United States General Accounting Office

GAO Report to the Chairman, Committee on

Labor and Human Resources, U.S.

Senate

May 1997 HEALTH INSURANCE

Management Strategies

Used by Large

Employers to Control

Costs

GAO/HEHS-97-71

GAO United States

General Accounting Office

Washington, D.C. 20548

Health, Education, and

Human Services Division

B-271083 

May 6, 1997

The Honorable James M. Jeffords

Chairman, Committee on Labor and

 Human Resources

United States Senate

Dear Mr. Chairman:

At your request, this report examines the strategies of large, innovative purchasers who have

attempted to stem the rapid escalation in health insurance costs while maintaining or enhancing

the quality of care for their employees. A better understanding of the strategies and tools

adopted by such purchasers should assist the Congress in reforming public health insurance

programs and in identifying potential areas for coordinated approaches by government and

private sector purchasers.

As agreed with your office, unless you publicly announce its contents earlier, we plan no further

distribution of this report until 30 days after its issue date. At that time, we will make copies

available to interested parties on request.

If you or your staff have any questions, please call me at (202) 512-7114. Major contributors to

this report are listed in appendix V.

Sincerely yours,

William J. Scanlon

Director, Health Financing and

 Systems Issues
Executive Summary

Purpose After several years of double-digit increases in the cost of employee health

insurance, the nation’s larger firms, employer coalitions, and even state

governments entered the 1990s with an aggressive approach to rein in

employee health insurance costs. The recent downturn in health insurance

premium growth—in which some large employers actually experienced

premium declines—is attributable, at least in part, to some of these efforts.

Spending pressures in public programs like Medicare and Medicaid also

slowed, though not as markedly as for most private purchasers.

A better understanding of the strategies and tools adopted by large,

innovative purchasers should assist the Congress in reforming public

health insurance programs and in identifying potential areas for

coordinated approaches by government and the private sector. For this

reason, the Chairman of the Senate Committee on Labor and Human

Resources asked GAO to examine the strategies of large purchasers that

have attempted to (1) stem the rapid escalation in health insurance costs

and, at the same time, (2) maintain or enhance the quality of care for their

employees. The sample included 25 private firms, purchasing coalitions,

and state governments. (App. I contains details about the sample.)

Background Employers have an important stake in the cost, structure, and quality of

their employee health benefit programs. Private business expenditures for

health services—dominated by health insurance premiums for

workers—now account for more than 5 percent of total employee

compensation compared with about 2 percent in 1970. Clearly, the

incentive for constraining the growth in health care costs has intensified

over the past few decades. Moreover, employers recognize the pivotal role

that health benefits play in attracting and retaining employees and in

maintaining productivity. More recently, this mixture of cost and

workforce concerns led employers to advocate health care delivery

systems with better-integrated care and to play a more active role in

managing their health benefit programs.

Results in Brief Several dominant themes emerged from GAO’s examination of the health

benefit purchasing strategies of 25 large purchasers: (1) an emphasis on

the delivery of services by better-integrated managed care plans; (2) a

focus on measuring and improving the quality of the services provided;

(3) a transition to the sharing of costs, responsibility, and information with

employees; and (4) a greater reliance on competitive market principles.

Large purchasers use their size and/or reputations—which gives them

Page 2 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Executive Summary

flexibility—to fashion health care purchasing strategies responsive to their

own needs. Some choose to adopt strategies that respond to specific

differences in the structure of health plans or employee characteristics at

their various locations across the country. Others choose a more uniform

approach at all or most of their key locations. Flexibility with regard to

timing permits some large purchasers to choose between a radical but

quick transformation or the adoption of a more gradual transition.

Strategies are also fashioned to respond to constraints such as unions or

contract rules and strengths like a younger, healthier workforce or market

presence in terms of a large number of employees at a particular location.

The size of a workforce in a specific market can translate into market

leverage. Large purchasers do not hesitate to use their market power to

make demands of potential health insurers or to influence provider

behavior. Among the requirements that a large purchaser can establish are

that health plans justify and substantiate premiums, submit performance

and quality data, and offer broad provider networks. While market

leverage is not necessarily viewed as the most important or only

dimension of a health care purchasing strategy by large purchasers, they

recognize that their size makes a broader range of specific tools available

in formulating their overall strategy.

The specific tools used by large purchasers in implementing their

strategies vary considerably but fall within three broad categories:

(1) health plan evaluation criteria, including techniques to assess

premiums and foster competition among plans; (2) incentives to sway

employee behavior; and (3) overt marketing strategies to influence

employees’ choice of delivery systems and of specific plans. By no means

is there unanimity on the use of evaluation criteria. Many large purchasers

GAO interviewed recognize the shortcomings of the cost, quality, and

access criteria that have been developed so far. Despite their

shortcomings, these criteria are of growing importance: first, they provide

purchasers with data that can be used to persuade often skeptical

employees about the quality of the health plans offered; second, the

criteria require competing health plans to demonstrate to equally skeptical

purchasers that managed care is indeed a cost-effective choice.

Most purchasers are convinced that providing an incentive for employees

to be cost-conscious in their selection of plans and use of health care is a

key component of an effective purchasing strategy. They also recognize

that lower copayments and deductibles coupled with a richer set of

benefits are probably insufficient incentives in terms of achieving

Page 3 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Executive Summary

significant increases in the number of employees who choose a managed

care option. Directly tying the employee’s share of the premium to the cost

of a health plan can become a much more powerful incentive for employee

choice and insurer behavior when the differences are large enough to

affect market share. For the purchasers in GAO’s sample, however,

introducing effective and reasonable financial incentives was perhaps the

most difficult aspect of implementing a proactive purchasing strategy.

Factors that limited purchasers’ flexibility in this regard included unions

or the corporate culture’s perspective on employee cost-sharing.

Principal Findings

Purchaser Flexibility Is

Key to Evolution of

Effective Health Care

Purchasing Strategies

Large employers have made dramatic changes in the way they purchase

health insurance. These changes, as well as the variations in the

approaches taken, are a testament to the flexibility of the private sector—a

characteristic that state governments appear to share. Some large

employers have ceased to offer a fee-for-service indemnity product or have

significantly increased the share of premium for employees who insist on

greater freedom in choosing their own doctor, the hallmark of such a

health plan. Others have substituted point-of-service (POS) plans that

resemble a health maintenance organization (HMO), but also allow access

to other providers outside of the HMO network. POS plans are seen by some

purchasers as a way to transition employees from the substantially free

choice of indemnity coverage to the more restrictive world of HMOs. Most

employers have become selective about the HMOs they offer and are

focusing greater attention on persuading employees that such health plans

are a smart choice. Often employers’ decisions about the type and mix of

options are influenced by the differences in the markets where they

purchase coverage or in the characteristics of their workforces. An

employer’s freedom to change the number and mix of health plans,

however, is not without constraint. For example, unions and corporate

culture can undermine the consistency among the elements of a firm’s

purchasing strategy.

Market Leverage Is a

Useful, Though Not

Essential, Component of

Market Strategies

Size can translate into influence and leverage in the marketplace.

However, the market power of large private sector employers is often

exaggerated. While a purchaser may be able to exert leverage over health

plans in a few local markets because of a relative concentration of

Page 4 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Executive Summary

workers, the number of employees and covered lives often masks the

geographic fragmentation of the workforce. For example, one firm GAO

interviewed has approximately 250,000 employees eligible for benefits

who are distributed across 19,000 zip codes. The largest number of

employees in any one location is only about 5,000. Such fragmentation was

sometimes accentuated by allowing different divisions of a corporation to

purchase HMO coverage separately. To enhance their leverage, some firms

have formed purchasing coalitions, reduced the number of plans offered,

consolidated HMO purchasing at a central office, and relied on their

national reputations to attract health plans. In markets with little managed

care penetration and a relatively small number of employees, some firms

choose not to devote resources to developing an effective purchasing

strategy. The number of employees simply does not justify the effort and

cost involved. States as purchasers of health care, on the other hand, have

substantial buying power. For several years, the California Public

Employees’ Retirement System has used the market power of the state and

local governments’ almost 1 million covered lives to demand HMO rate

reductions.

Purchasing Criteria Used

to Justify and Limit

Number of HMO Options

In the past, many large employers offered a choice between a standard

company indemnity product and a variety of HMOs. Some firms told GAO

that HMOs were selected without any specific criteria or coordination on a

company-wide basis. Nor were HMOs held accountable for actually

managing care, the presumptive benefit of such a delivery system.

Moreover, since employers were not advocating HMOs, choice and quality

were not major issues with their employees in selecting participating

plans. Today, many large firms have established criteria to help them

decide with which HMOs to contract. Generally, the effect of these criteria

is to limit the number of HMOs offered. For example, some firms require

that an HMO seek accreditation from the National Committee for Quality

Assurance and be able to report data on customer satisfaction and service

delivery. However, employers suggested that measures of quality are

imperfect at best and require some subjective judgment. Most have

pointed out the need to develop a consistent set of outcome-oriented

measures.

For many firms, a key criterion in selecting HMOs is cost. While the debate

continues over the degree to which large employers’ contracting decisions

are or should be influenced by cost, there is general agreement that

enhancing competition is key in a health care system that looks

increasingly to managed care to help moderate premium growth. In the

Page 5 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Executive Summary

past, rather than obtaining HMO premiums through marketplace

competition, large firms were frequently price takers—that is, they often

paid the “sticker price” rather than shopping for a lower or the best price.

HMOs practiced shadow pricing, that is, they simply tracked the costs of

alternative plans and set the rates slightly lower to retain a competitive

edge. Though often less expensive than indemnity coverage, HMOs had

little incentive to keep prices down.

Today, most firms use a variety of techniques to obtain the best price

possible from HMOs. Plans are asked to submit sealed premium bids with

the understanding that not all bids will be accepted and that justification

of and negotiation over increases is to be expected. Health plan bids are

carefully scrutinized and analyzed, sometimes with the assistance of

outside consultants. Employers recognize, however, that it is difficult to

determine the true cost incurred by managed care plans because of

inadequacies in the data currently available from such plans. During

negotiations, plans are often informed of their standing relative to

competing plans and of the impact of a proposed premium increase on the

employee contribution. While purchasers stress that giving employees an

incentive to be cost-conscious in selecting a health plan fosters a

competitive framework, they do not believe that the resulting competition

reduces the importance of or eliminates the need to negotiate.

Access objectives, a final criterion used by many purchasers to select

HMOs, may actually work at cross-purposes with the goal of selecting the

most cost-efficient or highest-quality plans. Employers recognize that very

broad networks affording the greatest choice of physicians are generally

not the most efficient and may lack the management features that are the

purported hallmark of a managed care delivery system. Because of the

limited availability of managed care in some markets, particularly rural

areas where a managed care option may not even exist, some employers

continue to offer indemnity-type products.

Financial Incentives and

Information Used to

Advocate HMO Enrollment

Purchasers also phased in or incorporated financial incentives to

encourage employees to transition from high- to lower-cost products.

Relatively few of the purchasers in GAO’s sample have tied their

contribution to a low-cost HMO, requiring the employee to pay the

difference for a higher-cost alternative. Most employers fall somewhere in

between the adoption of a low-cost formula and one that provides no

incentive to be cost-conscious. Whatever the formula, however,

purchasers generally now ask employees to contribute more to the cost of

Page 6 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Executive Summary

coverage, particularly for those who choose an indemnity option. On the

other hand, a few firms use incentives to encourage employees to enroll in

the indemnity plan if demographics suggested a lower use of health care

services. Such firms contend that HMOs can be more expensive for healthy

workers because under capitation, services must be paid for even if they

are never used.

Because union agreements or corporate culture may impede the use of

such financial incentives and because of what purchasers referred to as a

constant stream of negative publicity ranging from gag rules to maternity

stays, information on the advantages of managed care has assumed even

more importance in influencing employee health benefit decisions. Firms

have become advocates for managed care by stressing the differences

between indemnity and managed care products—no claim forms, better

preventive care services, increased continuity and coordination of care,

and lower out-of-pocket costs. Before implementing its current managed

care strategy, one firm only provided the names and phone numbers of

available HMOs. Now this firm provides considerable information to

employees on HMOs and, in fact, emphasizes HMOs in its open enrollment

literature. During open enrollment, some purchasers now routinely

provide comparative information on the managed care plans they offer,

including (1) basic information on the network such as size, participating

hospitals, and percentage of physicians accepting new patients; (2) the

results of customer satisfaction surveys; and (3) data on the delivery of

preventive services such as immunization or mammography screening

rates. As reflected by the prominence of such data in the information

provided to employees, access is the single most important issue for

employees.

Recommendations GAO is making no recommendations in this report.

Comments From

Purchasers

The purchasers in our sample commented on a draft of this report. They

generally agreed with our presentation of the information and our

observations. They also provided technical suggestions, which we

incorporated where appropriate.

Page 7 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Contents

Executive Summary 2

Chapter 1 

Introduction

10

What Is an “Active” Purchasing Strategy? 10

Active Purchasing Shaped by Employee Perspective 11

Managed Care Comes in Many Varieties 12

Transition From Payers to Purchasers 16

Objectives, Scope, and Methodology 17

Chapter 2 

Flexibility and

Leverage: Attributes

of Large Private and

Public Purchasers

20

Flexibility: The Foundation of an Active Purchasing Strategy 20

Importance of Market Leverage Often Overstated 29

Chapter 3 

Purchasers Use

Evaluation Criteria to

Pursue Price, Quality,

and Access Goals

33

Tension Between Need for and Adequacy of Evaluation Tools 33

Price: Tools Used to Evaluate Premiums and Enhance

Competition

34

Quality: Some Employers Hesitant About Using Quality Criteria 48

Access: Employers Accommodate Employee Concerns About

Choice

52

Application of Criteria Varies 54

Chapter 4 

Plan Options,

Incentives, and

Marketing Used to

Sway Employee

Behavior

57

Evolution in Employee Benefit Options 58

Developing Financial Incentives Poses Challenges for Purchasers 61

Firms Try Marketing to Overcome Resistance to Managed Care 70

Chapter 5 

Observations

74

Advocacy of Managed Care 74

Competitive Market Principles 74

Influencing Employee Behavior 76

Common Elements, Yet Diversity of Approaches 76

Page 8 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Contents

Appendixes Appendix I: Characteristics of Purchasers in GAO Sample 78

Appendix II: Background on HEDIS and NCQA Accreditation 80

Appendix III: Summary of Southern California Edison

Performance Measures

82

Appendix IV: Changes in HMO Enrollment, Plan Options, and

Financial Incentives

83

Major Contributors to

This Report

86

Tables Table 1.1: Employer-Employee Perspectives on Managed Care 12

Table 4.1: HMO Enrollment for Purchasers in GAO Sample Before

and After Changing Purchasing Strategy

57

Table 4.2: Health Care Options Available 59

Table 4.3: Hypothetical Firm-Employee Contribution Options 62

Table 4.4: Financial Incentives Adopted by Purchasers 63

Table I.1: Characteristics of Private Firms 78

Table I.2: Characteristics of Private Purchasing Coalitions 79

Table I.3: Characteristics of State Government Programs 79

Table II.1: Status of NCQA Accreditation Reviews as of

December 1996

81

Figures Figure 1.1: Change in Employer-Sponsored Managed Care

Enrollment From 1987 to 1996

13

Figure 1.2: Spectrum of Health Care Plans 14

Abbreviations

BHCAG Buyers’ Health Care Action Group

CalPERS California Public Employees’ Retirement System

HEDIS Health Plan Employer Data and Information Set

HIPC Health Insurance Plan of California

HMO health maintenance organization

IPA independent practice association

NCQA National Committee for Quality Assurance

OSC organized system of care

PBGH Pacific Business Group on Health

PCP primary care physician

POS point-of-service

PPO preferred provider organization

RFP request for proposal

Page 9 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

Large private sector purchasers we interviewed suggest that the

double-digit increases in the cost of health insurance common just a few

years ago have been controlled considerably in the last 2 years—a

development they attribute, at least in part, to their more active

management of employee health benefit costs. Virtually every study of

health care cost trends since 1990 corroborates the dramatic slowdown in

health care inflation. For example, surveys of private employers reported

1995 increases of 2.1 percent and 1996 increases ranging from 2.5 percent

to only .5 percent.1

 According to a Peat Marwick survey, health

maintenance organization (HMO) premiums experienced the least

fluctuation, growing by only four-tenths of a percent in 1995 and followed

by a decrease of the same magnitude the next year. It was the second

straight year, the survey reported, that the rate of increase in premiums

was less than the growth in three key indicators: (1) overall inflation,

(2) inflation in the heath care sector, and (3) growth in workers’ earnings.2

Moreover, some large purchasers have reported HMO premium decreases

for several years. While Medicare and Medicaid have also experienced a

slowing of cost growth, these public programs have not been as successful

as the private sector in subduing program cost growth. What remains

uncertain is whether this tempering of the rate of health care inflation is a

short-lived aberration or is due, at least in part, to tangible changes in the

way private and some state purchasers shop for and offer health benefits

to employees.

In order to understand how changes in health benefit purchasing

strategies have contributed to cost control, we examined the experience of

a group of 25 large health insurance purchasers—private firms, purchasing

coalitions, and state governments. Many of these entities have opted for an

approach to purchasing that demands more analysis on the part of the

buyer. They have developed and applied criteria in a competitive

environment to assist them in the selection of health plans. Finally, they

have restructured their benefit programs to encourage employees to

choose less expensive or more efficient health care options.

What Is an “Active”

Purchasing Strategy?

The approach adopted by some large employers can be characterized as

an “active” purchasing strategy. It is a systematic way of identifying and

offering a mix of health care options that meet a purchaser’s expectations

1

Foster Higgins and KPMG Peat Marwick conduct annual surveys of employer-sponsored health

benefits. The former includes both large and small employers from the private and public sectors

(more than 10 employees), while the latter focuses on firms with 200 or more workers.

2

Inflation is measured by the Consumer Price Index.

Page 10 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

in terms of access, quality, and price. Large purchasers use different terms

to describe what is essentially a similar approach. For some, the concept

of a “purchasing strategy” is synonymous with “managed care”—a delivery

system that some believe has the potential to be more efficient than

traditional, noncoordinated indemnity coverage. Others describe their

strategies as “managed competition,”3

 a blending of the competitive and

regulatory approaches that have coexisted for many years in the U.S.

health care system. Traditional economic theory suggests that market

forces are capable of promoting efficiency and responsiveness. To

advocates of this strategy, however, managed competition connotes a

needed rationalization of the health care marketplace intended to

encourage cost-consciousness on the part of both health plans and

employees. Finally, some describe their purchasing strategy as

“competitive” or “market-oriented,” that is, harnessing choice among plans

vying for market share to promote greater efficiency in the delivery of

health care. Whatever the terminology, these purchasing strategies have

one point in common—active intervention on the part of buyers to

encourage the development and acceptance of more cost-effective health

care delivery systems. Two natural attributes of the large purchasers in

our sample assisted their transition to active purchasing: (1) the flexibility

to adapt their benefit programs to individual markets and other

circumstances and (2) the ability to harness the market leverage conveyed

by their size.

Active Purchasing

Shaped by Employee

Perspective

An integral component of an active purchasing strategy is responsiveness

to employee concerns about managed care. Benefit managers we

interviewed believe that this delivery system offers the best value for the

benefit dollar. They also recognize that workers are generally skeptical

about managed care and about the motivation for adopting a benefit

management strategy that professes the compatibility between efficiency,

3

The economist Alain Enthoven proposed “managed competition” as a way of addressing recognized

flaws in the health insurance market, a market in which purchasers lack the data necessary to make

informed decisions and in which health plans have an incentive to avoid enrolling sicker and more

costly individuals. His concept advocates the establishment of sponsors, sometimes referred to as

health insurance cooperatives or purchasing coalitions, to act as buying agents for participating firms

and individuals in each market area. Just as most large employers do today, the cooperative would

enforce the participation rules for both enrollees and health plans. The rules would include guaranteed

access, risk-adjustment of premiums, community rating, and standardized benefits/coinsurance.

Enrollees would be offered a variety of health plans that compete not only on price but also in terms of

quality. Thus, the cooperative would be responsible for distributing standardized quality and outcomes

data on participating plans. Enrollees could choose any plan during an annual open season, but to

encourage price sensitivity, an employer’s contribution toward premiums would be limited to the cost

of the lowest-price health plan. Enthoven and others have refined and rearticulated the concept since

it was first introduced in the late 1980s. Without embracing Enthoven’s entire construct, some large

purchasers have adopted important elements of his managed competition theory.

Page 11 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

as reflected in lower premiums, and quality. Employees, we were told, are

usually aware of the cost issues underlying employer decisions about

health benefits. Moreover, purchasers cited the constant barrage of

negative publicity as a reinforcer of employee anxiety about managed

care—publicity that one benefit manager described as focusing on single

anecdotes to characterize the total picture. The negative publicity often

suggests that managed care

• promotes efficiency by denying needed services and

• impinges on the doctor-patient relationship.

