metadata: authors: 0: author: Bogetic, Zeljko
1: author: Heffley, Dennis
docna: 0: docna: Reforming health care : a case for stay well
            health insurance
docty: Policy Research Working Paper
subtopic: Health Care Services Industry,Public Sector Management and Reform,Health Economics & Finance,Health Insurance,International Trade and Trade Rules,Inflation
teratopic: Health, Nutrition and Population
abstracts: cdata!: All countries - whether industrial,
            developing, or in transition to a market economy - are
            interested in health care reform. A central focus of reform
            everywhere is to make patients more responsive to health
            care costs without diluting the protection offered by public
            or private insurance. Conventional insurance offers
            customers little incentive to monitor their own use of
            health care services or to adopt and maintain better health
            habits. The authors describe an alternative health insurance
            structure first adopted in Mendocino County, California, in
            1979, and compare it with conventional forms of insurance.
            The Mendocino or "stay well" plan offers consumers
            direct incentives to control their use of health care
            services and to adopt healthier lifestyles. How well this
            insurance can contain health care costs depends on the size
            of the incentives and consumer responsiveness to them.
            Conditions in some developing countries and in many
            countries moving to market based economies - overuse of
            services, poor health habits, and declining real incomes -
            improves the likelihood of a favorable response to such
            incentives. How to structure the stay well system depends on
            the country, but the stay well plan is a general flexible
            form of insurance that subsumes most conventional plans as
            special cases. The rewards for low use might take many
            forms. As in the Mendocino plan, the rewards might be a
            credit to a retirement account, but they could just as
            easily be annual cash rebates or credits against out of
            pocket expenses that exceed an individual's or
            family's spending goal in a future period.
            Administration of the stay well plan appears not to be
            unduly complex. If anything, incorporating stay well
            incentives in a single-payer or national health care system
            would be simpler than incorporating them in a self insured
            fund. The success of the plan hinges on whether incentives
            shift the frequency distribution of health care spending by
            reducing unnecessary utilization in the short run and
            through better health care habits, reducing long run costs.
            Despite additional payments to low users, the stay well plan
            could be less expensive than conventional plans with similar
            coverage. As in any insurance plan, solvency is enhanced by
            larger groups, better risk pooling, economies of scale in
            administration and claims processing, and greater bargaining
            power with health care providers.
repnme: repnme: Reforming health care : a case for stay
            well health insurance
display_title: Reforming health care : a case for
            stay well health insurance
listing_relative_url: /research/1993/09/698863/reforming-health-care-case-stay-well-health-insurance
topicv3: Human Resources m1326304 1211,Inflation m1326709 0870F4727ACED1CF8525815C00471347,Trade m1326924 698,Health Insurance m1327759 1287,Health m1504661 3480
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Health, Nutrition and Population
origu: Europe and Central Asia: Country Department I
no_of_pages: 23
model_extractions: **Pollay Rhwo**

# **Country Operations**

WPS 1181 This paper- a product of the Country Operations Division, Europe and Central Asia, Country Department **I -** is part of an effort in the region to strengthen the emphasis on the analysis of social sector issues. Copies of tle paper are availablM free from the World Bank, 1818 H Street NW, Washin.ton, DC 20433. Please contact Faith Smith, room H5-245, extension 36072 (September 1993, 17 pages).

All countries - whether industrial, developing, or in transition to a market economy - are interested in health care reform. A central focus of reform everywhere is to make patients more responsive to health care costs without diluting the protection offered by public or private insurance.

Conventional insurance offers customers little incentive to monitor their own use of health care services or to adopt and maintain better health habits.

Bogetic and Heffley describe an alternative health insurance structure first adopted in Mendocino County, California, in 1979, and compare it with conventional forms of insurance. The Mendocino or "stay-well" plan offers consumers direct incentives to control their use of health care services and to adopt healthier lifestyles. How well this insurance can contain health care costs depends on the size of the incentives and consumer responsiveness to them.

Conditions in some developing countries and in many countries moving to market-based economies - overuse of services, poor health - habits, and declining real incomes improves the likelihood of a favorable rtsponse to such incentives.

a general, flexible form of insurance that subsumes most conventional plans as special cases. The rewards for low use might take many forms. As in the Mendocino plarn, **die** rewards might be a credit to a retirement account, but they could just as easily be annual cash rebates or credits against out-of-pocket expenses that exceed an individual's or family's spending goal in a future period.

