

would yield total health care spending that was about 

12 percent higher than spending under that conventional 

design.8

 Alternatively, the deductible in the conventional 

plan could be increased (although the extent of the 

change that would be needed is not clear). Another way 

of raising the actuarial value of a consumer-directed policy would be to add funds to its linked account. If 

enrollees treated those funds as if they were just as valuable as cash—rather than discounting their value, as some 

HRA enrollees might do—then savings in total health 

care costs on the order of 5 percent could probably still be 

achieved. 

Systemic Effects of Cost Sharing. A more fundamental 

limitation of the RAND study is that it could not measure broader effects on the health care system that might 

result from widespread changes in levels of cost sharing—

because it examined the experience of only a few thousand enrollees. A recent study suggests that such broader 

changes could occur, but the implications of that finding 

for an analysis of consumer-directed health plans are not 

entirely clear.9

The study examined the impact that Medicare’s introduction in 1965 had on subsequent hospital spending in the 

United States. The share of seniors who had private 

health insurance coverage prior to 1965 varied by the 

region of the country in which they lived, so faster 

growth in hospital costs in regions where Medicare had a 

larger impact on insurance coverage can reasonably be 

considered an effect of the program. (By contrast, factors 

that affected hospital costs generally would tend to have 

the same impact in all regions.) Comparing the extent of 

spending growth that was due to the introduction of 

Medicare with the change in average coinsurance rates 

that it brought about, the author found that cost sharing 

had a much larger effect on hospital spending than the 

RAND study suggested—several times larger, in fact. 

That finding was attributed largely to changes in the 

treatments given to seniors, such as rapid expansion of 

cardiac care units. 

Several questions can be raised about this study’s findings 

and about how they apply to a comparison of current 

consumer-directed and conventional health plan designs. 

8. The Keeler and Buchanan studies on which those findings are 

based did not calculate actuarial values for the plan designs being 

considered, but a rough equivalence may be inferred from the estimate that the conventional design and the plan that had a $2,000 

deductible would both cover about the same share of total medical 

costs (70 percent to 72 percent). 

9. See Amy Finkelstein, The Aggregate Effects of Health Insurance: 

Evidence from the Introduction of Medicare, Working Paper 

No. 11619 (Cambridge, Mass.: National Bureau of Economic 

Research, September 2005). A more recent version of the 

study is available at www.nber.org/~afinkels/papers/Finkelstein_

Medicare_April06.pdf. 
36 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

First, Medicare’s impact on average rates of hospital coinsurance may have been larger than the author estimated—which means that the proportional effect on 

spending for a given change in coinsurance would be 

smaller. (Different methods of calculating the response 

also yield smaller estimates.) Second, Medicare’s introduction also increased coverage among seniors for physicians’ and other health care services; given the RAND 

study’s finding (discussed in the next section) that cost 

sharing outside the hospital can affect inpatient spending, 

it becomes difficult to determine which of those changes 

in coverage affected the treatment of Medicare enrollees. 

Third, even taking the results for Medicare’s introduction 

as a given, it is not clear that they would apply in a strictly 

proportional way to smaller-scale changes in cost sharing 

among insurance plan designs that cover most hospital 

costs. Finally, as the author notes, the findings may not 

apply (at least, not to the same extent) in the era of managed care. The potential effect of cost-sharing levels on 

the rate of growth of health care spending is an important 

area for further research. 

Other Findings from the RAND Experiment

Another limitation of the spending comparisons provided 

earlier is that they show the impact of cost sharing under 

unmanaged indemnity insurance policies. If the increased 

management of care by health plans also reduced enrollees’ use of services, the scope for additional savings from 

higher levels of cost sharing might be smaller (for reasons 

discussed in Chapter 2). The RAND study sheds some 

light on that issue because it included an HMO in its 

analysis. The study’s findings also provide insights about 

how initial cost-sharing requirements can affect spending 

that occurs above the levels of plans’ deductibles and outof-pocket limits.

Accounting for the Effects of Managed Care. The RAND 

study included a staff-model HMO, in which the plan’s 

doctors are paid a salary; that approach contrasts with the 

fee-for-service reimbursement of doctors and hospitals 

in the other (unmanaged) plans that were studied. The 

RAND analysts found that participants who were randomly assigned to that HMO plan used outpatient care 

to the same degree as those assigned to the unmanaged 

free-care plan. But HMO enrollees used much less inpatient care: compared with enrollees in the free-care 

plan, the share of HMO participants with one or more 

hospital admissions was one-third lower. Because hospital 

costs account for a large share of total spending, that 

reduction in inpatient care had a substantial effect on the 

total cost per HMO enrollee. 

Examining further the reason for the lower hospitalization rates among HMO enrollees, the RAND analysts 

concluded that it probably reflected “a treatment style 

involving more intensive outpatient treatment of those 

whom fee-for-service physicians would hospitalize, combined with less intensive treatment of those who would 

not be admitted” to the hospital under either system.10

That is, the overall similarity in outpatient costs masked 

the fact that the HMO generally reduced costs for all 

“episodes” of care (an episode encompassed all of the care 

associated with a given medical incident or condition). 

By contrast, the other plan designs that RAND studied, 

which relied on cost sharing to control spending, generally reduced the number of episodes per enrollee but not 

the costs per episode once treatment was initiated.

Overall, expenditures for the HMO group were estimated to be about 70 percent of expenditures for enrollees in the free-care plan.11 Thus, the effects on health 

care costs of shifting enrollees from free indemnity coverage to an HMO would be comparable to the impact of 

the plan included in the RAND experiment that featured 

coinsurance of 95 percent for all services and a familylevel limit on out-of-pocket costs—that design also 

yielded a reduction in spending of about 30 percent 

relative to the free-care plan. The costs for HMO enrollees would also be similar to the estimated effects of a plan 

with a $2,000 deductible for each family member (see 

Table 3-1 on page 33). But spending under the HMO 

design studied by RAND would be somewhat higher 

than the projected costs under a policy with a deductible 

of $4,000 for each family member. 

10. Newhouse and the Insurance Experiment Group, Free for All?, 

p. 279. 

11. Manning and others, “Health Insurance and the Demand for 

Medical Care,” pp. 265–266. The RAND analysts did not have 

data on actual spending per enrollee in the HMO, which is often 

difficult to calculate for staff-model plans because a separate payment is not made for each service provided. Instead, analysts had 

data on the utilization of services by HMO enrollees and imputed 

spending by using typical charges for those services—essentially 

the same prices they used for enrollees in the other plan designs 

studied in the experiment. Thus, the difference in spending 

between the HMO and other plans did not reflect any differences 

in the costs or prices of specific services.
CHAPTER THREE EVIDENCE ABOUT THE IMPACT OF CONSUMER-DIRECTED DESIGNS ON HEALTH CARE SPENDING 37

Table 3-2.

Estimated Effect of Cost Sharing on Inpatient Spending

(2004 Dollars)

Source: Congressional Budget Office based on Willard G. Manning and others, “Health Insurance and the Demand for Medical Care: 

Evidence from a Randomized Experiment,” American Economic Review, vol. 77, no. 3 (June 1987). 

Notes: In calculating spending, CBO took the adjusted total expenses reported in the study for 1984 and allocated them proportionally to 

unadjusted figures for inpatient and total spending. It then increased those amounts by the growth in U.S. health care spending per 

capita between 1984 and 2004. 

n.a. = not applicable.

a. Plans that featured coinsurance also capped out-of-pocket costs at the lesser of $1,000 or a specified percentage of family income.

b. One enrollee in this plan had an extremely expensive hospitalization, which affected the average cost per admission and the difference 

from other plans in total and inpatient spending. 

Two contrasting considerations affect the more general 

comparison of the costs of HMO plans and plans of a 

high-deductible design. On the one hand, the HMO 

plan studied in the RAND experiment required no cost 

sharing at all (so that the contrast with the free-care plan 

would reveal a “pure” HMO effect on expenditures). An 

HMO plan that had some cost sharing would almost certainly yield less total spending, although the magnitude 

of that reduction is uncertain. On the other hand, the 

staff-model HMO studied in the RAND experiment 

would be expected to yield somewhat lower costs than the 

more common HMOs of today—which typically feature 

networks of independent doctors and hospitals and negotiated fee-for-service payments to specialists within those 

networks. Those more typical HMO designs give the 

health plan less leverage over the treatments that enrollees 

receive. 

Effects on Spending Above a High Deductible. The 

RAND study also provides some indication about 

whether facing a high deductible might affect the costs 

people incur once their spending exceeds that deductible. 

In its analysis of that issue, CBO based its findings on the 

direct results of the RAND experiment, for which moredetailed data on spending are readily available. As noted 

earlier, the study, strictly speaking, did not include a 

high-deductible design. But it had a sufficiently similar 

plan—the policy that required 95 percent coinsurance up 

to a relatively high limit on out-of-pocket costs—to permit several inferences to be drawn.

The study found that enrollees who faced higher overall 

levels of cost sharing generally had lower inpatient spending (see Table 3-2). Compared with enrollees who faced 

95 percent coinsurance, enrollees who received free 

health care were about 30 percent more likely to have a 

hospital admission; they also incurred inpatient costs that 

were about 30 percent higher. Because the number of 

admissions per enrollee and hospital spending changed to 

the same degree, the costs per admission were comparable 

for both groups, at least on average. Thus, it appears that 

the drop in hospital costs for those who faced substantial 

cost sharing was not simply the result of eliminating some 

lower-cost admissions (which would have caused average 

costs per admission to increase). About 40 percent of the 

difference in total spending between the free-care plan 

 1,501 2,749 12.8 11,728 n.a. n.a. n.a.

 1,417 2,309 11.5 12,319 -440 -84 19

 1,331 2,262 10.5 12,672 -487 -171 35

50 percentb 1,402 2,100 9.2 15,242 -649 -99 15

 1,204 1,979 9.9 12,158 -770 -298 39

Inpatient Spending

Difference from Free-Care Plan

Total Average Hospital Admission

Share of

Difference from

Spending per Inpatient Probability Total Average Inpatient

95 percent

Enrollee Spending (Percent) Cost (Percent)

25 percent

Cost Sharing

None (Free care)

Outpatient Deductible

Coinsurancea

Spending Spending
38 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

and the plan that had 95 percent coinsurance came from 

reduced inpatient costs. Given that spending per hospital 

admission was usually much greater than the out-ofpocket limits that enrollees faced, it is reasonable to conclude that most of the savings on hospital costs were 

accounted for by spending that would have occurred 

above those limits (and therefore above the deductible 

of a similar high-deductible plan).

The finding that a high-deductible plan (or one of a similar design) could affect spending above the deductible 

might seem surprising because enrollees would not have a 

financial incentive to limit their use of services beyond 

that point. The RAND analysts concluded that the effect 

arose primarily because higher cost sharing led individuals to seek treatment less often, resulting in fewer episodes 

of care. Once treatment was initiated, however, spending 

per episode was comparable for those who received free 

care and those who faced cost sharing. Thus, the primary 

reason for the decline in inpatient expenditures was 

that enrollees who had to pay most of their initial costs 

avoided some episodes for which free-care enrollees were 

ultimately hospitalized. (Whether that difference affected 

those enrollees’ health is discussed in the next chapter.) 

By itself, cost sharing for inpatient services had a negligible impact on total spending. As one summary put it, the 

RAND results indicated overall that “patient decisions 

determine the frequency of treatment episodes while 

doctors determine the size of the episode.”12

A comparison of the plan that required 95 percent coinsurance with the other plans that required some cost 

sharing presents a murkier picture. Reductions in spending for hospital care still accounted for a substantial share 

of the total savings under the high-deductible-like plan, 

but the differences in inpatient costs across plans that had 

cost sharing were not statistically significant. (That is, the 

odds that those differences arose purely by chance were 

greater than one in 20, so that explanation could not be 

ruled out with sufficient confidence.) One part of the 

explanation is the small proportion of enrollees who were 

hospitalized, and another is the greater variability of their 

inpatient costs—both of which contributed to a larger 

range of uncertainty around the estimates of spending for 

inpatient care.13 The overall differences in spending 

across those plan designs were significant, however, and 

in most of the comparisons, it was more likely than not 

that the plan that required 95 percent coinsurance 

yielded lower inpatient costs than the other designs that 

required some (but less) cost sharing. In sum, it seems 

reasonable to conclude that a high-deductible design 

would probably reduce spending above that deductible 

when compared with conventional policy designs, but the 

extent of the impact on those high-end costs is uncertain. 

Estimated Effects of Adding a 

Tax-Favored Account

Building on the RAND experiment’s results, a number of 

researchers have sought to simulate the effects on health 

care spending of combining a high-deductible policy with 

a tax-favored account. Most studies have compared several specific plan designs, the features of which are held 

constant in a “static” analysis; the resulting impact on 

health care costs depends partly on the relative value of 

the plans being compared and partly on the assumptions 

about enrollees’ responses to cost sharing that the researchers have used. Such simulations have found that 

coupling high-deductible health plans with tax-favored 

individual accounts yields a smaller impact on total 

health expenditures than the same high-deductible plan 

by itself would produce, and the difference grows as the 

tax advantage for account funds becomes more substantial. That finding is not surprising: in such studies, the 

only effect of the tax advantage is to lower the relative 

cost of health care services. But other studies have also 

sought to consider effects over time—for example, the 

incentive for enrollees to switch to plans with higher levels of cost sharing once they can pay their out-of-pocket 

expenses with tax-subsidized funds and the potential 

for enrollees to accumulate funds in their accounts that 

might protect them against future medical claims. Some 

questions remain, however, about how to interpret the 

findings of those studies and how they apply to the case 

of consumer-directed plans. 

Simulated Short-Term Effects of Consumer-Directed 

Plan Designs

A number of studies that were conducted to simulate the 

impact on health care spending of medical savings 

12. Buchanan and others, “Simulating Health Expenditures Under 

Alternative Insurance Plans,” p. 1069. 

13. In addition, the plan that imposed 50 percent coinsurance had 

one enrollee who experienced an extremely expensive hospitalization—which also explains why that plan had the highest inpatient 

costs per enrollee. 
CHAPTER THREE EVIDENCE ABOUT THE IMPACT OF CONSUMER-DIRECTED DESIGNS ON HEALTH CARE SPENDING 39

accounts can be used to illustrate the potential effects of 

consumer-directed designs—because medical savings 

accounts are so similar to HSAs and HRAs. 

B In one study, researchers estimated the impact on total 

expenditures of switching a representative group of 

nonelderly enrollees from a conventional health plan 

to two types of consumer-directed designs.14 The conventional plan had a deductible of $400, followed by 

coinsurance of 20 percent up to a limit on out-ofpocket costs of $2,400. The first consumer-directed 

plan was similar to an individually purchased HSA, in 

that all out-of-pocket spending avoided income taxes 

but not payroll taxes. The second consumer-directed 

plan resembled an HRA design; it had only a modest 

contribution from the employer that went untaxed. 

The researchers estimated that under the first 

consumer-directed plan, spending for health care 

would not change appreciably (compared with spending under the conventional plan) if the deductible was 

set at $2,400 for individuals and $4,000 for families; 

total spending would decline by 7 percent if deductibles for individuals were $4,000 and those for families, $8,000. Under the second plan—which had 

fewer tax advantages for out-of-pocket costs—spending would be reduced by 6 percent and 13 percent, 

respectively. 

B A similar analysis conducted at about the same time 

also sought to estimate the effect on total health care 

spending of switching individuals from a conventional 

insurance plan to a consumer-directed design.15 That 

study found that the higher deductible by itself led to 

a decrease in total spending of 4 percent to 8 percent—but it also concluded that those savings would 

be partially offset by policyholders’ ability to pay their 

share of costs with untaxed funds. For a typical set of 

workers who faced a marginal income tax rate of 

20 percent, enrolling in a plan that had a consumerdirected design was estimated to reduce total health 

care spending by 2 percent to 4 percent, relative to the 

conventional plan. For an individual subject to a marginal tax rate of 50 percent, however, enrolling in a 

plan that had a consumer-directed design was estimated to increase their health care spending. That 

finding reflects the fact that the higher the marginal 

tax rate that enrollees in a consumer-directed plan 

face, the lower is the effective coinsurance rate that 

they must pay. 

B In another comparable analysis, researchers at the 

Urban Institute used an actuarial model to estimate 

health care spending under two hypothetical plans: a 

conventional (and unmanaged) indemnity plan that 

had a deductible of about $400, coinsurance of 

20 percent for spending above the deductible, and a 

maximum out-of-pocket amount of $2,150; and a 

consumer-directed design that had a deductible of 

$3,400 (which was also the out-of-pocket maximum) 

plus a contribution by the employer of $400 to an 

associated savings account.16 (Thus, the consumerdirected plan resembled an HRA design.) Those 

researchers estimated that health care spending would 

be 15 percent lower under the consumer-directed 

plan. They cautioned, though, that the practical 

impact of widespread adoption of consumer-directed 

designs would probably be smaller, for two reasons: 

first, many enrollees are already in managed care plans 

in the first place (reducing the scope for savings from a 

high-deductible plan); and second, enrollees might 

view the employer’s contribution and their account 

balances as being less valuable than cash (in which case 

14. Emmett B. Keeler and others, “Can Medical Savings Accounts for they would be more likely to spend those funds on 

the Nonelderly Reduce Health Care Costs?,” Journal of the American Medical Association, vol. 275, no. 21 (June 5, 1996). The 

parameters of the health plans used in that study were expressed in 

1996 dollars; for ease of exposition, those figures have been 

increased here by 60 percent to reflect the growth of health care 

costs per capita in the United States between 1996 and 2004. 

15. Larry Ozanne, “How Will Medical Savings Accounts Affect Medical Spending?” Inquiry, vol. 38, no. 3 (Fall 1996). After an adjustment to reflect current levels of health care spending, the 

conventional plan the author modeled had a deductible of about 

$325, coinsurance of 20 percent above that point, and a limit on 

out-of-pocket costs of about $1,650. The consumer-directed plan 

had a deductible of about $3,250 and no further cost sharing. 

16. Len M. Nichols, Susan Wall, and Marilyn Moon, Tax-Preferred 

Medical Savings Accounts and Catastrophic Health Insurance Plans: 

A Numerical Analysis of Winners and Losers (Washington, D.C.: 

Urban Institute, April 1996). It appears that the consumerdirected plans that the study examined did not make all out-ofpocket costs tax-free but allowed only a tax-free employer’s contribution (which reflected some of the constraints being debated for 

MSAs for the under-65 population at the time of the study). As 

with the other studies mentioned here, the dollar figures that the 

Urban Institute authors used have been increased (in this case, 

from 1994 levels to 2004 levels) to reflect rising health care costs 

per capita. 
40 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

health care services). An additional caveat is that the 

study apparently assumed that cost sharing would 

have a larger effect on health care spending than the 

RAND study’s results indicated.17

One limitation of those studies is that the researchers did 

not hold constant the overall value of the health plans 

they were comparing (so as to isolate the effects of a plan’s 

design). By contrast, analysts at the American Academy 

of Actuaries recently compared the effects of plan designs 

(described in Chapter 2) that had the same actuarial 

value.18 The analysts concluded that shifting a representative set of individuals from a conventional plan to a 

consumer-directed design with comparable overall value 

would yield reductions in total health care spending that 

ranged from 2 percent to 5 percent. The 2 percent figure 

represents a likely short-term response, in which spending for physicians’ services is modestly affected but hospital costs are not; the 5 percent figure represents a longerterm impact, in which spending for physicians’ services is 

reduced to a greater extent and hospital costs change 

modestly. The authors cautioned, however, that their estimates of savings relied on the assumption that employees 

would treat their account balances like cash and thus be 

inclined to reduce their utilization of health care services 

to build up those balances. As discussed in Chapter 2, 

that assumption may not be valid for all HRA enrollees 

(particularly those who expect their health care costs to be 

low), but it is likely to apply to HSA enrollees. One limitation of that study is that it is not clear whether the 

authors assumed that the tax subsidy for out-of-pocket 

costs under a consumer-directed plan would affect enrollees’ propensity to use care.