Table 1.1 characterizes the different viewpoints that sample employers and

their employees bring to the issue of managed care.

Table 1.1: Employer-Employee

Perspectives on Managed Care Employer perspective Employee perspective

Choice Choice means choice of a plan or

a delivery system.

Choice means “I can continue to

see my current doctor.”

Quality A delivery system that actually

manages care is more likely to

result in an efficient and

high-quality product.

Quality resides in ability of

employee to shop freely for the

“best” provider; restrictions

inherent in managed care are a

threat to quality.

Price Most cost-effective delivery system

may be one that limits choice; low

cost may reflect greater efficiency

rather than poor quality.

Managed care sometimes saves

money by rationing services;

employees are skeptical that lower

cost equates to higher quality.

These differing perspectives have helped shape the benefit management

strategies adopted by the employers in our sample. Though they remain

convinced that managed care has the potential to deliver higher quality at

a lower price, purchasers understand the employee retention value of

competitive health benefits. They recognize the need to implement

changes in ways that maintain good employee relations, protect their

ability to recruit workers, and enhance productivity. The attempt by

purchasers to respond to concerns about limited choice and poor quality

are evident in (1) the articulation of criteria designed to help evaluate

health plans, (2) the mix of plans actually offered to employees, and

(3) the marketing strategies used to address negative employee

perceptions about managed care.

Managed Care Comes

in Many Varieties

Because of the different types of managed care plans available to

employers, managed care is perhaps most clearly defined by its opposite,

Page 12 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

traditional indemnity coverage. In contrast with managed care, traditional

indemnity coverage allows a free choice of providers and reimburses

physicians and hospitals with limited or no review of the appropriateness

of the services rendered.4

 On the basis of a 1996 survey of health benefits

offered by firms with 200 or more workers, only 3 percent of employees

are enrolled in such a traditional indemnity program. Another 23 percent

are in managed indemnity plans that require precertification for inpatient

services and other forms of utilization controls. And the remaining

three-quarters are enrolled in a variety of managed care plans, including

(1) several different types of HMOs, (2) preferred provider organizations

(PPO), and (3) point-of-service (POS) plans.5

 The rise in managed care

enrollment has been swift. Figure 1.1 shows that since the late 1980s,

managed care enrollment has nearly tripled.6

Figure 1.1: Change in

Employer-Sponsored Managed Care

Enrollment From 1987 to 1996

27%

32%

41%

74%

3%

23%

Managed Care

Managed Indemnity

Traditional Indemnity

1987 1996

Despite the variety of managed care plans, most include one or more of

the following common cost-control features: (1) physician and hospital

networks with explicit criteria for inclusion, (2) alternative payment

methods and rates that often shift some financial risk to providers, and

4

Another characteristic of traditional indemnity coverage is its use of the fee-for-service payment

mechanism to reimburse providers. Fee-for-service is also used in PPOs and to some extent in POS

and HMO plans. For example, an HMO may pay fee-for-service for some highly specialized procedures.

5

KPMG Peat Marwick, Health Benefits in 1996 (Vienna, Va.: Oct. 1996).

6

1987 employer survey conducted by the Health Insurance Association of America.

Page 13 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

(3) utilization controls over hospital and specialist physician services.7 A

managed care plan’s potential for savings depends on the stringency of its

cost-control features. In general, HMOs tend to use more stringent controls

than PPO or POS plans (see fig. 1.2). However, there is variation within the

different types of managed care plans, and as a result, some HMOs have

weaker controls than PPO or POS plans.

Figure 1.2: Spectrum of Health Care Plans

7

For a description of the evolution and use of the term managed care, see Managed Health Care: Effect

on Employers’ Costs Difficult to Measure (GAO/HRD-94-3, Oct. 19, 1993). The traditional distinctions

among managed care plans are becoming outmoded as plans rapidly evolve in response to

marketplace demands. For example, Kaiser, a group-model HMO, now offers a POS product in certain

markets and sometimes contracts with non-Kaiser hospitals. Moreover, the broadening of HMO

provider networks in some markets is contributing to a blurring of the difference between some HMOs

and PPOs.

Page 14 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

• HMO: There are several types of HMOs. Staff- and group-model HMOs are the

most tightly controlled managed care plans. The former hires physicians

directly, while the latter contracts with one or more large physician group

practices. Most physicians serve HMO enrollees exclusively, often

practicing in clinics owned by the plan. Physicians are either paid a salary

or a fixed amount per enrollee, a practice referred to as capitation, for

providing comprehensive health services. A patient’s care, especially

referrals to specialists and hospitalization, is typically coordinated by a

primary care physician. A third type of HMO, the independent practice

association (IPA), consists of networks of individual physicians that also

serve non-network patients covered by other insurance. Typically, IPAs

contract with a large number of physicians, and their enrollees represent

only a small portion of each physician’s practice. As a result, IPAs generally

have less leverage over physicians’ use of services than do staff or group

model HMOs. About as many IPA model HMOs reimburse their primary care

physicians under a fee-for-service payment schedule as use capitation. By

1996, about 33 percent of insured employees were enrolled in HMOs.8

• PPO: To compete with and provide an alternative to HMOs, insurers and

employers began offering PPOs during the early 1980s. PPOs retain many

elements of indemnity coverage but provide enrollees a financial

incentive—lower cost-sharing (copayments)—to receive care from a

network of providers that are normally reimbursed at a discounted

fee-for-service rate. PPOs vary in the size of their networks and in whether

they employ a gatekeeper—a physician who controls referrals to

specialists. By 1996, about 26 percent of insured employees were enrolled

in PPOs.9

• POS: POS plans are a hybrid combining features commonly associated with

HMOs, PPOs, and, in some instances, indemnity coverage. As denoted by the

term, the condition under which medical services are provided is

determined by the enrollee each time care is sought. The HMO option often

includes a gatekeeper. The PPO option has higher cost-sharing but a larger

network of providers. Some POS plans even have a third option—free

choice of providers with the employee responsible for paying an even

larger share of the cost. By 1996, about 16 percent of insured employees

were enrolled in POS plans.10

8

KPMG Peat Marwick, p. 23.

9

KPMG Peat Marwick, p. 23.

10KPMG Peat Marwick, p. 23.

Page 15 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

Although the United States has had network-based managed care plans

since the 1940s,11 much of the growth and development of such plans has

occurred more recently. During the 1980s, sharply rising health care costs

encouraged rapid HMO enrollment growth and the emergence of new types

of managed care plans, including PPOs and POS plans. The most rapid

growth in managed care enrollment has been in IPA-model HMOs, PPOs, and

POS plans. Enrollment in staff- and group-model HMOs, the managed care

plans that most experts consider to have the greatest potential to control

cost growth, has been relatively flat since the late 1980s.

Transition From

Payers to Purchasers

In the past, large purchasers offered only indemnity coverage—the

pinnacle in terms of enrollee freedom of choice—and, at the time, the

solitary option for firms choosing to provide health insurance as an

employee benefit. Several factors contributed to the decision by

purchasers to add a managed care option if an HMO was available. First,

federal legislation enacted in 1973 required employers who provided

health benefits, paid the minimum wage, and had 25 or more workers to

offer a federally qualified HMO if one was available in the employer’s

geographic area.12 Second, employers in some markets found that HMO

costs were somewhat lower than the costs of their traditional indemnity

plans. Third, in some markets with higher managed care penetration,

workers asked for HMO options. As noted earlier, other types of managed

care plans were subsequently developed with employer encouragement as

alternatives to HMOs.

By the 1980s, some firms offered a dozen or more HMOs, especially in

markets like California’s. They believed that offering a large number would

contribute to price competition that would in turn stimulate greater

efficiency. Purchasers assumed that a broad choice of HMOs would also

serve as an inducement for employees to enroll.13 Purchasers in our

sample acknowledged, however, that they lacked a systematic approach to

or criteria for evaluating and selecting HMOs. Some firms did not even

11Kaiser-Permanente, a group-model HMO, began in California, Washington, and Oregon in 1942.

12The HMO Act of 1973, P.L. 93-222. To be federally qualified, an HMO was required to provide

comprehensive benefits, community-rated premiums, and an annual open enrollment period.

Subsequently, these requirements were amended to provide federally qualified HMOs with additional

rating flexibility. The HMO requirement was designed to promote the growth of such plans as a way of

improving the capacity and efficiency of the health care system. This law was repealed effective

October 24, 1995 (see P.L. 100-517, sec. 7(b)).

13James C. Robinson, “Health Care Purchasing and Market Changes in California,” Health Affairs, Vol.

14, No. 4 (1995), pp. 119-20.

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Chapter 1 

Introduction

coordinate their purchasing, resulting in a lack of consistency across the

company. Moreover, since firms were not advocating HMOs, choice and

quality were not major issues with their employees in selecting

participating plans. Managed care was simply seen as an additional option

that saved some money and expanded employees’ choice. The only

selection criteria noted during our interviews were price and expressions

of employee interest in joining a specific HMO.

Between 1970 and 1990, employer expenditures on health benefits climbed

from 2 to 5.2 percent of total compensation and was still growing.

Moreover, by the late 1980s, employers were experiencing double-digit

growth in indemnity premiums. While HMOs in developed markets were

somewhat less expensive than indemnity coverage, their premium

increases mirrored indemnity cost growth. Because of shadow

pricing—the practice of pegging premiums to just below the cost of

alternative plans—switching to an HMO might result in initial, one-time

savings followed by rapidly growing health care costs in future years,

although the premiums would be somewhat lower than those for

indemnity coverage. The combination of spiraling indemnity costs coupled

with HMO shadow pricing contributed to the widespread belief that a

different approach to selecting and offering HMOs was needed. The advent

of this active purchasing strategy coincided with a period of increased

competition among HMOs for market share.

Objectives, Scope,

and Methodology

To better understand how large, innovative purchasers have redesigned

their health benefit strategies to foster cost control, the Chairman, Senate

Committee on Labor and Human Resources, asked us to examine (1) the

design features of purchasing strategies that encourage price competition

among health plans, (2) the influence of different health care markets on

those strategies, (3) the efforts by purchasers to ensure that quality is not

sacrificed in order to achieve cost-containment, and (4) the incentives

used to encourage enrollment in less expensive or more efficient health

care options. We focused on large purchasers because they are credited

with helping to slow down the rate of health care inflation and with

increasing health plan accountability. Moreover, their experience is

frequently cited as an alternative for reforming publicly funded health

benefit programs such as Medicare or Medicaid. We believe that a clear

and objective understanding of the cost-control strategies of large

purchasers will be useful to policymakers in assessing reform proposals.

Page 17 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 1 

Introduction

The Washington Business Group on Health helped us identify large,

innovative purchasers of health care from different sectors of industry.

The firms selected (1) operate in a number of different states and (2) offer

workers a choice of different types of health plans. In addition to firms

recommended by the Washington Business Group, we identified others

through a literature review and made selections with the goal of obtaining

adequate geographic representation. Predicated on earlier work, we also

included a number of recognized private sector purchasing coalitions in

our sample; these coalitions, with the pooled resources of member firms,

have significant purchasing power in some major markets.14 Finally, we

selected several innovative public purchasers—government agencies that

are responsible for managing the health benefits of state employees;

county, municipal, and other public employees; and sometimes other

groups. State purchasers often surpass the private sector in terms of

purchasing leverage and are second only to the federal government in their

ability to influence the evolution of health care delivery in the United

States. Our sample is judgmental and was not intended to be

representative of the health care purchasing activities of large employers,

coalitions, or state governments. However, we believe that the selection

criteria enabled us to capture the experience of a group of purchasers that

has the most direct relevance to policymakers seeking to reform Medicare

or other publicly funded health insurance programs.

In total, we visited and collected data on the health benefit management

strategies of 15 firms, 4 coalitions, and 6 state government agencies.15

Appendix I identifies the purchasers we interviewed and their

approximate size in terms of employees eligible for health benefits (in the

case of firms) and covered lives (in the case of the coalitions and state

purchasers). Using a standard interview protocol, we met with the health

benefit manager or other appropriate staff for each purchaser to gain

insights on the evolution of its management strategy. In addition, we

examined pertinent material relating to each purchaser’s health benefit

program, such as requests for proposal, published performance standards,

employee benefit handbooks, annual open enrollment material, and report

cards on HMO performance provided to employees.

14Access to Health Insurance: Public and Private Employers’ Experience With Purchasing Cooperatives

(GAO/HEHS-94-142, May 31, 1994).

15One of the firms in our sample, Mervyn’s, is a division of another employer we interviewed, Dayton

Hudson. Although they were not formally a part of our sample, we included pertinent information on

the Medicaid purchasing strategies of Arizona and Florida, two state governments that have

incorporated competitive market principals into their programs.

Page 18 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
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Introduction

We also provided a draft of this report to the purchasers in our sample,

who generally agreed with our presentation of the information and our

observations. They provided us with technical suggestions, which we

incorporated where appropriate. Our review was conducted between

January and December 1996 in accordance with generally accepted

government auditing standards.

Page 19 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 2 

Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

Propelled by the dramatic rise in the cost of providing health coverage, the

large firms and state governments in our sample have (1) revamped their

benefit programs and (2) placed greater emphasis on managed care in the

mix of health plans they offer to employees. While their particular

situations varied considerably, these purchasers shared two natural

attributes that played a key role in their transformation from passive

payers to active purchasers of managed care products: flexibility and

leverage. These attributes have served as a foundation for launching

benefit management strategies aimed at increasing the accountability of

managed care plans for the cost and quality of the services they deliver.

Benefit managers we spoke with stressed the value of flexibility in

developing and implementing an effective health benefit management

strategy. The term flexibility conveys a mix of nimbleness, latitude, and

adaptability in that a purchaser is able to (1) incrementally or suddenly

change the mix and type of health plan options, (2) create employee

incentives within its benefit system, and (3) implement a strategy either

uniformly or differently in the various markets in which it operates. In our

sample, the private sector demonstrated the broadest flexibility. That

flexibility, however, is not without bounds. On the other hand, the state

purchasers we interviewed appear to have more flexibility than that

normally associated with the public sector, a latitude some have used to

fashion innovative health benefit strategies.

Leverage is a concept that may be more easily described than flexibility,

but in our sample, it was less clearly demonstrated. Also called “market

power,” it relates to a purchaser’s ability by virtue of size or reputation to

exert anticompetitive pressure on health plans to obtain a desired

outcome. Large purchasers can also take advantage of the economies of

scale conveyed by their size, a factor that should translate into lower

administrative costs for operating their benefit programs. While private

firms demonstrated the value of their size, it was not something they were

able to exercise on their own in many locations. In contrast, state

governments in our sample seldom had to rely on purchasing coalitions to

establish or augment their already considerable market power.

Flexibility: The

Foundation of an

Active Purchasing

Strategy

Purchasers we interviewed believe that flexibility is key to revamping both

the way they purchase managed care products and the operation of their

benefit programs. The variation in the approaches taken reflects the ability

of large purchasers to make changes where and when they believe it is

appropriate. Such flexibility, however, did not always translate into

Page 20 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

wholesale, dramatic changes. Instead, flexibility allowed firms to make

changes that were either incremental or limited by geographic,

organizational, and even demographic boundaries. While flexibility is

generally assumed to be an inherent private sector trait, the firms in our

sample were not always completely free to exercise it. These firms were

constrained by a variety of factors, such as labor agreements; paternalistic

corporate cultures that limit the extent of employee cost-sharing; or a

disinclination to alienate employees skeptical about managed care,

especially those plans with a more limited choice of providers.

Flexibility Permits

Dramatic Change, but

Some Purchasers Choose

Incremental Strategy

Many purchasers in our sample have redesigned their health benefit

programs to encourage employee migration into managed care plans.

Some employers made significant changes over relatively short time

frames, such as introducing new delivery systems or altering the

components within an existing system, such as incentive structures. In

some cases, the purchaser believed rapid change was necessary because

of its own poor financial performance or that of its self-funded indemnity

plan; others made changes in response to what they viewed as failures in

the local health insurance marketplace. Some purchasers, however, chose

to implement changes incrementally, recognizing that they could not

implement a managed care strategy overnight.

In 1989, Southern California Edison abandoned its fee-for-service

indemnity health plan and embarked on a well-publicized new strategy

involving considerable infrastructure investment. Edison established a PPO

wholly owned and managed by the company. Just 6 years later, Edison

discontinued the PPO plan and turned over the operation of its network of

clinics to a medical group. The PPO was replaced with a self-insured POS

option and some HMOs. Several state governments in our sample also made

rapid and dramatic changes in their health benefit programs. Both

Wisconsin and Missouri adopted a managed competition system in 1983

and 1994, respectively. In Wisconsin, the impetus was the imminent

bankruptcy of the state’s self-funded indemnity plan; the Missouri change

was prompted by a series of deficits in its indemnity option. In both states,

the employee contribution for indemnity coverage jumped considerably

with the introduction of a contribution formula based on the lowest-cost

plan. The result was a dramatic increase in HMO enrollment. Private sector

firms we interviewed have also relied on financial incentives to encourage

migration to more efficient/lower-cost plans. Over the course of a year,

one firm eliminated the subsidy for its indemnity plan, which, along with

utilization-based increases, resulted in more than a 250-percent increase in

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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

the cost of the employee contribution. This change contributed to a

significant drop in the number of employees opting for indemnity coverage

and an increase in HMO enrollment from about 30 percent to 60 percent.

This firm plans to eliminate the indemnity option in 1997 in areas where no

POS plan is available.

The structure of a particular market can also encourage large purchasers

to make dramatic changes. Concern over consolidation, overlap in

networks, and shadow pricing by managed care plans in the Minneapolis

health care market led the Buyers’ Health Care Action Group (BHCAG), a

purchasing coalition, to make a significant change.16 BHCAG decentralized

the management of care for its members by dropping the PPO model

originally offered in 1992 and contracting with 15 individual “care

systems”—groups made up of medical practices, clinics, and hospitals.

Enrollment in the new care systems began in January 1997. With this new

approach, BHCAG members essentially contract directly with providers.

Moreover, for the purposes of the BHCAG contracts only, the primary care

physicians are locked into exclusive arrangements with one care system.

This new approach represents a major change in the administration of

benefits and the focus of control for the actual management of care but

allows the employees of BHCAG firms to continue with their current

providers almost undisturbed. Although the primary reason state health

insurance purchasing agencies have joined private coalitions is to

participate in their quality initiatives, the Minnesota Department of

Employee Relations—the state’s health benefit administrator—is

exploring the possibility with its unions of offering the BHCAG care systems

to state employees by 1999. The state’s consideration of joint purchasing

through BHCAG appears to be motivated by a shared concern over

marketplace consolidation.

While many purchasers in our sample want employees to migrate into

HMOs, some recognized that they could not implement such a dramatic

change overnight. Instead, they chose to make incremental changes to

their health benefit programs. Some of these employers told us that they

viewed POS plans as a bridge between traditional indemnity coverage and

an HMO. (POS plans are essentially HMOs that offer an out-of-network

option.) Employers hope that the POS option will allow employees to

become familiar and comfortable with managed care, leading to eventual

enrollment in an HMO. The incentives—lower copayments, no deductible,

and lower limits on out-of-pocket expenses—are designed to attract

employees to the HMO network while still offering employees the option,

16BHCAG has 24 employer members and began joint purchasing in 1992.

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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

albeit a more expensive one, of broader physician choice. One firm that

implemented a POS option reported that out-of-network services only

accounted for about 10 percent of total plan costs. Surveys, we were told,

have shown that most firms implementing a POS plan have had a similar

experience. A benefit manager suggested that unlimited choice is

frequently desired but infrequently used when accompanied by a higher

price tag.

Some firms are deliberately phasing in their managed care strategy.

Avoiding use of the term HMO, one purchaser is slowly introducing what it

referred to as the next generation of managed care plan.17 To date, it has

only identified nine plans with the potential to meet its criteria for

information systems and care management. In many markets, even some

with mature HMOs, no such plans are available. Over the long term,

however, this purchaser hopes to be able to offer “next-generation” plans

to all employees. During the transition, the firm continues to rely on its

self-funded PPO as well as existing HMOs to cover the majority of its

workers. Another firm has phased in HMOs in four states where such plans

already enjoy a relatively high degree of acceptance. This firm plans to add

HMOs in other states as managed care capacity in these markets matures.

Regardless of the nature or pace of change, the private firms in our sample

often use their innate flexibility to advocate specific delivery systems and

occasionally even individual health plans that they believe offer the best

value. While some avoided any direct endorsement of a plan, they do

provide considerably more information about favored plans than about

others that they also offer. One firm developed and implemented a

substantial internal marketing strategy to dispel what it believed to be

myths about managed care and to encourage employees to enroll in one of

the available HMOs.