Administration of the stay-well plan appears not to be unduly complex. If anything, incorporating stay-well incentives in a single-payer or national health care system would be simpler than incorporating them in a self-insured fund. The success of the plan hinges on whether incentives shift the frequency distribution of health care spending by reducing unnecessary utilization in the short-run and through better health care habits, reducing long-run costs.

Despite additional payments to low usrers, the stay-well plan could be less expensive than conventional plans with similar coverage. As in any insurance plan, solvency is enhanced by larger groups, better risk-pooling, economies of scale in administration and clains processing, and grater bargaining power with health care providers.

How to structure the stay-well system depends on the country, but the stay-well plan is The Policy Research Working Paper Series disseminatew the fndings of work under way in **the** Bank. Anobjectiveof the series is to **get** these findings out quickly, even if presentations **mre** less than fully polished. The findings, interpretations, **sno** conclusions in **these** papers do not necessarily represen. official Bank policy.

Produced by the Policy Research Dissemination Center
# Reforming Health **_Care:_**

A Case for Stay-Well Health Insurance v by Zeljko Bogetic and Dennis Heffley* Country Operations Division Department I Europe and Central Asia Zeljko Bogetic is a country economist, Europe and Central Asia, Country Department I, World Bank. Dennis Heffley is a professor of economics at the University of Connecticut. The authors gratefully acknowledge thorough and constructive comments from Alexander Preker, World Bank.
# TABLE OF CONTENTS

||Section||
|---|---|---|
|1.|Background.|1 -3|
|II.|A Recurrent Question: How Can Patients Be Made More<br>Responsive to the Cost of Health Care Without Reducing<br>Insurance Protection?|3 -5|
|III.|Properties of Conventional Health Insurance.|_5_- 6|
|IV.|An Innovative Form of Health Insumnce: The Mendocino<br>or Stay-Well Plan.|6- 9|
|V.|Extending the Stay-Well Concept to a National Health<br>Care System.|9 - 12|
|VI.|Concluding Remarks.|12 - 13|
||References.|14 -_15_|

Figure 1: Conventional Insumance Plans.

Figure 2: The Stay-Well Plan.
**REFORMING HEALTH CARE**

# 7,eljko Bogetic and Dennis Heffleyl

# **I. BACKGROUND.**

'There is a pervasive feeling of imminent crisis with respect to the delivery of medical services in the United States. Expenditures on medical care ae rising without any offsetting decline in our mortality rates -- which compare poorly wvith tho " of many other countries. The costs of medical caro am increasing at an accelerating rate. Many big-city hospitals, which service the poor, are in a state of financial distress. Medicare and Medicaid, the programs developed to enable the disad-antaged to obtain medical care, set off the cwrent price spiral by creating a iapid increase in the demand for medical services while the supply of those ser-ices could be incmased only slowly. The middle class now finds it difficult to obtain the kind of medical care it has conwe to expe:t, namely that of an interested, warm physician who is familiar with the family history. There is a perceived over-all sho.tage of nurses and physicians. Moreever, many concerned individuals believe that the existing physicians are not distributed well. Th;y argue that there are relatively too few primary physicians and too many specialists, too few physicians in the inner cities and in rural areas, and too _miany_ in the affluent suburbs.' (Lave and LAve, 1970; pp.253-254).

Much attention is being given to possible health care reforms in the UJnited States<sup>2</sup> The preceding description of problems, written more than two decades ago, sug-. sts that the problerms of the health care system are not new. Nor are the problems unique to the United States. Efforts to rethink and reform health care systems are widespread in other developed countries, Eastern Europe, and less developed countries in general.<sup>3</sup>

1. Zeljko Bogetic is a Country Economist, Europe and Central Asia Region, Country Department 1, The World Bank. Dennis Heffley is a Professor of Economics at The University of Connecticut. The views expressed in this paper are the authors' and should not be construed as official views of their respective institutions. We gratefully acknowledge thorough and constructive comments from Alexander S. Preker, The World Bank.

2. Health care reform has emerged as a critical element of the Clinton agenda, but even the previous administration's economic advisors had come to view reform as an important issue. See Chapter 4 ('Tlhe Economics of Health Care') of the January 1993 _Economic Report of the President_ for a thorough overview of the issues and a discussion of various reform proposals.