In addition to comparing plans of equal value, the American Academy of Actuaries’ study also has the advantage 

of incorporating the effects of cost management by the 

health plan. Specifically, both the conventional and the 

consumer-directed plans that were analyzed delivered care 

through a PPO network. The academy’s findings are very 

similar to the results of the Keeler study, which indicates 

that the effect of PPO-style management on the central 

spending comparison may be small (at least in the longer 

term). Overall, the results of all of the studies reviewed 

here suggest that for a representative group enrolled in a 

consumer-directed health plan, total health care spending 

would eventually be reduced by about 5 percent when 

compared with a conventionally designed PPO plan of 

similar value.

Comparing costs for consumer-directed plans and plans 

with conventional HMO designs is more difficult, both 

because less information is available about direct comparisons at a point in time and because the stringency of 

HMO management has varied in recent years. On average, HMOs would probably have lower costs than conventional PPOs have—although the difference would 

vary from area to area, depending on the extent of competition among providers and whether HMO plans had 

developed a strong presence in the local market. In 

another recent study, CBO estimated that an HMO plan 

would, on average, have costs that were about 10 percent 

lower than those of a PPO to deliver a comparable package of benefits.19 Taken together, those findings imply 

that widespread enrollment in consumer-directed health 

plans that use a PPO network will probably not lower 

health care spending relative to that under conventional 

HMOs—and in fact could raise spending. That conclusion is also consistent with the spending comparison in 

the RAND study between an HMO and a plan that 

required very high coinsurance. 

Analyses of Longer-Term Effects and Responses

Although static comparisons of different plan designs for 

a given year are useful, it is also important to take the 

potential for longer-term effects into account. Making 

many out-of-pocket health care costs tax-deductible or 

tax-free should not only encourage enrollees to shift 

toward consumer-directed plans but also lead them to 

choose higher deductibles over time. Another consideration that is missed by single-year plan comparisons is the 

potential to accumulate account balances over a longer 

17. The model of enrollee responses that was used in the Nichols 

study came from earlier work by the American Academy of Actuaries, so the results of that organization’s more recent study (presented below) may provide a more up-to-date assessment of the 

likely response. 

18. American Academy of Actuaries, The Impact of Consumer-Driven 

Health Plans on Health Care Costs: A Closer Look at Plans with 

Health Reimbursement Accounts (January 2004), available at 

www.actuary.org/pdf/health/cdhp_jan04.pdf. Although that analysis focused on the case of an HRA, its findings seem to apply 

equally to the case of an HSA. 

19. See Congressional Budget Office, CBO’s Analysis of Regional Preferred Provider Organizations Under the Medicare Modernization 

Act (October 2004), p. 14. 
CHAPTER THREE EVIDENCE ABOUT THE IMPACT OF CONSUMER-DIRECTED DESIGNS ON HEALTH CARE SPENDING 41

period, which might make enrollees more willing to 

choose a plan that has a higher deductible.

Shifting Toward Higher Cost Sharing. As discussed in 

Chapter 2, there is a solid theoretical basis for the argument that providing favorable tax treatment for all cost 

sharing would ultimately result in higher net rates of 

coinsurance—which in turn would lower health care 

spending at least to some degree. Several studies have 

shown that the long-standing tax advantage for employersponsored coverage has led to lower rates of coinsurance 

in those policies, on average, but little direct evidence is 

available about the effect of favorable treatment for outof-pocket costs. 

The only study available that examines that question provides mixed evidence about those theoretical propositions 

and their implications for consumer-directed plans.20

The authors used data from 1993 to compare the coinsurance rates of health plans offered by firms that also 

offered flexible spending accounts and by firms that did 

not offer them. After attempting to isolate the effects of 

other factors, the researchers concluded that health plans 

at firms that offered FSAs had coinsurance rates that were 

about 7 percentage points higher—that is, coinsurance 

rates averaged 23 percent for firms that had FSAs and 

16 percent for firms that did not. Because FSAs had been 

available for many years at the time that the data for the 

study were gathered, that finding probably represents a 

long-term response. 

Several issues arise in trying to interpret that finding. One 

challenge in such a study is to identify factors that would 

affect whether a firm offered an FSA but that would not 

also affect the overall value of the health insurance plans 

it offered; that is, the firms that offered FSAs might have 

differed from the firms that did not in ways that confounded the analysis. It is not clear that the methodology 

the authors employed overcame that obstacle. Even if the 

reported results are taken as a given, the findings’ implications for consumer-directed health plans are ambiguous. 

Although the results are consistent with the view that 

preferential tax treatment for out-of-pocket costs will lead 

to an increase in gross coinsurance rates, the firms that 

offered FSAs did not end up with higher net coinsurance 

rates after taxes were taken into account.21 The incentives 

to increase coinsurance rates that an FSA creates are 

weaker than those associated with a consumer-directed 

plan, so it is likely that consumer-directed designs would 

eventually have a greater impact. But to the extent that 

consumer-directed plans were offered by firms that had 

already offered FSAs, the incremental effect on coinsurance rates and thus spending could be small. 

Accumulating Account Balances. Another dimension that 

is missed by snapshots of total and out-of-pocket health 

care costs under plans with a consumer-directed design is 

the pattern of account contributions and withdrawals 

over an extended period. Substantial balances in enrollees’ 

accounts would not only protect them against future 

medical claims but might also make them more willing to 

move toward policies with even higher deductibles. 

To examine that question, one study used three years of 

data on health insurance claims for the employees of a 

large U.S. firm to try to simulate the distribution of 

account balances that might arise over a lifetime of participation in a consumer-directed plan. Specifically, it examined how enrollees would fare if their employer provided 

an insurance policy with an annual deductible (and outof-pocket limit) of $4,000 and contributed $2,000 each 

year to their account.22 According to the simulation, virtually all enrollees would reach age 60 with a positive balance in their account; for many enrollees, the estimated 

balance would be substantial—even though the authors 

did not assume that enrollees would reduce their total use 

of health care services as a result of the new financial 

incentives to limit expenditures that they would face.

20. See William Jack, Arik Levinson, and Sjamsu Rahardja, Employee 

Cost-Sharing and the Welfare Effects of Flexible Spending Accounts, 

Working Paper No. 11315 (Cambridge, Mass.: National Bureau 

of Economic Research, May 2005).

21. In the study, the typical employee faced a marginal tax rate of 

about 30 percent. As a result, her net coinsurance rate in a firm 

that offered FSAs would be 16 percent (70 percent of the gross 

coinsurance rate of 23 percent).

22. See Matthew J. Eichner, Mark B. McClellan, and David A. Wise, 

Insurance or Self-Insurance?: Variation, Persistence, and Individual 

Health Accounts, Working Paper No. 5640 (Cambridge, Mass.: 

National Bureau of Economic Research, June 1996), pp. 1–29. 

For simplicity, the authors conducted the entire analysis by using 

then-current levels of health care spending—an approach comparable to assuming that the deductible and the employer’s contribution grow at the same rate as per capita health care costs over time. 

In this instance, CBO did not adjust dollar amounts to correspond to current levels of health care spending. 
42 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

One factor that the study highlighted was the variability 

over a (simulated) lifetime—or at least between the ages 

of 25 and 60—of total health care spending and account 

withdrawals. The authors reported that about 55 percent 

of employees accounted for about 80 percent of expenditures over that extended period. Some concentration of 

expenditures would be expected in any area in which 

individuals had purchased insurance—because people 

would be trying to protect themselves against the small 

probability that they would incur large costs. But those 

lifetime costs are somewhat less concentrated than costs 

over a five-year period would be. For example, the study 

found that after five years (at age 30), the share of employees who accounted for 80 percent of expenditures 

was only about 35 percent.

As for enrollees’ withdrawals to cover the out-of-pocket 

costs they incurred (those below the deductible), the 

authors reported that by age 60, about 20 percent of 

enrollees would have used more than 50 percent of their 

employer’s contributions and 5 percent would have used 

more than 80 percent. However, 50 percent of enrollees 

would have used less than 30 percent of the contributions, the authors estimated. That finding has been cited 

by some proponents of consumer-directed plans.23

The study’s finding about the potential for people to 

accumulate balances in their accounts must be tempered 

by several caveats, however.

B Larger Payments by Employers. The consumer-directed 

design that the researchers modeled would apparently 

cause the employer’s total payments to increase substantially. The costs of the catastrophic insurance policy that the plan incorporated were estimated to be 

$700 per enrollee per year; the annual cost to the 

employer (including the contributions to an 

employee’s account) would thus be $2,700 per person 

per year. By contrast, the conventional insurance policy in which employees had previously been enrolled 

was estimated to cost the employer about $1,400 per 

person per year. If the account contributions had been 

set at $700 per year—thus holding the employer’s 

total costs constant while rearranging the form of the 

payment—the balance in a typical account at any 

given point would have been much smaller.24

B Unusual Catastrophic Policy. The catastrophic health 

insurance policy that the study analyzed had an 

unusual feature: if the enrollee’s account balance 

dropped to zero, the plan would cover all remaining 

expenses.25 Thus, there could be no negative balances, 

a feature that would weaken enrollees’ incentive to 

limit their use of care. With annual contributions of 

$2,000, the risk of exhausting all balances would be 

smaller, so the cost of covering claims beyond that 

point would be relatively low. However, if the 

employer’s contribution to the account had been 

$700, then a policy that covered any shortfalls would 

be more expensive to provide—so the account contribution would have had to be less than $700 to keep 

the total payments by the employer constant. 

B Limited Data on Spending Patterns Over Time. The 

authors had three years’ worth of claims data with 

which to work. That approach represented a substantial improvement over many other analyses, and the 

authors were able to check the overall accuracy of their 

projections of lifetime medical costs by comparing 

their imputed distributions of health care spending at 

various ages with actual distributions. But the authors 

23. See Michael F. Cannon, Health Savings Accounts: Do the Critics 

Have a Point? Policy Analysis No. 569 (Washington, D.C.: Cato 

Institute, May 30, 2006), p. 4, available at www.cato.org/pubs/

pas/pa569.pdf. 

24. As the authors noted, “the results would look quite different if 

[the] contribution were $1,000 instead of $2,000” (Eichner, 

McClellan, and Wise, Insurance or Self-Insurance?, p. 27). According to their data, average account withdrawals over a lifetime 

would be at least $24,000, whereas an account contribution of 

$700 annually for 35 years would yield $24,500 in total deposits. 

If average payments by the employer and average health care costs 

per enrollee had been held equal, it would follow that average outof-pocket costs would also be unchanged (because the authors did 

not assume that enrollees’ use of health care would change). 

Median withdrawals over the entire 35 years appear to have been 

somewhat smaller than those average amounts—about $20,000 

for men and $25,000 for women. 

25. The authors note that if the account “balance goes to zero, all 

expenses are paid by the insurance plan” (Ibid., p. 23); the costs of 

that feature were included in the premium for the consumerdirected design. Because a gap exists between the annual contribution and the out-of-pocket limit, enrollees would still have to pay 

costs that fell within that gap out of any prior accumulated balances. An offsetting benefit to enrollees would be that they would 

have no true out-of-pocket costs for their care—all expenses 

would be covered by the insurance plan or the account. However, 

one of the conventional plans in which they had been enrolled 

had also required no cost sharing; the other had a low deductible 

and an annual out-of-pocket limit of $500 per family.
CHAPTER THREE EVIDENCE ABOUT THE IMPACT OF CONSUMER-DIRECTED DESIGNS ON HEALTH CARE SPENDING 43

also noted that more years of data on prior expenditures would yield better estimates of persistence. Their 

findings about the distribution of lifetime health care 

costs might overstate the degree to which the fluctuations in annual costs evened out over time. As a result, 

they might have understated the variation in lifetime 

medical costs and account withdrawals as well as the 

variability of the account balances that individuals 

would retain at retirement. 

CHAPTER

4

Effects of Consumer-Directed Designs on the 

Prices, Quality, and Outcomes of Health Care

Besides encouraging enrollees to limit their use of 

health care services by exposing them to a greater share of 

the services’ costs, consumer-directed plans could also 

reduce spending for health care—or increase the efficiency of its delivery—by lowering the prices that are 

paid for services and increasing the effectiveness of services that are received. Some advocates of consumerdirected designs maintain that those effects will be so significant that they will transform the market for health 

care and bring about substantial improvements in the 

overall quality of care that is provided.1 The incentives 

for enrollees to consider both the costs and benefits of 

care under consumer-directed designs, it is argued, could 

yield not only lower prices—either through direct negotiations between enrollees and providers or by competitive 

pressures on providers—but also changes in the treatments that enrollees seek or that doctors recommend. But 

it is not clear that individuals will be more effective than 

health plans in bringing about such changes (which 

health plans also have financial incentives to encourage). 

At present, the dearth of information that is available on 

actual prices and the quality of care also makes it more 

difficult to improve the performance of the health care 

system.

Critics of consumer-directed designs have raised concerns 

that such plans will reduce spending simply by discouraging enrollees from getting needed treatments. If that 

occurred, it would have adverse effects on enrollees’ 

health and might lead to higher health care spending in 

the future (to deal with diseases at a more advanced or 

more acute stage). But there appears to be little evidence 

to support those concerns. The RAND Health Insurance 

Experiment, which randomly assigned individuals and 

families to various health plan designs and tracked their 

experience for several years, found no differences in the 

health of enrollees when it compared plans that required 

some degree of cost sharing. Another important consideration is that consumer-directed plans may provide coverage below their deductibles for preventive services, which 

may identify health problems at an early point—although 

it appears that many consumer-directed plans have chosen not to offer such coverage.

Price Setting and Provider Networks

Some proponents of consumer-directed health plans have 

argued that enrollees should bargain with providers to 

establish prices for the care they receive.2 For routine or 

lower-cost services, enrollees in consumer-directed plans 

would have a strong financial incentive to get the best 

prices they could. But for some kinds of care—for example, expensive hospitalizations or emergency services—

the plans would generally need to establish prices. In the 

case of high-cost procedures, enrollees would have little 

incentive to bargain once they had exceeded their deductible (or if they expected to exceed it at a later point), and 

in the case of urgent care, enrollee-level bargaining would 

generally be infeasible. 

1. See the statement of John C. Goodman, President, National Center for Policy Analysis, Health Savings Accounts, before the Senate 

Special Committee on Aging, May 19, 2004; and Greg Scandlen, 

“Consumer-Driven Health Care: Just a Tweak or a Revolution?” 

Health Affairs, vol. 24, no. 6 (November/December 2005).

2. See Regina E. Herzlinger, “Let’s Put Consumers in Charge of 

Health Care,” Harvard Business Review, vol. 80, no. 7 (July 2004); 

and Herzlinger, ed., Consumer-Driven Health Care: Implications 

for Providers, Payers, and Policymakers (San Francisco: Jossey-Bass, 

2004), pp. 74–101. For examples in which enrollees in consumerdirected plans bargained directly with providers, see Vanessa 

Fuhrmans, “Childbirth for Bargain-Hunters: Pregnant Women 

Take Lead in Negotiating Over Prices Amid Cutbacks in Coverage,” Wall Street Journal, April 5, 2005.
46 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Several factors make it unlikely that individual-level 

negotiations would result in lower prices for health care 

services than those that are currently being paid.

B Administrators of a conventional health plan also have 

strong incentives to negotiate lower prices with providers, either to increase their plan’s profits (in the 

short run) or to hold down premiums and compete 

for enrollees (in the longer term). Although thirdparty reimbursement by health insurers does discourage enrollees in conventional plans from considering the prices paid for their care, such third parties 

have a strong interest in keeping those prices as low as 

possible. 

B Insurers might have a stronger bargaining position 

than individuals would have. In particular, insurers 

could more effectively use the threat of exclusion from 

the health plan’s network—and the associated loss of 

patients and income—to secure lower payment rates 

from providers. The magnitude of that effect would 

depend on the threat’s credibility, which is partly a 

function of the insurer’s share of the local market and 

the degree of competition among providers.

Box 4-1.

Administrative Costs

Proponents of consumer-directed health plans have 

suggested that the plans could lower total health care 

spending by reducing some of the administrative 

costs associated with health insurance. The accounts 

that such plans include—which enrollees can use to 

pay their medical bills—might be tapped at the time 

that services are received by using what amounts to a 

debit card. That approach could replace the common 

practice in conventional health plans of doctors’ submitting claims to insurers and being reimbursed at 

some later date, often after some review, paperwork, back-and-forth communications, and dispute 

resolution.

In many cases, however, administrative review of 

billed charges and payments would still be necessary 

under consumer-directed plan designs.1 For both 

health reimbursement arrangements (HRAs) and 

health savings accounts (HSAs), plan administrators 

would certainly want to review payments once enrollees had exceeded their annual deductible because the 

plan would be responsible for paying most of the 

health care costs that enrollees incurred from that 

point forward. But they would also want to monitor 

spending below that point because it would affect 

when the insurer’s liability began; in particular, 

enrollees who anticipated that they would exceed 

their deductible (but had not yet done so) would 

have only a limited incentive to keep careful track of 

their medical bills. In the case of HRAs, plan administrators would have an additional incentive to review 

withdrawals from enrollees’ accounts and to ensure 

accurate billing—because only at the time of a withdrawal from the HRA do those costs become actual 

expenses for the employer that sponsors the plan. 

In other cases, administrative costs might decline 

only as an accounting matter. For spending incurred 

before their deductible was met, enrollees in 

consumer-directed plans would typically have the 

same incentives as the administrators of conventional 

plans to review their bills (for example, by checking 

1. For a discussion of problems that have arisen regarding payment procedures, see Sarah Rubenstein, “Savings Accounts 

for Health Care Cause Confusion,” Wall Street Journal, 

November 30, 2004. 
CHAPTER FOUR EFFECTS OF CONSUMER-DIRECTED DESIGNS ON THE PRICES, QUALITY, AND OUTCOMES OF HEALTH CARE 47

B Another consideration is the time it might take providers and individuals to conduct price negotiations. 

Any additional costs to providers from bargaining over 

rates with each patient would probably be passed on in 

the form of higher prices. The costs to individual 

enrollees would not be counted as an explicit health 

care expenditure, but there would still be an opportunity cost for the time involved.3

 By contrast, a health 

plan could conduct one negotiation for all its enrollees. (Other potential effects of consumer-directed 

plans on the administrative costs that are associated 

with health care delivery are considered in Box 4-1.) 

For those reasons, most enrollees would probably prefer 

to essentially contract out to their health plan the task of 

negotiating a provider fee schedule. Consistent with that 

assessment of enrollees’ preferences, a recent industry survey found that more than 90 percent of enrollees who 

had health savings accounts were in plans that used a preferred provider organization; in general, those enrollees 

paid the same negotiated prices for care as enrollees in the 

insurers’ other PPO offerings. As for comparisons with 

the prices of health maintenance organizations, some evidence shows that the rates HMOs pay providers are 

lower than the rates that PPO plans pay. The prices in 

HMOs could thus be somewhat lower than the prices in 

consumer-directed plans. For both PPOs and HMOs, 

the price discounts that health insurers can obtain from 

providers will depend in part on the degree of competition among providers in the area—but that is a factor 

that would also affect any individual-level negotiations. 

Box 4-1.

Continued

to ensure that the payment they made for a service or 

provider was the correct amount). In that case, however, the result of switching to a consumer-directed 

plan might simply be to transfer some administrative 

burdens from plan administrators to individuals. The 

administrative costs would no longer be counted as 

health care spending because they would not be part 

of the health plans’ costs, but there would still be economic costs in the form of enrollees’ time and effort. 

Thus, whether debit-card arrangements introduced 

by consumer-directed plans would reduce administrative costs in an economic sense is unclear.2

Shifts in enrollment toward consumer-directed health 

plans might also raise two other issues related to 

administrative costs. First, costs for doctors and hospitals might increase somewhat if increased efforts 

were required to collect payments from enrollees 

(either because their plan did not feature a debit-card 

mechanism or because enrollees chose not to use that 

option). Second, employers appear to be concerned 

about the additional administrative costs they might 

have to incur if they switched to or added consumerdirected options—costs that would stem from having 

to explain the somewhat more complex features of 

those options. Given the interest in consumerdirected plans that employers have expressed in surveys, the potential for additional costs may not be a 

substantial barrier to the plans’ broader adoption. But 

any resulting savings on health claims that those 

plans generated might be at least partially offset by 

one-time costs for introducing the new plans.

In sum, the overall effect of consumer-directed 

designs on administrative costs for health care 

appears uncertain. 