Flexibility Permits

Adaptation to Market

Realities and Other Factors

To many of the firms in our sample, flexibility also means being able to

adapt the benefit strategy to market conditions and to treat specific groups

of employees differently. Such differentiation makes it possible to focus

management resources in areas with large concentrations of

employees—and where a firm spends a large percentage of its benefit

dollars. Differences may also stem from a firm’s decision to manage

benefits by division rather than centralizing administrative functions in a

single benefit staff. Finally, in some cases, the differentiation takes

17See cg. 3 for a more detailed description of what this purchaser refers to as organized systems of

care.

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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

advantage of a perceived variation in the cost of covering certain

demographic groups.

Market conditions often leave a clearly identifiable mark on the benefit

strategy of a large purchaser. California purchasers told us that currently

there is heightened competition among a large number of undifferentiated

managed care plans with broad overlapping networks. This provider

overlap led one coalition we interviewed to characterize the state’s HMO

products as “commodities.” Convinced that there is excess capacity and

inefficiency in the managed care delivery system, the Pacific Business

Group on Health (PBGH), a coalition of 33 West Coast employers, continues

to pressure HMOs to lower prices and to justify any increases with

demonstrable quality and service improvements. Minnesota, on the other

hand, has experienced considerable market consolidation over the past

several years. Only four plans control over 80 percent of the market.

Managed care plans, we were told, are aggressively buying physician

practices. As described above, this apparent march toward monopoly led

BHCAG to a dramatic turnaround in its purchasing strategy.

Finally, certain markets have little managed care or are only beginning to

see its development. Moreover, purchasers believe that some of these

markets are not receptive to the development of HMOs. For example, in

some rural markets, providers, especially hospitals, have actively blocked

the entry of managed care by refusing to contract with such plans. One

purchaser cited the evolution of managed care in Oklahoma City as typical

of emerging HMO markets. Several years ago, this market only offered

purchasers the choice of an inefficient plan that resembled an HMO.

Premiums were high, care was not really managed, and every doctor was

in the plan. The entry of two large managed care plans has introduced

competition, a development that is helping to transform the local market.

For a variety of reasons, purchasers do not offer HMOs at all operating

locations. Thus, some purchasers introduce managed care plans on the

basis of the degree of employee concentration or the extent of HMO

penetration, or both. In certain markets, they have too few employees to

justify the administrative effort. In others, because of the immaturity of the

market, HMOs are more expensive than an indemnity product and are not

offered. Finally, HMOs are often unavailable in rural areas. Even the state

governments in our sample, which generally strive to offer HMOs to all

employees, are unable to do so in some rural markets.

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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

A purchaser that adopted extensive quality criteria to screen out

unacceptable plans and to monitor performance told us that the

administrative burden precludes the firm from applying these criteria in

every market where it has employees. Rather, the purchaser focuses its

attention on areas with high concentrations of employees. In such

markets, it (1) monitors HMO performance against published requirements,

(2) works with health plans to build more efficient processes, (3) plans to

produce a report card based on the Health Plan Employer Data and

Information Set (HEDIS) measurements, and (4) analyzes HMO rates by

component. In areas with 500 or fewer employees, we were told, such

extensive monitoring is not economical. In these markets, the firm still

offers HMOs, but relies on the National Committee for Quality Assurance

(NCQA) accreditation as a proxy for health plan quality.

One firm in our sample decentralized management of its benefit program

along internal company lines. We were told that creating a single strategy

for the firm’s separate operating divisions would have been inappropriate

given the potential for disruption that would accompany a centralization

effort. Lack of profitability in one division led to the adoption of an HMO

strategy, but benefit managers were hesitant to adopt this strategy for a

different division that was financially strong. According to benefit

managers, it was not worth disrupting the workforce at the latter division

even if it saved the company money. Consequently, it was possible for

employees working in the same state, but in different divisions, to have

completely different health care options. On the other hand, another firm

is in the process of centralizing responsibility for HMOs in order to

introduce greater consistency across its operating divisions for screening

and selecting such plans.

Employee demographics can also play a role in designing a health benefit

program. Two of the firms in our sample targeted specific coverage

options at their younger, unmarried employees. Believing that these

employees are generally healthy, these firms wanted to encourage the

selection of their self-insured indemnity plan in which the company only

pays for the services used, rather than an HMO with a monthly capitation

rate that must be paid even if the enrollee is never sick. For example, one

firm has an indemnity option called the “Single Person’s Plan”; this option

is free and pays 100 percent of the first $600 of covered medical expenses;

the employee is responsible for the next $500 in expenses before

cost-sharing kicks in. While this option and others are not limited to

younger, single employees, the firm’s intent is to encourage those who do

not fit this demographic profile to select alternative plans.

Page 25 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

State Governments Also

Demonstrate Flexibility

Legislatures have frequently given the governing boards and agencies that

purchase health care for state employees and other groups wide latitude in

designing and managing the benefit program. The authorizing legislation

often provides a general framework but leaves important operational

decisions to others. In some states in our sample, employee unions also

play an active role in defining benefits, incentives, and how the program

actually operates.

Many of the state purchasing agencies we visited have the authority to

determine the number and type of participating plans and the benefits

offered. Moreover, like benefit managers in private firms, they often have

the authority to negotiate premiums with participating plans. The

legislation establishing the Health Insurance Plan of California (HIPC) is

broadly drawn and gives the governing board considerable discretion.18

The HIPC board initially considered the possibility of severely limiting the

number of plans offered; eventually, the board settled on a strategy of

offering a large number of competing health plans. In 1987, Minnesota

amended authorizing legislation and gave the agency that manages state

employee benefits the power to exclude any health plan from the program.

Previously, any licensed carrier had to be offered. In some states, the

governing board or agency that manages employee benefits has

standardized HMO benefits. HIPC’s governing board actually designed the

benefit package.

In 1992, Missouri passed legislation creating a new public employer

purchasing organization known as the Missouri Consolidated Health Care

Plan, with a governing board to manage health benefits for state

employees and other government entities. The legislation was prompted

by deficits in the state’s self-funded indemnity plan and by a recognition

that purchasing leverage was not being maximized under the current

approach. We were told that the authorizing legislation gives the governing

board significant flexibility to adapt its health care approach to the

continual evolution of the health insurance marketplace. After selling its

indemnity plan, the board subsequently included the plan’s fee-for-service

PPO in a competitive bidding process along with insured HMOs, and

instituted a managed competition system. In 1995, the board was also

given some negotiating authority with health plans. Flexibility allowed the

board to adapt to market conditions in 1995 that resulted in significant

reductions in HMO premiums.

18As part of 1992 insurance market reforms, California established HIPC—the first

government-sponsored voluntary purchasing coalition for small employers.

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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

Flexibility Is Not Without

Constraints

Looking across our sample, the flexibility of purchasers to develop

wide-ranging variations on a health benefits management strategy is clear;

the constraints that helped shape each purchaser’s strategy are less

obvious. Several factors, such as concern about the potential disruption of

employees’ relationships with their doctors, individual corporate cultures,

labor agreements, and the nature of the health care markets in which the

firms are located, have limited the degree to which any particular strategy

has been implemented.

Purchasers recognize that (1) employees do not necessarily share their

enthusiasm for managed care and (2) a managed care strategy could be

disruptive to employees’ medical care and adversely affect their morale. A

variety of approaches have been used to minimize the impact on

employees, but in some instances, these approaches may actually be at

cross-purposes with the efficiency goal that underlies the adoption of such

a strategy. In order to address employee concerns about disturbing

existing relationships with physicians, many firms insist that participating

HMOs include broad provider networks. At the same time, benefit managers

acknowledge that such networks are difficult to manage and are therefore

generally less efficient. One firm conducted a “provider disruption

analysis” to determine the extent to which employees’ physicians

participated in the networks of various HMOs. This firm told us that it

ended up contracting with two HMOs that were more expensive but that

had also scored well in its analysis.

Once a benefit management strategy is adopted, corporate culture and

labor contracts may limit a firm’s ability to create incentives for employees

to move from indemnity to managed care plans. One of the strongest

incentives, requiring employees to pay a portion of the cost of the health

plans they select, is essentially unavailable to firms that have a history of

paying the full cost of coverage or to firms that face stiff competition for

employees. One employer told us that it operates under the paternalistic

notion that an employee choosing single coverage should not have to

contribute to the cost.19 In other firms, the zero-premium benefits

19This same paternalism often does not apply to coverage of dependents. Missouri pays about

55 percent of the cost of health benefits for children, but only 28 percent for a spouse and 36 percent

of family coverage. These percentages were increased in recent years, utilizing savings realized

through the managed competition process adopted for the state employees’ health benefit program.

Washington offers free coverage for children in all but the most expensive plans, but the employee

must always pay for coverage of a spouse. Xerox has adopted a policy of basing total compensation

(benefits and pay) less on family status and more on the employee’s contribution to the business. As a

result, it is gradually increasing its allowance for workers choosing employee-only coverage and

decreasing the amount for those selecting family coverage. However, the allowance is still so generous

that an employee can purchase full family coverage, including prescription drugs, in an efficient HMO

with little or no out-of-pocket costs.

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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

negotiated by labor unions have a spillover effect on the rest of the

company. One employer told us that it offers benefits free to nonunion

employees so as not to encourage greater unionization of its workforce.

A strong union presence affects not only the cost of health care coverage

to employees but also the pace with which changes can be made. Any

significant changes in the structure of the health benefits for these

purchasers must be included in the collective bargaining process, which

may occur only once every 2 or 3 years. The insistence of unions on

maintaining a free indemnity option has limited the ability of some

purchasers we interviewed, especially those in the private sector, to

implement a uniform managed care strategy for their entire workforce.

However, two firms in our sample, U S WEST and Southern California

Edison, were able to negotiate the substitution of a POS option for more

traditional indemnity-type coverage. In the case of U S WEST, the POS plan

is free. Two state purchasers we interviewed still offer either traditional

indemnity or PPO coverage but have been more successful than the private

sector firms in negotiating labor contracts that require employee

cost-sharing, that is, targeting the state’s contribution to the least

expensive managed care plan. The state of California, on the other hand,

has been discussing a new cost-sharing formula with its unions since the

early 1990s and, as of August 1996, had been unable to reach an agreement

with most bargaining units. We were told that agreement on a new

cost-sharing formula could enhance the leverage of the agency that

manages employee benefits for the state—the California Public Employees

Retirement System (CalPERS)—during negotiations with health plans.20

Characteristics of individual markets can also constrain private firms as

they attempt to implement new health care strategies. Market-based

constraints, in their most basic form, may prevent purchasers from even

offering managed care products. For example, few very rural areas are

served by HMOs. Market characteristics may also dictate the type of

benefits an employer offers. One firm in our sample said that the structure

of benefits first popularized by the automotive industry in the

metropolitan Detroit area makes it difficult to retain employees without

offering first-dollar coverage. That is, most services are provided with no

or minimal copayment or deductible.

20Since 1967, other public agencies in the state have been allowed to join CalPERS.

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Flexibility and Leverage: Attributes of Large

Private and Public Purchasers

Importance of Market

Leverage Often

Overstated

According to the conventional wisdom, large purchasers have a natural

advantage in the health insurance marketplace. Health plans value their

business not only for the number of covered lives but also for the prestige

that is associated with having a well-known employer as a client. In turn,

these two factors allow a health plan to attract more, higher-profile

providers, which in turn attracts more business. Some of the private sector

purchasers in our sample believe that their size or reputation has been

instrumental in obtaining favorable rates from health plans. However,

some employers also admit that (1) they do not have leverage in many

markets in which they have employees and (2) acting alone, they may not

even have a significant amount of leverage in markets where they have

large concentrations of employees. Compared with the private sector,

some state purchasers we interviewed are second only to the federal

government in terms of the number of covered lives in a specific market

area.

Several Factors Can

Reduce the Leverage of

Large Purchasers

Large private sector employers appear to be taking advantage of their size

in purchasing health care coverage in some markets. However, given the

size of their payrolls, they generally have less leverage than conventional

wisdom would suggest. Factors such as the geographic distribution of

employees, large numbers of part-time employees ineligible for benefits,

and decentralization of the management of health benefits reduce

employer leverage. PepsiCo has approximately 450,000 employees

nationwide. Because a large number of them are part-time employees, only

about 250,000 are eligible for health benefits. About 170,000 are hourly

restaurant workers; they are eligible for a specialized health plan, but few

elect to enroll despite the modest contribution required. As a result,

PepsiCo only purchases standard health coverage for 85,000 workers.

Moreover, benefit-eligible employees are located in all 50 states and

distributed across 19,000 zip codes. The firm’s largest concentration of

employees in a single state is 5,000, and the next largest concentration is

only 2,000, in Southern California. Some firms are organized along product

lines or divisions, which purchase health care coverage independently.

Different philosophies in the sales and manufacturing divisions of one firm

in our sample result in decentralized health care purchasing. Another firm,

with some demographic differences among its operating divisions, has

decentralized health care administration along divisional lines. Employee

demographics led another firm to divide its workforce into separate

groups for the purpose of health care purchasing. While such

arrangements may demonstrate flexibility, they come at the expense of

purchasing power.

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Flexibility and Leverage: Attributes of Large

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Little Consensus on

Number of Employees

Needed to Have Leverage

There was little consensus among benefit managers on the number of

employees needed in a given market to wield significant buying power.

Some firms were confident that they had leverage at least in the state

where they were headquartered and often had their largest concentration

of employees. One large regional firm in our sample told us that it has

employees in every state but only has a significant concentration of

employees in about 14 states. In several of these 14 states, the firm has

between 7,000 and 17,000 workers and believes it has negotiating leverage.

The firm’s benefit manager noted, however, that whether a purchaser is

one of the top employers at a location can sometimes be more important

than its actual number of employees. Other benefit managers looked to

purchasing coalitions to enhance their market power—even where their

corporate headquarters were located. In areas where firms had small

numbers of employees, the managers admitted that they had little leverage

and frequently were price-takers.

State purchasers have considerable buying power, and some, like CalPERS,

have used their leverage to obtain favorable rates. They are often the

largest employer in a state, and their workforce is concentrated in a

smaller area, that is, usually within the confines of state boundaries. As a

result, they appear to have sufficient negotiating leverage on their own

without joining coalitions.21 CalPERS represents about 425,000 employees

and nearly 1 million covered lives generally concentrated in the state of

California. As noted earlier, PepsiCo, the largest private employer in our

sample, had 450,000 employees, but only 85,000 were enrolled in the

company’s health benefit program. Since 1994, CalPERS has used its buying

power to demand rate reductions and improved data collection from HMOs.

Moreover, several states are taking steps that could further enhance their

buying power. Thus, Washington and Minnesota are attempting to

coordinate the purchase of managed care benefits by different state

agencies such as Medicaid.

Firms without a major presence in any particular market believe that large

purchasers do have significant leverage—leverage that translates into

better rates at the expense of smaller buyers. For example, two of

California’s largest purchasing groups—PBGH and CalPERS—have seen HMO

rates decrease in recent years. The benefit manager from a California firm

that had seen rate increases over the same time period suggested that

health plans are shifting the cost of these discounts to smaller purchasers.

21CalPERS and HIPC are members of the Pacific Business Group on Health, but they only participate in

the coalition’s quality initiatives, not in its separate negotiating alliance.

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Firms Use Variety of

Techniques to Enhance

Leverage

Faced with limited purchasing power resulting from the geographic

distribution of employees and other factors, some firms in our sample

have sought to enhance their leverage through a variety of techniques such

as joining coalitions, relying on their national reputations, and limiting the

number of health plans with which they contract.

Even in metropolitan areas, the large private sector firms in our sample

often constituted only a small percentage of the potential business

available to a health plan. As a result, about half of the firms in our sample

have joined purchasing coalitions.22 While some BHCAG member firms have

fewer than 4,000 employees in the Minneapolis area, the coalition consists

of 24 major local employers, including firms with a national reputation

such as 3M, Dayton Hudson, and General Mills; the firms represent about

400,000 covered lives—15 percent of the metropolitan area market. The

PPO product offered to member firms through the end of 1996 attracted

100,000 enrollees, giving the coalition considerable market power.

Similarly, the minimum number of employees required for a firm to join

the PBGH negotiating group is only 2,000.23 Altogether, however, this group

represents 18 employers with about 400,000 active employees and

dependents. All the members of the negotiating group we interviewed told

us that they obtain lower HMO rates by jointly negotiating through the

coalition.

While coalition administrators believe that there are still significant

efficiencies to be gained in the health care market, it is not clear that

mature coalitions will continue to achieve rate discounts. For example,

after 2 years of rate decreases, 1997 rates for PBGH were flat. To further its

purchasing goals, PBGH is looking for ways to strengthen its market power,

such as recruiting new member firms or reducing the number of health

plans with which it negotiates. This latter tactic could result in more

aggressive plan bids because of the potential gain in new enrollees.

Several firms in our sample that are not members of a purchasing coalition

also cited the benefits of reducing the number of HMOs offered. This tactic

not only rewards health plans that bid aggressively but also reduces the

administrative cost of managing a benefit program. As with flexibility,

maximizing buying power by reducing the number of available plans does

not come without a cost. Thus, purchasers may find it difficult to eliminate

22One coalition’s executive director noted that even firms that have leverage on their own in a

particular location may join a coalition because it provides access to a broader range of data on the

local health care market.

23Not all PBGH member firms are part of the negotiating group. For the 1997 benefit year, 18 of the

coalition’s 32 members participated in the coalition’s joint purchasing initiative.

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health plans because of the impact on employees. One purchaser noted

that it would like to drop plans with high prices and poor quality, but the

firm’s corporate culture is to not disrupt employees. In some cases,

agreement with unions may be needed to drop a plan.

In areas where no local coalition exists, firms use every means at their

disposal to negotiate favorable rates. Like brand-name products, large

firms frequently have a national reputation. Association with such an

employer can be valuable to a health plan, even when the firm may only

have a few hundred employees in the area. The value of such an

association increases when it is a firm with a national reputation for

innovation in health care purchasing. Benefit managers at PepsiCo, a large

employer with a reputation for focusing on quality issues, told us that the

firm has benefited from its reputation in markets where it only has a small

number of employees. Other approaches used by firms in our sample that

are trying to increase their market power include (1) establishing the

National HMO Purchasing Coalition—an organization of large employers

that have joined forces to buy coverage in markets where they each have

too few employees to possess any leverage, (2) purchasing coverage from

a limited number of insurance carriers that operate nationwide, and

(3) using benefit consultants who also work with other large purchasers.

Because of their relationship with and knowledge of premiums being

quoted to other purchasers, benefit consultants may exert some market

leverage over health plans on behalf of their clients.

Labor contracts or disagreement with what they referred to as the “cost

focus” of some coalitions prevented a number of private sector firms from

joining together with other employers to increase their purchasing

leverage. Citing its labor agreements regarding benefit plan design as an

impediment to joint purchasing, Southern California Edison only

participates in PBGH quality initiatives. Other firms in our sample are more

interested in driving changes in how the managed care industry operates

than in obtaining discounts. For example, Xerox is philosophically

opposed to negotiating discounts because of the potential for cost-shifting.

Several firms told us that such discounts only represent a short-term

phenomenon and that market power would be better used by insisting on

improvements in the way health plans manage care, that is, data

collection, analysis, and reporting. Firms with such views, however, may

still join a purchasing coalition in order to participate in customer

satisfaction surveys or other quality initiatives.

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Purchasers Use Evaluation Criteria to

Pursue Price, Quality, and Access Goals

Flexibility and market leverage are often considered to be natural

attributes of the private sector—a foundation that some large purchasers

have used effectively in their transformation from passive to active buyers

of health benefits. However, flexibility and leverage alone are insufficient

to achieve the accountability, increased efficiency, and quality

improvements being sought by many large purchasers. For this reason,

buyers have turned to a number of additional tools to help achieve their

goals.

We have grouped these tools into three general categories: (1) health plan

evaluation criteria, including techniques to assess premiums and foster

competition among health plans; (2) incentives to sway employee

behavior; and (3) overt marketing strategies to influence both the choice

of delivery systems and of specific plans. This chapter focuses on health

plan evaluation criteria; a subsequent chapter looks at how purchasers

attempt to persuade an often reluctant workforce that a managed care

strategy is also in their best interest.

Tension Between

Need for and

Adequacy of

Evaluation Tools

The adoption of a strategy that encourages employees to join managed

care plans contributed to, if not necessitated, the development of health

plan evaluation criteria to help select HMOs. Price alone was no longer a

sufficient criterion given employee reservations about choice and quality.

The criteria, though imperfect and still evolving, serve several purposes.

First, they help both employers and employees to compare health plans.