3. Health has been selected as the primary focus of the 1993 _World Dwvelopment Report,_ reflecting the concen **jf** The World Bank ard other international agencies for improving health care in developing countries and ber understanding the role of health in rtimulating economic development. In a survey of the link between health and development and the contribution of health research, Birdsall (1990) identifies 'Analysis of altemnative financing
2 Escalating expenditures and lack of universal insurance are the focal points of American health care reform, while in Britain, where expenditures are substantially lower and services are available to all, the length of queues, quality of services, and internal misallocation of medical resources have driven reform efforts. Many Eastern European nations face the dilemma of trying to maintain universal access to health care services in the face of sharp de lines in public sector revenues associated with general economic reforms. The health care systems in these transitional economies often suffer from overstaffing, unnecessanly large physical facilities with inadequate medical equipment, and overutilization of services.<sup>4</sup> Health care reform in the LDCs is focused more cn the fundamental problerns of inadequate medical resources (providers, facilities, equipment and supplies), the geographic distribution of these resources, and the failure of financing mechanisms to instill providers and patients with adequate concern for the cost of care. Between and wit-iin these blocks of countries there clcarly are differences in the urgency, nature, and scope of health care reform efforts. Yet common elements do exist, and lessons learned Di one context may help to solve related problems in other settings. This, of course, is why current U.S. health care reform efforts are being monitored closely by other countries and international agencies such as The World Bank.

In addition to common concerns about how to finance and control rising health ca;e expenditures,<sup>5</sup> many countries face similar problems in encouraging healthier lifestyles that would reduce the need for medical intervention. While some developed countries report significant reductions in per capita consumption of tobacco and distilled spirits,<sup>6</sup> personal health habits remain poor in many areas, including Central and Eastern Euwope. For example, a recent review of Bulgaria's publir sector notes that: "Indicators of the health of the population in Bulgaria show an overall pattern that compares unfavorably with W- 2em Europe but is typical of the countries in anXtral and Eastern Europe." The report further notes that "...the main source of differences in life expectancy between Bulgaria and other countries is in diseases of the circulatory system, with nechanisms for health care, and alternative mechanisms for controlling costs' as a key area of potentially fruitful research.

4. For a detailed discussion of the problems and prospects for health care reform in these countries, see Preker and Feachem (1993).

5. Korea, for example, ' experienced very rapid increases in health expenditures. In the 1980-1985 period, real health expenditure. grew at an annual rate of almost 17 percent, of which 15.4 percent was attributable to rising utilization and intensit , only 1.4 percent of the increase was due to demographic factors. Overutilization appears to be a significant problem in Korea, despite considerable 'out-of-pocket' fmincing (51 percent in 198S). For further details of the Korean experience, see De Geyndt (1991).

6. See, for example, Tables No.201 (p.123) and No.209 (p.127) of the _Statistical Abstract of the United Star_ (1991).
3 particularly hi"h levels of stroke." (The World Bank, 1993a; eh. 6). In Hungary, where mortality rates are among the highest in the world, "...expenditures have not secured large gains in health standards, primarily because of unhealthy lifestyles and a bias toward curative hospital care." (Preker, 1993; p.4). Similarly, in a recent World Bank study of Romania, it was noted that morbidity patterns reflect "...(a) poor individual preventive health measures; (b) unhealthy behavior patterns (i.e., smoking)..." and that "circulatory diseases are the most impottant cause of death and disability, and account for 10 percent of hospitalizations.(The World Bank, 1992, p.107). Similar patterns exist in other Eastern European countries, but the incidence of behaviorally-induced diseases is also high in some Latin American countries. These problems have contributed to rising utilization rates and the escalation of health care costs, causing a number of countries (e.g., Chile, Costa Rica, and Brazil) to embark on major hea)th reforms.<sup>7</sup> The purpose of this paper is not to discuss U.S. health care reform, about which much has been written, but rather to describe an innovative, more flexible, and more general form of health insurance that has been owerlooked in current discussions of reform. Some ideas about how this type of insurance might be adapted to a broad range of health care systems, regardless of whether insurance is privately or publicly funded, also will be given. The remainder of the paper is organized as follows. Section II describes a fundamental problem in most health insurance arrangements and poses a question that is central to the success or failure of proposed reforms. Properties of conventional health insurance are described in Section m, while Section IV outlines the essential features of an innovative plan that has operated successfully in one California county school system for more than a decadc. Adaptation of this plan to national health care systems is discussed in Section V, and some final remarks are offered in Section VI.