2. Adding a debit-card mechanism might boost administrative 

costs. For example, Aetna announced that enrollees in 

consumer-directed health plans would be able to “begin 

accessing those accounts later this year by using a company 

linked checkbook or debit card arrangement.” But “the cost 

of the program will be worked into the premium amount . . . 

and will cost on average about $3 per month per employee.” 

See “Aetna to Offer HSAs to Small Employers, Individuals; 

Debit Card Program Unveiled,” BNA Health Care Daily, 

February 18, 2005. 

3. An opportunity cost of an activity is the value of the best option 

that could have been pursued instead—that is, the cost of not 

being able to put that time (and any other resources involved) to 

another use.
48 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Even without explicit bargaining, stronger incentives for 

enrollees to consider the prices of the services they receive 

could put downward pressure on those prices—if enough 

consumers were willing to switch to lower-priced providers and if providers responded by lowering their prices to 

compete more aggressively for patients. But whether such 

market pressure would make consumer-directed plans 

more effective than other kinds of designs in holding 

down prices is not clear. Conventional health plans also 

have financial incentives to negotiate low prices with network providers and to limit the participation of highpriced providers. Providers thus have an incentive to 

compete on the basis of their prices for inclusion in the 

health plans’ networks. 

In the near term at least, the limited availability of information on providers’ prices constrains the efforts of 

enrollees to seek the best value in their care. As summarized by one recent news article, “no source has detailed 

information comparing prices from provider to provider” 

that enrollees can use.4

 Plans with a consumer-directed 

design could provide information about the typical costs 

for treating a given condition. But individuals currently 

have no clear way to obtain meaningful estimates, before 

health care is provided, of both the services that they need 

and the net price of those services—information that they 

frequently obtain for other kinds of services (such as car 

repairs). The confidentiality provisions often contained 

in contracts between health insurance plans and providers 

may be one of the factors that hinders such price 

transparency.5

Over time, if more information became available about 

the prices charged by specific providers, enrollees in 

consumer-directed health plans would have stronger 

incentives than enrollees in conventional plans to consider whether the added cost of a given provider was 

worth paying. As conventional plans are currently structured, enrollees face that trade-off only when they are 

choosing between a network and a nonnetwork provider. 

To match the incentives that consumer-directed designs 

provide when enrollees choose among network doctors, 

conventionally designed plans would have to adopt a different approach than they do now—perhaps reimbursing 

an average amount for each procedure or service and 

requiring enrollees to pay any difference between that 

amount and their chosen provider’s charges.6 (Such 

approaches are sometimes called reference pricing.) 

That payment structure would be somewhat more complex than one that imposed a common copayment or 

coinsurance rate for each service, but it would not be 

without precedent. Prior to the advent of managed care, 

health plans typically limited their payment for a service 

to a percentage of a regional average of charges, and 

enrollees were responsible for paying any excess amount 

that their doctor billed. 

The Quality of Health Care

Both supporters and critics of consumer-directed health 

plans agree that if such arrangements are to work well, 

enrollees need useful information not only about prices 

but also about the quality of the care that different providers offer. Depending on the type of service, that information might include direct, objective measures (such as 

survival rates or indicators of patients’ functional 

improvement), indirect measures that seek to capture the 

use of best medical practices (such as the extent to which 

certain “evidence-based” treatment guidelines are followed), or more-subjective measures (such as enrollees’ 

satisfaction). If consumers face differing prices among 

providers, they will need information on the quality of 

the care that those providers offer to determine whether 

higher-cost providers are delivering better outcomes for 

their patients and then whether the value of the added 

quality is worth the added costs. Yet even establishing 

what is meant by the term “health care quality” can be 

difficult (see Box 4-2).

4. See Vanessa Fuhrmans, “Patients Give New Insurance Mixed 

Reviews: Consumer-Directed Health Plans Can Cut Costs, But 

Early Users Cite Problems Comparing Prices,” Wall Street Journal, 

June 14, 2005. More recently, however, Aetna has given its members in selected geographic areas access to information about the 

prices charged by specific doctors for 30 of the most widely used 

services (as well as some comparative information about their 

quality). See January W. Payne, “The Secret’s Out: Aetna Members Gain Access to Care Price, Quality Data,” Washington Post, 

August 22, 2006. 

5. If competition among providers is limited, the confidentiality of 

price information might yield lower prices because it would 

inhibit efforts by those providers to cooperate (actively or passively) to keep prices higher. See the statement of Paul B. Ginsburg, President, Center for Studying Health System Change, 

Consumer Price Shopping in Health Care, before the Subcommittee 

on Health of the House Committee on Energy and Commerce, 

March 15, 2006. 

6. The extent to which health plans pay different rates to different 

providers for the same services—rather than a common rate for 

each procedure—is not generally known. 
CHAPTER FOUR EFFECTS OF CONSUMER-DIRECTED DESIGNS ON THE PRICES, QUALITY, AND OUTCOMES OF HEALTH CARE 49

Developing more information about the quality of health 

care services could have several beneficial effects. In addition to discouraging enrollees from using inefficient providers, it could also dissuade them from getting care that 

does little to improve their health. Perhaps more significantly, better comparative information about providers 

and treatments might also encourage doctors to improve 

the care they provide and lead them to reevaluate the 

treatments they recommend. But whether spending for 

health care would increase or decrease as a result is uncertain. On the one hand, greater emphasis on the quality of 

health care services could avoid some costly complications arising from poorly provided care. On the other, it 

could lead to greater use of more-expensive (but higherquality) providers. Further, a common problem—

according to many current measures of care quality—is 

that individuals often fail to receive recommended treatments. Whether better information would lead to an 

increase or decrease in the amount of care demanded is 

thus difficult to predict. 

Currently, many consumer-directed health plans provide 

online tools to help enrollees search for network providers, and some also provide tools to help enrollees choose 

among treatment options. However, the information on 

quality that is currently available on plans’ Web sites is 

relatively sparse—in no small part because widely 

accepted and useful measures of the quality of providers’ 

services are not generally available.7 Moreover, health 

insurance companies that provide information about the 

quality of services and decision-support tools to enrollees 

in their consumer-directed health plans appear to offer 

similar kinds of information and tools to enrollees in 

health plans of conventional design. For example, Aetna, 

which offers plans that have health savings accounts and 

health reimbursement arrangements, includes information on the quality of hospital services on its Web site—

and provides the same information to enrollees in all of 

the health plans that the firm offers, including conventional plans. 

More generally, all types of plans appear to be moving in 

the direction of providing more information to their 

enrollees about the quality and benefits of providers’ services to encourage enrollees to get better care for their 

money. If such information improved outcomes for 

enrollees, lowered health care costs (and thus a plan’s 

expenditures), or enhanced enrollees’ satisfaction, conventional health plans would also have an incentive to 

monitor their providers and offer the information they 

collected to enrollees. And enrollees in those plans would 

have a powerful incentive to use such information: because they would generally pay only a small share of 

the costs for their care, their choice of a provider could be 

guided more by differences in the quality of providers’ 

services than by differences in the services’ costs.8

Health plans face substantial challenges in developing 

appropriate measures of the quality of providers’ care that 

enrollees can use effectively. Plans must gather the necessary information, adjust for apparent differences in outcomes that stem from other factors, and report the results 

in an accessible, useful fashion for consumers. (For example, doctors and hospitals that provide higher-quality services may also treat sicker patients and thus may appear 

to have worse outcomes—so the raw data require some 

form of risk adjustment to present a more accurate picture.) In some cases, simply achieving a consensus in the 

medical community about how to assess quality might be 

difficult. And even if accurate measures of quality could 

be developed, the extent to which enrollees would be able 

to understand and make use of that information would 

vary; some enrollees would find it easy, whereas others 

might find that the complexity of medical care made it 

very difficult. Enrollees in conventional plans would face 

the same challenges in comparing providers, but it might 

be that consumer-directed health plans will appeal to 

7. Because the Congressional Budget Office did not conduct an 

exhaustive search of health plan Web sites or assess the information that they provide to enrollees about health care quality, that 

conclusion is tentative. But a recent report by the Government 

Accountability Office examined the decision-support tools provided by five of the largest insurance carriers that offer consumerdirected plans and found that they “do not provide sufficient 

information to allow enrollees to fully assess the cost and quality 

trade-offs of health care purchasing decisions.” See Government 

Accountability Office, Consumer-Directed Health Plans, GAO-06-

514 (April 2006), p. 25.

8. Some observers have argued that competition in health care currently takes place at the “wrong level”—occurring when health 

plans compete for enrollees rather than when providers compete 

to offer the services that a patient needs. See Michael E. Porter and 

Elizabeth Olmstead Teisburg, “Redefining Competition in Health 

Care,” Harvard Business Review, vol. 82, no. 6 (June 2004). But if 

providers also compete for patients on the basis of quality and 

compete to be included in health plan networks on the basis of 

both quality and price, then the current system could also be 

effective in balancing the costs and benefits of care.
50 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Box 4-2.

What Is Health Care Quality?

For many types of goods and services, it is not difficult to describe or understand what is meant by their 

quality—the term generally reflects how well-made 

they are and how well they perform or fulfill their 

desired functions. For health care services, a general 

definition of higher quality might be care that is more 

likely to yield the desired health outcomes. However, 

the central role that doctors play in diagnosing their 

patients’ health problems, recommending an overall 

course of treatment, and guiding the determination 

of the specific services that are provided complicates 

the application of that concept of quality. Those 

additional steps mean that the quality of health care 

depends not just on performing a given medical procedure well but also on choosing which type of treatment to provide and which specific procedures (if 

any) to perform.

Reflecting that complexity, an influential report 

issued by the Institute of Medicine’s Committee on 

Quality of Health Care in America put forward the 

following six objectives. It recommended that health 

care be provided in a manner that is:

B “Safe—avoiding injuries to patients from the care 

that is intended to help them.

B Effective—providing services based on scientific 

knowledge to all who could benefit and refraining 

from providing services to those not likely to benefit (avoiding underuse and overuse, respectively). 

B Patient-centered—providing care that is respectful 

of and responsive to individual patient preferences, needs, and values and ensuring that patient 

values guide all clinical decisions.

B Timely—reducing waits and sometimes harmful 

delays for both those who receive and those who 

give care.

B Efficient—avoiding waste, including waste of 

equipment, supplies, ideas, and energy.

B Equitable—providing care that does not vary in 

quality because of personal characteristics such as 

gender, ethnicity, geographic location, and socioeconomic status.”1

The committee’s goals capture the many dimensions 

of health care quality, but in some respects, they may 

go beyond the meaning of the term. (For example, 

the sixth goal above, equitable treatment quality, 

could be considered an additional objective.) Even so, 

the goals highlight three widely acknowledged types 

of shortcomings in the quality of care that people 

receive—although efforts to determine the extent of 

those shortcomings have been hampered by the limited availability of data on the quality of care. 

Misuse. That term includes incorrect diagnoses as 

well as medical errors and other sources of avoidable 

complications (such as infections that patients 

acquire during a hospital stay). Over the past decade, 

the Institute of Medicine has issued several reports 

that seek to document the extent of medical errors 

and their consequences.2

1. Institute of Medicine, Crossing the Quality Chasm (Washington, D.C.: National Academy Press, 2001), p. 6. 

2. For example, see Institute of Medicine, To Err Is Human

(Washington, D.C.: National Academy Press, 1999).
CHAPTER FOUR EFFECTS OF CONSUMER-DIRECTED DESIGNS ON THE PRICES, QUALITY, AND OUTCOMES OF HEALTH CARE 51

Box 4-2.

Continued

B Underuse. In this context, the term is defined as a 

failure to provide services that would have been 

medically beneficial. Several recent studies have 

reported that individuals frequently do not receive 

care that is recommended or deemed appropriate, 

even when they have insurance coverage.3

B Overuse. In this case, the term means the provision 

of a service even though its risk of harm exceeds its 

potential benefit—that is, when it is not warranted on medical grounds. A number of studies 

have found (on the basis of after-the-fact reviews 

by independent panels of doctors) that a sizable 

share of certain surgeries were performed despite 

their being clinically inappropriate or of equivocal 

value. Those findings held true under a variety of 

insurance plan designs.4

An important caveat is that those definitions of 

underuse and overuse do not take into account the 

costs of providing the services involved. That approach is appropriate in considering the quality of 

care by itself because the focus should be on the benefits of care. And resource costs are a factor in considering the efficiency with which a given level of care 

quality is obtained (which is another one of the committee’s goals). If providers use resources that do not 

improve the odds of a favorable outcome—or that, 

like medical errors, detract from the benefits of 

care—they could provide that level of quality at a 

lower overall cost. But if higher-quality care is also 

more expensive to provide, then trade-offs between 

costs and quality must be made. 

The goal of having patient-centered care also highlights the important role of preferences in determining which type of health care is “better.” A more invasive treatment that involves surgery, for example, may 

have a higher probability of curing a disease but also 

pose a greater risk of complications and adverse side 

effects. Whether such care is of higher quality than a 

less aggressive treatment thus depends on how an 

individual weighs those competing considerations. 

Complicating that determination may be substantial 

uncertainty—or differences in views within the medical community—about the effects that a given treatment or procedure will have on a particular type of 

patient, even if performed well. And over time, standards of care quality must be continually updated as 

new studies are released (sometimes with conflicting 

results) and new treatments and procedures are developed. All of those factors combine to make it difficult 

to provide summary measures of the quality of the 

services that health care providers deliver.

3. See Elizabeth A. McGlynn and others, “The Quality of 

Health Care Delivered to Adults in the United States,” New 

England Journal of Medicine, vol. 348, no. 26 (June 26, 

2003); and Stephen F. Jencks, Edwin D. Huff, and Timothy 

Cuerdon, “Change in the Quality of Care Delivered to Medicare Beneficiaries, 1998–1999 to 2000–2001,” Journal of the 

American Medical Association, vol. 289, no. 3 (January 15, 

2003).

4. For a useful discussion of care quality issues, see Mark R. 

Chassin, “Is Health Care Ready for Six Sigma Quality?” Millbank Quarterly, vol. 76, no. 4 (1998). For a summary of studies on the overuse of care, see Elizabeth A. McGlynn, 

“Assessing the Appropriateness of Care: How Much Is Too 

Much?” RAND Research Brief (Santa Monica, Calif.: 

RAND, 1998), available at www.rand.org/pubs/

research_briefs/RB4522. 
52 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

individuals who feel more comfortable in evaluating such 

information and making such choices themselves. 

What remains to be seen is whether the added financial 

incentive that enrollees in consumer-directed plans have 

to use more information about care quality will be 

enough to overcome the other challenges that arise in trying to provide that information. Improvements in health 

information technology and the development of electronic medical records could accelerate progress on those 

fronts. For example, electronic medical records would 

make it easier to collect data on the outcomes of care 

(although tensions could arise between gathering more 

information and protecting patients’ privacy). But those 

developments would also yield information useful to conventional health plans in determining which treatments 

to cover for particular conditions and which providers to 

include in their networks. Thus, the impact that better 

information about the quality of care would have on the 

relative costs or efficiency of consumer-directed and conventional health plans is uncertain. 

Impact of Consumer-Directed Designs 

on Enrollees’ Health 

Although greater demand for information about the 

quality of health care could eventually yield improved 

health for enrollees in consumer-directed plans, critics of 

such plans argue that they will have a more immediate 

impact: they will lead enrollees to forgo necessary medical 

treatments and thus adversely affect enrollees’ health. A 

primary source of information about the issue is, once 

again, the RAND Health Insurance Experiment, which 

in addition to examining the impact of cost sharing on 

expenditures also sought to measure its effect on participants’ health. 

Analysts generally agree about the implications of the 

RAND study for health care spending and the use of services, but views differ about whether its results show that 

the reduced use of services under high-deductible insurance designs will have a detrimental effect on health care 

outcomes for such plans’ enrollees. Although the RAND 

researchers found little direct evidence that higher levels 

of cost sharing had any adverse effects on health, observers disagree about whether those findings are persuasive 

or merely reflect the difficulty of detecting such effects. 

Some evidence suggests that higher cost sharing will discourage individuals from using some services that would 

probably be medically beneficial, but whether those services would actually have been cost-effective for the particular individuals concerned is unclear. 

In principle, enrollees should consume care only when 

the benefits to them exceed the costs of the care. When 

faced with a higher deductible, therefore, they should 

forgo only those treatments that provide modest benefits 

relative to their full costs. Even within that framework, 

some individuals might forgo some health benefits if they 

used fewer services, but they would still be better off overall as long as their financial savings more than compensated them for the change in their health status or prospects. But even before addressing that potential trade-off, 

a central question is whether the health of individuals is 

affected at all when they face higher levels of cost sharing. 

Evidence from the RAND Health Insurance 

Experiment

The RAND research team—and other researchers who 

used data from the RAND study—have sought to measure the effect of cost sharing on enrollees’ health in two 

ways: first, by looking for any impact on the treatments 

that enrollees received, and second, by considering more 

direct (though harder-to-measure) effects on their underlying health. A related consideration is the evidence about 

coverage for preventive care and the effects of cost sharing 

on its use. 

Effect of Cost Sharing on Treatments Received. The first 

line of analysis of the RAND data focused on whether 

plans that imposed cost sharing discouraged the use of 

“appropriate” or “inappropriate” health care, compared 

with a plan that offered free care to enrollees. Because 

making that determination case by case can be difficult, 

researchers often used various proxy measures. 

As one example, the RAND team measured the use of 

emergency room services, separating them according to 

more urgent and less urgent diagnoses (as characterized 

by an independent team of doctors).9

 For less urgent conditions, the use of emergency room services among 

enrollees in the free-care plan was about 90 percent 

higher than among enrollees in the plans that required 

cost sharing; for more urgent diagnoses, by contrast, 

emergency room use under the free-care plan was only 

about 30 percent higher. That finding suggests that many 

9. Joseph P. Newhouse and the Insurance Experiment Group, Free 

for All? Lessons from the RAND Health Insurance Experiment (Cambridge, Mass.: Harvard University Press, 1993), pp. 152–159.
CHAPTER FOUR EFFECTS OF CONSUMER-DIRECTED DESIGNS ON THE PRICES, QUALITY, AND OUTCOMES OF HEALTH CARE 53

emergency room visits for less urgent conditions by 

enrollees in the free-care plan were unnecessary, but it 

also raises the concern that enrollees in the plans that 

required cost sharing did not receive prompt treatment in 

some cases that were more urgent.

Whether those differences in treatments might have had 

an adverse effect on the health of enrollees who faced cost 

sharing is difficult to determine, however. Among the 

more urgent diagnoses, enrollees’ use of emergency room 

services under the free-care plan and the cost-sharing 

plans varied by diagnosis; for example, enrollees in the 

free-care plan who had asthma were nearly three times as 

likely to go to the emergency room as enrollees who faced 

cost sharing, but enrollees in both plans who were diagnosed with chest pain or acute heart disease had comparable rates of emergency room use.10 For the specific cases 

in which cost sharing made a difference, the medical benefits of more-prompt treatment are hard to ascertain. And 

it is even more difficult to say whether or not the emergency room visits for more urgent diagnoses that were 

discouraged by plans’ cost-sharing features would have 

been worth their full costs. That determination would 

depend in part on whether an enrollee could have 

received treatment in a less costly setting, outside of an 

emergency room, at the time. 

The RAND team also analyzed the more general probability that enrollees would seek care in any setting for various diagnoses, which researchers grouped according to 

the estimated effectiveness of medical treatment for 

them.11 The analysis showed that among diagnoses for 

which medical care was considered highly effective, cost 

sharing reduced the likelihood of using services, on average, by about 25 percent. It reduced the use of generally 

effective treatments to a greater degree among poorer 

children than among children in higher-income families, 

whereas among adults, the effects of cost sharing did not 

differ significantly by income. Among diagnoses for 

which professional medical care (at the time of the study) 

was considered rarely effective or for which self-care was 

effective, cost sharing yielded reductions in the use of services that ranged from 20 percent to 33 percent.

Those results might suggest that cost sharing did not differentially discourage the use of low-value treatments but 

instead operated more bluntly to reduce the use of all services. But here, too, it is hard to predict the net impact on 

enrollees’ health—that is, whether the reduced use of 

effective and ineffective treatments offset one another or 

whether the downsides of receiving fewer effective treatments outweighed the benefits of avoiding some ineffective care. Another consideration is that the tests of 

whether treatments were effective looked only at their 

likely medical benefits and did not try to assess whether 

they were also cost-effective in each case; in principle, 

some care that is highly effective might also be prohibitively expensive, whereas some care that is rarely effective 

might still be cheap enough to pass a cost–benefit test. 