Second, the criteria serve as improvement and development goals for the

plans themselves. Third, employers use the criteria and the information

collected from participating plans to justify their choices to employees.

Finally, some employers use the criteria to select plans and/or to limit the

number of HMOs offered in a given market.

Generally, the HMO evaluation tools developed by the purchasers we

interviewed can be grouped into three broad categories: (1) price,

(2) health plan quality, and (3) employee access to a choice of physicians.

Many purchasers have not only articulated criteria that they expect health

plans to meet, they have gone a step further and actually specified their

requirements in a request for proposal (RFP) and/or in published

“performance measures.” These criteria not only set forth a variety of

performance thresholds but also require plans to demonstrate their level

of performance by providing reliable data in specified formats. A few

purchasers use the data to monitor the health plans with which they

contract and impose sanctions if these goals are not met.

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Some purchasers view their health plan evaluation criteria, especially

those pertaining to price and quality, as works in progress, that is,

rudimentary and imperfect. For example, one firm pointed out that the

criteria are too process-oriented, too focused on what is measurable when

the most important factors still cannot be quantified. This benefit manager

characterized the firm’s standards as “indemnity measures.” Others even

categorized some of their criteria as subjective. Furthermore, purchasers

recognized that few plans could meet all of the criteria. As a result of these

shortcomings, firms told us that they applied the criteria flexibly, using

them more as goals than as absolute requirements. As research yields

increasingly sophisticated measures of quality and efficiency, these

purchasers expected to institute better and more rigorous requirements.

Price: Tools Used to

Evaluate Premiums

and Enhance

Competition

In the past, widespread shadow pricing by HMOs had often resulted in

premiums that bore little relation to actual health plan costs—a fact that,

according to purchasers we interviewed, HMOs readily acknowledge.

Rather than pursuing efficiency and passing the savings on to purchasers,

HMOs competed at the employee level: they offered enrollees richer

benefits with lower out-of-pocket costs and emphasized types of

preventive care that appealed to younger and healthier individuals. In

seeking to transform themselves from price-takers into active purchasers

of health benefits, the large purchasers we interviewed have adopted a

number of tools to encourage health plans to become more efficient and to

ensure that savings accrue to the purchaser of health care.

Among the tools frequently cited as enhancing price competition at the

purchaser level are (1) analyzing and negotiating premiums, (2) using a

structured bidding process to solicit premiums, and (3) joining coalitions

and eliminating plans to increase leverage. Purchasers told us that these

tools have been successful in actually reducing premiums or in

constraining premium growth. The variety of ways that large purchasers

use and integrate these tools, however, makes it difficult to attribute their

recent cost experience to any single tool or combination of tools.

Moreover, some purchasers recognize that the context of fierce

competition among HMOs for market share and the downturn in costs

normally associated with the underwriting cycle clouds the entire issue of

HMO pricing. As a result, other factors may be more important

determinants of purchasers’ recent cost experience than the specific tools

used to enhance health plan competition.

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Despite Difficulties,

Purchasers Evaluate

Premiums as a Prelude to

Negotiations

Though cost is sometimes characterized as more transparent than quality,

purchasers have had mixed experience in assessing the reasonableness of

capitation payments requested by HMOs. As with quality indicators, some

purchasers characterized current premium assessment techniques as

rudimentary. Nonetheless, many view them as an essential prelude to

subsequent negotiations. Some approaches are essentially analytical—a

process one benefit manager characterized as akin to the delicate and

difficult process of peeling back the layers of an onion. Others, however,

rely on more subjective indicators, such as a “reading of market

conditions” or evaluating the salaries of health plan executives. Often,

purchasers seek assistance from consulting firms and actuaries. The

purchasers in our sample said they used the following premium

assessment techniques either alone or in combination: (1) adjusting for

differences among the age and gender of employees (risk adjustment),

(2) reviewing plan rate development methodologies, (3) comparing

premiums with a standard or benchmark, (4) requesting utilization data

from health plans, (5) examining health plan financial indicators, and

(6) assessing market conditions.

Risk Adjustment There can be significant differences in the cost of providing health

insurance to different groups of individuals. Risk adjustment looks for

demographic, geographic, health status, and other characteristics that can

help predict the use of medical services.24 Two common characteristics

used by the purchasers in our sample were demographic, that is, age and

gender. While the easiest to adjust for, they only partially account for

differences in the health expenditures of different groups of employees.

Several purchasers told us that they believed other factors might be more

important predictors of the use of medical services, such as education

level and nature of employment (sitting at a desk versus engaging in

physical labor). Consequently, one health benefit manager asserted that it

was “inappropriate” to base negotiations on an analysis of workforce

demographics. Use of demographics is common, she maintained, not

because of its predictive capability but because there are so few other

widely accepted analytical tools. This same benefit manager also noted

that health plans often do not have the capacity to prove otherwise when

an employer asserts that the youth of its workforce justifies a rate

reduction.

While demographic analysis may not be the most sophisticated means of

assessing the risk of a population, when used in conjunction with other

24Health Care Reform: Considerations for Risk Adjustment Under Community Rating

(GAO/HEHS-94-173, Sept. 22, 1994).

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tools, it can highlight apparent inconsistencies in a health plan’s rate

methodology. One firm told us that it has retained a consultant who has

extensive data on the costs of delivering care by zip code. This consultant

analyzes HMO premiums on the basis of age, gender, and geographic

location. No HMO data on the actual utilization of services by enrollees is

employed in this assessment. If analysis suggests that premiums are too

high, the results are used during negotiations to obtain a reduction. Both

PBGH and the Gateway Purchasing Association25 analyzed members’

premiums for differences in benefits and risk and found a lack of

correlation with the rates actually charged. Thus, some firms with low-risk

employees paid higher premiums than those with high-risk employees.

Moreover, premiums did not appear to correspond to the volume of

business. In short, some prices appeared arbitrary and too high across the

board. At the same time, several members of the coalition we interviewed

emphasized that PBGH is currently unable to determine the true cost of

benefits delivered by contracting HMOs.

Review of Rate-Setting

Methodologies

Several purchasers told us that they either engage consultants and

actuaries to examine health plan rate-setting methodologies or perform

the assessment themselves. The Minnesota state government’s focus is on

whether the plan’s methodology is sound and accurate and whether any

subjective elements are reasonable. For example, Minnesota found that

one plan calculated its premium for family coverage by multiplying the

single rate by 2.8—a significantly higher ratio than is commonly used. The

plan, we were told, was trying to discourage more expensive families from

joining. The state has since mandated use of a standard ratio of 2.5 by all

plans. When Minnesota officials first began to ask plans to substantiate

their rate-setting methodologies, some carriers were not well prepared to

do so. This process uncovered significant errors that would have been

costly to the state, but plans now do a better job and changes are less

prevalent. Like Minnesota, Wisconsin and HIPC reported similar benefits

from their reviews of health plan rate-setting methodologies.

Benchmarking Evaluation of premiums often involves comparison with some standard or

reference point. The types of benchmarks used by the purchasers in our

sample include (1) indemnity or POS cost experience for which they often

have considerable utilization data, (2) trends in health care premiums over

several recent years, (3) premiums paid by employers with similar

workforce demographics, and (4) rates charged by health plans that are

judged as both efficient and of high quality.

25Gateway represents 30 St. Louis area firms.

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The Washington Health Care Authority estimates the per-memberper-month cost of enrolling all of its employees in the self-funded PPO plan.

This analysis is facilitated by the similarity between PPO benefits and those

that participating HMOs are required to offer. The Washington Health Care

Authority told us that it then asks each HMO to bid using the assumption

that all state employees would be enrolled in the bidder’s plan. Minnesota,

Wisconsin, and the Arizona Medicaid program also develop target

premiums on the basis of the extensive data that managed care plans are

required to submit. A Wisconsin official noted that this process alerts the

state to underpricing by large plans trying to buy market share and

prepares the state for subsequent negotiations if bids appear to be higher

than they need to be. Since BHCAG members paid their self-funded PPO

under a fee-for-service arrangement, they had several years of claims data

to assess the reasonableness of the bids received from 15 so-called care

systems. Purchasers also told us that HMO bids should be lower than their

indemnity costs because such plans are known to attract healthier and

therefore less expensive individuals than options that offer an unfettered

choice of providers.

A different type of benchmark identified by purchasers we interviewed is

reliance on trends in premiums over the past several years. Firms told us

that they tend to challenge large premium increases. On the other hand,

some purchasers are more inclined to go along with a proposed rate

increase if it seems consistent with their recent experience. One firm said

that it had seen some HMO rate increases in the neighborhood of 3 percent,

which it views as reasonable and is willing to pay. On the other hand,

many of the purchasers we interviewed told us that they have experienced

actual HMO premium decreases in certain markets—a fact that may

establish a different expectation.

Some firms told us that in markets where they are not a member of a

coalition, they rely on consultants to tell them how well they are doing.

For example, in return for sharing data on claims, premiums, and quality

indicators, one consultant provides firms feedback on the average and

best rates in a given market, adjusted for workforce demographics. A

benefit manager said that prior to participating in this survey, the firm had

no idea how well it was doing outside of California. Similarly, a coalition

told us that its consultant has a large database on HMO rates that allows the

coalition to compare its bids with the rest of the market. Since the levels

of benefits provided by purchasers differ, such comparisons only provide a

rough, but nonetheless useful, indicator.

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In addition to comparing proposed premiums with indemnity costs, trends,

and the experience of other firms, purchasers told us that they use the

premiums of an HMO that they believe serves as a benchmark in terms of

both cost and efficiency. Thus, PBGH told other plans that they had to meet

Kaiser’s rates. Similarly, another purchaser noted that many California

HMOs see Kaiser as a market trendsetter. Thus, we were told, a rumor in

April that Kaiser would drop its rates sent tremors throughout the market.

Health Plan Utilization Data Many state governments, coalitions, and firms in our sample require HMOs

to submit data on the utilization of services by their employees,

information also referred to as encounter data. Reflecting a typical

viewpoint, one health benefit manager told us that his firm wants to pay a

fair rate that can be substantiated by documentation that employees have

actually received medical services. Both firms and coalitions noted,

however, that the quality of the data submitted by HMOs was often variable.

CalPERS told us that staff-model HMOs or those that are claims-driven tend to

have better data; on the other hand, larger, more loosely managed plans

and those that are heavily capitated have poorer data. The vagueness or

incompleteness of the data was attributed to plans simply lacking the

information or not wanting to share it. California purchasers also cited the

increased use of capitation within HMOs as having a negative impact on the

availability of data. One firm said it was close to freezing enrollment in a

plan whose move to capitate its hospitals had diminished the integrity of

its data. Finally, a HIPC official told us that HIPC had to limit its

risk-adjustment methodology to inpatient encounter data because many

HMOs could not provide outpatient statistics. However, several plans

admitted to HIPC that they even had trouble collecting the inpatient data. A

California HMO noted that it is developing an outpatient database that is

clinically, rather than claims-oriented. Thus, there may be a disconnect

between the type of data systems plans are developing to effectively

manage care and the type of data purchasers perceive they need.

Some private coalitions have put health plans at financial risk for poor

results on performance measures, including the provision of data,

customer service, and quality. For example, PBGH has negotiated individual

HMO performance targets, and HMOs have agreed to put 2 percent of their

premium at risk. Gateway Purchasing Association in St. Louis negotiated a

similar arrangement. HIPC currently has the authority to fine a plan if data

are turned in late and commented that it would also be helpful if it could

penalize plans that submit poor-quality data.26

26Effective in July 1997, HIPC will no longer require HMOs to submit utilization data. Instead, HMOs

will be asked to provide audited HEDIS data that in turn will be reported to enrollees beginning with

the May 1998 open season.

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Financial Indicators Some purchasers told us that they look at financial indicators on plan

profitability, loss ratios, administrative margins, and the salaries of top

executives. In some cases, the purchaser’s RFP requires the submission of

such data. CalPERS said that it would like to see administrative expenses,

including profit, at about 10 to 12 percent. Similarly, its goal is for health

plans to spend at least 86 percent of premium revenues on medical

care—the so-called loss ratio. Digital also negotiates on the basis of a

variety of financial indicators, including plan overhead. A company official

told us that when premiums include a 15 to 20 percent charge for

administrative costs, it establishes performance goals to reduce this

component over time. Finally, purchasers expressed concern about the

high salaries of health plan executives; such salaries, along with other

financial indicators, suggested to them that more could be done to

improve health plan efficiency without adversely affecting quality. An

official at HIPC, however, sounded a note of caution about the reliability of

plan financial data. He said that HIPC would like to use encounter data to

calculate loss ratios but that it is not possible now because the data are

simply too “hazy.”

Market Expectations Assessments of the extent and nature of competition in a given market can

also influence the stance that a purchaser takes during premium

negotiations. One coalition that characterized competition in its market as

“fierce” approached 1996 negotiations with the expectation that further

rate concessions were still possible. Moreover, the coalition did not

believe that it had reached the point where quality had been adversely

affected by premium decreases. A coalition in a different market, however,

cited the fact that plans were losing money as a factor that would make

additional rate concessions difficult to obtain. Finally, officials at the

Missouri Consolidated Health Care Plan, a coalition that represents state

employees as well as other local government workers, benefited from

what it characterized as a “market-share-buying” temperament among

health plans in its 1996 bidding strategy.

Negotiations Seen as

Essential to Controlling

Growth in HMO Premiums

The extent to which purchasers in our sample—from both the private and

public sectors—rely on negotiations to supplement structured bidding or a

managed competition framework suggests that these approaches are

either insufficient by themselves or that purchasers lack confidence in

them as cost-containment tools. In fact, one state that added negotiation

several years after it adopted a managed competition system now

emphasizes that negotiation is a critical component of a competitive

framework. Only one firm we interviewed characterized itself as a

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“price-taker,” rejecting negotiation with health plans because the process

simply extracts a discount while shifting costs to other purchasers.

During our interviews, we observed two basic strategies for negotiating

with health plans. The primary emphasis of purchasers appears to be

either market leverage or analysis of premiums. The two approaches,

however, are not mutually exclusive. In markets where they believe they

have sufficient size, purchasers may rely more on their leverage, while in

others, they may see analysis as more appropriate. And, at times, the

distinction between the two strategies is blurred as firms or coalitions

adapt to market context or other circumstances. Regardless of the strategy

used, purchasers (1) approach the negotiating table with a shared

skepticism about health plan premiums and (2) often resort to similar

tactics during their face-to-face meetings with health plans.

Skepticism: Foundation for

Negotiations

Purchasers told us that they generally approach HMO premiums with

skepticism—an attitude reinforced by past shadow pricing. One coalition

told us that HMO pricing was still irrational. The benefit manager at another

firm said that the pricing process appeared to be arbitrary—it looked as if

plans decided what rates they wanted to charge and then backed in the

costs to justify them. A few purchasers noted that the frequency with

which errors are detected has not convinced them that HMO rate-setting

methodologies are sound. Several years of premium decreases for some

purchasers have probably reinforced skepticism about the actual basis for

HMO rates, especially since these same purchasers do not believe that the

quality of care has been adversely affected. The analysis conducted by

both PBGH and the Gateway Purchasing Association noted earlier lends

support to this general skepticism over the fairness of HMO rate-setting

methodologies.

Negotiation: Continuum

Ranging From Market Power to

Analysis

Perhaps the most publicized advocate of the use of market power is

CalPERS. CalPERS began to exert its market power when it sought a zero

increase in premiums for the 1992 contract year. Citing the state’s

worsening fiscal crisis, it asked HMOs to freeze rates and benefits at the

1991 levels. When Kaiser refused to accede to this strategy, CalPERS froze

new enrollment for 8 months, sending a powerful message to California

HMOs about the seriousness of its negotiating demands.

Starting with the 1994 contract year, CalPERS adopted an even bolder tactic:

each year it has publicly announced, in advance of negotiations, that it was

seeking a specific percentage reduction in premiums. And during three

consecutive negotiating sessions with HMOs, CalPERS has achieved premium

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reductions. An official at another coalition noted that CalPERS has a “huge

hammer” when it negotiates with health plans—for many, CalPERS is their

largest single customer. For example, about one-third of CalPERS enrollees

are in Kaiser, and CalPERS’ members represent about 7 percent of Kaiser

enrollment in California, a statistic few private purchasers can rival.

The PBGH Executive Director also characterized the coalition’s current

approach to negotiations as one based on the use of market leverage—the

size of the purchasing pool—to rein in prices. Like CalPERS, PBGH has

threatened sanctions when plans appeared reluctant to offer rate

concessions, a tactic one firm characterized as essential in shaping the

outcome of negotiations. After 2 years of HMO premium decreases,

however, the coalition was unable to gain further concessions in 1996,

though that was clearly its intent. According to member firms, the

coalition is now considering options to enhance its leverage—including

expanding its membership and eliminating some health plans. The

National HMO Purchasing Coalition has pursued an exclusionary policy

from the outset. A coalition official attributed its success in obtaining

several years of rate reductions not to analysis but to the policy of telling

bidders up front that it only intends to contract with two to four HMOs in

each market. Firms we interviewed criticized some purchasers as too

focused on price. However, officials at PBGH, CalPERS, and Gateway

Purchasing Association are convinced that continued pressure on HMOs to

lower prices and to justify any increases will force plans to become more

efficient, encouraging competition based on quality rather than on price.

As one coalition director explained, “plans won’t focus on quality if

employers are not tough on price. Nothing breeds innovation like

necessity.”

For some large or influential purchasers, it is difficult to isolate the role of

analysis from the context in which negotiations occur—a large purchaser

whose business is important to a health plan asking informed questions

about proposed premiums. As demonstrated by Gateway and PBGH,

analysis of HMO premiums can be a powerful negotiating tool. Though

PBGH, as it is currently configured, appears to have exhausted its market

power, the coalition’s initial negotiating success may have relied more on

its finding that differences in member premiums were not always

correlated to firm size or risk pool.

Some purchasers we interviewed are motivated less by a concern over

price concessions and more by a desire for fair and reasonable premiums

that accurately reflect the utilization of their employees. And these same

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purchasers are convinced that in the long run an emphasis on quality will

do more to restrain cost increases than a short-range focus on prices.

These purchasers generally rely on the analytical approaches outlined

earlier in this chapter. For example, Minnesota uses the negotiating

process to go over the results of its actuarial analysis of health plan bids.

During these meetings, it may seek additional information and, where

appropriate, ask for reasonable changes to the rates. Similarly, Wisconsin

meets with plan representatives if its analysis suggests that proposed

premiums are higher or lower than the target estimated by its actuary.27

The target is developed on the basis of a review of plan-specific

demographic, charge, and utilization data. The state asks all plans to

submit a “best-and-final” offer. Finally, a number of purchasers appear to

combine the use of market power—albeit on a different level compared

with CalPERS—with reliance on analytical tools. For example, HIPC not only

looks at health plan rate-setting methodologies and utilization data, it also

asks health plans whether the proposed rate is commensurate with HIPC’s

importance to their group of clients in the small-group market.

Feedback Provides Opportunity

for Plans to Reconsider Bids

Regardless of the emphasis placed on market leverage versus analysis,

many purchasers use a common set of tactics during negotiations. In

general, negotiations are an opportunity to provide feedback to health

plans on their respective bids. The objective is not to disclose the

premiums of competitors but rather to give each plan an opportunity to

reconsider its initial bid in the context of additional information.

Thus, Gateway Purchasing Association tells plans in general terms how

they are positioned relative to the competition—high, low, or in the

middle. Similarly, HIPC meets individually with health plans and gives them

an overall evaluation of where their bids fall in relation to others in a

specific market area. For example, during 1993 negotiations, HIPC informed

one plan that its premiums were 40-percent higher than the lowest-priced

competitor. Though it did not tell health plans that they were too

expensive or that they had to reduce their prices, one-third of the plans

lowered their premiums after these meetings. Providing feedback,

however, does not guarantee that a plan will change its bid. For example,

BHCAG told us about one Minneapolis plan that bid high in order to test

community loyalty to its hospital. The plan believed this bid was worth the

risk because it was already at capacity and BHCAG only represented about

5 percent of its business.

27A premium lower than the actuary’s estimated target can alert the state to underpricing by a plan

trying to buy market share. Unrealistically low premiums can give way to very large increases in

subsequent years.

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Purchasers commented that they also found it useful to provide feedback

on the possible employee reaction to price increases. Thus, HIPC conducted

an analysis of enrollees who changed plans during open season. During

negotiations, it pointed out that 41 percent of enrollees changed health

plans because of price and that one plan lost 16 percent of its enrollment

after it raised prices 8 percent. Another coalition said it often sees price

reductions after informing plans that their bids will result in employees

having to pay more than they would for plans offered by competitors.

Some purchasers suggested that it is a mistake to accept the first price

proposed by any health plan: asking for a second or even a third bid is just

common sense. One benefit manager told us that had the firm not asked

for best-and-final offers, it would have left about $500,000 on the table.