- **II.** A RECURRENT QUESTION: HOW CAN PATIENTS BE MADE MORE RESPONSIVE TO THE COST OF HEALTH CARE WITHOUT REDUCING INSURANCE PROTECTION?

To ensure greater access to services and reduce the risk of financial loss from illness, many health care systems have severed the link between the utilization and financing of health clre services. This severance occurs in systems of socially provided care, as in Britain, as well as in systems where government serves only as the principal insurer, such as Canada. In both cases, health care services ultimately are financed through general tax revenues rather than direct user charges. Under both arrangt .nents, effective prices at the time of utilization are negligible. The consumer is insulated from risk but also becomes less aware of the true social cost of providing health care. The fiully insure, consume; may have less incentive to undertake personal 7. See _World Development Report_ (1993b), chapters 3 and 7.
4 activities that reduce the need for medIical care. Both responses -- more utilization of covered services and less risk avoidance -- have been desc-4hed as 'moral hazard," the tendency for consumers to behave differently when insured.<sup>8</sup> Because of these moral hazard effects, insurance increases the demand for medical services.<sup>9</sup> If the supply of services cannot satisfy the demand forthcoming at a near-zero price, some form of non-price rationing must be adopted or inevitably will emerge.

Even in the U.S. health care system, where the private sector has played a more important role in insuring consumers and providing health care, the introduction of major public insurance programs (Medicare and Medicaid) and the spread of private insurance, especially through the workplace,<sup>10</sup> have expanded the demand for care, raised concerns about moral hazard and socially inefficient levels of utilization, and stimulated the search for offective ways to control utilization and costs. These cost containment approaches include greatsr 'cost-sharing" (highez coinsurance rates), various forms of utilization review under the rubric of "managed care,' ana the introduction of ""lternative delivery systems' (e.g., health maintenance rganizations or HMOs) that are thought to have stronger incentives or more effective ways to contxol utilization. However, any such effort to raise coinsurance rates or to limit access to services often is perceived by consumers as a benefit reduction and loss of insurance protection.'<sup>1</sup> Indeed, the natural 8. Pauly (1968) generally is credited with explaining the economic incentives underlying the moral hazard problem. While moral hazard has been extensively discussed within the context of private health insurance plas, the same problem plagues public health insuance systems. For example, moral hazard appears to be a particularly acute problem in Easter. Europe. For an overview of the problem in the Bulgarian health care system, which is quite similar to those of other Eastem European co..utries, see The World Bank (1993a), Ch. 6.

9. If the agency relationship between consumers and providers of health care extends beyond medical decisions to include financial interests, providers also may exhibit a form of moral hazard by recommending services to insured patients that would not be recommended to uainsured patients. We focus on the problem of structuring insurance to give consumers appropriate incentives, but the problem of structuring provider reimbursement- to induce costeffective forms of health care also merits attention.

10. In 1960, consumers directly paid 55.9 percent of U.S. personal health care expenditures. By 1990, this figure had declined to 23.3 percent [see Levit _et aL_ (1991), p.50]. This average coinsurance rate for the entire population may understate the degree of insurance coverage among _insured_ individuals, since approximately 35 million Americans have no insurance _[Eonomic Report of the President_ (1993), p. 1<sup>3</sup> 4].

11. Beyond the problem of consumer resistance to cost-sharing, there is considerable debate about the effectivwess of higher coinsurance rates or copayments on utilization and expenditures. The Rand Health lsurance Study is viewed as one of the most comprehensive attempts to evaluate the effects sf cost-sharing on utiliz..ion, expenditures and L.alth status. Rand researchers conclude that "...the response to cost-sharing is nontrivial.' [Manning _et aL_ (1987)1. Implied price elasticities of demand in the Rand study are roughly -.2, but such estimates vary across
_5_ resistance by consurners to such changes has been an obstacle to meaningful health care reform in the U.S. and elsewhere. The success of reform efforts in many settings .nay well hinge on one central quesdon: _Can wefind more positive ways to encourage the rational use of health care - ways that reward healthy lifestyles and pndent consumption of health care services -- without substantially reducing thefinancial -rotection offered by he -'th insurance?_ Finding aii answer to this question may require fundamental change3 in the stin'iture of public and private health insurance.