Related to that point, the study’s categories of highly 

effective and rarely effective treatments were quite heterogeneous. For example, diagnoses for which highly effective treatments were available included strep throat and 

nonfungal skin infections (which are probably inexpensive to treat and more prevalent among children) as well 

as more serious conditions, such as congestive heart failure. Diagnoses for which treatments were considered 

rarely effective ranged from fever and headaches to chest 

pain and degenerative joint disease.

Another set of studies sought to analyze (on the basis of 

after-the-fact reviews of medical charts by a team of doctors) whether specific procedures or hospital admissions 

for specific patients were medically necessary. The most 

relevant of those studies for the purposes of this analysis 

examined whether the prevalence of appropriate and 

inappropriate hospital admissions depended on the level 

of cost sharing that patients faced. Researchers found the 

following: “In plans with cost sharing for all services 

[including hospitalization], 22 percent of admissions and 

34 percent of hospital days were classified as inappropriate, as compared with 24 percent of admissions and 

35 percent of hospital days in the plan under which care 

was free to the patient (these differences were not statistically significant).”12 As discussed in Chapter 3, patients 

10. A more recent study found that among HMO enrollees who were 

having a heart attack, those who had to make a copayment did not 

delay their trips to the emergency room relative to those who 

faced no cost sharing for emergency care. See David J. Magid and 

others, “Absence of Association Between Insurance Copayments 

and Delays in Seeking Emergency Care Among Patients with 

Myocardial Infarction,” New England Journal of Medicine, 

vol. 336, no. 24 (June 12, 1997). 

11. Newhouse and the Insurance Experiment Group, Free for All?, 

pp. 159–165.

12. See Albert L. Siu and others, “Inappropriate Use of Hospitals in a 

Randomized Trial of Health Insurance Plans,” New England Journal of Medicine, vol. 315, no. 20 (November 13, 1986), p. 1259. 
54 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

who faced cost sharing were less likely to be admitted to 

the hospital overall; however, those results indicate that 

patients still used some services that were judged not to 

provide positive medical benefits—and they used such 

services in about the same proportion as did patients who 

received free care.

Taken together, the findings that cost sharing led enrollees to forgo treatments that were judged to be urgent, 

effective, or medically appropriate could indicate that 

those enrollees were made worse off as a result. Yet even if 

enrollees in plans that required cost sharing saw their 

health deteriorate (or improve to a lesser degree than it 

would have under the free-care plan), it would be difficult 

to determine from the studies alone whether those effects 

outweighed the financial savings that those plans generated. Nor is it clear whether differences in treatment grew 

with the level of cost sharing that was required (most of 

the comparisons were made between the free-care plan, 

on the one hand, and all of the cost-sharing plans as a 

group, on the other). But an overall assessment of those 

findings depends to a substantial degree on whether cost 

sharing had adverse health effects on balance, taking into 

account all of the reductions in the use of services that 

cost sharing generated—which is the second line of analysis that the RAND team conducted.

Effect of Cost Sharing on Underlying Health. The RAND 

researchers sought to estimate the effects of cost sharing 

on health more directly by using a wide variety of measures. Also, in an effort to capture longer-term effects, 

enrollees in the experiment were followed for at least 

three years and some for as many as five years. The study 

team’s overall assessment was that for the average enrollee, 

“there were no substantial benefits from free care.”13 In 

other words, plans that required cost sharing generally 

did not have an adverse effect on the health of their 

enrollees. Given that enrollees who faced cost sharing did 

not receive some treatments that (on average) have positive medical benefits, that result may seem surprising. 

The RAND analysts considered the argument that 

adverse health effects actually occurred for those enrollees 

and were simply not measured effectively in the experiment; however, they concluded that they were

. . . confident that our health status measures 

were sufficiently accurate and comprehensive to 

have captured any important gain in health status. We interpret the proportionate change in 

appropriate and inappropriate care to mean 

that the benefits of the additional appropriate 

care were offset by the additional inappropriate 

care received by those with full coverage. In 

other words, the increased inappropriate care 

was not just zero-benefit care; it actually had 

negative effects.14

Otherwise, the RAND team found only limited evidence 

of adverse health consequences for enrollees in the plans 

with cost sharing. Specifically, they found that lowincome enrollees who were in the least healthy quartile 

(basically, one quarter) of their sample had better results 

for blood pressure control and vision correction when 

they received free care than when they faced cost sharing; 

researchers found no statistically significant discrepancies 

among the many other measures that they examined and 

the groups of enrollees that they compared. Although 

lower-income enrollees might be expected to have more 

difficulty than other enrollees in financing care out of 

their own pocket, researchers saw those adverse health 

effects even though less affluent enrollees faced lower caps 

on their out-of-pocket costs. (In the experiment, out-ofpocket costs were limited to a fixed dollar amount or a 

percentage of family income, whichever was less.) At the 

same time, the RAND analysts ruled out any adverse 

health impacts from cost sharing for higher-income 

enrollees, even though those enrollees faced a correspondingly higher limit on their out-of-pocket costs.15

The RAND team also sought to estimate whether differences in enrollees’ health affected their risk of death. To 

estimate that risk, researchers used epidemiological 

models—that is, they did not compare actual rates of 

death among the various plans, which (given the number 

and age of the enrollees involved) would probably not 

13. Newhouse and the Insurance Experiment Group, Free for All?, 

p. 201. The RAND study also examined the effect on health of 

enrolling in an HMO and found no significant impact relative to 

free care, even though the HMO yielded substantial reductions in 

total health expenditures. 

14. Ibid., p. 356.

15. To ensure that potential participants in the RAND experiment 

who had richer insurance coverage would not be discouraged from 

enrolling, researchers offered them “participation incentive” payments, which were “calculated as the maximum loss risked by 

changing to the experimental plan from existing coverage, and 

were independent of health care use” during the experiment. See 

Newhouse and the Insurance Experiment Group, Free for All?, 

p. 12.
CHAPTER FOUR EFFECTS OF CONSUMER-DIRECTED DESIGNS ON THE PRICES, QUALITY, AND OUTCOMES OF HEALTH CARE 55

have differed in a statistically significant way. Although 

they found that, on average, cost sharing had no measurable effect on the risk of dying, they detected an effect 

among the least healthy quartile of their sample, particularly for the poorer enrollees in that group. For that lowincome, high-risk group, the change in the probability of 

death, according to the researchers, was 

about 10 percent (0.2 percentage points). Thus, 

a person [in that group] with a 2.1 percent 

chance of dying on the cost-sharing plans 

would have that chance reduced to about 

1.9 percent on the free-care plan. This effect is 

attributable solely to the effect of free care on 

blood pressure control. The other two factors 

that affect [the probability of death in their 

model]. . . , cholesterol and smoking, were 

unaffected by the additional medical care that 

free care induced.16

That finding of a 10 percent increase in the risk of dying 

has been a central point for opponents in the debate 

about consumer-directed health plans. However, two 

important caveats about that finding must be taken into 

account. 

B First, although the RAND study found some negative 

effects on health when comparing the free-care plan 

(on the one hand) with the plans that required cost 

sharing (on the other), the researchers could detect no 

differences in health outcomes among enrollees in the 

plans that required cost sharing. That result suggests 

that any adverse impact (relative to free care) would 

also arise under plans of conventional design and that 

there would be no effect on health when comparing 

conventional plans with high-deductible designs.

B Second, although free care had a beneficial impact on 

the control of high blood pressure, the RAND team 

concluded that most of those health gains could be 

achieved with a one-time screening examination. 

Because consumer-directed health plans may pay for 

preventive services before an enrollee has satisfied the 

general deductible, those plans could cover such 

screening fully and might thus see little diminution in 

the health of their enrollees relative to outcomes under 

a free-care plan.

Overall, results from the RAND experiment do not 

appear to support the argument that converting health 

plans from conventional to consumer-directed designs 

will necessarily cause enrollees to have worse health outcomes. Whether effects on health occur for some subgroups may depend on the coverage that consumerdirected plans provide for preventive services and the 

extent to which enrollees use those services. 

Coverage and Use of Preventive Services. In the RAND 

study, preventive services received the same coverage that 

other services received—they were either free to enrollees 

or subject to a deductible or coinsurance, depending on 

the overall design of the enrollees’ plan. The study compared the use of any preventive services over a three-year 

period by men, by women, and by children (with additional analysis of Pap smears for women and immunizations for children).17 In some cases, the differences 

between the plans that charged coinsurance or imposed a 

deductible, on the one hand, and the free-care plan, on 

the other, were relatively small and not significant statistically. In other cases, the differences were statistically significant, with the cost-sharing plans’ reducing the likelihood of using preventive care by 10 to 20 percentage 

points. The underlying utilization rates for preventive 

care varied widely, however, so the percentage reductions 

in use that resulted from cost sharing also differed substantially. A primary conclusion of the study was that for 

all types of preventive care except well-child examinations 

of newborns, the amount of such care used by participants was much less than the levels that were generally 

recommended on the grounds of health. Moreover, that 

gap was also evident among participants in the free-care 

plan. 

Given those results and the RAND study’s findings about 

blood pressure control for some groups of participants, 

another consideration is whether insurers that offer 

consumer-directed plans are availing themselves of the 

option to cover preventive services below the general 

deductible. According to the most recent survey of 

employers by the Henry J. Kaiser Family Foundation, 

22 percent of workers who are enrolled in consumer16. Ibid., pp. 209–210. The risk-of-dying measure that the RAND directed plans offered by their employers get such coverteam used reflected risk over a three-year period. For reference, at 

the time of the study, a 40-year-old male of average health had a 

1 percent chance of dying during that three-year period. 17. Ibid., p. 179. The analysis was also divided by age group. 
56 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

age, compared with 47 percent of workers enrolled in 

conventional PPO plans that have a deductible.18 The 

possibility that those differences in coverage for preventive services might have an effect on enrollees’ health cannot be ruled out. (As discussed in Chapter 2, the issue of 

whether coverage for preventive services pays for itself by 

generating savings later on other health care costs is both 

distinct from whether those services yield health benefits 

and more difficult to determine.) 

A final issue that arises concerning consumer-directed 

plans and preventive services is whether the cost sharing 

that those plans require for other services would have an 

indirect effect on the use of preventive care. That is, even 

if preventive services were fully covered, they might be 

provided only in conjunction with other services (such as 

a visit to a physician) that were still subject to the plan’s 

deductible—so enrollees would have to consider those 

costs as well. The RAND study did not address that 

point. But one recent study generally found small and 

statistically insignificant reductions in the use of free preventive services by enrollees who faced cost sharing for 

office visits to physicians.19

Other Studies of Health Effects

Other studies besides the RAND experiment have investigated the link between insurance coverage and health 

care spending on the one hand and health outcomes on 

the other. Those studies, however, face a challenge arising 

from the nonrandom nature of enrollment in health care 

plans: people who purchase insurance or choose moreextensive coverage may differ from those who do not in 

ways that also affect their spending for health care, and if 

the researcher who conducts the study cannot discern 

those differences and isolate their effects, they may confound the study’s results. (For some factors, such as 

income or education, the differences may simply not have 

been measured in the available data; for other factors, 

such as preferences about health care, they may not be 

observable.) In addition, the applicability of the results to 

an analysis of consumer-directed health plans may not be 

straightforward. 

One set of studies has reported that the lack of health 

insurance has adverse effects on health.20 For example, 

uninsured individuals who developed cancer generally 

had poorer outcomes and died more quickly than cancer 

patients who had private health insurance. (That difference was attributed partly to later diagnosis for those 

uninsured individuals; broader studies of the uninsured 

population have found that they are less likely to receive 

screening tests, such as mammograms.) Similarly, uninsured individuals who had heart disease were less likely to 

receive expensive treatments for it and also had higher 

rates of mortality than those who had heart disease but 

were privately insured. Even if those studies were able to 

control for other differences between insured and uninsured patients, however, it is not clear that those findings 

are relevant to consumer-directed plans. Enrollees in 

those plans would have coverage for expensive procedures, and their use of health services below their deductible would probably differ from the use of services by 

individuals who had no insurance coverage at all. 

Other studies have examined the relationship between 

health care spending and health outcomes, drawing 

largely on data from the Medicare program. For example, 

researchers at Dartmouth examined the differences in 

Medicare spending and patterns of treatment for the 

same condition in different geographic areas; to prevent 

differences in the degree of enrollees’ sickness from influencing their results, they examined spending in the last 

six months of life.21 Overall, they found substantial differences in spending but little variation in the measures 

of health—and in some cases, higher spending was associ- 18. See Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2006 Annual Survey (Washington, D.C.: Henry J. Kaiser Family Foundation, September 

2006). Less is known about whether HSAs purchased in the individual insurance market give preferential coverage to preventive 

services. 

19. See Geetesh Solanki, Helen Halperin Schauffler, and Leonard S. 

Miller, “The Direct and Indirect Effects of Cost-Sharing on the 

Use of Preventive Services,” Health Services Research, vol. 34, no. 6 

(February 2000), pp. 1331–1350. Nearly all of the enrollees in the 

health plans that were studied received blood pressure screening, 

Pap smears, and mammograms regardless of their plans’ costsharing requirements. 

20. For a review of those studies, see Institute of Medicine, Care Without Coverage: Too Little, Too Late (Washington, D.C.: National 

Academy Press, 2002), available at www.iom.edu/Object.File/

Master/4/160/Uninsured2FINAL.pdf.

21. See John E. Wennberg, Elliot S. Fisher, and Jonathan S. Skinner, 

“Geography and the Debate Over Medicare Reform,” Health 

Affairs (February 13, 2002); and Elliot S. Fisher and others, “The 

Implications of Regional Variations in Medicare Spending; Part 1: 

The Content, Quality, and Accessibility of Care,” Annals of Internal Medicine, vol. 38, no. 4 (February 18, 2003), available at 

www.annals.org/cgi/content/full/138/4/273. 
CHAPTER FOUR EFFECTS OF CONSUMER-DIRECTED DESIGNS ON THE PRICES, QUALITY, AND OUTCOMES OF HEALTH CARE 57

ated with worse outcomes. Some questions remain about 

whether the study’s methodology was able to mimic that 

of a randomized trial, but the differences that the researchers found in practice styles in different areas were 

large and difficult to explain. Rates of cardiac bypass surgery, for example, varied fourfold among the regions they 

examined but were not correlated with the incidence of 

heart attacks in each region. 

Those studies of Medicare spending did not directly 

address the effect of cost sharing on health outcomes. 

Other analyses have shown that Medicare enrollees who 

have a supplemental medigap insurance policy that covers 

their cost sharing use more Medicare services than do 

enrollees who have no supplemental coverage. But those 

analyses did not directly address whether the differences 

in spending are associated with differences in health outcomes. Thus, although the research relating health care 

spending and outcomes is consistent with the findings of 

the RAND study about the impact of cost sharing on 

spending, it does not appear to shed additional light on 

the relationship between cost sharing and health. 

Whether allowing tax-free accounts to be combined with 

high-deductible policies would lead to a change in the 

conditions that give rise to the disparities in treatments 

among regions is also unclear—given that any financial 

incentives to provide more care do not seem to vary geographically.

CHAPTER

5

The Potential for Favorable Selection and 

Its Effects on Spending and Insurance Markets

How consumer-directed health plan designs 

might affect health care spending would depend not only 

on the incentives that individuals faced once they were 

enrolled but also on the types of people who chose to 

enroll. Some individuals would be more likely than others to select a consumer-directed health plan. Factors that 

would affect their chances of enrolling are the source and 

type of their current insurance coverage—which would 

also influence the extent to which their incentives to use 

health care services changed once they had enrolled in the 

new plan. For those who already had a high-deductible 

policy (whether it had been provided through an 

employer or purchased in the individual insurance market), the tax subsidy for out-of-pocket costs in a consumer-directed plan would provide a strong reason to 

switch, but health care spending might increase as a 

result. For those who were currently uninsured, however, 

the added attraction of such plans would seem modest.

At least initially, the impact of consumer-directed plans 

on spending for health care would also depend on 

whether enrollment in them—particularly among the 

large share of people who get their insurance coverage 

through an employer—was representative of the general 

(nonelderly) population or was instead concentrated 

among individuals who had lower health care costs and 

fewer health problems. The prospect of such favorable 

selection is a primary concern raised by critics of 

consumer-directed designs; if it occurred, conventional plans would be left with enrollees who had aboveaverage health care costs—a phenomenon known as adverse selection. Over time, that adverse selection would 

cause premiums in conventional plans to rise, and critics 

of consumer-directed designs worry that as a result, conventional health plans would ultimately be driven from 

the market—not because they are an inferior product but 

simply because of the dynamics of the market for health 

insurance.

Some degree of favorable selection in consumer-directed 

plans seems likely, because individuals whose health care 

costs are low would have stronger incentives to switch to 

those plans and because health care spending has some 

predictability from year to year. If individuals with lower 

costs did switch, those who had higher costs would probably end up paying somewhat more for their health care, 

either in the form of higher premiums (if they remained 

in a conventional plan) or higher cost sharing (if they 

switched to a consumer-directed plan). But other factors 

could limit the extent of favorable selection—including 

steps to counteract selection pressures that employers 

would have financial incentives to take—with the result 

that consumer-directed and conventional plans could 

continue to coexist. 

Incentives for Enrolling in a 

Consumer-Directed Health Plan

The potential attractions of a consumer-directed health 

plan will differ for people who are currently uninsured, 

for those who purchase coverage in the individual insurance market, and for those who get coverage through 

their employer. The incentives for an individual to enroll 

will also depend on their expected health care costs. 

Enrollment Incentives and Current Insurance 

Coverage

Most Americans under age 65 get their health insurance 

coverage through their employer, and in most cases, that 

coverage is provided through a large firm (see Table 5-1). 
60 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Table 5-1.

Sources of Health Insurance Coverage and Prevalence of High-Deductible Plans 

Among the Nonelderly Population in 2004

Source: Congressional Budget Office based on the 2001 Survey of Income and Program Participation conducted by the Bureau of the Census; Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2004 Annual Survey (Washington, D.C.: Henry J. Kaiser Family Foundation, September 2004); and America's Health Insurance Plans, Individual Health Insurance: 

A Comprehensive Survey of Affordability, Access, and Benefits (Washington, D.C.: America's Health Insurance Plans, Center for Policy and Research, August 2005), available at www.ahipresearch.com/pdfs/Individual_Insurance_Survey_Report8-26-2005.pdf.

Note: n.a. = not applicable.

a. Includes Medicare, Medicaid, and other government health insurance programs.

In the longer term, then, the number of enrollees in 

consumer-directed plans (and their impact on overall 

health care spending) may depend primarily on whether 

employees of large firms switch to those plans. In the 

nearer term, however, policies that are provided through 

small employers or that have been purchased in the individual insurance market are much more likely to have 

deductibles above the minimum levels required for a 

health savings account—indicating that initial interest in 

consumer-directed designs may be greater among those 

groups. People who lack health insurance represent 

another potential market for consumer-directed plans, 

although interest among those individuals may be limited 

by the same factors that have led them to be uninsured in 

the first place. 

People Who Have Individual Health Insurance Policies. 

Many people who have purchased their own policy in the 

individual health insurance market already have deductibles on those policies that exceed the minimum required 

deductible for an HSA. As a result, some proponents of 

consumer-directed health plans have expected those 

policyholders to convert their insurance to an HSA relatively rapidly to take advantage of the tax subsidy for outof-pocket costs.1 Estimating the number of people whose 

primary source of insurance is an individually purchased 

policy is difficult, and published figures vary widely; 

nevertheless, the Congressional Budget Office estimates 

that in 2004, about 10 million people were covered by 

them and that about half that number had deductibles 

that would have met the HSA requirements for that year 

(see Table 5-1). 

If policyholders switched to an HSA from a highdeductible plan that had no associated account, there 

would be countervailing pressures on their health care 

spending. The immediate impact would probably be an 

increase in their total health care spending because the 

new tax subsidy for their out-of-pocket costs would lower 

the effective coinsurance rate that they faced (at least 

until they reached the annual limit on HSA contributions). An offsetting pressure on those individuals’ spendemployees) 125.3 50 31.6 2 93.7 2

employees) 39.7 16 13.0 14 26.7 11

10.0 4 4.1 69 5.9 49

37.4 15 n.a. n.a. n.a. n.a.