Another health benefit manager acknowledged that some, but not all,

plans “game the system” by bidding high initially in expectation of

lowering the bid during negotiations. The executive director of one

purchasing coalition emphasized the importance of arranging a one-on-one

meeting with a key decisionmaker at each plan in order to ensure that the

plan understands its competitive position. Using this and other techniques,

this director said that the coalition is able to move rates down from initial

bids. We were told, however, that it is critical not to let a plan lower its bid

once negotiations are completed. Plans should be forced to live with the

consequences of their decision on premiums until the next round of

bidding and negotiations. Finally, in accepting best-and-final offers, one

purchaser told us that it will only accept new bids from the same plan that

are lower than the initial offer.

Bidding Used to Structure

Health Plan Competition

Many of the purchasers we interviewed are now using some form of

bidding to select health plans and to help determine HMO capitation

payments. Bidding is often used in conjunction with evaluation and

negotiation. Plans are invited to submit sealed bids according to rules set

forth in an RFP. The RFP also stipulates requirements for a plan to be

considered qualified to bid. Generally, the purchasing coalitions and state

governments in our sample re-solicit bids annually or on some other

regular basis; individual firms, on the other hand, may use a bidding

process to make their initial plan selections but not periodically rebid

contracts unless a problem arises, such as employee complaints or

dramatic price increases.28

28One firm that is playing an instrumental role in establishing a new purchasing coalition told us that

no matter how good relations are with the contracting HMOs, soliciting bids every several years helps

to restrain premium growth.

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The underlying assumption of a bidding process is that competition among

plans for market share will result in premiums that reflect costs plus a

normal rate of profit. There is, however, no single, patented design for

competitive bidding, and research does not indicate which attributes

would clearly constitute the best system. In fact, competitive bidding is

commonly associated with commodities whose costs and quality are

easier to evaluate than the delivery of health care.

Consensus on Key Features Although there is potential for considerable variation in the design of a

bidding system, the purchasers in our sample cited the following general

features as critical to eliciting more competitive bids: (1) standardized

benefits, (2) employee incentives, (3) negotiation, and (4) flexibility.

Standardized Benefits. State governments and purchasing coalitions

standardized benefits in the late 1980s and early 1990s, which contributed

to their ability to undertake a rough comparison of premiums from

competing HMOs.29 In fact, benefits standardization may be a precondition

to collective purchasing by private coalitions.30 A second major advantage

of standardization is that it constrains the ability of plans to compete or

avoid risk on the basis of the benefits they offer. Some purchasers in our

sample may lack the market power—that is, a sufficient number of

employees in an area—to insist that all competing HMOs offer the same or

roughly similar benefit packages. Another factor that may inhibit

standardization for some firms is mandated state benefits that result in

variations in covered services from state to state.

Employee Incentives. Purchasers understand that providing a financial

incentive for employees to be cost-conscious in their selection of health

plans can be a powerful inducement for greater competition among HMOs.

As discussed in the next chapter, however, purchasers vary in the extent

to which they have implemented effective incentives. Only a few

purchasers have adopted what some consider to be the most effective

employee incentive—tying the employer contribution to the lowest-cost

plan offered. The losses in health plan enrollment that can result when a

plan bid requires a greater out-of-pocket contribution from employees can

29The degree of standardization ranges from identical benefits in Wisconsin to roughly comparable

benefits in Minnesota. CalPERS allows health plans to offer several supplementary benefits.

Washington Health Care Authority has a roughly comparable benefit design that applies to both its

self-funded PPO and its HMO, albeit with different limits, copayments, and deductibles. Thus, both the

PPO and HMOs cover preventive care. However, the state allows HMOs to waive inpatient hospital

copayments of $100 per admission. Gateway Purchasing Association has focused considerable energy

on standardizing the benefit exclusion policies of contracting HMOs.

30Private sector coalitions may accept bids on a standard benefit package but allow member firms to

vary the mix of benefits that they actually offer to employees.

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send a strong message to health plans. Although the structure of Medicaid

prevents the use of financial incentives, since it is offered largely free of

charge to beneficiaries, Arizona exercises the option of assigning the

approximately 50 percent who fail to select a health plan to lower-cost

bidders.

Negotiation. All but one of the bidding systems we examined assume that

negotiation is an integral part of the process. Initially, however, one of the

states in our sample did not negotiate with plans that submitted bids.

Rather, this state’s officials assumed that the competitive framework itself,

coupled with heightened employee price sensitivity as a result of

incentives, would help to control premium increases. A resumption of

rapid price increases and concern about shadow pricing necessitated a

modification of the original design. Wisconsin now sees evaluation of

health plan bids and direct negotiation as integral to the design of its

managed competition system. Unlike Wisconsin, CalPERS had previously

discussed premium increases with health plans. However, pressure to

contain costs became critical in 1991 when California froze the state

contribution to premiums, magnifying the impact of rate increases on state

employees. As a result, CalPERS began aggressive negotiations with health

plans in 1992.

Flexibility. Purchasers in our sample believe that flexibility is key to

maintaining and nurturing a successful bidding system.

• As noted earlier, Wisconsin’s response to anticompetitive behavior was the

introduction of negotiations. According to BHCAG, the 1996 care system

bids resulted in a 9.5-percent reduction in per-member-per-month incurred

claim costs—without negotiations. However, the coalition’s Executive

Director commented that he would not rule out negotiations in the future

if the current approach showed signs of not working.

• Arizona Medicaid’s competitive bidding process has continually evolved

since its inception in 1982.31 Thus, the state’s most recent RFP, issued in

February 1997, contains a number of departures from past practice

intended to increase competition and lower costs. First, bids will be

solicited for a 5-year period rather than for 3 years. Second, the state has

consolidated the 12 rural counties into 6 geographic areas and intends to

maintain its policy of awarding a minimum of only two contracts for each

31Analysts familiar with the Arizona program have stressed the importance of allowing the bid process

to change as the marketplace in a community changes. At some times, it may be important to stimulate

entry by relaxing plan participation requirements. At other times, it may be important to ensure the

stability of the program by requiring strict financial or other criteria for entry. See Lynn Paringer and

Nelda McCall, “How Competitive Is Competitive Bidding,” Health Affairs (1991), p. 229.

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area. This consolidation could eliminate some health plans. Finally, in one

urban county, the state’s target is to contract with six rather than eight

plans.

• As an incentive to bid competitively, Digital adopted a policy of allowing

only its benchmark plan (in terms of quality and price) to offer a POS

option to its employees. A company official added that this opportunity

can be taken away from a plan if either its cost or quality performance

slips. And, he noted, such slippages have caused Digital to change POS

partners.

• In 1996, the Washington Health Care Authority switched from a 1-year to a

2-year contract period. An official told us that health plans realized that if

they did not attract a large enrollment base with their bid, they would not

be able to recover for 2 more years. A board member on the Missouri

Consolidated Health Care Plan told us that the board believes its approach

to multiple-year bids is unique. In 1994, it solicited bids that locked in rates

for 5 years with a maximum yearly increase tied to the medical Consumer

Price Index. However, because a buyer’s market persisted and new

entrants were willing to bid, it has tested the waters every year since then

by calling for new bids. If an existing plan rebids, the board retains the

right to accept the new bid if it beats the 5-year guaranteed rate or stick

with the guaranteed rate through a renewal if the new bid is higher. In

1995, it did the former, while in 1996, the latter. Rebids also permitted the

state to insert additional contract terms, which would not have been

possible with a straight renewal.

Major Differences Observed

Among Bidding Systems

Two major differences surfaced among the bidding systems we examined:

(1) the number of winning bidders and (2) the criteria used to select them.

Number of Winning Bidders. Whether or not they belong to a

purchasing coalition, the firms we interviewed are less likely than state

governments to offer a large number of HMOs to their employees. They are

concerned that fragmentation of their workforce among a large number of

HMOs will reduce their leverage, not only in markets where they have a

large presence but also in those where they have a small number of

workers and there is no active purchasing group. In contrast, the state

governments in our sample appear to have sufficient leverage on their

own.32 They are often the largest employer in a state, and their risk pool is

concentrated in a smaller area, that is, usually within the confines of state

boundaries. Their large workforce allows them to negotiate with and

32CalPERS and HIPC are PBGH members, but they only participate in the coalition’s quality initiatives,

not in its separate negotiating alliance. A HIPC official, however, told us that one motivation for joining

PBGH was to observe the coalition’s negotiating strategy and evaluate it for approaches applicable to

HIPC.

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actually offer more HMOs without fear of fragmenting their risk pool and

diminishing their leverage. A CalPERS official told us that such a strategy

might not be viable for smaller purchasers. For them, narrowing the

competition might be a better approach.

Although there was no consensus on the optimal number of plans needed

to maintain competition, a number of private firms suggested that, at a

minimum, two plans should be required. Offering only one HMO, a benefit

manager told us, opens up the possibility of becoming “a captive of that

plan.” The number of plans typically offered is a “market-by-market”

decision. Some markets have no competing HMOs, others are only

beginning to experience competition, and some have undergone a

consolidation that restricts competition. Thus, one coalition noted that the

two to three dominant plans in a mature HMO market area refused to

submit bids unless they were guaranteed that only one plan would be

selected. The coalition refused to go along. A few firms did indicate that

they only contract with a single HMO in certain market areas. According to

one such firm, a consultant had advised it to add a second HMO in a

particular market because offering only one plan had adversely affected its

negotiating position. This firm now thinks competing plans is a better way

to go. Another firm recounted that rates fell by 30 percent when it added a

second HMO.

While firms may only contract with a handful of HMOs in a given market,

some of the private coalitions in our sample appear to believe that

competition and leverage are enhanced by accepting bids from a large

number of plans. For the first round of negotiations in 1994, all HMOs in

California were invited to submit bids. More recently, PBGH negotiated with

and offered its members a choice of 15 HMOs for benefit year 1996.

However, no member firm offers employees all of the plans and most

contract with four or fewer. The inability of the coalition to obtain a third

straight year of price reductions from participating HMOs has led PBGH to

consider a number of options to enhance its market power, including

expanding its California membership, moving into other nearby states, and

excluding some HMOs from the negotiation process. We were told that the

HMOs themselves suggested that further premium concessions might be

possible if the market share of participating plans was increased.

Selection Criteria. In addition to price, many bidding systems

incorporate quality and access criteria. The final section of this chapter

describes how the purchasers in our sample integrate these three criteria

to arrive at a decision.

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Quality: Some

Employers Hesitant

About Using Quality

Criteria

Ensuring the quality of health plans, particularly HMOs, poses a formidable

challenge to purchasers—one for which past experience with indemnity

coverage provides limited guidance. Nonetheless, the private sector has

been on the cutting edge in exploring and mapping this new frontier.

Capitation, a key characteristic of HMOs, underscores both the importance

of purchaser-sponsored quality initiatives and the extent of the challenge.

HMOs are usually prepaid a fixed per capita amount rather than reimbursed

after the fact for each service rendered—an arrangement that some

analysts believe creates an incentive to underserve.33 Moreover, capitation

negates what had previously served as a proxy for quality—the itemized

invoice that gave indemnity insurance its fee-for-service nickname.

Without claim forms, how are employers to assure themselves that

employees are indeed gaining access to medical services? The

overwhelming response to what is frequently referred to as the HMO “black

box” can be summarized in one word—accountability.

Large Purchasers

Developed Managed Care

Accountability Tools

Large private sector purchasers have driven the development of two

interrelated approaches to fostering accountability among managed care

plans—accreditation and the Health Plan Employer Data and Information

Set, commonly known as HEDIS. Accreditation involves a review of a health

plan’s quality assurance system against 50 standards. The standards look

for evidence that a health plan has the structures and processes in place to

report on and continually improve effectiveness. HEDIS, on the other hand,

actually measures performance in specific areas. The most well-known

HEDIS measures focus on the ability to deliver a set of preventive services,

including mammography, childhood immunizations, and cholesterol

screening, to enrollees. While accreditation and HEDIS are closely related,

accreditation is perhaps the easiest of the two criteria to interpret. An HMO

is in one of three categories: (1) seeking or not seeking accreditation,

(2) fully or provisionally accredited, or (3) denied accreditation. HEDIS

data, on the other hand, demands more analysis and explication,

particularly if an employer is attempting to compare a number of health

plans across all 63 indicators.

Appendix II describes the origins of HEDIS and contains background

information on the accreditation process. Appendix III summarizes the

type of quality-related data that purchasers we interviewed typically

expect from HMOs. The summary is based on performance goals published

by Southern California Edison in 1995. Edison’s goals fall into four broad

33On the other hand, reimbursement for each service, as in fee-for-service plans, may create an

incentive to provide unnecessary medical treatment.

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categories: (1) structure and philosophy, (2) service to enrollees,

(3) clinical quality, and (4) finance and information. An Edison official told

us that putting the goals in writing and using them during contract

negotiations frequently strengthens the positions of individuals in health

plans, such as medical directors, who have been stressing quality issues

for a long time but have not received sufficient attention. In establishing

its goals, Edison consulted with Digital Equipment Corporation, a

founding member of the HEDIS initiative, and with NCQA. Though the

specific measures parallel the 63 indicators found in HEDIS, Edison, like

other employers, has customized the performance goals to reflect its own

focus on patient-centered care in an organized, accountable delivery

system.

How Purchasers Use

Quality Indicators

Given the range of quality standards and measures available, which

indicators do firms find the most useful? Two minimum requirements for

contracting with managed care plans were frequently mentioned by the

purchasers we interviewed—NCQA accreditation status and a willingness to

collect and report HEDIS data.

Many purchasers told us that they give considerable weight to NCQA

accreditation status.34 Some view accreditation as an essential criterion for

a plan to be offered, while others view it as a minimum proxy for quality.

Thus, one purchaser added a particular HMO in order to send a message to

other plans that it was serious about quality: This firm explained that the

new plan’s “strongest suit” was its NCQA accreditation. Though many of the

private purchasers in our sample said they would refuse to contract with

an HMO that has been denied accreditation, they continue to contract with

HMOs seeking or making progress toward accreditation. In 1996, Xerox

suspended new enrollment in 10 HMOs that it believed had not made

sufficient progress. A Xerox official also told us that it threatened to freeze

enrollment in a highly regarded HMO who argued that its reputation

justified being exempted from the requirement. The plan in question is

now well on the path to accreditation.

The second key indicator for the firms in our sample is a health plan’s

willingness to report HEDIS indicators or to provide other data. Some

purchasers told us that health plans were initially reluctant to comply but

that most now recognize it as a fundamental requirement for contracting

with many large purchasers. Purchasers vary in the extent to which they

34The Joint Commission on Accreditation of Health Care Organizations, a private, not-for-profit

organization, also accredits HMOs.

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actually use the data available from plans. It appears that, as with

accreditation, some firms use the ability and willingness to report data as a

proxy for quality. Thus, a benefit manager told us that although the firm

lacked the resources to analyze health plan data, the plans themselves had

to have HEDIS-type data to effectively manage care. Other firms, however,

look beyond the mere ability to report data, and evaluate a plan’s

responsiveness to partnering with purchasers to continuously improve

quality. For example, at a minimum, one firm conducts annual site visits to

assess performance against its written goals and may schedule other visits

to discuss ongoing projects directed at improving performance in the

future. A coalition’s executive director told us that it uses contract

negotiations to provide plans comparative feedback on issues such as

physician credentialing and compensation of doctors.

Some of the purchasers we interviewed are concerned about the integrity

of the HEDIS data they receive from health plans. The Gateway Purchasing

Association pointed to the discrepancies between plan-reported enrollee

satisfaction and the results of an independent survey that it commissioned.

While plans reported 90 percent or better satisfaction, Gateway’s survey

showed a range of satisfaction from 60 percent to 80 percent. Gateway

also hired a consultant to audit four randomly selected preventive care

measures. Gateway’s Executive Director told us that data are more likely

to be reliable if a plan believes that it might be audited. PBGH also uses

independently verified data on preventive care measures in its quality

reports and conducts its own annual satisfaction survey. Some purchasers,

however, accept self-reported data and pass it on to their employees.

Recognizing that plan-level data may conceal performance differences

among medical groups in large, broad network-model HMOs, several

purchasers told us that they have recently been encouraging such plans to

report data by medical group as well as for the plan as a whole. According

to one firm, however, few plans are now willing to share such information.

PBGH is also focusing on the differences between medical groups and is

conducting its first survey that looks at enrollee satisfaction at the medical

group level. Its sample is drawn from enrollees in 55 participating

physician groups. PBGH hopes to use the data to gain a more complete

understanding of the impact of health plan and medical group selection on

satisfaction.

Purchasers Emphasize

Need for Plans to Manage

Care

Purchasers we interviewed are convinced of the potential for managed

care to out-perform indemnity coverage in terms of quality. One firm told

us that even in immature markets lacking well-developed HMOs, such plans

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deliver higher-quality care than traditional indemnity coverage. The

Executive Director of Gateway Purchasing Association told us, however,

that purchasers want more clinical management, more integration, and

more differentiation among the HMO products available. Though they see

today’s HMOs as a step in the right direction, this view does not connote

satisfaction with the plans currently offered. Gateway requires health

plans to sign an indemnification affirming that they are actually organized

to manage the care delivered to enrollees. Although several large insurers

had reservations about this contract provision, they eventually acquiesced.

Another coalition observed that the majority of HMOs do not currently have

the integrated information systems necessary to manage care. Instead,

HMOs manage cost—not care. Gatekeepers, we were told, too often limit

access to more expensive services, rather than facilitating receipt of the

care actually needed. The coalition’s observations are based on medical

reviews directed at identifying whether plans have the systems in place to

(1) identify immediately the enrollees who are in need of care and

(2) manage that care appropriately. The review itself consists of an

examination of a random sample of high-cost cases to determine how the

HMO responded. The coalition uses a staff of doctors and experts to review

plan records. The focus is on the adequacy of the systems and procedures

rather than on the outcomes themselves. The rationale for highlighting

high-cost cases rather than more routine ones is statistical: a tiny

percentage of individuals account for a disproportionate amount of health

care costs. To become more efficient, we were told, purchasers and plans

need to focus more attention on what actually generates costs rather than

on easier-to-measure preventive services.

Benefit managers at another firm told us that they had come to a similar

conclusion: sometimes an HMO tries to limit services at the front

end—frustrating healthy people and delaying necessary treatment for

people who are sick. Rather than continuing to hold premiums down by

adding members, they suggested that HMOs need to make fundamental

improvements in the way care is managed. Though this firm offers

employees a choice of HMOs, where available, it is seeking to develop

partnerships with plans that it identifies by a new acronym—OSC, or

organized system of care.35 The firm hoped that its OSC program will push

health plans to reevaluate the way that they deliver care. An OSC, we were

told, is what an HMO should aspire to be—that is, a plan that integrates the

financing and delivery of a full continuum of care and is held clinically and

35Company officials told us that they adopted the concept from the Washington Business Group on

Health. Digital also now looks to the HMO to provide its services as an organized system of care.

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fiscally accountable for the outcomes and health status of its enrolled

population. Though such care systems do not actually exist today, the firm

was attempting to identify plans that have the potential to evolve into OSCs

because of their operating philosophies, information systems, and

physician alignments. Eventually, the firm plans to drop its PPO and

nonqualifying HMOs and contract exclusively with such care systems. The

number of potential OSCs identified has grown from one in 1995 to nine in

1997. Benefit managers at this firm do not believe that some markets

currently exhibit the innovation necessary to produce potential care

system partners. Even a mature HMO market like Minneapolis, we were

told, is not close to the point at which any plan would be considered a

potential OSC.

Access: Employers

Accommodate

Employee Concerns

About Choice

Employers and employees often use different criteria in evaluating access.

Employers look at access in terms of the implications for health plan

efficiency and the adequacy of an HMO’s physician and hospital network,

that is, its mix of physicians and their proximity to the population served.36

Some purchasers we interviewed suggested that more tightly controlled

HMOs with smaller networks are the most likely to yield efficiently

delivered, high-quality health care. However, purchasers recognize that

workers are still likely to judge access by their ability to maintain a

relationship with a particular physician or by how easily they can obtain

referrals to specialists of their choice.

Ensuring access to employees’ physicians has become a major criterion in

selecting HMOs. The firms we interviewed frequently stated that they like to

offer HMOs with large networks, preferably ones that operate statewide.

Such HMOs are often made up of numerous, independent medical groups or

independent physicians operating throughout the state. One firm told us

that its preference for statewide HMOs had led it to drop what it referred to

as “mom and pop” plans that were only available in regional markets. In

general, firms believe it is unnecessary to offer a large number of

broad-based networks. Thus, most of the California purchasers in our

sample offer only four HMOs to in-state workers, including at least one

smaller, group-model HMO. One argument used to justify offering fewer

HMOs is the overlapping networks of large plans. Because many physicians

or physician groups contract with multiple HMOs, including additional

plans with broad networks accomplishes little. One firm that wants to

36For example, one of the purchasers we interviewed requires contracting plans to have at least two

primary care physicians and two hospitals within 10 miles of 90 percent of its employees at a given

location. Other purchasers have similar standards.