# III. PROPERTIFS OF CONVENTIONAL HEALTH INSURANCE.

Consumers derive proit-ztion from health insurance by knowing that when expenses are incurred they will not have to pay the full amount out-of-pocket. Indeed, under full insurance (zero coinsurance, c = 0), common in mary public insurance programs, out-of-pocket expense (E1 ) is zero regardless of the full expense (E). In some public programs and most private insurance plans, some fraction of the total expense (c < 1) must be paid by the patient. The larger the coinsurance rate, the less the insurance protection. For each of these conventional types of insurance, full coverage and partial coverage, the relationship between out-of-pocket expense and total expense is shown in Figure 1.

# [FIGURE 1]

In the absence of insurance xc = 1), out-of-pocket expense equals the _full_ expense, as depicted by the 45 degree line in Figure 1. Under partial insurance plans, E. rises with increases in E, but the lower the coinsurance rate (c), the less the increase in E will be felt by the consumer. Under full coverage, Eo is always zero and the consumer is entirely insulated from the full cost c' care. Thus, conventional insurance, particularly full coverage, reduces the financial risk associated with illness, but also diminishes the consumer's sensitivity to the true cost of care; this, in turn, may lead to excessive utilization and reduced personal efforts to remain healthy (i.e., moral hazard). One way to discourage unnecessary utilization in convendonal insurance plans is to impose a deductible, where coverage only begins after the consumer has expended a specified different types of services and may be sensitive to the unusual insurance structure used in the experiment. In general, one would expect cost-sharing to be most effective in containing utilization of elective or non-emergency medical services, but the effectiveness of cost-sharing is asso likely to vary with existing levels of price, coinsurance, income and other factors that influence the demand for medical services. For a thorough review of the demand-side literatue, see Chapter 3 of Rosko and Broyles (1988).
6 initdil amount (Ed) on health care.<sup>12</sup> In Figure 1, this case is depicted by the kinked relationship between Eo and E Note that any increase in the coinsurance rate or the deductible level will be viewed by the consumer as a reduction in insurance benefits.

A general problem withl most conventional forms of insurance is that low utilization by consumers goes unrewarded. In partial or full covtrage plans, low utilizers may be reassured by the fact that, if the need arises, a portion or even the full cost of care will be paid by the insurer. But invariably there may be a strong feeling that benefits of the insurance are "lost' if no medical services are consumed. Thwre typically is no way to convert this foregone insurance benefit to some oither form of reward. Apart from the psychic security of knowing he or she is insured, there is no way for the insured person to benefit from conventional forms of coverage unless services are utilized. This lack of reward for low utilization encourages unnecessary use of the systein.

A second, related problem in conventional insurance plans is the lack of direct incentives for consu-ners to adopt healthier lifestyles. Although some private pl'ans offer lower premiums to non-smokers, non-obese, or other groups who exhibit lower health risks, once an individual is enrolled in such plaus there is little, if any, reward for maintaining or further improving personal healtt. habits. The significance of this second flaw in the structure of conventional i urance grows as we acquire additional empirical evidence that lifestyle strongly influences the incidence of major diseases and the cost of health care.<sup>13</sup>

# **IV.** AN INNOVATIVE FORM OF HEALTH INSURANCE: THE MENDOCINO OR STAY-WELL PLAN.

Health insurance markets in the U.S. have changed significantly in the past decade or two. Of particular note are insurers' efforts to monitor and control costs in more direct ways. Ilese efforts, among others, include: the introduction of requirements for second opinions by physicians or pre-approval by the insurer for certain types of treatment; consolidation of health insurance and health care provision in the form of prepaid HMOs; and direct bargaining by the insurer for service fee discounts from a specific group of providers (preferred provider organizations or PPOs). Since the 1980s also has been a period of unprecedented increase in U.S. health care expenditures, 12. One problem with imposing a deductible is that it is properly viewed by the consumer as a reduction in insurance protection; the insured is now fully exposed for the first Ed dollars of expenswe. Hospital expenses are often subject to an initial deductible with additional expenses fully covered. In Figure 1, this insurance structure would appear as a kinked relationship following the 45 degree line to Ed and then becoming honizontal for E > Ed. 13. For a detailed analysis of the social cozts of poor health habits, see Manning _ei al._ (1991).
7 there is little _primafacie_ evidence that these structural chan-cs have helped to contain outlays on health care.<sup>14</sup> This lack of apparernt success in cortrolling U.S. health care costs may reflect the fact that, even in prepaid plans, the fundamnental problemns of health ins.rance, cited earlier, have not been addressed. For example, once enrolled, the HMO or PPO member faces zero o. very small copayments and has little incentive to control utilizatio:n; thus low utilization remains unrewarded. S;milarly, the near complete coverage in preEaid plans provides little incentive or personal changes in lifestyle that might reduce the need ior servicoes. Unfortunately, popular reform proposals do little more to alter the basic _structure_ of heath insurance. Health insurance may be extended to a larger percentage of the populaffon to reduce the problem of 'uninsureds," but the structure of the insurance is apt to look mnuch like one of the couventional forms of insurarce depicted abcvc in Figure 1. Alternatives, however, do exist.