44.1 17 n.a. n.a. n.a. n.a.

Deductible of

More Than

$1,000

Nongroup (Individual market)

(Percent)

People

Covered

Publica 

Small firm (Fewer than 100 

Employer Sponsored

Nonelderly

(Millions)

Number of

Source of Health Insurance (Millions)

No Insurance

Individual Policies Family Policies

Number of

Covered

Individuals

Percentage

of the

Population

Large firm (100 or more 

Deductible of

More Than

$2,000

(Percent)

Number of

People

Covered 

(Millions)

1. See Greg Scandlen, Health Savings Accounts (Alexandria, Va.: 

Galen Institute, December 17, 2003), available at www.galen.

org/fileuploads/HSA.pdf. 
CHAPTER FIVE THE POTENTIAL FOR FAVORABLE SELECTION AND ITS EFFECTS ON SPENDING AND INSURANCE MARKETS 61

ing would stem from the incentive to increase their 

deductible. But how far they might go in that direction 

would depend on several factors. 

B If the deductible in their individually purchased plan 

was just below the minimum level required for an 

HSA, then increasing it (when enrolling in the HSA) 

would reduce both their premiums and their net outof-pocket costs—because all of those out-of-pocket 

costs would become eligible for the tax subsidy as a 

result. 

B If their deductible was above the minimum HSA 

threshold but below the maximum HSA contribution, 

then increasing their deductible would save them 

more on their premiums than they might expect to 

pay in higher out-of-pocket expenses. Their gross outof-pocket costs would, on average, go up by about the 

same amount as their premiums went down; however, 

their net savings on premiums, which are paid for with 

after-tax dollars, would exceed the net increase in 

expected cost sharing, which would be paid for with 

untaxed dollars.2 The incentive for such individuals to 

boost their deductible would affect their choice only 

up to a point, however, because a higher deductible 

would also expose them to greater financial risk for 

their uncovered costs. 

B The incentive that faced policyholders whose deductibles already exceeded the contribution limit for 

HSAs would be unchanged. If their deductible was 

increased, it would reduce their premiums for the policy—just as it would have if there had been no HSA 

option—but it would not permit them to make additional tax-free contributions to their account.

Overall, it is not clear whether the resulting increase in 

policyholders’ deductibles—and the dampening effect of 

those increases on health care spending—would be large 

enough to offset the immediate impact of the tax subsidy 

on those individuals’ incentive to use health care. 

People Who Are Uninsured. At any given point in 2004, 

according to recent survey data, about 44 million people 

in this country lacked health insurance.3 The factors that 

led them not to purchase coverage would also affect their 

interest in a plan that had a consumer-directed design. In 

principle at least, many of those individuals could already 

have purchased high-deductible coverage in the individual insurance market (or, in the case of uninsured children, their family could have purchased such coverage). 

That they have not done so, despite the relatively low premiums for such policies, suggests that—compared with 

the other demands on their resources—they do not value 

that health insurance coverage enough to incur its costs. 

For uninsured individuals, the new factor that might persuade them to purchase a high-deductible policy with a 

health savings account would be the tax advantage—the 

ability to make all or most of their out-of-pocket payments with tax-free money. That inducement would 

be somewhat weaker for the uninsured than for the 

nonelderly population as a whole, however, because uninsured people tend to have less income and thus face 

lower income tax rates. Depending on how “uninsured” is 

defined, the estimated share of the uninsured whose family income is below 200 percent of the federal poverty 

level is between two-thirds and three-quarters.4 CBO 

estimates that currently, the median marginal income tax 

rate that individuals who are uninsured face is 15 percent 

(combining federal and state income taxes), whereas the 

median rate that insured individuals face is 21 percent. 

2. For example, suppose an increase in the plan’s deductible would 

reduce the policy premium by $100. If one ignored other factors 

that might affect that premium (such as the administrative costs of 

the insurer), the policyholder’s expected out-of-pocket costs would 

increase by $100 in gross terms. But because those out-of-pocket 

costs would be tax-subsidized, the net cost to the policyholder 

(assuming a marginal tax rate of 25 percent) would be only $75—

so the policyholder would gain financially from the change. That 

logic applies even if contributions above the deductible avoid 

taxation. 

3. That estimate is based on the Survey of Income and Program Participation, which is administered by the Bureau of the Census. 

Estimates from that survey differ somewhat from estimates that 

are based on the Census Bureau’s Current Population Survey—

which is more commonly cited and which generated an estimate 

for 2004 of 45 million uninsured individuals. 

4. According to a study by the Henry J. Kaiser Family Foundation, 

among people who are uninsured at a given point in time, twothirds are members of families whose income is below 200 percent 

of the federal poverty level. See Kaiser Commission on Medicaid 

and the Uninsured, The Uninsured: A Primer (Washington, D.C.: 

Henry J. Kaiser Family Foundation, January 2006), available at 

www.kff.org/uninsured/upload/7451.pdf. Among those who are 

uninsured all year, the share whose income is below the poverty 

threshold rises to 75 percent. See Congressional Budget Office, 

How Many People Lack Health Insurance and For How Long? (May 

2003). 
62 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

The tax advantages of establishing a consumer-directed 

plan would be greater if the plan was set up through an 

employer—because enrollees could then avoid both 

income and payroll taxes on their out-of-pocket expenditures.5

 Several factors, however, lessen the likelihood that 

uninsured individuals will obtain such coverage through 

their employer. According to one recent study, four-fifths 

of the uninsured had a family member who was employed (full-time, in most cases), but 64 percent of uninsured workers were employed by firms that did not 

offer health benefits; another 17 percent worked in firms 

that offered health insurance, but those employees were 

not eligible for the benefit.6 Employers who have chosen 

not to offer coverage and the remaining employees who 

were eligible for it but have chosen not to take it up have 

done so even though their insurance premiums would 

receive favorable tax treatment. For many uninsured people, the added incentive of paying their out-of-pocket 

costs for health care tax-free through a consumer-directed 

plan may not be enough of a draw for them to demand 

such coverage (which they would have to pay for directly 

or in the form of reduced wages). Consequently, their 

employers may not be motivated to begin offering it to 

them. 

Even so, the availability of consumer-directed health 

plans is likely to have an impact on the number of uninsured individuals and on their health care spending. 

But measuring that impact is complicated by the fact that 

people are gaining and losing insurance coverage with 

some frequency—even as the total number of uninsured 

individuals at any given time stays relatively stable. As a 

result, tracking the number of previously uninsured people who purchase consumer-directed health plans may 

not accurately measure the plans’ net impact on the share 

of the population that lacks health insurance. The analytic problem is that it is not clear what choice those purchasers would have made if the option of enrolling in a 

consumer-directed plan had not been available. If they 

would otherwise have remained uninsured, then their 

enrollment in such plans would reduce the uninsured 

population; if they would have secured another form of 

coverage instead, the availability of consumer-directed 

plans would have had no effect on the number of uninsured people. To the extent that the availability of such 

plans reduced the number of uninsured people, it would 

probably increase their total spending for health care—

both because of the new tax subsidy that enrollees would 

receive for their initial spending and because of the insurance protection that they would gain for their higher-end 

costs. 

People Who Have Employer-Sponsored Health Insurance. Most people under the age of 65 who have health 

insurance get that coverage through their employer or the 

employer of a family member—about 165 million people 

in 2004, CBO estimates. Because that group is so large, 

even a relatively small change in the share of people who 

have high-deductible policies could translate into a substantial number of enrollees and a noticeable impact on 

overall health care spending. 

One consideration that would affect both the propensity 

of individuals to enroll in consumer-directed plans and 

the impact on health care spending that would result is 

the level of cost sharing that employees currently face in 

employer-sponsored health insurance plans. According to 

recent survey data, many enrollees in such plans have a 

relatively low—or even no—deductible. For example, 

among employees enrolled in a self-only health insurance 

policy (individual coverage) in 2004, roughly half had a 

deductible of zero; about 5 percent were enrolled in policies that would have met the minimum deductible 

requirement of $1,000 for an HSA.7

Those figures include individuals who are enrolled in 

health maintenance organizations, which typically have 

no deductible. (To limit the use of health care services, 

HMOs focus more on management techniques aimed at 

providers than on financial incentives aimed at enrollees.) 

For plans whose design features a preferred provider organization—plans that typically rely on some cost sharing 

5. Employees who were receiving the earned income tax credit could 

also avoid the tax that is effectively imposed by the credit’s phaseout schedule because contributions to the plan’s associated savings 

account would take the form of reductions in salary. Those reductions could be adjusted temporarily (in amounts that varied from 

paycheck to paycheck) to cover the costs of a health service after it 

had been received; putting aside the money to cover out-of-pocket 

costs in advance would not be necessary. 

6. Kaiser Commission on Medicaid and the Uninsured, The Uninsured: A Primer, pp. 4 and 13.

7. See Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2004 Annual Survey (Washington, D.C.: Henry J. Kaiser Family Foundation, September 

2004). That survey did not provide comparable figures for the 

share of family policies that had no deductible. The figures shown 

here combine results for large and small employers. 
CHAPTER FIVE THE POTENTIAL FOR FAVORABLE SELECTION AND ITS EFFECTS ON SPENDING AND INSURANCE MARKETS 63

Figure 5-1.

Distribution of Deductibles for Enrollees in Preferred Provider

Organization Plans, 2005

Source: Congressional Budget Office based on Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2005 Annual Survey (Washington, D.C.: Henry J. Kaiser Family Foundation, September 2005). 

to limit expenditures and that have become the most 

popular form of employer-provided health insurance—

the distribution of deductibles among enrollees presents a 

somewhat different picture (see Figure 5-1). According to 

survey data, the average deductible for PPO enrollees in 

2005 was $323 for individual policies and $679 for family policies.8

The prevalence of relatively low deductibles in current 

employer-sponsored plans has conflicting implications 

for the potential impact of consumer-directed plans on 

health care spending. On the one hand, it suggests that a 

move toward consumer-directed designs might encounter 

resistance among enrollees, who seem to prefer lower 

deductibles (although that resistance could be offset at 

least in part if an employer’s contributions to the linked 

account were large enough). And if the level of enrollment in consumer-directed plans was low, the plans’ 

impact on total U.S. health care spending would be 

correspondingly reduced. On the other hand, the low 

deductibles of current plans indicate a greater potential 

for reducing costs among enrollees who switch to 

consumer-directed plans because those enrollees would 

be liable for a larger share of their health care costs (even 

if they could finance some of those expenses through an 

employer’s contribution to their account).

In determining the effect of consumer-directed plans on 

spending for health care, another important consideration is whether firms convert their health insurance 

entirely to a consumer-directed model or simply add such 

an option to their existing set of conventional plan offerings. The former scenario is more straightforward analytically and probably has the greatest potential for immediately reducing health care spending. The only caveat 

would be that the magnitude of the impact on total 

spending would depend on whether employers that 

switched completely from conventional coverage to 

No Deductible

 (29%)

Less Than $500

 (15%)

$500–$999

 (32%)

$1,000–$1,999

 (16%)

$2,000 or

More

 (8%)

No Deductible

 (29%)

Less Than $500

 (47%)

$500–$999

 (14%)

$1,000–$1,999

 (9%)

Individual Policies Family Policies

8. See Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2005 Annual Survey (Washington, D.C.: Henry J. Kaiser Family Foundation, September 

2005). The figures shown here are the deductibles that apply, on 

average, for services received within the plan’s network of providers. Comparable figures were not provided in the 2006 report.
64 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

consumer-directed designs had employees who had average, above-average, or below-average costs for health care. 

If firms that switched to consumer-directed plans had 

employees whose health care costs were lower and whose 

health was generally better than average, the impact on 

total health care spending would be proportionally 

smaller—because those individuals’ spending would 

constitute a smaller share of the total.

Only a limited amount of information is available about 

whether firms that offer consumer-directed plans are converting their coverage entirely to that form or adding it as 

an option. One recent survey indicated that about half of 

the enrollees in employment-based consumer-directed 

plans (compared with about one-third of those who had 

conventional employer-based coverage) did not have 

another health plan option. However, whether the survey’s results are representative of all consumer-directed 

plans offered by employers is not clear.9

 A more recent 

and representative survey of employers indicated that 

about 40 percent of employees who had enrolled in consumer-directed plans—about 1.1 million workers—were 

not offered another option. But the survey also showed 

that the total number of employees who are offered a 

consumer-directed plan (whether by itself or alongside 

other options) is about 10 million. Thus, it is relatively 

rare for employers to fully convert their health care coverage to a consumer-directed design.10

For employers that add such options to their current 

menu of health plan choices, the impact on health care 

spending will depend at least initially on whether enrollment in the consumer-directed plans is broadly representative of the population that has employer-sponsored 

insurance. Whether and to what extent incentives exist 

for lower-cost, generally healthier enrollees to choose 

plans that have a consumer-directed design is discussed in 

the next section. 

Enrollment Incentives and Expected Health 

Care Costs 

Among people who have employer-sponsored health 

insurance and who are offered a choice between convention and consumer-directed plan designs, a key determinant of whether they will enroll in a consumer-directed 

plan is whether they expect to gain or lose financially as a 

result. Such prospects will also influence whether an 

employer adds a consumer-directed plan as an option or 

converts the firm’s coverage entirely to that design. The 

earlier example of conventional and consumer-directed 

health plan designs—which was based on a study by the 

American Academy of Actuaries and was used in 

Chapter 2 to highlight the differences in incentives to 

seek care that enrollees face—also illustrates how the 

financial incentives to enroll in consumer-directed plans 

differ for healthier, lower-cost individuals and less 

healthy, higher-cost individuals.

B A person who had low levels of spending for health 

care or no spending and who enrolled in a health 

reimbursement arrangement or health savings account 

would have negative out-of-pocket costs—that is, positive balances that could be carried forward to the next 

year. In the example in Chapter 2, the employer’s contributions that could be rolled over if not used were 

$800 for the HRA and $600 for the HSA. As a result 

of those contributions, individuals who had health 

care spending of less than about $1,000 would have 

lower out-of-pocket costs under those consumerdirected plans than under the conventional plan. 

B For people who had intermediate levels of health care 

spending, however, HRA and HSA plans would generally result in higher cost-sharing liabilities than a 

conventional plan would, even after accounting for 

the spending that would be covered by the employer’s 

contributions to the associated accounts. In the example, individuals with health care spending of $2,000 

would have $515 in out-of-pocket costs under the 

conventional plan, but their gross out-of-pocket costs 

would be $685 higher under the HRA and $885 

higher under the HSA. The difference in gross costsharing liabilities between the conventional and 

consumer-directed plans would gradually increase 

until total health care spending equaled $7,000 (at 

which point the out-of-pocket limit in the consumer9. Paul Fronstin and Sara Collins, Early Experience with HighDeductible and Consumer-Driven Health Plans: Findings from the 

EBRI/Commonwealth Fund “Consumerism in Health Care” Survey, 

EBRI Issue Brief No. 288 (Washington, D.C.: Employee Benefit 

Research Institute, December 2005), available at www.ebri.org/

pdf/briefspdf/EBRI_IB_12-2005.pdf. The results of that study 

were based on an online survey and so may not be representative 

of the general nonelderly population.

10. Jon R. Gabel, Jeremy D. Pickreign, and Heidi H. Whitmore, 

Behind the Slow Enrollment Growth of Employer-Based ConsumerDirected Health Plans, Issue Brief No. 107 (Washington, D.C.: 

Center for Studying Health System Change, December 2006), 

available at www.hschange.com/CONTENT/opp/opp.pdf.
CHAPTER FIVE THE POTENTIAL FOR FAVORABLE SELECTION AND ITS EFFECTS ON SPENDING AND INSURANCE MARKETS 65

directed plans would be reached) and then would 

begin to decline.11

B In the example, individuals who had the highest levels 

of total health care spending would incur higher outof-pocket costs under the consumer-directed plans 

than under the conventional plan. But as discussed in 

Chapter 2, those plans could have been designed to 

have comparable limits on out-of-pocket costs, at least 

on a net basis (after taking employers’ contributions 

into account).

Which type of plan would result in higher out-of-pocket 

costs for individuals who ended up using the most health 

care services is thus difficult to determine in advance. All 

else being equal, however, the nature of the plans’ designs 

is such that the individuals who have the lowest health 

care costs overall will have lower out-of-pocket costs 

under the consumer-directed plan (because of employers’ 

contributions to the savings accounts). Conversely, people who have intermediate-level health care spending will 

have lower out-of-pocket costs under the conventional 

plan (because of the lower deductible). Thus, the same 

features of consumer-directed plans that encourage 

enrollees to be prudent in their use of services—the high 

deductible and control over account funds—also generate 

pressures for favorable selection in those plans, which 

raises a potential trade-off.

Two additional factors would lessen the difference in net 

costs between the consumer-directed and conventional 

plan designs but would probably not change the basic 

financial calculus for most potential enrollees. 

B First, the tax advantage given to out-of-pocket spending under consumer-directed plans would make for 

smaller net differences in cost-sharing liabilities, particularly in the case of HSAs. But it would be unlikely 

to eliminate those differences because the tax savings 

are a percentage of an enrollee’s gross out-of-pocket 

payments. In the example, an individual with total 

health care spending of $2,000 would have gross costsharing liabilities of $1,400 under the HSA, or $885 

more than under the conventional plan. If that person 

faced a marginal income tax rate of 25 percent, 

though, the net liability under the HSA would be 

$1,050, and the difference between that figure and the 

liability under the conventional plan would fall to 

$535.

B Second, total health care spending would be reduced 

under the consumer-directed designs, which would 

generate a reduction in out-of-pocket costs and would 

also lower plan premiums somewhat—reflecting the 

stronger incentives to control costs that those designs 

incorporate. But the effect of those incentives would 

have to be relatively large—much larger than the 

RAND study or the Academy of Actuaries’ analysis 

would indicate—to appreciably change the premiums 

and thus the break-even point for enrollees. In the 

example, the actuarial value of the conventional and 

consumer-directed plans (which represents what the 

total premium would be for those plans if enrollees’ 

use of health care did not change) was about $2,100. 

Thus, a reduction of 5 percent in total spending 

would translate into premium savings of about $100. 

Predictability of Health Care Costs. A limitation of the 

forgoing analysis—which focuses on individuals’ costs 

under different plan designs, given their spending for 

health care—is that people cannot be certain about their 

future costs for care when they are choosing an insurance 

plan. Instead, their choice will tend to reflect the level of 

future spending they expect to incur as well as the potential variability of that spending. 

Even so, the available data on nonelderly insured individuals indicate that those with low health care costs in one 

year tend to have similarly low costs the next year; the 

data also suggest that high costs for health care are likely 

to persist (see Table 5-2). Within that population, for 

example, individuals who used less than $1,000 worth of 

care in 2003 had a 78 percent chance of using less than 

$1,000 worth of care in 2004 but only a 5 percent chance 

of using more than $5,000 worth of care. By contrast, 

individuals who used between $1,000 and $5,000 worth 

of care in 2003 were much less likely (a 41 percent probability) to have used less than $1,000 worth of care in 

2004. Those individuals had about an even chance 

(47 percent) of incurring costs in the $1,000-to-$5,000 

range again in 2004. Individuals who used more than 

$5,000 worth of care in 2003 were more than three times 

11. In the example, the maximum difference in liabilities would occur 

for individuals who had $7,000 in total health care spending. At 

that point, an HRA enrollee would have incurred $2,200 in outof-pocket costs (after using the employer’s account contribution), 

and an HSA enrollee would have incurred $2,400. An enrollee in 

a conventional plan would have incurred $1,015 in out-of-pocket 

costs. 
66 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Table 5-2.

Persistence of Health Care Spending

Source: Congressional Budget Office based on merged data for 2003 and 2004 from the Medical Expenditure Panel Survey conducted by the 

Department of Health and Human Services’ Agency for Healthcare Research and Quality.

Notes: The figures include only individuals who were under the age of 65 in 2003 and were privately insured for all of that year.

CBO increased total health care spending for 2003 to 2004 dollars by using the growth in health care spending per capita as estimated 

from the National Health Expenditures compiled by the Department of Health and Human Services.

as likely as the lowest-cost group (a 76 percent chance 

compared with a 22 percent probability) to have expenditures that exceeded $1,000 in 2004. 