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reduce the number of HMOs it contracts with told us that it will target such

plans.

State purchasers, on the other hand, generally contract with a larger

number of HMOs. For example HIPC, Washington, Wisconsin, and CalPERS

each contract with between 9 and 24 HMOs.37 Moreover, they are more

likely to offer small, local plans or staff-model HMOs that operate in some

but not all counties. A motivating factor is the desire to extend the HMO

option to all enrollees, an option that is often considerably less expensive

than the indemnity-type alternatives. In fact, an explicit criterion used by

both CalPERS and HIPC for adding an HMO is the plan’s ability to expand

coverage to underserved areas.38 Consequently, CalPERS has reduced to

only one the number of counties without an HMO option. Similarly,

Minnesota has cut in half the number of rural counties that have only one

health plan option.

The states in our sample also offer employees a choice of broad

network-model HMOs. Questioning whether such plans really compete

against one another, Minnesota has a long-standing policy against

expanding the number of broad network “look-a-likes.” When state

employees disenroll into another IPA-model HMO, they are often able to

continue seeing the same physician—a factor that reduces plan control

over provider behavior. However, when an employee leaves a staff-model

HMO, the patient also leaves the provider. A HIPC official told us that it was

hard to justify additional broad-network HMOs since 90 percent of

physicians in California now participate in the plans it offers. In fact, HIPC

has dropped one of its original access criteria: Does the plan bring in a

new medical group not currently available through some other HMO? BHCAG

is making a direct attack on broad-based networks. Starting in 1997, it will

contract with 15 separate care systems. The RFP requires that primary care

physicians contract with no more than one participating care system.

Overall, however, the number of participating physicians will be larger

than under the coalition’s previous PPO product.

37The number of HMOs offered by CalPERS varies considerably among California’s 58 counties: 40

have between 4 and 11 HMOs; 5 have between 2 and 3; 12 have only one; and 1 county has no HMO

option.

38For the benefit year beginning August 1995, CalPERS began offering National HMO to state

employees. National HMO is available in 13 counties, including three that had previously lacked an

HMO option.

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Application of Criteria

Varies

We found that the purchasers we interviewed varied considerably in

(1) the significance that they attach to a given criterion; (2) how they

integrate access, quality, and cost criteria to arrive at a decision; and

(3) their willingness to eliminate a plan on the basis of specific criteria.

Purchasing coalitions and state governments, in particular, appear to be

more reluctant than private purchasers to use quality indicators to select

or eliminate HMOs. In general, the use of criteria by many purchasers we

interviewed appeared to be subjective. One coalition that expressed

confidence in the outcome of a quantification of bids acknowledged that

the evaluation was subjective rather than scientific in some areas.

Few of the large purchasers we interviewed told us that price is their most

important selection criterion. However, a recent study conducted jointly

by a benefits consulting firm and the Washington Business Group on

Health found that virtually all of the 368 large, medium, and small firms it

sampled listed cost as their most important health plan selection and

evaluation criterion.39 Other highly-rated criteria were satisfaction with

services, availability of utilization data, and access by employees. The

survey noted that comparatively few used available quality assessment

tools such as HEDIS, plan sponsorship of practice protocols, audited report

cards, health outcomes, or accreditation status to evaluate health plans.

These information tools were ranked at the bottom in terms of usefulness.

The study concluded that while employers are interested in quality-based

purchasing, they rate existing measures as less helpful than measures

related to cost and service. The survey emphasized, however, that

employers of various sizes use the available assessment tools differently.

For example, large purchasers with more than 10,000 employees are far

more likely than small employers to use HEDIS or report cards and to have

adopted health plan accreditation criteria. Moreover, the study projected a

significant increase in the use of these assessment tools over the next few

years, especially by large employers.

Xerox, Digital, and Southern California Edison exemplify a large-employer

approach that separates the consideration of quality from price. Both

Digital and Edison have published the extensive performance measures

that they use to evaluate plans and accept bids only from health plans that

meet these quality standards. Digital told us that it only applies the

performance measures to about one-half of the HMOs with which it

contracts. It is difficult, an official explained, to impose standards on

health plans in a market where the firm only has a small number of

39Washington Business Group on Health and Watson Wyatt, Worldwide, Is Cost Everything? Getting

Value for Your Health Care Dollar (Washington, D.C.: Feb. 1996).

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employees.40 Though it has no published performance standards, Xerox

develops a quality ranking for each plan with which it contracts. The

ranking includes a large number of variables, such as accreditation, and

involves assigning a numerical score for each variable. A benefit manager

told us that Xerox shares these quality rankings with HMOs to let them

know where they stand. The firm is considering eliminating plans that fail

to meet an acceptable threshold. As noted earlier, Xerox does not

negotiate with health plans and considers itself a price-taker. Though

Xerox will contract with plans that are considerably more expensive than

its benchmark plan, employees must pay the difference.

Access is clearly an important criterion—one that appears to have had an

unintended effect on the size and efficiency of health plans. Although

some employers emphasized that they want plans to compete on the basis

of the quality and efficiency of the medical groups in their networks, many

acknowledged that they prefer plans with broad-based networks. The

plans themselves, we were told, believe that they compete at the consumer

level, where paramount importance is attached to maintaining ties to one’s

own doctor. As a result, some plans attempt to recruit as many medical

groups as possible. One purchaser we interviewed conducted an access

study to help it select HMOs. The rationale behind the study was that

employees would be more inclined to join an HMO if they did not have to

change doctors to do so. The firm’s health benefit manager told us that

two of the HMOs selected had higher costs, but the best access scores.

Other purchasers, we were told, also based their selection of HMOs on

access studies.

Finally, some purchasers took a quantitative approach to evaluating health

plan bids. For example, the National HMO Purchasing Coalition and the

Arizona Medicaid programs assign a weight of about 70 percent to quality

and access criteria, and 30 percent to cost. The coalition’s goal is to

identify two to four HMOs in each market. In 1997, it will contract with 134

of the 380 HMOs that submitted bids. Arizona awarded contracts to 14 of

the 21 health plans that submitted bids in 1994, selecting fewer contractors

in rural areas than in urban centers. Florida Medicaid is also about to

adopt a quantitative evaluation methodology. Although plans that do not

achieve a minimum quality and access score will be eliminated, Florida

plans to contract with all qualified bidders. Enrollment will be allocated

among plans on the basis of their overall ranking. Plans with higher scores

40Digital estimates that between 80 and 85 percent of employees are enrolled in plans subject to its

performance standards.

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will be rewarded with larger enrollment. Cost accounts for 20 percent of

the total score.

Given the difficulty of distinguishing among HMOs using today’s

state-of-the-art techniques, some purchasers use criteria to establish a

minimum threshold for health plan participation and to evaluate and

monitor HMO performance. In some instances, a purchaser’s market power

allows it to dictate the minimum requirements for the plans it contracts

with. Some of these purchasers tend to view any narrowing of the market

as premature, given the preliminary nature of some of the criteria. The

root of this caution is the difficulty of measuring an HMO’s efficiency, true

cost, and quality of services. Is one HMO less costly than another because it

has healthier enrollees, rations care to save money, or puts effective

systems in place to actually manage care?

The Executive Director of the Gateway Purchasing Association in St. Louis

referred to this minimum threshold as the “ground-rules” for health plan

participation. Plans that want to contract with Gateway must be licensed

HMOs, be willing to provide data, agree to the coalition’s benefits designs,

and be willing to undergo performance measurement audits. State

governments also have such minimum thresholds. Adopting minimum

requirements, however, does not mean that such purchasers contract with

every qualified health plan or that they forsake the use of specific criteria

to eliminate health plans. Thus, as described earlier, HIPC, CalPERS, and

Minnesota have specific criteria that they apply in deciding whether to

expand employee health benefit options.

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As of 1994, 19.5 percent of Americans were enrolled in HMOs; enrollment in

HMOs by state ranged from over 35 percent in 5 states to less than 5 percent

in 11 others. Measured against this standard, a representative group of

purchasers in our sample has achieved significantly higher rates of HMO

enrollment, even among unionized workers and retirees who are often

exempt from requirements placed on active, nonunion employees. For

example, only two purchasers have fewer than 50 percent of their active

employees enrolled in HMOs, while 7 out of 11 purchasers have over

70 percent of such employees enrolled in HMOs. Table 4.1 summarizes, for

a representative group of employers in our sample, changes in HMO

enrollment that occurred after implementing major changes in their

purchasing strategies. More recent statistics for some purchasers show

how HMO enrollment has changed over time.

Table 4.1: HMO Enrollment for

Purchasers in GAO Sample Before and

After Changing Purchasing Strategy HMO enrollment

Numbers in percent

Purchaser

Before changes in

purchasing strategy

After changes in

purchasing strategy

State purchasers

CalPERS active employees 84 (1993) 84 (1996)

CalPERS retirees 50 (1993) 49 (1996)

Minnesota active employees 51 (1989) 48 (1993), 72 (1996)

Missouri active employees 32 (1994) 75 (1997)

Washington total employees 66 (1995) 77 (1996)

Washington active employees 70 83

Washington retirees 46 52

Wisconsin active employees 20 (1983) 55 (1984), 83 (1996)

Private sector purchasers

American Express 29 (1993) 62 (1994), 74 (1995)

Digital 28 (1990) 60 (1992), 66 (1996)

NYNEX total employees 31 (1993) 46 (1996)

NYNEX union employees 34 (1993) 40 (1996)

NYNEX management 24 (1993) 64 (1996)

Safeway 21 (1992) 37 (1995), 63 (1996)a

U S WEST total employees 12 (1991) 42 (1996)

U S WEST union employees Not available 45 (1996)

U S WEST nonunion

employees

Not available

33 (1996)

Xerox 40 (1990) 80 (1997)

aProjected.

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To what factors do these purchasers attribute increased enrollment in

HMOs or in other forms of managed care? The purchasers in our sample

identified three basic tools that they believe had a major impact on

employee health plan selections: (1) the type and mix of health plans

offered, (2) financial incentives, and (3) the information provided on

health plan options.

Evolution in

Employee Benefit

Options

The movement toward a managed care purchasing strategy is reflected in

the type and mix of health plans offered by the purchasers in our sample.

In some cases, however, purchasers told us that the current list of options

is only an interim step in the direction of increased reliance on HMOs to

serve the health care needs of their employees—albeit HMOs from which

they expect improved management and accountability for the delivery of

care. The range of plans offered reflects (1) a willingness to accommodate

the high priority employees attach to selecting a physician and (2) the lack

of alternatives to indemnity products in some markets. Few of these

purchasers have abandoned plans that allow access to a wider choice of

physicians, specialists, and hospitals. And still fewer offer only the most

restrictive type of managed care—the staff-model HMO that employs its

own doctors, operates its own hospitals, and uses a gatekeeper to regulate

access to specialists.41 Instead, what has evolved often strikes a middle

ground by restricting, but not eliminating, the right to select a physician

and by addressing concerns about having too few physicians from which

to choose.

Table 4.2 summarizes the health plan options for a representative group of

purchasers in our sample.

41As noted earlier, the distinctions among managed care plans are becoming outmoded as plans rapidly

evolve in response to marketplace demands. For example, Kaiser, a group-model HMO, now offers a

point-of-service product in certain markets and sometimes contracts with non-Kaiser hospitals.

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Table 4.2: Health Care Options

Available

Purchaser

Type and mix of plans

offered

State purchasers

CalPERS PPO and HMO

Minnesota PPO and HMO

Missouri PPO, POS, and HMO

Washington PPO and HMO

Wisconsin Indemnity, PPO, and HMO

Private sector purchasers

American Express Indemnity, PPO, and HMO

Digital Indemnity,a POS, and HMO

NYNEX Indemnity, POS, and HMO

Safeway PPO,a POS, and HMO

U S WEST POS and HMO

Xerox Indemnity and HMO

aEffective in 1997, Digital’s indemnity option will be available only in areas with no POS plan.

Safeway’s PPO option is no longer available in 1997.

Indemnity Although purchasers in our sample still offer an indemnity option, they

have often introduced elements of managed care into their plan designs.

Hybrid “managed indemnity” products now include features such as

(1) utilization review; (2) mandatory case management of expensive

services; (3) precertification for surgery, hospitalization, certain tests, and

inpatient mental health treatment; and (4) centers of excellence renowned

for treating certain diseases. Escalating costs have also persuaded some of

the purchasers we interviewed to place special restrictions on some

services—especially mental health. One company has even required

precertification for substance abuse treatment. Some purchasers are

worried about the continued viability of their indemnity option because of

the tendency for higher utilizers of care to choose plans with fewer

restrictions on selecting providers. In many markets, especially rural

areas, there is no real alterative to an indemnity option.

Preferred Provider

Organization

Some purchasers have substituted a PPO—a somewhat narrower network

of doctors and hospitals—for their indemnity option. For example, the

CalPERS PPO includes 83 percent of physicians in California, while the PPO

offered to Washington State employees includes 85 out of 89 hospitals.

Some PPO designs even incorporate an out-of-network option that provides

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employees with a safety valve back to traditional indemnity coverage. As

with indemnity coverage, purchasers have introduced similar management

features to help control costs. The introduction of a management feature

can be triggered by employee demographics or analysis that identifies a

high-cost area. For example, analysis by one firm with a predominately

young workforce suggested that maternity costs were its biggest expense.

To help identify potential prenatal problems, this employer instituted a

voluntary nurse advocate hotline. In Minnesota, state employees must now

select a primary care physician gatekeeper, a feature often associated with

HMOs, if they elect to enroll in the state’s self-funded PPO. The use of

gatekeepers is often associated with more restrictive HMOs. CalPERS

developed a second, self-funded PPO product that was first offered in 1993.

It was intended as a more affordable option for members who want fewer

restrictions on their choice of providers. Its lower premiums are offset by

higher out-of-pocket costs for enrollees. Minnesota also developed a

second, more restrictive self-funded product in order to respond to an HMO

with a self-referral option that was competing with the state’s PPO product.

A state official referred to this new option as an “HMO clone.”42 It consists

of a high-performance network of doctors and clinics that were

handpicked because they were good at managing care. The only difference

between the larger PPO network and this new option is that it eliminates

the self-referral option still available through the larger network.

Point-of-Service Some purchasers have replaced indemnity or PPO plans with a

point-of-service (POS) option—a less contentious move, from the

standpoint of employee relations, than adopting an HMO-only strategy. POS

is a hybrid design that can have elements of an HMO, a PPO, and even a

traditional indemnity product. Employees may decide which tier to utilize

each time they seek medical services. Several purchasers told us that they

view POS as a bridge from indemnity plans to HMOs. A few purchasers in

our sample offer POS in conjunction with either traditional indemnity or a

PPO option. In some instances, an indemnity-type option is only available if

a POS plan is not offered in a particular market. Some purchasers, however,

offer no middle ground between indemnity coverage and an HMO. HMO

enrollees of one such firm have an out-of-network option for certain

serious procedures, such as transplants.

Health Maintenance

Organization

As discussed in chapter 3, most private sector purchasers emphasize

broad-network HMOs that operate statewide and provide access to a wide

42Although not licensed or regulated as an HMO, a state official told us that this option operates like an

HMO with a closed panel of physicians.

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choice of primary care physicians, specialists, and hospitals. State

purchasers, on the other hand, are more likely to contract with smaller,

local health plans in an attempt to provide an HMO option to as many

employees as possible.

Developing Financial

Incentives Poses

Challenges for

Purchasers

Purchasers we interviewed believe that financial incentives are an

important tool in facilitating acceptance of HMOs by employees. They are

often inherent in the design of a managed care or HMO option in the form of

lower premiums, copayments, and deductibles coupled with a richer set of

benefits. Such incentives, however, were generally viewed by the

purchasers in our sample as less effective than ones that focus on the

amount deducted from an employee’s paycheck—that is, the employee

share of the cost of health care coverage.

Before purchasers adopted a managed care strategy, employees were

insulated from the true costs of their health care. To a greater extent than

in the past, the purchasers we interviewed are exposing workers to the

financial implications of their choices. The ability of purchasers to adopt

stronger financial incentives, however, is often limited by a common set of

constraints, including the extent to which workers are unionized or the

corporate culture’s perspective on employee cost-sharing.

The Theory Behind

Contribution Formulas

Most employers pay a fixed percentage of an employee’s health plan

premium. Table 4.3 uses hypothetical monthly premiums for four health

plan options to demonstrate the impact of different cost-sharing formulas

on employee out-of-pocket expenses. For each option, the firm pays

90 percent of the premium according to the specified formula and the

employee pays the remainder. For example, under the option 3 formula,

the employer contribution is based on the cost of the benchmark plan43

—in this instance, HMO A—and totals $108 (90 percent of $120). An

employee selecting HMO A pays the remaining 10 percent ($12). On the

other hand, an employee electing to enroll in the most expensive plan is

responsible for 46 percent of the premium, and one choosing the least

costly option pays nothing.

Moving across the table from left to right, each successive formula

provides a stronger financial incentive for an employee to consider cost in

choosing between indemnity and managed care options. So when an

43The term “benchmark” is associated with Xerox and Digital, which screen the HMOs that they offer

to employees on explicit quality criteria. Generally, the benchmark HMO is the lowest-priced plan in

that market that year.

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employer pays 90 percent of the cost of any plan (option 1), the employee

only faces a $10 differential between the low-cost HMO and the indemnity

option. If, on the other hand, the employer’s contribution is tied to

90 percent of the low-cost plan (option 4), an employee considering the

indemnity option must contribute $100 more each month compared with

the least expensive HMO. In addition to widening the cost gap between

indemnity and managed care options, each successive formula also forces

an employee to take a closer look at the cost differential among managed

care options. In our examples, HMO A is designated as a benchmark HMO

because of outstanding quality. Under option 2, HMO A is free; however,

under option 4, which uses a low-cost formula, the employee’s share of the

premium is $30—$20 more than HMO B, an acceptable, but less expensive,

HMO.

Table 4.3: Hypothetical Firm-Employee

Contribution Options (Single

Coverage/Per Month)

Formula: Firm pays 90% of (employee pays remainder)

Option 1: Cost

for any plan

selected

Option 2:

Average cost

of all plan

options ($124)

Option 3: Cost

for benchmark

plan (HMO

A/$108)

Option 4: Cost

for low-cost

plan (HMO

B/$90)

Indemnity: premium = $200

Firm pays $180 $124 $108 $90

Employee pays $20 $76 $92 $110

Point-of-service: premium = $130

Firm pays $117 $124 $108 $90

Employee pays $13 $6 $22 $40

Benchmark HMO A: premium = $120

Firm pays $108 $120 $108 $90

Employee pays $12 $0 $12 $30

Low-cost HMO B: premium = $100

Firm pays $90 $100 $100 $90

Employee pays $10 $0 $0 $10

The strength of any financial incentive is also influenced by a number of

other factors, including (1) the magnitude of the difference among health

plan premiums, (2) employer generosity, and (3) the characteristics of the

workforce. The closer premiums are clustered together, the less incentive

an employee has to discriminate among plans due to cost differences.

Similarly, an employer electing to pay a higher percentage of the premium

may reduce employee cost-sensitivity. Finally, a young, relatively healthy

workforce will probably be more responsive to small changes in price than

one that is older and sicker. Generally, however, a fairly significant price

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differential may be required to convince employees to switch to a

managed care plan with a more restrictive choice of physicians.

Employees Asked to Share

More of Health Care Costs

We were told that in the past many employers targeted their contribution

to higher-cost plans, reducing the incentive for an employee to choose a

less expensive alternative. Although some purchasers in our sample

continue to use higher-cost plans as a reference point in determining the

level of employee cost-sharing, others have adopted contribution formulas

that more explicitly encourage migration to what they consider efficient

health plans. Only one firm told us that it did not believe in using financial

incentives to influence employee choice. As noted earlier, the specific

formula adopted, cost differentials between plan options, and employer

generosity all influence the effectiveness of incentives. Whatever formula

is used, however, purchasers we interviewed generally now ask employees

to contribute more to the cost of coverage, particularly employees who

choose an indemnity option. Table 4.4 describes the employee

contribution formulas of a representative group of purchasers in our

sample and provides a rough comparison of employee out-of-pocket costs

if the employee elects to enroll in an indemnity-type product.

Table 4.4: Financial Incentives

Adopted by Purchasers

Purchaser

Financial incentives (for

active employees only)

Monthly employee share of

family coverage under

indemnity-type option

State governments

CalPERS Incentive for state employees

based on California’s freezing

its contribution at the 1991 level.