The plan of interest is one that originated ir California in 1979. In the late 1970s, California local and county governments were seeking ways to bring their costs into line with state-wide limitations on property-tax revenues. As a result, education officials in Mendocino County devised an innovative health insurance plan for their employees. The plan, which remains solvent and in effect today, provided incentives to limit unnecessary utilization and to adopt healthier lifestyles, without sacrificing relatively complete coverage.

Before the stay-well plan was introduced, Mendocino County school employeer had enjoyed 'first-dollar coverage" which, in 1979, cost about $1260 per employee per year. The County terminated this plan and signed a new contract with Blue Shield of California, a non-profit insurer. Tlhe new contract called for a lower-premium ($780 per employee per year) policy with a $500 deductible. The savings ($480 per employee) were set aside by the County in an interestbearing, self-insurance fund that would be used to pay the first $500 of any employee's annual medical bills. Total annual chorges in excess of $500 were to be paid by the new Blue S"..eld policy. Thus, from the employee's perspective, he or she still enjoyed complete coverage. 'Tiis was an important aspect in eliciting employee acceptance of the new plan.

The most interesting and innovative component of the Mendocino Plan was a further stipulation that any portion of the $500 in the self-insurance fund not used by an employee during the year would accrue in his or her name and be paid to the employee upun quitting or retiring from 14. Barth and Heffley (1992) give an overview and analys.s of health care policy, receot expenditure paterns, and reform proposals. A more technical analysis of the potentially adverse effects of HMOs on health care prices is given by Beaaglou and Heffley (forthcoming).
8 County service. For example, an employee with only $200 in claims during the year would not only have those claims paid by the self-insurance fund, but would receive a future bonus of $300 (plus any other accumulated amounts) at the time of separation. This inceitive component of the plan, similar to the "no claims bonus" found in some auto insurance policies, directly rewarded the employee for not overutilizing health care, but it also provided some incentive to adopt healthier lifestyles that might reduce the need for medical care. In addition to significantly reducing claims,<sup>15</sup> the rAay-well plan reportedly prompted a number of employees to increase their exercise, lose weight, quit smoking, reduce alcohol intake, etc. These, of course, are precisly the types of responses we would like a health insurance plan to evoke, yet conventional full-coverage plans are likely to _reduce_ the insured party's incentive to adopt hea!th-preseving habits.

Thc employer (M.-ndocino County) appears to have been very satisfied with this plan. The new, lower premiums were stabilized due tw the favorable claims performance of the group and, although sorie of the premium savings placed in the self-insurance fund were paid out to r,meet the first $500 of each employee's claims, not all of the funds were used, and the interest generated by the fund was retained by the employer.

Employees, too, benefitted. Despite some initial resistance of employee groups who feared a reduction in benefits, it soon became obvious that workers were truy better uff. Effective firstdollar coverage was preservec for high-utiliL_rs, since the first $500 in claims were covered by the self-insurance fund and excess claims were covered by Blue Shield. Moreover, low-utilizers now had something that they had not enjoyed under the previous conventional plan. If a worker's total Oaims on the self-insurance fune were less than $500, the 'unused" portion of this self-insurance was converted to a future cash benefit for the employee. This reward for lcw utilization did not exist under the previous conventional insurance plan.

The Mendocino or stay-well plan received a good deal of national at.ention in the early 1980s,16 and a few other employers adopted similar plans. Yet, despite Mendocino County's apparent success and sat.faction with the plan, it has not been implemented on a much larger scale in the U.S.<sup>17</sup> This may well be due to resistance from insurers to any plan that significantly reduces premium cash flow. For many insurers, investment income from the premium flow, as 15. Conway (1980) reports that only 38 of the 2i$ persons initially enrolled in the plan exceeded the $500 figure and therefore received no bonus. Each of the remaining 180 persons' had claims of less than $500 and received a bonus, including 66 who received the naximum bonus of $500 for baving no claims.