Those raw correlations probably understate the extent to 

which individuals who have had various levels of spending in the past can anticipate their likely needs for health 

care in the future—because the correlations take no 

account of what led to the earlier spending. In practice, 

people who have had health problems that are unlikely to 

recur and those who have conditions that are more 

chronically costly will use that information in choosing a 

health insurance plan. Thus, although individuals still 

face substantial uncertainty about the exact level of their 

future health care costs—and would generally value 

insurance coverage against incurring very high costs, 

which both plan designs provide—they may still have 

enough information in many cases to determine which 

design would be most advantageous for them. 

A related question is the period to use in analyzing the 

persistence of health care spending. A focus on year-toyear correlations is most relevant in the case of employees 

who are offered a choice between consumer-directed and 

conventional plans because they typically have the option 

of changing plans once a year. If they can predict their 

spending for the next year, they might choose to enroll in 

consumer-directed plans when they expected their health 

care costs to be low and then to switch to a conventional 

design when they expected their costs to be higher. For 

employees of firms that convert their coverage entirely to 

a consumer-directed design, however, a longer perspective 

is useful because gains in one year might be offset by 

losses in another. According to the study by Matthew 

Eichner, Mark McClellan, and David Wise (which is discussed further in Chapter 3), health care spending is less 

concentrated over longer periods—that is, the share of 

spending accounted for by a given percentage of the 

highest-cost cases declines.12 But that study’s attempt to 

model account withdrawals and accumulations under a 

consumer-directed design also showed that individuals 

varied substantially in their use of care over a (simulated) 

lifetime. Some individuals had very little health care 

spending over a 35-year period, whereas others used their 

accounts year after year and did not build up a balance.13

The questions of whether and to what extent health care 

costs are persistent or predictable over time are tied to the 

relationship between such costs and health status. Clearly, 

both actual and expected health care spending may differ 

among individuals for a number of reasons. Even among 

people with the same disease, spending may vary because 

of their preferences about seeking care in the first place or 

about the type of treatment that they will receive. The 

increase in out-of-pocket costs under consumer-directed 

designs would fall partly on those enrollees who chose a 

Percentage of

Total 2003 Population in $1,000 to All

Spending Range (Dollars) Range 0 to $1,000 $5,000 Ranges Mean

Zero to 1,000 50 78 17 5 100 1,214 279

1,000 to 5,000 35 41 47 13 100 2,597 1,313

More Than 5,000 15 24 39 37 100 7,765 3,316

Percentage of 2003 Subgroup with 

Total 2004 Spending in Range

Median

Spending in 2004

More Than

$5,000

(Dollars)

12. See Matthew J. Eichner, Mark B. McClellan, and David A. Wise, 

Insurance or Self-Insurance? Variation, Persistence, and Individual 

Health Accounts, Working Paper No. 5640 (Cambridge, Mass.: 

National Bureau of Economic Research, June 1996).

13. For an analysis of health care spending for Medicare enrollees over 

an extended period, see Congressional Budget Office, High-Cost 

Medicare Beneficiaries (May 2005). 
CHAPTER FIVE THE POTENTIAL FOR FAVORABLE SELECTION AND ITS EFFECTS ON SPENDING AND INSURANCE MARKETS 67

more expensive treatment for their condition. Substantial 

differences in spending are also apparent among geographic areas—differences that go beyond variations in 

the prices of services and that appear to reflect differences 

among local providers in their styles of practice (for 

example, how likely they are to recommend surgery).

At the same time, a significant correlation exists between 

prior health problems and future levels of health care 

spending. That correlation can be seen in so-called riskadjustment models that attempt to predict future health 

care costs on the basis of past diagnoses; although such 

models can account for only a portion of the overall variation in health care costs, they show clear relationships 

that are independent of other considerations. Thus, 

although better health status is not always synonymous 

with low costs for health care, as a group, people who 

have lower expected costs tend to be healthier than those 

who have higher expected costs.

Access to Providers. Deductibles and coinsurance rates 

are not the only factors that would induce people to select 

one kind of health plan over another. In particular, some 

advocates of consumer-directed health plans have argued 

that sicker individuals will want to enroll in such plans 

because they will have greater access to providers and 

more control over their health care as a result. As noted in 

Chapter 4, however, consumer-directed designs appear to 

feature PPO networks, so the issue of improved access to 

providers would not arise in comparisons of consumerdirected plans and conventional PPO plans. Such plans 

would probably be comparable in their use of care management as well—which under both designs would be 

focused on expensive hospitalizations—so enrollees’ control over their care under the two plans would not seem 

to differ substantially either. 

The argument that sicker enrollees might value greater 

control over their care and easier access to providers has 

greater relevance in comparisons of consumer-directed 

health plans and HMOs. Enrollees in HMOs may obtain 

care outside of their plan’s provider network—or receive 

services that their plan does not deem necessary and thus 

will not cover—if they are willing to pay the full costs of 

that care. Thus, they must make the same determination 

in those circumstances that enrollees in consumerdirected plans face when they are below their deductible: 

are the services worth their full costs? People who had 

more health problems would find it easier to pay for such 

care if they were enrolled in a consumer-directed plan 

than if they participated in an HMO because they could 

use the funds in their associated account. In deciding 

whether to enroll in a consumer-directed plan, they 

would have to balance that gain against the higher out-ofpocket costs that they would face for approved treatments 

received within the plan’s network. 

Overall, some degree of favorable selection in consumerdirected plans seems likely among people who have 

employer-sponsored coverage and a choice among health 

plan designs. For relatively healthy individuals whose 

health care costs were low, the incentives to enroll in a 

plan with a consumer-directed design would be fairly 

clear. For people who had more health problems and 

higher health care costs, the financial calculus would vary 

but would tend to discourage enrollment; although 

broader access to providers might lead some members of 

that group to choose consumer-directed plans, the likelihood of their enrolling would appear to be smaller. However, the degree to which such selection will occur is difficult to predict. It depends not only on how individuals 

assess the advantages and disadvantages of consumerdirected plans but also on whether there are ripple effects 

on insurance markets and whether employers take 

steps to counter the pressure for favorable selection in 

consumer-directed plans.

Impact on Health Care Costs and 

Insurance Markets 

If enrollment in consumer-directed health plans was concentrated among people who had low health care costs, 

the plans’ initial impact on total spending for health care 

would probably be much smaller than if enrollment had 

been more representative of the entire population. In 

part, that is because the change for the lower-cost group 

in their financial incentives to use care would be less significant: under a typical PPO design, enrollees whose 

health care costs were low would also have had to pay the 

full cost of a substantial portion of their treatments. The 

main reason for the small effect, however, is that those 

individuals account for a relatively small share of total 

spending for health care. 

Over time, the impact of consumer-directed health plans 

on insurance markets could lead to greater and more representative enrollment in those plans as well as a larger 

effect on health care spending. Favorable selection in 

consumer-directed health plans would tend to push up 

premiums in conventional plans to reflect the higher 
68 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

average costs of the remaining enrollees. By itself, that 

phenomenon would have little effect on total health care 

spending, but as premiums rose in conventional plans, 

the relatively healthy enrollees still in them would be 

more inclined to switch to the consumer-directed plans. 

Indeed, continued switching into consumer-directed 

plans might occur even if individuals were willing to pay 

the added premium that conventional plans with representative enrollment would charge. In that case, the 

factor that would be pushing people to enroll in the 

consumer-directed plan would be the additional gap 

between the plans’ premiums that was due to adverse 

selection in the conventional plans. 

Critics of consumer-directed designs have argued that in 

the extreme, a selection spiral might ensue—with enrollment in conventional plans continuing to decline as their 

average costs and premiums continued to increase—

culminating in the loss of conventional plans as a health 

insurance option. As discussed later, that outcome may be 

avoided, for a number of reasons. If conventional plans 

were essentially eliminated, however, the ultimate effect 

on health care spending of adding consumer-directed 

options would be comparable to the case of an employer 

that switched all of its employees to a consumer-directed 

plan—that is, total spending would probably fall modestly (at least compared with spending under the predominant PPO designs) because of the stronger incentives to 

control costs. 

Another scenario—which could arise even if an employer 

did not offer its employees a consumer-directed option—

would involve lower-cost and relatively healthy enrollees 

in an employer-sponsored plan who decided to opt out 

and purchase an HSA in the individual insurance market. 

In that case, premiums for the employer-sponsored plan 

of conventional design would also tend to rise, which in 

turn could lead more of the relatively low-cost employees 

to drop out of that plan. Some analysts have argued that 

such developments would lead certain employers—

particularly small firms that are less likely to subsidize 

employees’ health insurance premiums as part of their 

compensation—to stop offering health insurance coverage of any kind. If that happened, and if some of the 

remaining employees were unable to find an affordable 

policy in the individual insurance market or another 

source of coverage, those employees would end up uninsured.14

Under either scenario, an important consequence of the 

dynamics of the insurance market is that higher-cost and 

generally less healthy individuals would probably end up 

paying more for their health care. They would face higher 

premiums if they continued to enroll in a health insurance plan of conventional design and higher cost-sharing 

liabilities if they switched to a consumer-directed plan. 

How much worse off those individuals would be financially would depend on several factors—including how 

persistent their health care spending was over a long 

period. 

One source of uncertainty about the ultimate financial 

impact on individuals who have higher health care costs is 

whether they are already paying more for their health 

insurance—through lower wages—than other employees 

are. A common assumption is that among the enrollees in 

a given employer-sponsored health care plan, those who 

have lower expected costs for health care subsidize those 

who have higher expected costs because they all pay the 

same premium despite the differences in their use of 

health care services. (That phenomenon is sometimes 

referred to as a “cross subsidy.”) In principle, however, 

people who anticipated a greater need for health insurance would be more willing than people who had a lower 

demand for that fringe benefit to accept a given job at a 

lower wage—as long as it provided insurance. If that was 

the case, and if employees with higher health care costs 

were already paying more for their health insurance than 

lower-cost employees were, then any adverse financial 

impact caused by consumer-directed plans would be correspondingly smaller. Most analysts agree that workers as 

a group pay the full cost of their health insurance in the 

long run, but there is less evidence about whether those 

who are more likely to use health insurance pay more for 

it in the form of forgone wages. One study found that 

maternity benefits were largely if not entirely paid for

14. A recent analysis examined proposals to expand the tax advantages 

of HSAs and found that on balance, the proposals would slightly 

increase the number of people who were uninsured. See Jonathan 

Gruber, The Cost and Coverage Impact of the President’s Health 

Insurance Budget Proposals (Washington, D.C.: Center on Budget 

and Policy Priorities, February 15, 2006). That analysis did not 

address the effects of the original legislation that established HSAs 

as a health insurance option.
CHAPTER FIVE THE POTENTIAL FOR FAVORABLE SELECTION AND ITS EFFECTS ON SPENDING AND INSURANCE MARKETS 69

(through lower salaries) by those most likely to gain from 

them. How widely that phenomenon occurs in practice, 

however, is uncertain.15

If conventional insurance options became less affordable 

or less widely available because of a selection spiral, what 

overall impact would that have on individuals? The losses 

for people who had higher health care costs and the gains 

for those who had lower costs might be largely a zero-sum 

result—that is, the losses and gains might offset each 

other in the aggregate. But some studies suggest that 

there would be a small net decline in economic wellbeing from losing that insurance option and from facing 

greater variability in health care costs. The costs of those 

losses in well-being would have to be weighed against 

the net benefits of reduced health care spending that 

consumer-directed plans could yield. 

B A study examined Harvard University’s experience 

when it required employees to pay the added costs of 

joining a PPO plan that was loosely managed—which 

triggered a selection spiral that led to the PPO plan’s 

demise.16 Researchers estimated that the resulting loss 

for sicker enrollees outweighed the gain for healthier 

ones, yielding an overall decline in economic wellbeing (valued at 2 percent to 4 percent of average 

health insurance costs). An important factor in that 

analysis, however, was that the ensuing reduction in 

health care spending came from a lower level of profits 

for insurers (which simply transferred well-being from 

the insurers to their customers) and not from less use 

of low-value health care services (which could have 

yielded offsetting gains in economic well-being). 

B Another analysis of high-deductible plans examined 

the cost to individuals of bearing additional financial 

risk for their health care costs—which would rise 

somewhat under consumer-directed designs because 

enrollees’ out-of-pocket costs might vary more widely 

(even if the average liability was the same). The study 

found that the magnitude of added risk was affected 

primarily by whether the plan capped out-of-pocket 

spending; higher deductibles and higher rates of coinsurance were associated with higher risk, but the differences among plans with similar caps were not 

large.17 That finding suggests that widespread enrollment in consumer-directed plans will cause a relatively 

small loss of economic well-being from increased 

risk—as long as the out-of-pocket limits in those plans 

are comparable to the limits in conventional plans. 

Simulations of Enrollment in Consumer-Directed 

Health Plans

A number of the studies cited in earlier chapters—which 

looked at how enrollment in consumer-directed plans 

that was broadly representative would affect health care 

spending—also examined whether lower-cost, healthier 

individuals would be more likely to choose those plans 

and what the potential consequences of that tendency 

would be.18 As noted earlier, the American Academy of 

Actuaries compared conventional and consumer-directed 

health insurance plans of equal value and found that individuals with little or no health care spending would fare 

better under a consumer-directed plan, whereas individuals with medium or high levels of health care spending 

would have lower out-of-pocket costs under the conventional PPO design. Those researchers concluded that if 

“low cost participants are allowed to choose from multiple plan offerings, they would likely choose a CDHP 

[consumer-directed health plan] design. Conversely, high 

users are more likely to prefer remaining in a traditional 

plan. As a result, multiple plan offerings may result in significant selection issues.”19 The Academy of Actuaries’ 

15. See Jonathan Gruber, “The Incidence of Mandated Maternity 

Benefits,” American Economic Review, vol. 84, no. 3 (June 1994), 

pp. 622–641. For a broader discussion, see Gruber, “Health Insurance and the Labor Market,” in A.C. Cuyler and J.P. Newhouse, 

eds., Handbook of Health Economics, vol. 1A (Amsterdam: Elsevier, 

2000), pp. 645–706.

16. See David M. Cutler and Sarah Reber, “Paying for Health Insurance: The Trade-Off between Competition and Adverse Selection,” Quarterly Journal of Economics, vol. 113, no. 2 (May 1998), 

pp. 433–466.

17. See Joan L. Buchanan and others, “Simulating Health Expenditures Under Alternative Insurance Plans,” Management Science, 

vol. 37, no. 9 (September 1991).

18. See, for example, Emmett B. Keeler and others, “Can Medical 

Savings Accounts for the Nonelderly Reduce Health Care Costs?” 

Journal of the American Medical Association, vol. 275, no. 21 

(June 5, 1996); and Len M. Nichols, Susan Wall, and Marilyn 

Moon, Tax-Preferred Medical Savings Accounts and Catastrophic 

Health Insurance Plans: A Numerical Analysis of Winners and Losers

(Washington, D.C.: Urban Institute, April 1996). 

19. American Academy of Actuaries, The Impact of Consumer-Driven 

Health Plans on Health Care Costs: A Closer Look at Plans with 

Health Reimbursement Accounts (Washington, D.C.: American 

Academy of Actuaries, January 2004), p. 4, available at www.

actuary.org/pdf/health/cdhp_jan04.pdf. 
70 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

analysis also noted that such issues may arise, at least to 

some extent, any time multiple health insurance plans are 

offered. 

Several other researchers developed models to simulate 

individuals’ decisions about whether to enroll in a hypothetical consumer-directed plan or a conventional plan. 

Although the details of the models and the specific features of the plans varied, a common assumption was that 

individuals who expected to have a low level of spending 

for health care were more likely than people who 

expected to have high health care costs to enroll in the 

consumer-directed plan.20 As a result, premiums for the 

conventional plans rose over time to reflect their enrollees’ higher average costs. As those premiums increased, 

enrollment of relatively low-cost individuals in conventional plans tended to decline further.

In one example of such studies (by Daniel Zabinski and 

others), the main finding was that enrollment of primarily healthier, lower-cost individuals in consumer-directed 

health plans could generate selection spirals in which traditional plans were ultimately driven out of the market.21

Not surprisingly, those researchers reported that selection 

spirals were more likely if individuals could foresee their 

medical spending and if consumer-directed plans had 

higher caps on out-of-pocket costs than conventional 

plans had. The Urban Institute study also reached the 

conclusion that offering workers a choice of plan designs 

was likely to generate strong pressures for favorable selection in the consumer-directed plan and adverse selection 

in the conventional plan. The results of any such model, 

however, are affected by the assumptions that researchers 

use about how enrollment, spending, and premiums for 

each plan option evolve over time. Thus, those findings 

may be informative about the possibility of a selection 

spiral, but it is not clear what predictive power they 

hold—particularly if employers take steps to limit selection pressures.

Factors That Could Limit Selection Pressures

As noted above, favorable selection in consumer-directed 

plans by employees with lower health care costs could 

occur in two ways. First, employees who were offered a 

choice of health plan designs by their employer might 

flock to the consumer-directed plan. Second, employees 

might opt out of their employer’s conventional coverage 

and purchase an HSA in the individual insurance market. 

The relatively low premiums for such policies could be 

attractive—particularly if they were priced to reflect the 

assumption that enrollees would have below-average 

health care costs. 

Forgone Subsidies. Under current law, several factors 

would limit the probability that employees would take 

the second route noted above. Most employees’ purchases 

of health insurance are subsidized—not only through the 

tax system (their premiums are paid with pretax dollars) 

but also by their employers (which pay a share of the premiums). According to a survey of employers, workers 

who are offered health insurance currently pay, on average, 16 percent of the total premium for individual coverage and 27 percent of the premium for family coverage.22

Employees would forgo both of those subsidies if they 

shifted to individually purchased insurance. Even if 

employees who dropped the coverage offered through 

their employer and purchased their own HSA could 

arrange to receive more cash compensation in the bargain 

(or if they switched to a firm that did not offer subsidized 

health insurance), their HSA premiums would not be 

tax-deductible. In addition, their contributions to their 

account would be exempt from income taxes but not 

20. An exception is the Keeler study of medical savings accounts that 

was cited earlier (Keeler and others, “Can Medical Savings 

Accounts for the Nonelderly Reduce Health Care Costs?”). It 

found that if the gross deductible is sufficiently low, the tax advantage of using account funds to cover out-of-pocket costs could 

make the consumer-directed plan attractive to enrollees who have 

the highest medical spending—because the net deductible would 

be lower than the conventional plan’s limit on out-of-pocket costs. 

It is not clear from the study, however, what assumptions the 

researchers made about enrollees’ ability to predict their future 

medical costs. The study also found that a higher deductible could 

cause a substantial degree of favorable selection in the consumerdirected plan and that total health care spending would be largely 

unaffected if enrollees were given a range of plan designs from 

which to choose, because some of those choices would cause 

spending to increase.

21. See Daniel Zabinski and others, “Medical Savings Accounts: 

Microsimulation Results from a Model with Adverse Selection,”

Journal of Health Economics, vol. 18, no. 2 (April 1999).

22. Kaiser Family Foundation and Health Research and Educational 

Trust, Employer Health Benefits: 2006 Annual Survey (Washington, 

D.C.: Henry J. Kaiser Family Foundation, September 2006). The 

survey found that for individual coverage, workers at smaller firms 

(those with fewer than 200 employees) paid about the same share 

of the premium, on average, as did workers at larger firms, but for 

family coverage, workers at smaller firms paid a larger share 

(33 percent, compared with 23 percent for workers at larger 

firms).
CHAPTER FIVE THE POTENTIAL FOR FAVORABLE SELECTION AND ITS EFFECTS ON SPENDING AND INSURANCE MARKETS 71

from payroll taxes. Those considerations reduce the attractiveness of shifting from employer-sponsored coverage to individually purchased HSAs. 

Incentives for Employers. Employers that offered a 

choice between conventional and consumer-directed 

health plans would have financial incentives to limit the 

extent of favorable selection in their consumer-directed 

plans. In the short run at least, such selection could raise 

their total costs, particularly in the case of HSAs, because 

employers incur the full cost of their account contributions when they make them and employees may use the 

funds for any purpose. By contrast, in the case of HRAs, 

the costs of employers’ contributions are incurred only 

when the funds are used to pay for health care services. 