Ranges from $80 to $256 for

state employees, depending on

the PPO option chosen.

Minnesota Low-cost plan formula

introduced in 1989. Low-cost

plan is free for full-time

employees.

$84 in the Minneapolis area

(PPO enrollment in 1996 was

about 27%).

Missouri Low-cost plan formula

introduced for state employees

in 1995. Low-cost plan is free

for employees.

$266 in the Jefferson City area

for the PPO option. In contrast,

the lowest-cost HMO is $112.

Washington First introduced cost-sharing in

1996. PPO is benchmark for

cost-sharing.

$36 (Enrollment in the state’s

self-funded PPO dropped 35%

with the introduction of

cost-sharing).

Wisconsin Low-cost formula introduced in

1984. State pays the lesser of

90% of indemnity option or

105% of qualified lowest-cost

plan.

Ranges from about $75 (where

there are no low-cost

alternatives) up to $333.

(continued)

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Purchaser

Financial incentives (for

active employees only)

Monthly employee share of

family coverage under

indemnity-type option

Private sector

American Express Gradually moving to benchmark

plan formula by 2001. The

benchmark is the local HMO

with the highest value measured

in terms of quality (70%) and

cost (30%) and is usually, but

not always, the lowest-cost plan.

1994 increase in HMO

enrollment attributed to

promoting HMOs in open

season literature.

Unavailable.

Digital Introduced a benchmark plan

formula in 1991 in which firm

pays 85% of plan that meets its

cost and quality criteria. The

benchmark plan is usually, but

not always, the lowest-cost plan

in an area.

$623.92 in the Boston area (less

than 6% are in the indemnity

option in 1997); 16% are in POS

in 1997.

NYNEX union No incentive—free. Indemnity option is free.

NYNEX management Cash-back incentive increased

significantly in benefit year 1994

for employees electing to join an

HMO.

Ranges from $214 to $340,

depending on the employee’s

location.

Safeway First introduced cost-sharing in

1994. Starting in 1996, will pay

90% of average-cost plan.

Replacing PPO with POS in

benefit year 1997. PPO

enrollment dropped by 50%

between 1994 and 1996.

U S WEST union Limited incentive—POS and

low-cost HMO are free;

employee pays difference for

higher-cost HMOs.

Indemnity no longer offered.

U S WEST

management

Limited incentive—POS and

low-cost HMO are free;

employee pays difference for

higher-cost HMOs.

Indemnity no longer offered.

Xerox union No incentive—indemnity option

is free to employee.

Unavailable.

Xerox management Benchmark plan (low-cost) is

free, and, in addition, employee

gets cash back.

$201.

Relatively few of the purchasers in our sample—only six—elected to

target their contribution to the low-cost or benchmark plan. The two firms

that use a benchmark formula screen plans using explicit quality criteria

before offering them to employees. In adopting this approach, purchasers

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need not penalize individuals living in markets with limited managed care

alternatives. Thus, in rural areas with few HMOs, Wisconsin and Minnesota

designate their indemnity and fee-for-service PPO plans as the low-cost

option. In rural Wisconsin, a state employee pays only $75 monthly for

family coverage under the indemnity plan, while in areas with competing

HMOs, the same plan costs as much as $333.

The impact of a low-cost plan formula on employee choice can be

dramatic. For example, Digital saw enrollment in HMOs double in one year

from about 30 to 60 percent—a level where it appears to have stabilized.

Xerox’s enrollment in HMOs now stands at about 80 percent. Digital, unlike

Xerox, offers a POS alternative that has attracted a steady 15 to 16 percent

enrollment.44 HMO enrollment by Wisconsin State employees went from 20

to 55 percent the year after it adopted a low-cost contribution formula that

only offered a choice between HMOs and an indemnity plan.

On the other hand, Minnesota implemented a low-cost plan option in 1989.

By 1993, HMO enrollment by Minnesota State employees had actually

decreased slightly, from 51 percent to about 48 percent. During this

period, the cost differential between the low-cost plan and the state’s

self-insured, fee-for-service PPO remained fairly constant. Officials

attributed the recent growth in HMO enrollment, which now stands at

72 percent, to a widening of this cost differential. In 1995, an HMO with a

self-referral option and a network that closely resembles the state’s

fee-for-service PPO product cut its rates by 25 percent. Since this HMO was

now substantially cheaper, the state fee-for-service PPO lost 10 percent of

its enrollment. The actual amount of an employee’s share of the premium

for alternative types of coverage also helps explain the impact of a

low-cost formula on plan enrollment. For example, in 1996, a Minnesota

State employee in the Minneapolis area who elects fee-for-service PPO

coverage for his family paid about $64 a month more than for the

lowest-cost HMO. Minnesota still has about 27 percent of state employees in

its PPO option. In contrast, a Digital worker in the Boston area who chose

indemnity coverage for his family paid about $560 per month more than

for the lowest-cost HMO. Not surprisingly, only about 5 percent of Digital

employees are still enrolled in the company’s indemnity plan.

Over time, the already strong, low-cost incentive can become stronger:

Those remaining in indemnity plans tend to be higher utilizers of health

care services, increasing the cost per enrolled employee and the

44As of January 1, 1997, Digital managed care enrollment stood at 82 percent: 66 percent of employees

are enrolled in an HMO and 16 percent in a POS plan.

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associated premium. But a firm may choose to subsidize its indemnity

option to prevent this adverse selection “death spiral.” The incentive

structure of such firms is based on the assumption that younger, single

individuals use little health care and are thus cheaper to insure under an

indemnity option.45 Thus, single employees at two firms in our sample pay

nothing for indemnity, while families are given a greater financial incentive

to join an HMO. A different firm, on the other hand, has removed most of

the subsidy for the indemnity option. Its goal is to eventually replace this

option with a POS alternative.

The Missouri Consolidated Health Care Plan, which manages health

benefits for public employees, adopted a low-cost formula for state

workers in 1995. A board member suggested that purchasers who

self-insure their indemnity plan often find it difficult to be neutral about

the plan’s success or failure, including the extent to which employees

share in ever-rising costs. Self-insurance, he argued, clouds a purchaser’s

view of competing plans, a factor that contributed to the board’s decision

to sell its indemnity product and offer a fee-for-service PPO option through

an independent carrier. The logic behind the decision is that an insurance

company is more likely to take the necessary steps to make such a plan

competitive and to charge realistic premiums that ensure profitability.

Another program for state employees, the Washington Health Care

Authority, has been directed by the state legislature to study the

advantages of selling off its fee-for-service PPO product.

One purchaser we interviewed adopted a more radical and costly

approach to increasing HMO enrollment. Initially, a management-level

employee paid nothing for the low-option indemnity plan and, in fact, got

money back. To increase HMO enrollment, the firm required single

employees to contribute toward the cost of this indemnity option and

offered what the firm’s benefit manager characterized as a “huge”

managed care incentive—$2,000 to $3,000 cash back. Its popularity has

forced the company to gradually scale back the value of the incentive.

Over a 3-year period, the firm’s nonunion HMO enrollment grew from

24 percent to 64 percent. Firms that pay 100 percent of coverage have also

adopted a cash-back incentive model to increase participation in certain

types of health plans. Another firm offers employees additional benefit

options, such as dental and vision, rather than cash when they choose less

expensive options.

45This group also tends to be sensitive to smaller cost differentials.

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The contribution formulas used by most of the purchasers we interviewed

fall somewhere between a low-cost formula and one that pays a fixed

percentage of any plan selected. Some of the approaches adopted include

• average cost of all plans, including the indemnity option,

• use of a PPO as a benchmark,

• grouping plans into low- and high-cost tiers, and

• freezing the employer contribution at the 1991 level.

BHCAG employers have agreed to group care system bids into three tiers

and to base the contribution for each tier on the average premium.

Employees choosing a plan in the first tier would pay the lowest cost for

single coverage, but selecting a plan in the third tier would cost the

employee the most. Moreover, some BHCAG members told us that they may

eliminate some or all of the other plans currently offered to employees.

Other purchasers we interviewed recently implemented or are in the

process of phasing in stronger financial incentives. One firm is moving

toward the low-cost plan approach over a period of 7 years. Other

purchasers we interviewed also phased in stronger employee contribution

formulas.

Purchaser failure to periodically review and update the contribution

formula can water down its impact on employee behavior, especially when

premiums are rising slowly or even declining in some markets. Such

trends also lessen the urgency for a purchaser to strengthen incentives.

For example, until 1991, the state of California based its contribution for

active employees under the CalPERS program on the cost of the four most

popular plans, which were also among the most expensive.46 Since then,

the monthly contribution level has been frozen at $410 for family coverage.

Although the goal was to establish a new contribution formula through

collective bargaining, as of August 1996 no agreement had been reached

for most of the bargaining units. The pressure to agree on a new formula

may have been undercut by the fact that (1) many HMO premiums are now

less than they were in 1993 and less than the state’s “frozen” contribution

level, (2) the most popular PPO has experienced a modest price increase of

only 4.5 percent over 4 years, and (3) an alternative PPO option fell nearly

20 percent in cost since 1993. Chevron negotiates a fixed-dollar

contribution with its employees every 3 years. With the decline in

California HMO rates through its participation in PBGH, HMOs are now free to

46Under the CalPERS program, California still uses the average weighted cost of the four most popular

plans to calculate the premium contribution for state retirees. In 1996, the state’s monthly contribution

fell from $410 to $369. If this formula had still applied to active state employees, family coverage in the

most popular HMO would have been about $15 a month rather than free.

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employees. Since the cost of the firm’s POS alternative has also decreased,

we were told that there is now little incentive for employees to join an

HMO.

Purchasers also use financial incentives to steer employees toward

specific health plans. Xerox announced that it would give employees a

$120 price break for joining HMOs that were fully accredited by NCQA.

Members of the National HMO Purchasing Coalition meet annually by

region with contracting HMOs and ask plans to set their own performance

standards. Subsequently, one coalition member surveyed employees to

measure health plan progress against these self-defined standards.

Depending on the survey results, this firm will increase or decrease its

contribution for the plan by up to 20 percent.

Constraints on Employee

Cost-Sharing

Corporate culture, collective bargaining, and the low salaries of some

workers limited the ability of firms in our sample to share the cost of

health insurance coverage with their employees. The corporate culture of

some firms in our sample is paternalistic toward employees, placing limits

on the extent to which employees could be asked to contribute toward the

cost of health care. One firm told us that it had a huge internal debate over

employee cost-sharing and the adoption of a low-cost contribution

formula. For years, the firm had told employees that it did not choose

health plan partners on the basis of cost. Thus, switching to a low-cost

contribution formula would have directly contradicted 10 years of

emphasis on partnering with plans. The firm adopted a more modest

cost-sharing formula, but the benefit manager was not sure that the

differential between the plan options was significant enough to encourage

migration into HMOs.

Other firms had a significant portion of their workforce covered under

labor agreements that prohibit cost-sharing for traditional indemnity, PPO,

and even POS plans. One company not only offers many of its plans free to

union employees but also feels compelled to do the same for

management-level staff to avoid making a union attractive to nonunion

employees. The benefit manager of this firm commented that a larger

percentage of union than management-level staff had enrolled in HMOs. All

of the company’s executives are in the POS plan, and there is not much

encouragement from top management to develop stronger incentives for

HMO enrollment. A few firms, however, have been able to persuade their

unions to accept a POS plan in lieu of a PPO option. Benefit managers told

us that a relatively small percentage of their POS costs were attributable to

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Used to Sway Employee Behavior

enrollees who sought services outside the HMO tier, that is, the PPO or

indemnity tiers.

Finally, some purchasers are limited in their ability to impose cost-sharing

by the character of their workforce. A firm told us that even though it kept

the premium contribution low, few of its hourly employees signed up for

health benefits. One factor was low wages. This firm said that if it charged

more than $50 a month for single coverage, few, if any, employees would

sign up. Another factor, we were told, was the youth of many employees,

who would “rather spend the money on a car stereo instead.” Those who

did enroll tended to be married and planning to have children.

Relative Importance of

Incentives Sometimes

Difficult to Discern

The relative importance of financial incentives versus other factors that

influence an employee’s choice of health plans is difficult to distinguish.

Clearly, workforce demographics, degree of HMO penetration, or dislike of

the paperwork often associated with indemnity plans can also affect

employee plan selection. Union employees are a case in point. Many of

these workers have no explicit financial incentive to join an HMO other

than copayments and deductibles, since indemnity coverage is often free.

Yet purchasers told us that many union employees have chosen HMOs.

Some firms attributed the high HMO enrollment of unionized workers, in

part, to dislike for the indemnity claim forms and “red-tape.”47

HMO penetration in a given market is another factor affecting the behavior

of union workers. Thus, when Xerox began to implement its benchmark

HMO strategy for management-level employees in 1990, the firm already

had 40 percent HMO enrollment—largely among its union workers in

Rochester, New York. According to Xerox, HMOs have long been accepted

in Rochester and include almost every doctor in the area. In the early

1990s, HMOs provided insurance to more than half of the city’s residents.48

In general, the purchasers in our sample have more employees enrolled in

HMOs in areas with significant HMO penetration.

47One employer, whose no-cost indemnity option for union employees had a $250,000 lifetime limit,

told us that many such employees chose an HMO not because of this low limit but to avoid the

indemnity paperwork hassle.

48Health Care: Rochester’s Community Approach Yields Better Access, Lower Costs (GAO/HRD-93-44,

Jan. 29, 1993), p. 8.

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Firms Try Marketing

to Overcome

Resistance to

Managed Care

The most serious obstacle to the health benefit management strategies

described in this report is often the negative employee perception of

managed care. This general antipathy for restricted choice and

apprehension about the quality of care have been heightened over the past

several years by what purchasers characterize as a constant stream of

negative publicity ranging from gag rules to maternity stays.49 Employers

have used three basic tools to help sway employee opinion and to assuage

specific employee concerns about managed care. First, as discussed in

chapter 3, they articulate and explain the criteria used to select managed

care plans. Second, they now more prominently feature HMOs in their open

enrollment literature. Finally, they provide employees specific

comparative data about the quality of the available health plan options.

The purchasers in our sample are not merely supplying relevant

information; their role during the annual open season is sometimes one of

advocate rather than neutral broker.

Open Enrollment Season

Offers Opportunity to

Promote HMOs

The purchasers in our sample give employees an opportunity to reassess

their health plan selections annually during what is commonly referred to

as an “open season.” American Express told us that after switching to an

HMO strategy, it began to devote more space to the managed care options

in its open season literature. Previously, this material had zeroed in on the

company’s indemnity plan, leaving it up to the employee to take the

initiative to learn more about participating HMOs. The open season

brochure merely provided plan names and phone numbers. According to a

benefit manager, the firm was more knowledgeable about and comfortable

with how its own indemnity plan worked, and the open season literature

simply reflected this fact. It was much harder to describe HMO benefits,

since they differed from plan to plan.

Some purchasers we interviewed now routinely provide employees with

basic information about the HMOs they offer. Although the specific data

vary from employer to employer, the following categories of information

usually were included:

• General: Description of how an HMO works, including an explanation of the

difference between group/staff and IPA model plans, the role of the primary

care physician, and how to obtain referrals to specialists.

• Plan-specific data: How long the plan has been operating, whether it is

for-profit or not-for-profit, the number of enrollees it has, the growth or

49The typical comments about HMOs from a focus group conducted by one purchaser were (1) “the

care is inferior,” (2) “I don’t think my doctor participates,” and (3) “top-quality physicians aren’t

available through an HMO.”

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decline in enrollment over time, and the percentage of fellow employees

who have selected each plan.

• Physician data: Physician turnover, the number of board-certified

specialists and primary care physicians, and the percentage of primary

care physicians accepting new patients.

• Hospital: Hospitals affiliated with the plan and those most frequently used.

• Accreditation: NCQA accreditation status.

Some purchasers in our sample give employees a context for interpreting

the data provided, such as including a benchmark or goal for evaluating

the physician turnover rate. Xerox informs employees how plan premiums

have changed over the last few years and suggests a goal of less than

4 percent over a 3-year period.

As shown by the prominence of such data in this list, access may be the

single most important issue for employees. One firm told us that it put

together a special brochure to educate employees on the differences

between Kaiser and several new IPA-model HMOs that were being offered

for the first time. It wanted to be sure that employees understood that the

new plans were different from Kaiser, which is a staff-model HMO with a

much narrower choice of physicians and hospitals. This firm, as well as

other purchasers, told us that employees are more willing to choose an

HMO or other managed care product when they know that their doctors and

local hospitals participate. While it is relatively simple to provide a list of

affiliated hospitals, the names of network providers are generally only

available from individual health plans. One purchaser, however, went a

step further. HIPC now publishes a semiannual list of participating

providers and the health plans with which they are affiliated. When a

provider is available through several plans, as is often the case in

California, it gives employees an opportunity to focus on other selection

issues.

Some purchasers are also attempting to provide information on HMO

benefits and exclusions in their open season material. This task was

simplified for those purchasers who have adopted standardized HMO

benefits. Standardized benefits, however, do not mean that the policies

and procedures of each HMO are identical. For example, Wisconsin

furnishes additional information on each plan regarding the policy on

maternity stays, the operation of the drug formulary, procedures for

dispensing drugs, covered outpatient mental health services, and how to

obtain disposable diabetic supplies. For other purchasers we interviewed,

however, explaining HMO benefits is complicated by the lack of

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Used to Sway Employee Behavior

standardization. Despite the difficulty, some firms do provide comparative

information on HMO copayments and limits for various services, while

others still refer their employees to each health plan.

Quality Is Focus of Some

Data, Especially Report

Cards

Generally, purchasers recognize that they cannot advocate enrollment in

managed care plans without addressing a fundamental employee

concern—the suspicion that cost, not quality, is the motivating factor for

adopting a managed care strategy. Some of the basic information just

described touches indirectly on the issue of health plan quality—like the

percentage of board-certified physicians and accreditation status. What

are commonly referred to as “report cards” are an attempt to tackle the

quality issue head on.50

About half of the purchasers in our sample currently provide employees a

report card on the HMOs that they offer, and others are planning to do so in

the near future. These report cards focus on the results of employee

satisfaction surveys and, to a lesser extent, health plan performance in

delivering HEDIS preventive services such as immunizations or cancer

screening. Purchasers offered a number of explanations for not putting

greater emphasis on HEDIS measures. One firm that was involved in the

development of HEDIS told us that it had doubts about sharing these data

with employees because the attempts to measure quality are in their

infancy. This firm is only issuing its first report card for the 1997 benefit

year. Another purchaser noted that employees are not interested in HEDIS

performance data; employees only wanted to know what the firm was

doing to ensure that the “right” plans, that is, high-quality plans, were

offered. Finally, research suggests that individuals have greater confidence

in and attach more weight to the opinions of peers. A purchasing coalition

that tested its report card on a focus group told us that individuals were

unimpressed with the HEDIS data and were more likely to rely on the

member satisfaction results.

As with other information on managed care plans, some purchasers try to

help employees understand and use the report card data. Thus, rather than

merely reporting a raw score, some report cards rank plans as either

above or below average, making it easier for employees to compare plans

and draw conclusions from the data. Xerox publishes a goal or standard

for most satisfaction and performance measures. CalPERS actually includes

a worksheet and encourages employees to use the report card data to

50See Health Care Reform: “Report Cards” Are Useful but Significant Issues Need to Be Addressed

(GAO/HEHS-94-219, Sept. 29, 1994).

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compare plans and highlight areas of concern. Minnesota tells state

employees how the satisfaction results for each plan have changed in

targeted areas since the last survey. A few purchasers also include results

on their own self-funded indemnity plan or the POS option, giving

employees an opportunity to see how their peers rate satisfaction among

the different types of plans available

Marketing Strategy: Using

Information to Advocate

Managed Care

The purchasers we interviewed believe that managed care offers the best

“value”—the right combination of price and quality—for employees.

Moreover, some are convinced that choosing a health plan is seldom a

rational decision based on good information or even on the right

information. Although they hesitate to recommend or endorse a particular

plan, these purchasers are not bashful about advocating enrollment in

particular types of managed care plans that they offer. And they use

information both to support their position and to encourage employees to

be more analytical about their health care options. According to one

benefit manager, however, large purchasers are careful to make sure

employees understand both the pros and the cons of managed care; they

prefer not to deal with angry individuals who subsequently decide that this

option is not for them.

Communications can be a powerful tool, because a purchaser has the

latitude to either minimize or maximize the exposure it gives to a health

plan in the plan’s interactions with employees. One firm told us that it was

using compelling arguments and information to interest employees in a

new class of managed care plans. When it first introduced these

plans—without a lot of fanfare—only about 1 percent of those eligible

signed up. It attributed a large enrollment increase the following year to an

intensive marketing effort. Though written information played a role, the

firm believes that meetings with employee groups was also a key factor in

promoting these plans.51 A second firm implemented a sophisticated

marketing strategy with similar results. This firm used employee focus

groups to develop a video script; the video was produced with

professional actors and a local physician, who responded to employee

concerns and observations. The firm credited a significant jump in HMO

enrollment to use of this video and to time spent talking with employees

about HMO quality.

51A different firm told us that during open enrollment, it asks participating HMOs to bring in medical

group representatives to talk to employees. Plans tend to bring in their best medical groups, which

makes them more attractive to employees.

Page 73 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 5 

Observations

Our work suggests that some large purchasers and state governments have

taken a more aggressive role in managing their employee health benefit

costs. Double-digit premium increases common a few years ago have been

controlled considerably in the last 2 years, a development attributable, at

least in part, to more active management of health insurance costs. Some

common elements distinguish these purchasers’ benefit management

strategies: (1) advocacy of managed care; (2) the application of

competitive market principles to purchasing decisions; and (3) increased

sharing of costs, responsibility, and information with employees. Despite

common elements, a diversity of approaches is also evident—a diversity

fostered by institutional flexibility and the willingness to pursue and wield

purchasing leverage.

Advocacy of Managed

Care

Advocacy of managed care, particularly HMOs, is the linchpin of the active

purchasing strategies we examined. In response to employee skepticism,

labor constraints, or the immaturity of HMOs in certain markets, some

purchasers have introduced hybrid or less restrictive forms of managed

care as a bridge to future HMO enrollment. The purchasers we interviewed

have either incorporated elements of managed care in their indemnity

products or replaced them with a fee-for-service PPO product. Their

explicit promotion of HMOs contributed to, if not necessitated, other

common elements of an active purchasing strategy: (1) the development of

evaluation criteria based on price, access, and quality goals and (2) the

adoption of financial incentives and information strategies to influence

employee behavior. The criteria serve both employers and employees in

comparing and contrasting plans and in justifying their selections.

Competitive Market

Principles

Large purchasers have spurred the development of explicit criteria to help

them evaluate and select competing health plans. Often, these criteria are

spelled out in a request for proposal used to solicit bids. The criteria range

from quality benchmarks such as National Committee on Quality

Assurance accreditation or the ability to report HEDIS data, to standardized

benefits that simplify a cost comparison among plans. Today, few of these

purchasers would describe themselves as price-takers. Some closely

analyze proposed premiums to help assure themselves that price

quotations are based on the demographics and utilization experience of

their workforce. Most actively negotiate with health plans and some use

their market power to extract discounts.

Page 74 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Chapter 5 

Observations

Some employers do not hesitate to use their relative size to influence

health plan behavior—a purchasing tool unavailable to a small firm or

individual. Thus, size—either innate or attained by joining like-minded

employers—allows some purchasers to demand that health plans

negotiate or adopt a particular approach to quality assurance. However,

market leverage stemming from a firm’s size or reputation is probably

oversold as key to an effective health care purchasing strategy. Indeed, the

firms we reviewed were more likely to adopt strategies that rely on

competition among a number of health plans as opposed to strategies that

would maximize a firm’s market power by demanding concessions from a

single health care plan. To some extent, the development of employer

coalitions, which combine the purchasing power of a number of large

firms, appears to be an attempt to magnify a firm’s leverage. But even such

coalitions appear to rely more heavily on setting up a competitive

framework among rival plans. The public purchasers in our sample—often

the largest single employer in a state—have also focused on developing a

competitive framework.

By no means is there unanimity on the use of evaluation criteria. Many

large purchasers we interviewed recognize the shortcomings of the cost,

quality, and access criteria that have been developed so far. Thus, some

told us that today’s quality criteria are too process oriented and incapable

of distinguishing the plans that produce the highest-quality outcomes.

Similarly, despite efforts to analyze proposed premiums, many purchasers

acknowledged that they still have little idea of the true cost of providing

coverage through HMOs. Though some are comfortable with using one or

more criteria to eliminate health plans from contention, others see the

criteria more as improvement and development goals for the plans

themselves.

The purchasers in our sample generally believe that efficiency and quality

are closely linked: in a situation in which care is, in fact, managed, lower

cost is compatible with higher quality. Some are convinced that continued

pressure on HMOs to lower prices and to justify any increases will force

plans to become more efficient, encouraging competition based on quality

rather than price. Others, however, are concerned that employers and

coalitions are so focused on cost that they are doing little to ensure that

health plans are taking the necessary steps to become more efficient.

While the debate continues over the degree to which large employers’

contracting decisions are or should be influenced by cost, there is general

agreement that enhancing competition is key in a health care system that

looks increasingly to managed care to help moderate premium growth.

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Observations

Influencing Employee

Behavior

The negative public perception of managed care has played an important

role in shaping purchasers’ attempts to influence employee behavior.

Employees, we were told, have been convinced by a barrage of

unfavorable publicity that managed care achieves lower costs, not

efficiency, by denying needed services and impinges on the doctor-patient

relationship. In addition, employees are usually aware of the cost issues

underlying employer decisions about health benefits. As a result,

purchasers have used three basic tools to sway employee opinion and to

assuage specific concerns about managed care. First, purchasers articulate

and explain their criteria for selecting managed care plans; second, they

now more prominently feature such plans in the open season material;

finally, they attempt to provide employees specific comparative data about

the quality of the available options.

Intuitively, financial incentives would appear to be a more powerful tool

than communication in influencing an employee’s health plan selection.

For the purchasers in our sample, however, introducing effective and

reasonable financial incentives was perhaps the most difficult aspect of

implementing an active purchasing strategy. Few have adopted what is

said to be the strongest financial incentive to select a managed care

plan—targeting the employer contribution to the lowest-cost option. Most

employers fall somewhere in between the adoption of a low-cost formula

and one that provides no incentive to be cost-conscious. Whatever the

formula, however, the purchasers we interviewed are generally now

asking employees to contribute more to the cost of coverage, particularly

for those who choose an indemnity option.

Common Elements,

Yet Diversity of

Approaches

Despite these common elements, a diversity of approaches more aptly

characterizes the individual strategy and specific tools adopted by each of

the purchasers in our sample. They have used the flexibility inherent in the

private market to fashion strategies that are contingent on the unique

characteristics of their workforce and the health markets where their

employees reside. Their flexibility has temporal, locational, and structural

dimensions. Thus, we observed firms that opted to make marginal changes

and, in some cases, radically revised their strategies just a few years later.

Firms can choose to employ a uniform strategy across all their plant

locations or tailor their strategy to the characteristics of particular

markets. Indeed, many firms choose to develop a benefit management

strategy only in those markets where they have a reasonable expectation

of gain.

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Observations

These organizations face some important constraints in developing

effective health benefit management strategies. Their approaches must be

developed within the context of (1) labor-management negotiations and

collective bargaining agreements; (2) the health care market structure in

the firm’s major locations; and (3) corporate cultures, which may require

uniformity of benefits or cost-sharing by employees. These differing

constraints are another factor that demands flexibility and contributes to

the diversity of strategies by these large purchasers.

Page 77 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix I 

Characteristics of Purchasers in GAO

Sample

Table I.1: Characteristics of Private Firms

Firm Primary business

Number of active,

U.S. employees

eligible for health

benefits

Headquarters

location

Year current

health benefit

purchasing

strategy was

adopted

Purchases through

coalition

American Express Financial services 51,000 New York, NY

1993

Yes (National HMO

Purchasing Coalition)

Bank of America Banking 60,000 San Francisco,

CA 1994

Yes (Pacific Business

Group on Health)

Chevron Oil and natural gas 30,000 San Francisco,

CA 1993

Yes (Pacific Business

Group on Health)

Dayton Hudson Retail 110,000 Minneapolis, MN

1991

Yes (Buyers’ Health

Care Action Group)

Digital Equipment

Corp.

Computers 27,000 Maynard, MA

1991

No

General Mills Food processing 9,500 Minneapolis, MN

1992

Yes (Buyers’ Health

Care Action Group)

Mervyn’s a Retail 15,000 Hayward, CA

1994

Yes (Pacific Business

Group on Health)

NYNEX Telecommunications 62,000 New York, NY 1994 No

Pacific Bell Telecommunications 48,000 San Ramon, CA

1988

Yes (Pacific Business

Group on Health)

PepsiCo Beverages, snack

foods, and

restaurants

250,000 Purchase, NY

1989

No

Safeway Supermarkets 8,000b Pleasanton, CA

1994

Yes (Pacific Business

Group on Health)

Southern California

Edison

Utilities 14,000 Rosemead, CA

1995

No

Toyota Motor Sales Automobiles 5,400 Torrence, CA Not applicable No

U S West Telecommunications 60,000 Englewood, CO 1991 Noc

Xerox Office equipment 49,000 Stamford, CT 1991 No

aMervyn’s is a division of Dayton Hudson.

bSafeway has about 85,000 employees. However, all but about 8,000 are union members whose

health benefits are managed by a Taft-Hartley Trust.

cIn 1997, U S WEST plans to purchase coverage for employees in Arizona through the Pacific

Business Group on Health.

Page 78 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix I 

Characteristics of Purchasers in GAO

Sample

Table I.2: Characteristics of Private Purchasing Coalitions

Date activities initiated Headquarters

location Member firms Covered livesa Quality Purchasing

Buyers’ Health Care Action

Group

Minneapolis 24 100,000 1992 1992

Gateway Purchasing

Association

St. Louis 30 114,000 1995 1996

National HMO Purchasing

Coalition

New York 9 Unavailable 1993 1993

Pacific Business Group on

Health

San Francisco 18b 280,000b 1989b 1994

aRepresents employees and dependents insured through options negotiated by the coalition.

Member firms frequently offer employees and their dependents health benefit options other than

those jointly negotiated through the coalition. For example, Gateway firms employ 100,000

workers, for a total of 260,000 covered lives. However, only about 114,000 employees and

dependents have enrolled in the HMOs with which Gateway negotiates.

bThirteen additional firms plus CalPERS and the Health Insurance Plan of California also

participate in the coalition’s quality initiatives. Altogether, the 33 firms and state agencies involved

in quality initiatives represent about 2.5 million covered lives.

Table I.3: Characteristics of State

Government Programs

Location

Covered

lives

Year strategy

implemented

Coalition

membership

CalPERS Sacramento, CA 1,000,000 1992 Pacific

Business Group

on Healtha

Health Insurance

Plan of California

Sacramento, CA 123,000 1993 Pacific

Business Group

on Healtha

Minnesota Dept. of

Employee Relations

St. Paul, MN 150,000 1989 Buyers’ Health

Care Action

Group

Missouri

Consolidated Health

Care Plan

Jefferson City,

MO

115,000 1994 None

Washington Health

Care Authority

Olympia, WA 290,000 1996 None

Wisconsin Madison, WI 209,000 1983 None

aDoes not participate in the Pacific Business Group on Health subgroup that jointly negotiates

premiums.

Page 79 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix II 

Background on HEDIS and NCQA

Accreditation

The Health Plan Employer Data and Information Set (HEDIS) is the result of

a 3-1/2-year cooperative endeavor between representatives of major

employers and a combination of both large and small health plans.

Employers had been searching for credible tools to help them identify, and

demonstrate to others, the “value” resulting from premiums paid to HMOs.

Their specific objective was to develop standardized performance

measures that would help purchasers evaluate the quality of services

across the managed care plans with which they contract. In 1991, a draft

set of HEDIS performance measures known as version 1.0 was presented to

several business coalitions and health care organizations for their use.

When it became apparent that further revisions and refinements were

necessary, HEDIS 1.0 was turned over to a committee of health plan

representatives and corporate purchasers under the auspices of the

National Committee for Quality Assurance (NCQA)—an independent,

nonprofit institution that reviews and accredits managed care

organizations.52 The result was HEDIS 2.0, which was released in

October 1993. HEDIS 3.0, the latest iteration, has over 60 indicators that

describe performance in five key areas.53

NCQA only reviews health plans that are fully licensed and have been

operational for at least 18 months. The typical review for a 50,000-member

HMO is conducted by a team of three physicians and an administrative

reviewer who spend 2 to 4 days meeting with key personnel and reviewing

health plan records in six areas: (1) quality improvement, (2) provider

credentialing, (3) utilization management,54 (4) members’ rights and

satisfaction, (5) preventive health services, and (6) medical records. Since

NCQA began accrediting managed care plans in 1991, it has reviewed over

40 percent of the nation’s approximately 574 HMOs. Table II.1 summarizes

the results of those reviews.

52NCQA was founded in 1979 by two trade associations that represent the managed care industry. It

became independent in 1990 and now represents the interests of purchasers and consumers, as well as

health care organizations.

53Compared with earlier versions, HEDIS 3.0 moves quality measurement closer to an outcomes

perspective by including more standardized, relevant, useful measures than its predecessors.

54Does the plan use a reasonable and consistent process when deciding what health care services are

appropriate for individuals? When the plan denies payment for services, does it respond to member

and physician appeals?

Page 80 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix II 

Background on HEDIS and NCQA

Accreditation

Table II.1: Status of NCQA

Accreditation Reviews as of

December 1996

Accreditation status Number of plans Percent

Full (3-year) 115 46.0

1-year 86 35.0

Provisional 21 8.5

Denied 26 10.5

Under review 21

Scheduled for review 65

Plans receiving a 1-year accreditation meet most standards and are

reviewed again after a year to determine whether they should be granted

full accreditation. Provisional accreditation means that a plan meets only

some standards. According to NCQA, each of the plans denied accreditation

was state-licensed and, in some instances, federally qualified as well.

Page 81 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix III 

Summary of Southern California Edison

Performance Measures

Structure and philosophy Service to enrollees Clinical quality Finance and information

Goals

Assess plan commitment to principals of total

quality management/continuous quality

improvement.

Assess plan ability to meet

enrollee needs.

Assess plan ability to meet

goals for providing medical

and behavioral services.

Assess plan ability to

manage resources

efficiently and

monitor/improve data

processes, integrity, and

reporting.

Criteria

Demonstrate and document results of quality

improvement initiatives.

Provide choice of primary

care physicians (PCP) that

are a reasonable distance

from Edison enrollees and

maintain low PCP turnover

rate.

Conduct systematic

assessment of

doctor/medical groups

against accepted standards

for referrals, clinical

performance, utilization, use

of protocols, and so on.

Use integrated information

systems to provide

high-quality care more

cost-effectively.

Possess integrated information systems to

track improvement initiatives, clinical

outcomes, and enrollee satisfaction.

Provide reasonable

appointment availability for

nonurgent, urgent, and

emergency care.

Credential and recredential

physicians following NCQA

standards.

Provide

per-member-per-month

trend data by category of

service for administrative

and medical costs/revenues

for (1) all plan enrollees and

(2) Edison enrollees.

Achieve full NCQA accreditation. Ensure accurate/ timely

communication with

enrollees about how plan

operates, for example,

referrals, copayments, PCP

selection, and grievances.

Develop clinical guidelines

and disease-specific

programs to reduce

variation in practice

patterns.

Pursue management goals

that provide for efficient

collection and reporting of

all HEDIS data.

Conduct annual satisfaction

survey and/or focus groups.

Conduct health risk

assessments that promote

prevention, for example,

cholesterol testing and

prenatal care.

Ensure hospital affiliations

result in coordinated care.

Provide care that integrates

treatment of mental

health/substance abuse

under PCP.

Note: Most criteria are backed up by specific standards. For example, PCP access criteria

specify time and distance requirements, the availability of obstetricians/gynecologists and

pediatric PCPs, and direct access to gerontologists.

Page 82 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix IV 

Changes in HMO Enrollment, Plan Options,

and Financial Incentives

HMO enrollment for active

employees (percent)

Purchaser Type/mix of plans

Before

making

changes in

purchasing

strategy After changes

Monthly employee

share of family

coverage under

indemnity option

Financial incentives

(for active

employees only )

Public purchasers

CalPERS PPO and HMO 84 (1993) 84 (1996) Ranges from $80 to

$256 for state

employees

depending on the

PPO option chosen.

Incentive for state

employees based on

California’s freezing

its contribution at the

1991 level.

Minnesota PPO and HMO 51 (1989) 48 (1993), 72

(1996)

$84 in the

Minneapolis area.

1996 PPO enrollment

was about 27%.

Low-cost plan formula

introduced in 1989.

Low-cost plan is free

for full-time

employees.

Missouri PPO, POS, and

HMO

32 (1994) 75 (1997) $266 in the Jefferson

City area for the PPO

option. In contrast,

the lowest-cost HMO

is $112.

Low-cost plan formula

introduced for state

employees in 1995.

Low-cost plan is free

for employees.

Washington PPO and HMO 70 (1995) 83 (1996) $36. Enrollment in the

state’s self-funded

PPO dropped 35%

with the introduction

of cost sharing.

First introduced

cost-sharing in 1996.

PPO is benchmark for

cost-sharing.

Wisconsin Indemnity, PPO,

and HMO

20 (1983) 55 (1984), 83

(1996)

Ranges from about

$75 (where there are

no low-cost

alternatives) to $333.

Low-cost formula

introduced in 1984.

State pays the lesser

of 90% of indemnity

option or 105% of

qualified lowest-cost

plan.

(continued)

Page 83 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix IV 

Changes in HMO Enrollment, Plan Options,

and Financial Incentives

HMO enrollment for active

employees (percent)

Purchaser Type/mix of plans

Before

making

changes in

purchasing

strategy After changes

Monthly employee

share of family

coverage under

indemnity option

Financial incentives

(for active

employees only )

Private sector purchasers

American Express Indemnity, PPO,

and HMO

29 (1993) 62 (1994), 74

(1995)

Unavailable. Gradually moving to

benchmark plan

formula by 2001. The

benchmark is the

local HMO with the

highest value

measured in terms of

quality (70%) and

cost (30%) and is

usually, but not

always, the

lowest-cost plan.

1994 increase in

HMO enrollment

attributed to

promoting HMOs in

open season literature.

Digital Equipment Corp. Indemnity,a

POS, and HMO

28 (1990) 60 (1992), 66

(1996)

$623.92 in the Boston

area (less than 6%

were in the indemnity

option in 1997);

16% were in POS in

1997.

Introduced

benchmark plan

formula in 1991 in

which firm pays 85%

of plan that meets its

cost and quality

criteria. The

benchmark is usually,

but not always, the

lowest-cost plan in an

area.

NYNEX total 31 (1993) 46 (1996)

NYNEX union Indemnity, POS,

and HMO

34 (1993) 40 (1996) Indemnity option is

free.

No incentive—free.

NYNEX nonunion Indemnity, POS,

and HMO

24 (1993) 64 (1996) Ranges from $214 to

$340 depending on

the location of the

employee.

Cash-back incentive

increased

significantly in benefit

year 1994 for

employees electing to

join an HMO.

Safeway PPO,b POS, and

HMO

21 (1992) 37 (1995), 63

(1996, projected)

Replacing PPO with

POS in benefit year

1997. PPO enrollment

dropped by 50%

between 1994 and

1996.

First introduced costsharing in 1994.

Starting in 1996, will

pay 90% of

average-cost plan.

(continued)

Page 84 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Appendix IV 

Changes in HMO Enrollment, Plan Options,

and Financial Incentives

HMO enrollment for active

employees (percent)

Purchaser Type/mix of plans

Before

making

changes in

purchasing

strategy After changes

Monthly employee

share of family

coverage under

indemnity option

Financial incentives

(for active

employees only )

U S WEST total 12 (1991) 42 (1996)

U S WEST union POS and HMO Unavailable. 45 (1996) Indemnity no longer

offered.

Limited incentive—

POS and lowest-cost

HMO are free;

employee pays

difference for

higher-cost HMOs.

U S WEST nonunion POS and HMO Unavailable. 33 (1996) Indemnity no longer

offered.

Limited incentive—

POS and lowest-cost

HMO are free;

employee pays

difference for

higher-cost HMOs.

Xerox total 40 (1990) 80 (1997)

Xerox union Indemnity and

HMO

Unavailable. Unavailable. Unavailable. No incentive—

indemnity option is

free to employee.

Xerox nonunion Indemnity and

HMO

Unavailable. Unavailable. $201 Benchmark plan (lowcost) is free and, in

addition, employee

gets cash back.

Note: If the state contribution exceeds the Medicare risk premium, the retiree can use the

difference to pay the part B premium.

aOnly if no POS option is available.

bPPO option no longer available in 1997.

Page 85 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
Major Contributors to This Report

Michael Gutowski, Assistant Director, (202) 512-7128

Walter Ochinko, Senior Health Policy Analyst, (202) 512-7157

Mark Ulanowicz, Senior Health Policy Analyst

(101398) Page 86 GAO/HEHS-97-71 Health Insurance Purchasing Strategies
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