Some observers have suggested that concerns about the 

costs to employers of favorable selection can explain why 

many employers are offering HRAs instead of HSAs.23

Although such concerns may be more extensive in the 

case of HSAs—because of the greater portability of the 

account funds—HRAs could also bring about a rise in 

employers’ spending as a result of favorable selection. In 

part, that is because employees who expect their health 

care costs to be low may treat the funds as first-dollar coverage (and increase their use of care). But even if no such 

behavioral response occurred, employers who sponsored 

an HRA would be covering health care expenditures of 

low-cost enrollees that under a conventionally designed 

plan would fall below the deductible (and thus would create no liability for the plan). The example used earlier in 

this chapter of actuarially equivalent health plans—which 

illustrated the circumstances in which employees could 

lower their own out-of-pocket costs by switching to a 

consumer-directed health plan—also shows that employers’ costs tend to increase correspondingly in the 

process.24

Options for Employers. If employers provided a choice 

between conventional and consumer-directed health plan 

designs, they could take several steps to reduce selection 

pressures. For example, they could offer plans of comparable actuarial value and then charge enrollees the same 

premium for each one, regardless of who actually decided 

to enroll in each plan; in effect, that approach would 

maintain any cross subsidies between higher-cost and 

lower-cost employees even as they sorted themselves 

among the plans. It would still be the case, however, that 

employers’ total costs would rise in the short run as a 

result of that sorting—because employers would be paying more for enrollees who had low total health care 

expenditures and who switched into a consumer-directed 

plan. The approach of offering plans with equal actuarial 

values would also run counter to the goal of offering 

employees a range of health plan options and exposing 

them—through differing premiums—to the financial 

consequences of choosing a plan that offered more or 

fewer benefits. That alternative approach, sometimes 

called managed competition, is seen as another way to 

encourage individuals to be cost-conscious in their use of 

health care services.25

Employers could instead try to structure the options they 

provide, including the level of their contributions to 

HSAs and HRAs, to take the prospect of favorable selection into account. For example, they could offer a smaller 

contribution to the accounts for all enrollees. In that case, 

the conventional and consumer-directed plans would not 

be equally rich overall but would have more comparable 

costs for insuring the set of healthier, lower-cost employees that might be expected to enroll in the consumerdirected plan. That step would reduce the financial 

incentive for lower-cost enrollees to switch into that 

plan—but it would also make the consumer-directed 

plan less attractive for higher-cost employees because it 

would reduce the plan’s actuarial value. As a result, the 

net effect of such a strategy on selection pressures is difficult to predict.

23. See Paul Fronstin, Health Savings Accounts and Other AccountBased Health Plans, EBRI Issue Brief No. 273 (Washington, D.C.: 

Employee Benefit Research Institute, September 2004), p. 12, 

available at www.ebri.org/pdf/briefspdf/0904ib1.pdf.

24. If employers’ costs did rise, firms would be expected to offset those 

costs over time by reducing other forms of compensation. Also, in 

deciding whether to offer an HRA or HSA, they would have to 

take into account employees’ preferences about the design of 

health plans as they competed in the labor market for workers. 

The Academy of Actuaries’ analysis notes another reason that 

HRAs may be less likely to see favorable selection: the account 

funds may be forfeited if enrollees switch back to a conventional 

plan design at a later point (even if they remain with the same 

firm). That prospect would reduce the incentive for individuals to 

enroll in an HRA when their health care costs are low and then 

switch to a traditional plan if their health care costs subsequently 

rise. 

25. For a recent discussion of managed competition, see Alain C. 

Enthoven, “Market Forces and Efficient Health Care Systems,” 

Health Affairs, vol. 23, no. 2 (March/April 2004). 
72 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Another option would be for employers to vary their contributions to the accounts to reflect enrollees’ expected 

health care costs based on their medical history—that is, 

to apply risk-adjustment methods to those contributions. Employers would contribute less to the consumerdirected plan accounts for healthier enrollees and more 

for sicker ones, which could help weaken the pressures for 

favorable selection in the consumer-directed plan. However, such a strategy would raise several issues.

B Comparability and nondiscrimination rules that currently govern employees’ compensation would not 

appear to permit differentiation in the amounts contributed to consumer-directed plans’ accounts.26 To 

address that constraint, the President’s budget request 

for 2007 included a proposal to change those rules to 

permit employers to contribute additional amounts to 

the HSAs of chronically ill employees or their dependents. (The recently passed Tax Relief and Health 

Care Act of 2006 modifies the comparability rules to 

permit larger account contributions for workers who 

make less than $100,000 per year.)

B Even if risk adjustment of contributions was allowed, 

existing risk-adjustment models tend to overestimate 

costs for healthier enrollees and underestimate costs 

for sicker ones. Risk adjustment would therefore tend 

to reduce but not eliminate pressures for favorable 

selection. 

B Employers would incur some costs in implementing 

risk-adjustment procedures, and the adjustment of 

contributions could raise legal and other concerns 

about the privacy of an enrollee’s health history.27

A final consideration regarding selection pressures and 

their impact comes from the experience of HMOs, 

which—like consumer-directed health plans—have been 

viewed as more attractive to healthier individuals who 

have lower health care costs. (Healthier people may be 

less concerned than people who have health problems 

about having a limited network of health care providers, 

and they may be more likely to accept prior-authorization 

requirements, utilization review, or other steps that 

HMOs take to limit their use of health care services.) The 

rise of HMOs and PPOs has led to dramatic reductions 

in the number of enrollees in indemnity insurance plans, 

which buttresses concerns about selection spirals. At the 

same time, HMOs have continued to coexist with more 

loosely managed PPOs for many years, even in markets in 

which both types of health plan are widely available. On 

the basis of that experience, potential scenarios for the 

future include one in which consumer-directed health 

plans drive loosely managed plans of conventional design 

from the market. Another possibility, however, is that a 

new equilibrium—with relatively stable enrollment in 

each type of plan—will eventually be achieved.

26. According to one recent analysis (Bob Lyke, Chris Peterson, and 

Neela Ranade, Health Savings Accounts, CRS Report for Congress 

RL32467, Congressional Research Service, updated March 23, 

2005, available at www.law.umaryland.edu/marshall/crsreports/

crsdocuments/RL3246703232005.pdf), contributions by employers to consumer-directed plans “must be comparable. Generally, contributions must be the same dollar amount or the same 

percentage of the . . . annual deductible, adjusted [only] to reflect 

the proportion of the year the employees have worked” (p. 8).

27. A related alternative would be for employers to adjust enrollees’ 

premiums for each kind of plan to factor out any effects from the 

sorting of higher- and lower-cost employees. The goal would be to 

have differences in premiums among plans reflect only the differences in the plans’ costs for treating a representative group. That 

type of risk adjustment (which Medicare employs in its system for 

paying private health care plans) could mitigate selection pressures 

(without running afoul of nondiscrimination rules) and still require enrollees to consider the differences in benefits and costs 

among plans. 
CHAPTER

6

Preliminary Evidence from

Consumer-Directed Health Plans

Although health reimbursement arrangements 

and health savings accounts have been offered for only a 

few years, the available data about them shed some light 

on the issues discussed in earlier chapters. Much of that 

information comes from industry reports and from surveys of the firms that offer such plans and the individuals 

who have enrolled in them. That information must be 

considered preliminary; in many cases, its implications 

are ambiguous or leave room for multiple interpretations. 

Reports about the age of enrollees in consumer-directed 

plans or the share of them who were previously uninsured, for example, may not reveal whether those 

enrollees are healthier than the general population or 

whether they would have remained uninsured in the 

absence of consumer-directed plans. Meanwhile, comparisons of health care spending and the use of services 

under consumer-directed and conventional plans in 

many instances fail to account for possible differences in 

the value of the policies being compared or in the enrollees in those plans. 

Studies about consumer-directed plans that have been 

published in academic journals are generally more rigorous than industry reports, but they also have limitations. 

Only a handful of such studies are available, and they 

focus on the experience of plans that feature health reimbursement arrangements (which became available 

before health savings accounts did). As discussed in more 

detail later, one such study found that enrollees in a 

consumer-directed plan were not noticeably younger or 

healthier than enrollees in conventional plans, but two 

others showed that consumer-directed plans attracted 

individuals who had much lower health care costs prior to 

enrolling—even though they did not differ noticeably 

from conventional-plan enrollees in their demographic 

characteristics. Yet even in those studies, the results may 

reflect idiosyncrasies of the particular health plans and 

the relatively small populations that were analyzed or the 

particular statistical techniques that researchers used to 

adjust for other differences between enrollees. Given the 

problems with the available data, it is appropriate to exercise caution before reaching any definitive conclusions on 

the basis of this evidence about the impact of consumerdirected designs on health care costs or other measures.1

Surveys of Insurers and Enrollees 

The initial descriptive statistics that have been released 

about enrollees in consumer-directed health plans—most 

of which reflect the experience of HSAs—provide a useful starting point for evaluating the available evidence 

about those plans. Some surveys have sought to measure 

the age and health status of enrollees; others have tried to 

examine enrollees’ use of health care services and compare 

the costs of HSAs with those of conventionally designed 

plans; and still others have addressed the share of HSA 

enrollees who previously had been uninsured. One 

consideration to keep in mind in reviewing the studies’ 

findings is that they reflect early adopters of consumerdirected plans, and those individuals may not be representative of the kinds of people who will enroll in such 

plans as they become more prevalent. For comparisons of 

consumer-directed and conventional plans that are based 

on surveys of individuals, another issue is whether the 

people who responded to the survey are a representative 

sample of the current enrollees in each type of health 

plan. 

1. For another review of many of the studies examined here, see 

Melinda Beeuwkes Buntin and others, “Consumer-Directed 

Health Care: Early Evidence About Effects on Cost and Quality,” 

Health Affairs Web Exclusive (October 24, 2006), available at 

http://content.healthaffairs.org/cgi/content/full/25/6/w516. 
74 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Age and Health Status of Enrollees

Several studies have considered the age of HSA purchasers, a statistic that has generated interest largely because it 

is seen as a proxy for their health status—reflecting the 

fact that, on average, older individuals have more health 

problems than younger ones do. One analysis released in 

the summer of 2005 reported that “about half” of HSA 

purchasers were older than 40.2 A more recent census 

conducted by the insurance industry examined all enrollees in plans that were “HSA-compatible”; that is, the 

plans had deductibles and out-of-pocket limits that conformed to the requirements for an HSA, but it was not 

known whether enrollees had actually established an associated savings account. That study found that half of 

those covered by individually purchased HSA-compatible 

plans and about 45 percent of those covered by such 

plans through their employer (in the “group” market) 

were age 40 or older.3

Those figures are comparable to the overall shares of the 

nonelderly population who are covered by individual and 

employer-sponsored insurance, respectively, who are 

above the age of 40—but whether the age of HSA enrollees is indicative of their health status or expected medical 

costs is unclear. Although age and health care spending 

are correlated, people’s health status and health care 

spending also vary substantially within age groups. 

Regardless of their age, therefore, people who have chosen HSAs may be healthier or sicker than average, or 

comparable to the average individual in the nonelderly 

population—there is no way of knowing without additional data. 

Some direct evidence about the health status of enrollees 

in consumer-directed plans comes from a recent report by 

the Blue Cross and Blue Shield Association, a trade group 

that represents Blue Cross and Blue Shield plans.4 (Those 

plans sell a variety of health insurance policies, including 

health savings accounts.) Researchers found that enrollees 

in HSA-compatible and conventional insurance plans 

provided comparable assessments of their own health status. About 10 percent of enrollees in each type of plan 

characterized their health as either excellent or fair, and 

nearly half reported themselves as being in good health. 

That study has been criticized, however, on the grounds 

that it failed to distinguish between purchasers in the 

individual market, who tend to be healthier than average, 

and purchasers in the group market.5

 If the survey 

respondents who had conventional health plans were 

more likely to have purchased their policies in the individual market, then the comparison of enrollees’ health 

status in the two types of plan would not reveal whether 

employer-sponsored HSAs are more attractive to healthier individuals.

Another survey, conducted in 2005, supports the argument that enrollees in consumer-directed plans in the 

individual insurance market are healthier than enrollees 

in such plans who have employer-sponsored coverage, 

but the survey’s other results do not imply favorable 

selection in consumer-directed plans.6 It found that 

42 percent of enrollees in consumer-directed health plans 

that were sponsored by employers considered themselves 

to be in excellent or very good health, compared with 

62 percent of enrollees in consumer-directed plans that 

had been purchased in the individual market. The study 

did not directly compare enrollees in consumer-directed 

and conventional plans who had employment-based coverage, but the results indicate that the health status of the

2. See Grace-Marie Turner, Consumerism in Health Care: Early 

Evidence Is Positive (Alexandria, Va.: Galen Institute, August 11, 

2005), pp. 1–2, available at www.galen.org/fileuploads/

Consumerism.pdf. 

3. AHIP Center for Policy and Research, January 2006 Census Shows 

3.2 Million People Covered by HSA Plans (Washington, D.C.: 

America’s Health Insurance Plans, March 9, 2006), available at 

www.ahipresearch.org/pdfs/HSAHDHPReportJanuary2006.pdf. 

The figures included dependents (spouses and children) covered 

under family policies. 

4. Blue Cross and Blue Shield Association, “Consumer-Directed 

Plans in Practice: Perspectives from Consumers and the Blues” 

(presentation by Maureen Sullivan at the National Press Club, 

Washington, D.C., September 28, 2005), available at www.

bcbshealthissues.com/events/consumer/sullivan_presentation.

ppt.

5. Edwin Park and Robert Greenstein, Latest Enrollment Data Still 

Fail to Dispel Concerns About Health Savings Accounts (Washington, D.C.: Center on Budget and Policy Priorities, revised 

January 30, 2006), available at www.cbpp.org/10-26-05health2.

pdf.

6. See Paul Fronstin and Sara R. Collins, Early Experience with HighDeductible and Consumer-Driven Health Plans: Findings from the 

EBRI/Commonwealth Fund “Consumerism in Health Care” Survey, 

EBRI Issue Brief No. 288 (Washington, D.C.: Employee Benefit 

Research Institute, December 2005), available at www.ebri.org/

pdf/briefspdf/EBRI_IB_12-2005.pdf.
CHAPTER SIX PRELIMINARY EVIDENCE FROM CONSUMER-DIRECTED HEALTH PLANS 75

two groups was comparable.7 The survey also reported 

that enrollees who had high-deductible policies were 

much more likely than enrollees in conventional plans to 

spend more than 5 percent of their income on out-ofpocket health care costs. Although that finding may raise 

concerns about the financial burden on enrollees in 

consumer-directed plans, it suggests as well that a number of those enrollees end up having relatively high health 

care spending—a finding that is not entirely consistent 

with the view that such enrollees are disproportionately 

healthy. (Because the study is based on an online survey, 

however, its results may not be representative of the nonelderly population.)

Finally, a recent survey by the Henry J. Kaiser Family 

Foundation provides a variety of comparisons between 

enrollees in consumer-directed health plans and people 

who have employer-sponsored health insurance.8

 The 

survey found that enrollees in consumer-directed 

plans were more likely than enrollees in conventional 

employer-sponsored plans to report being in excellent or 

very good health (64 percent versus 52 percent) and were 

less likely to report having a chronic health condition, 

such as diabetes (35 percent versus 23 percent). Although 

the analysis did not indicate whether those differences 

were statistically significant, it appears that they were. As 

with the data from the Blue Cross and Blue Shield Association, however, a limitation of those comparisons is that 

the enrollees in consumer-directed plans included people 

who had purchased their coverage in the individual insurance market, whereas all members of the comparison 

group had employer-sponsored coverage. Thus, it is not 

clear from the results of the survey whether consumerdirected plans are experiencing favorable selection within 

the employer-sponsored market.

Effect on the Uninsured Population

Another area of interest and debate regarding consumerdirected health plans has been the impact of their availability on the number of individuals who lack health 

insurance. The insurance industry study cited earlier estimated that 31 percent of the 855,000 people who were 

covered by individually purchased health plans that were 

HSA-compatible had previously been uninsured.9

 (That 

estimate was based on responses that represented about 

40 percent of those policyholders.) Because purchasers of 

HSAs in the individual insurance market constitute 

about one-third of all HSA policyholders, purchasers who 

were previously uninsured would account for about 

10 percent of all HSA enrollees. By comparison, recent 

estimates indicate that about 15 percent of the general 

U.S. population and 17 percent of the nonelderly population are uninsured at any given time. As another recent 

study noted, however, “a significant share of new purchasers of any type of health insurance on the individual market will be previously uninsured. Thus, those data do not 

reveal whether HSAs are more attractive to the uninsured 

than other types of coverage.”10

The studies that are available also provide conflicting 

evidence about how enrollment in consumer-directed 

health plans would affect insurance coverage rates in the 

employer-sponsored group market. 

B The census of insurers cited earlier found that 

33 percent of small employers who purchased HSAcompatible plans had not previously offered health 

care coverage to their workforce.11 7. According to the survey, the overall share of people who had con- However, the data 

ventional coverage and who were in excellent or very good health 

was 45 percent. Because the survey was limited to individuals who 

had private insurance—about 95 percent of which is employersponsored—nearly all enrollees in such conventional plans probably had employer-sponsored coverage. That finding thus suggests 

that their health status was comparable to the health status of 

enrollees in employer-based consumer-directed plans (42 percent 

of whom reported that their health status was excellent or very 

good). The 2006 survey reported similar results; see Paul Fronstin 

and Sara Collins, The 2nd Annual EBRI/Commonwealth Fund 

“Consumerism in Health Care” Survey 2006, EBRI Issue Brief 

No. 300 (Washington, D.C.: Employee Benefit Research Institute, December 2006).

8. Henry J. Kaiser Family Foundation, National Survey of Enrollees in 

Consumer-Directed Health Plans (Washington, D.C.: Henry J. 

Kaiser Family Foundation, November 2006).

9. AHIP Center for Policy and Research, January 2006 Census Shows 

3.2 Million People Covered by HSA Plans.

10. Michael F. Cannon, Health Savings Accounts: Do the Critics Have a 

Point? Policy Analysis No. 569 (Washington, D.C.: Cato Institute, 

May 30, 2006), p. 10, available at www.cato.org/pubs/pas/

pa569.pdf. The Blue Cross and Blue Shield Association study 

cited earlier reported that among purchasers of HSA-compatible 

plans, the percentage of people who had been previously uninsured was lower—about 12 percent—although in part that 

discrepancy might reflect the particular combination of individually purchased and employer-sponsored coverage in the association’s data. 

11. AHIP Center for Policy and Research, January 2006 Census Shows 

3.2 Million People Covered by HSA Plans.
76 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

do not indicate how many of those employers were 

also new firms, which (by definition) could not have 

offered coverage previously. And as with estimates of 

the number of HSA policyholders in the individual 

market who were previously uninsured, the net impact 

of those purchases on insurance coverage rates 

depends on what the small employers would have 

done if HSAs had not been available.

B Some analysts have argued that the availability of 

consumer-directed health plans in the individual market will lead some smaller employers to cease offering 

insurance coverage and that some employees (and 

their dependents) will end up uninsured as a result. 

The net effect could be to increase the total number of 

uninsured people.12

Overall, the net effect that the availability of consumerdirected health plans has had on the number of people 

who are uninsured remains unclear. 

Impact on Premiums and Health Care Costs

A limited amount of information has been released by 

insurers and consulting firms in the health care industry 

that compares the costs of plans with consumer-directed 

and conventional designs. (Those sources, it should be 

noted, may have a financial interest in the outcome of 

their analyses.) For example, Aetna released a study that 

examined the growth of spending for clients that had 

adopted HRA plans in January 2003.13 In the first year, 

employers that offered those plans as an additional option 

reportedly saw relatively small increases in medical costs 

(3.7 percent), whereas an employer that switched its coverage entirely to an HRA design saw spending fall by 

11 percent. According to the study, those figures compared favorably with double-digit increases in spending 

for a similar population of Aetna members. A more 

recent analysis found that clients who switched entirely to 

an HRA design experienced very slow growth in medical 

costs between 2002 and 2005—an increase of only 3 percent.14 For employers that added an HRA option, costs 

grew by about 21 percent over three years. Although that 

study did not contrast those figures with the growth rates 

for Aetna’s conventional plans, they are lower than the 

25 percent increase in private health care spending that 

was observed nationally over that period. Such comparisons prompt several caveats, however. 

B When comparisons of spending growth across health 

plans are adjusted to account for differences in the 

plans’ enrollees, as was the case in the first Aetna study, 

the results may be very sensitive to the precise methods used to make the adjustments. 

B Even if the populations of enrollees had been similar, 

some of the impact on spending might have come 

from changing the overall extent of coverage rather 

than simply changing its design; the studies do not 

indicate the relative values of the plans being compared or the size of any account contributions by the 

employers that sponsored the HRA plans.

Another issue that arises in comparing costs under 

consumer-directed and conventionally designed plans is 

whether the comparison is measuring total health care 

costs or only the costs covered by insurance. Comparisons 

of insured costs depend even more strongly than comparisons of overall costs on whether the value of the coverage 

differs between the two designs. Total spending would be 

affected only by the response of enrollees to the change in 

value, but insured costs would reflect both the change in 

value and the response of enrollees. The results of a survey of employers conducted by Mercer Human Resource 

Consulting help illustrate that point.15 The firm reported 

that in 2004, the costs for employers of providing coverage under consumer-directed plans were significantly 

lower, on average, than the costs for providing coverage 

under plans that featured a preferred provider organization. But the difference in insured costs was smaller when 12. See Jonathan Gruber, The Cost and Coverage Impact of the President’s Health Insurance Budget Proposals (Washington, D.C.: Center on Budget and Policy Priorities, February 15, 2006). That 

study reviewed proposals to change the laws governing HSAs but 

did not estimate how the original legislation that established 

HSAs affected insurance coverage rates. 

13. See Aetna, Inc., “Aetna HealthFund® First-Year Results Validate 

Positive Impact of Health Care Consumerism” (press release, 

Hartford, Conn., June 22, 2004), available at www.aetna.com/ 

news/2004/pr_20040622.htm. 

14. See Aetna, Inc., “Aetna Releases Broadest Study to Date of 

Consumer-Directed Plans” (press release, Hartford, Conn., 

October 2, 2006), available at http://www.aetna.com/news/

2006/pr_20061001.htm. 

15. Mercer Human Resource Consulting, “Consumer-Directed 

Health Plans Were Least Costly Plan in 2004” (press release, 

New York, February 10, 2005), available at www.mercerhr.com/

pressrelease/details.jhtml/dynamic/idContent/1170045. 
CHAPTER SIX PRELIMINARY EVIDENCE FROM CONSUMER-DIRECTED HEALTH PLANS 77

consumer-directed plans were compared with PPO plans 

that had a high deductible.16

Impact on the Use of Care

Another recent study of consumer-directed plans that has 

received some attention, conducted by the consulting 

firm McKinsey & Company, did not primarily examine 

effects on health care costs but instead focused on what 

might be called “intermediate,” or “process,” measures of 

the plans’ impact.17 To address concerns about favorable 

selection in consumer-directed plans when employees are 

given a choice among plan types—a tendency that would 

bias the results of the analysis—the researchers looked at 

firms that had switched their health insurance coverage 

entirely to a consumer-directed design (which is sometimes called a full-replacement approach) and compared 

them with firms that offered only conventional insurance. The study was based on data from a survey of 

employers and their employees; because of the very limited experience with HSAs at the time of the survey, it 

examined primarily HRA plans. 

The McKinsey team’s approach addresses one of the 

problems that can arise in comparing conventional and 

consumer-directed plans, but other issues remain. The 

firms that responded to their survey may not be representative of all firms that offer health insurance. A more 

important reservation about the study is that it did not 

take steps to account for potential differences between 

firms (and employees at firms) that switched entirely to 

consumer-directed plans and those that offered no 

consumer-directed option. Such cases of complete 

switching might involve groups of employees who were 

generally more health- or cost-conscious, or both, regardless of whether they had joined a consumer-directed 

health plan. Because the McKinsey survey lacked information about enrollees’ behavior before they joined a 

consumer-directed plan, it could use only those who 

remained in a conventional health care plan as a comparison group; researchers were not able to present beforeand-after comparisons for people who enrolled in 

consumer-directed plans. 

As a result of those limitations, it is difficult to determine 

whether some of the McKinsey team’s findings represent 

the impact of consumer-directed designs or reflect differences in the types of people who enrolled in such plans. 

For example, researchers found that the enrollees they 

studied “demonstrated strong value-conscious shopping 

behaviors” when choosing prescription drugs, even 

though enrollees received “carve-out” drug benefits comparable to those offered by conventional health plans—

that is, purchases of prescription drugs were administered 

separately and were not subject to the high deductible. 

The McKinsey team took that behavior as evidence that 

enrollees in consumer-directed plans “may develop a sustained shift in mind-set that increases their value consciousness in all health decisions” (p. 9), a shift that 

applied even to those services that saw no change in coverage. The possibility that enrollees experienced such a 

substantial change so quickly cannot be ruled out altogether, but a more plausible explanation is that enrollees in those consumer-directed plans were more cost- and 

value-conscious to begin with. Similarly, the McKinsey 

team reported that those enrollees were “25 percent more 

likely to engage in healthy behaviors” (p. 5), compared 

with enrollees in conventional plans. The large magnitude of that difference also suggests that underlying disparities between the two groups of enrollees—rather than 

the rapid modification of enrollees’ behavior in the 

consumer-directed plans—are a more likely explanation 

for that finding. 

16. Specifically, Mercer reported that, on average, “CDHP 

[consumer-directed health plan] coverage cost significantly less 

per employee than PPO coverage in 2004—$5,233 compared to 

$6,096, a difference of nearly 17 percent. However, CDHPs have 

deductibles of $1,000 or more. The average cost for a standard 

PPO with a deductible of $1,000 or more was even lower than the 

CDHP cost, at $4,801. That is to be expected, as the CDHP peremployee cost includes all employer contributions to the employees’ accounts.” The Mercer study also reported a median contribution by employers of $700 for individual enrollees and $1,200 for 

families under consumer-directed plans—suggesting that the average cost for consumer-directed plans would be about $4,300 after 

excluding those contributions. Given that nearly all consumerdirected plans use a PPO network, it is not clear why the difference in costs remains when comparing only high-deductible plans.

17. Vishal Agrawal and others, Consumer-Directed Health Plan 

Report—Early Evidence is Promising (Pittsburgh, Pa.: McKinsey & 

Company, June 2005), pp. 1–16, available at www.mckinsey.com/

clientservice/payorprovider/Health_Plan_Report.pdf. The 

researchers reported that “companies participating in our study 

found that the switch to CDHPs [consumer-directed health 

plans] lowered their total medical costs, even when the expenses 

now borne by employees were included in their calculations” 

(p. 9). As with the Aetna and Mercer studies, it is unclear whether 

the firms that offered consumer-directed plans maintained or 

reduced the actuarial value of their coverage in the process. Nor is 

the comparison for the cost calculation evident—that is, whether 

the comparison was done relative to the prior year’s costs, to a 

counterfactual projection of contemporary costs under the prior 

insurance arrangement, or to costs for firms that continued to 

offer only conventional coverage. 
78 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

Additional data on how consumer-directed health plans 

affect enrollees’ use of care is provided by the EBRI/

Commonwealth Fund study discussed earlier in this 

chapter.18 That study reported that enrollees in consumer-directed and other high-deductible health plans 

were “more likely to avoid, skip, or delay health care 

because of costs” than were enrollees in conventional 

health insurance plans and that those differences were 

“particularly pronounced among those with health problems or incomes under $50,000” (p. 1). It is not surprising that enrollees in high-deductible plans reduced their 

use of services; as with the similar findings of the RAND 

study, however, a key question is whether the health care 

services that were not used had benefits that would have 

exceeded their costs. The study did not measure the 

extent of the reduction and could not estimate how those 

differences in the use of services affected enrollees’ health. 

Thus, it is hard to tell whether the findings buttress the 

concerns of critics of consumer-directed plans that enrollees will skimp on effective care or whether they instead 

support the arguments of advocates that enrollees in 

consumer-directed plans will reduce their use of marginally valuable treatments. 

Studies Published in Academic 

Journals

Other studies of consumer-directed health plans have 

appeared in recent years in academic journals. One study 

examined patterns of enrollment in insurance plans at a 

firm that began offering two consumer-directed plans; 

the firm happened to be the health insurance company 

Humana (that is, the data it published were for its own 

employees).19 Those plans had fairly standard designs: 

a contribution of $500 to the savings account by the 

employer and a deductible of either $1,500 or $2,500. 

The plan that had a deductible of $1,500 required coinsurance of 20 percent beyond that point, up to an outof-pocket limit of $2,000; the plan that had a deductible 

of $2,500 covered all costs above that amount.20 The 

consumer-directed plans had one notable feature that 

differentiated them from a standard HRA, however: the 

funds in the account could not be rolled over and were 

forfeited if they went unused. Thus, it might be more 

accurate to describe the plans as providing full coverage 

for the first $500 worth of spending, followed by a 

“doughnut hole,” in which enrollees paid all costs 

between $500 and their deductible. Because the study’s 

authors did not try to measure the change in spending for 

enrollees once they had joined the consumer-directed 

plans, the lack of a rollover feature could have affected 

their reported findings only by influencing who signed 

up for the plans. 

The authors focused on the effects of selection; thus, they 

primarily sought to compare the characteristics of enrollees in the various types of plans, characteristics that were 

observed in the year before the consumer-directed plans 

were made available. Researchers had access to both 

demographic data (including enrollees’ salaries, as a proxy 

for their total income) and claims records for the period 

before and after the consumer-directed plans were added 

to the firm’s insurance options. As noted in the study, “a 

number of CDHP [consumer-directed health plan] sponsors have used demographic data to suggest that these 

plans have not disproportionally attracted low-risk [that 

is, lower-cost] members” (p. 1177). By comparing the 

results they got based on demographic characteristics 

alone with their findings about prior spending levels, the 

authors could test whether such inferences were valid.

Their findings indicate that comparing enrollees on the 

basis of their demographic characteristics alone may 

present a misleading picture. When the researchers 

looked only at the demographic data, they saw little 

apparent difference between those who enrolled in the 

consumer-directed plans and those who did not. But 

when they compared data on prior claims and prior use 

of services, they found that people who later chose to 

18. Fronstin and Collins, Early Experience with High-Deductible and 

Consumer-Driven Health Plans. The November 2006 survey by 

the Henry J. Kaiser Family Foundation that was cited earlier in 

this chapter reported several similar results, as did the December 

2006 survey (The 2nd Annual EBRI/Commonwealth Fund “Consumerism in Health Care” Survey 2006) that Fronstin and Collins 

analyzed.

19. See Laura A. Tollen, Murray N. Ross, and Stephen Poor, “Risk 

Segmentation Related to the Offering of a Consumer-Directed 

Health Plan: A Case Study of Humana Inc.,” Health Services 

Research, vol. 39, no. 4 (part II, August 2004), pp. 1167–1187.

20. The deductibles and out-of-pocket limits for family coverage were 

larger. The consumer-directed plans also had provider networks, 

and enrollees faced different deductibles, cost-sharing requirements, and out-of-pocket limits for out-of-network care. Coverage 

for prescription drugs and mental health benefits was “carved 

out.” It was not clear from the study whether the out-of-pocket 

limit in the first plan included spending covered by the account 

contribution.
CHAPTER SIX PRELIMINARY EVIDENCE FROM CONSUMER-DIRECTED HEALTH PLANS 79

enroll in the consumer-directed plans “were healthier 

than those electing to remain in more traditional coverage 

. . . with prior total claims less than 50 percent of [the] 

average” (p. 1167). Examining hospital and maternity 

admissions, they found that the use of those services by 

enrollees who subsequently joined a consumer-directed 

plan was less than 30 percent of the overall average. Even 

when they focused on the enrollees who were admitted to 

the hospital and compared the average length of stay 

(which served as a crude measure of each admission’s 

complexity) under each plan design, the researchers 

found that enrollees in the consumer-directed plans had 

substantially shorter hospital stays.

Taken together, those findings suggest that highdeductible plans coupled with some sort of contribution 

by employers toward up-front costs may generate substantial favorable selection. Because those results are comparisons of health care spending and the use of services 

before the consumer-directed plans were introduced, they 

reflect the health and preferences of enrollees in each 

plan—not the response of the enrollees in the consumerdirected plans to the new incentives they faced once they 

joined those plans. Yet some caution is warranted in 

interpreting those results because the study’s data 

included only about 500 enrollees in the consumerdirected plans who accounted for about 6 percent of the 

pool of employees (and dependents) that was analyzed. 

More recently, Humana has released its own analysis of 

the impact on spending of adding those new consumerdirected designs to its package of health plan options.21

In the first year that the new options were introduced 

(affecting about one-third of employees), the firm experienced substantially lower growth in health care costs: 

4.9 percent growth, compared with an “expected claims 

trend of 19.2 percent” (p. 4). About two-thirds of the 

resulting savings were attributed to reductions in the use 

of services, particularly for inpatient care. (The remainder 

was due to reductions in benefits and in the overall share 

of employees who enrolled.) Humana also reported savings for its other clients—compared with marketwide 

trends in the growth of health care spending—from 

adopting the new package of health plans.

The study’s methodology raises several issues. Among its 

own employees, Humana found that the healthier members were the first ones to enroll in the consumer-directed 

plans. The study thus noted that “if the results of only the 

consumer-driven plan are compared to the results of the 

entire group before introduction of the consumer-driven 

plan, the analysis will be flawed because a healthier group 

of employees [is] being compared with average employees” (p. 4). To keep the effects of such favorable selection 

from skewing the results, the firm presented the cost 

trends for enrollees in all of its health care plans combined—whether they chose the consumer-directed 

options or more conventional HMO and PPO plans that 

were offered at the same time. Although that approach 

addresses the problems that stem from favorable and 

adverse selection, it complicates efforts to estimate the 

specific effect that the new consumer-directed options 

had on health care spending. As noted above, the study 

by Laura Tollen, Murray Ross, and Stephen Poor found 

that only 6 percent of enrollees chose the consumerdirected designs.22 Humana also reported that a subsequent expansion of the program to its remaining employees achieved similar savings, even though the share of 

those employees who chose the consumer-directed 

designs was 20 percent. 

It seems unlikely that the simple addition of consumerdirected options would have had such a large effect on all 

health care spending by the firm’s employees—including 

spending under the conventional plans—so other explanations need to be considered. Some of the reported 

effect on the growth of costs may simply reflect the statistical phenomenon known as regression to the mean. That 

is, if firms that are experiencing the most rapid cost 

growth are also the first ones to adopt those new insurance options, then some of the reduction in spending 

that is observed in the next year would probably have 

happened even if the new options had not been adopted

—simply because some of the factors that were causing 

above-average growth in health care costs for those firms 

were likely to have been temporary. The study by Tollen, 

Ross, and Poor also indicates that cost sharing increased 

in the HMO and PPO plans that most enrollees chose; 

21. Humana Inc., Health Care Consumers: Active or Passive? (Louisville, Ky.: Humana Inc., June 2005), pp. 1–14, available at http://

apps.humana.com/marketing/documents.asp?file=519272. Note 

that this study was not published in an academic journal and so 

was not subject to the peer review process. The first year of operation for the new package of plans ran from July 1, 2001, to 

June 30, 2002. 

22. Tollen, Ross, and Poor, “Risk Segmentation Related to the Offering of a Consumer-Directed Health Plan.” 
80 CONSUMER-DIRECTED HEALTH PLANS: POTENTIAL EFFECTS ON HEALTH CARE SPENDING AND OUTCOMES

the responses of enrollees to those changes might have 

accounted for an important share of the total savings.

A final set of academic studies comes from Stephen 

Parente, Roger Feldman, and Jon Christianson, who published two papers on consumer-directed plans in 2004, 

each of which examined the experiences of a specific 

employer that added an HRA option. One study looked 

only at who chose a consumer-directed plan when given a 

choice between it, a health maintenance organization, a 

PPO, and one other insurance product.23 The authors 

found, on the basis of a survey of employees, that the 

“CDHP was not chosen disproportionately by the young 

and healthy, but [that] it did attract the wealthy and those 

who found the availability of providers more appealing” 

(p. 1091). The researchers also asked employees about 

their interest in using online tools to help manage their 

own health care and found that it was not a significant 

factor in the choice of the consumer-directed plan. But as 

the authors themselves noted, the small number of 

respondents to their survey and the possibility that those 

respondents were not representative of all employees both 

raise questions about whether their results would apply 

more broadly to other enrollees in consumer-directed 

plans. 

The second study by Parente, Feldman, and Christianson 

looked at the actual health care claims of employees at 

another firm that had offered an HMO and a PPO in 

2000 and then added the option of a consumer-directed 

plan for 2001 and 2002.24 Examining who enrolled in 

each type of plan, they found that the “two largest differences between the CDHP population and other cohorts 

at baseline were income and case-mix” (p. 1198). In other 

words, high-income employees were more likely to enroll 

in the consumer-directed plan, low-income employees 

disproportionately avoided enrollment in it, and enrollees 

in the consumer-directed plan reported fewer health 

problems in the year before they joined the plan than 

other employees did. Turning to health care costs, the 

authors found that by 2002, enrollees in consumerdirected plans had “higher expenditures than the HMO 

cohort” in that year and incurred “lower total expenditures than PPO enrollees, but higher utilization of 

resource-intensive hospital admissions” (p. 1189). 

A closer examination of the authors’ data provides a 

mixed picture of the consumer-directed plan’s impact on 

health care costs. For reasons that remain unclear, all 

three plans experienced very rapid growth of costs from 

2000 to 2001 (increases of about one-fifth in the study’s 

raw data and about one-third in its adjusted figures). 

Subsequently, the PPO plan and, in particular, the 

consumer-directed plan that they studied both experienced an extremely fast rise in costs between 2001 and 

2002 (costs for the consumer-directed plan grew by onehalf as measured in the raw data and by one-third as measured in the adjusted amounts).25 Hospital expenditures 

for enrollees in the consumer-directed plan were lower in 

2000—the year prior to enrollment, consistent with there 

being some favorable selection in that plan—and comparable with those in the other plans in 2001; however, in 

2002, hospital expenditures in the consumer-directed 

plan ended up dramatically higher. 

Those somewhat curious results indicate that either 

spending by enrollees in consumer-directed plans experienced regression to the mean relatively quickly or their 

enrollment in the consumer-directed plan induced them 

to use more health care—or some combination of the 

two phenomena occurred. The authors’ own analysis 

indicated that regression to the mean might explain some 

of the increase in costs for consumer-directed plan enrollees between 2000 and 2001 but did not contribute to the 

change between 2001 and 2002. Another noteworthy 

finding was that the costs covered by the insurer were 

actually greatest for the consumer-directed plan in 2002 

but that those enrollees had been less costly to the 

employer than the other two groups in 2000 and 2001. 

(Out-of-pocket costs for enrollees also varied among the 

three plans but by smaller dollar amounts.) As indicated 

earlier, however, it may be unwise to draw overly firm 

conclusions about the effects of those plan designs—

whether favorable or adverse—until a much more robust 

set of studies is available for review. 

23. Stephen T. Parente, Roger Feldman, and Jon B. Christianson, 

“Employee Choice of Consumer-Driven Health Insurance in a 

Multiplan, Multiproduct Setting,” Health Services Research, 

vol. 39, no. 4 (part II, August 2004), pp. 1091–1111. 

24. Stephen T. Parente, Roger Feldman, and Jon B. Christianson, 

“Evaluation of the Effect of a Consumer-Driven Health Plan on 

Medical Care Expenditures and Utilization,” Health Services 

Research, vol. 39, no. 4 (part II, August 2004), pp. 1189–1209.

25. Ibid., Table 3, p. 1200. The authors adjusted the raw data to 

control for confounding factors by using “annual trends, health 

plan choice, health plan choice interacted with annual trends, age, 

gender, case mix, income, number of covered lives in contract, 

[and] use of a healthcare flexible spending account.” Overall, for 

the two-year period, raw costs increased by 97 percent for the 

consumer-directed plan, 73 percent for the PPO, and 19 percent 

for the HMO; adjusted costs increased by 85 percent, 60 percent, 

and 36 percent, respectively.