16. See, for example, Conway (1980), _Newsweek_ (1980), and _lTm_ (1980).

17. Zweifel (1988) describes a premium rebate scheme offered by some private health insurers in Germany. Empirical results te-nd to confurm that the plan contains costs more effectively than simple increases in coinsurance rates.
9 opposed to net income from selling and servicing policies, is<sup>a major source of final profit. Any</sup> private insurance reform that reduces the premium flow is likely to be opposed<sup>by insurers.</sup> There have been concerns about the Mendocino plan. Critics, for example, worried about the possibility of truly sick employees foregoing needed care, resulting in poorer health and<sup>larger</sup> outlays in the future. Mendocino County and Blue Shield tried to minimize the possibility of<sup>such</sup> a response by issuing a brochure that encouraged members of the plan to be sensible<sup>about seeking</sup> ,re and alerted them to various symptoms that should not be ignored. It is also likely, that<sup>at least</sup> some of the reported reduction in claims was due to shifting of claims to<sup>other policies by</sup> employees with dual coverage under a spouse's health care plan. Yet,<sup>in a market setting, even</sup> this response could be beneficial: the adoption of a stay-well incentive by some insurers<sup>might</sup> force other insurers to adopt similar provisions to avoid the adverse effects<sup>of claims shiftirg.</sup> More recently, concerns also have emerged about the declining real incentives; the $500 maximum bonus for zero utilization has not been increased since the plan began. Measured<sup>in 1980 dollars,</sup> the maximum bonus has decreased from $500 to $293 due to the effects of general<sup>inflation. Even</sup> more rapid inflation in medical care prices also has made it increasingly<sup>difficult for members of the</sup> plan to qualify for a bonus. These problems, which are readily overcome by appropriate<sup>indexing</sup> of the plan, have weakened but apparently not eliminated the initial incentives<sup>embodied in the</sup> stay-well plan.

The stay-well approach adopted in Mendocino County seems to have a number of<sup>attactive</sup> features including: the preservation of rather complete coverage; direct incentives<sup>for individuals to</sup> monitor their utilization without heavy-handed forms of managed care, since the<sup>implicit price of an</sup> unnecessary visit or procedure is a smaller future reward; incentives to adopt<sup>healthier lifestyles; an</sup> opportunity for low-utilizers and those with healthy lifestyles to convert unused<sup>portions of their</sup> health insurance into cash benefits; and potentially a lower overall outlay on<sup>health care for the</sup> insured group.

# V. EXTENDING THE STAY-WELL CONCEPT TO A NATIONAL HEALTH CARE SYSTEM.

In order to see how the the stay-well incentive might be applied to a<sup>national health care</sup> system, as opposed to a particular group of workers, it is important to understand<sup>how this plan</sup> differs in structure from the conventional forms of insurance depicted in Figure 1. The stay-well plan contains three important parameters: (1) a goal expenditure level (per<sup>individual or household)</sup> which may be denoted Eg; (2) a rate of reward, denoted r, for individuals or households<sup>with</sup>
10 health care expenditures less than Eg; and (3) a rate of coinsurance, denoted c, for total expenditures in excess of E. Figure 2 illustrates the relationship between out-of-pocket expense and the full cost of health care for a hypothetical stay-well plan.

# [FIGURE 21

Note that when expenditures are less than the goal (E < Eg), out-of-pocket expense is _negative,_ reflecting the potential reward to low utilizers. Here, where r = 1, the insuired receives the entire difference between Eg and E. There is no reason why this value (r = 1) would be optimal, but the smaller the reward parameter, the weaker the incentive to remain healthy and to avoid unnecessary utilization. When full cost exceeds the goal (E > Eg), the coinsurance parameter (c) determines the portion of the excess cost that must be borne by the insured. In Figure 2, c is depicted as a fraction; full coverage would require a zero coinsurance rate. As in any insurance plan, the problem faced by the insurer is how to structure the plan or, here, how to select Eg, r, and c to achieve certain objectives. For commercial insurers, profitability, or at least actuarial soundness, may be the overriding objective; for public insurers the objective(s) may be more complex, reflecting concerns for the overal! cost of the plan, its effects on particular groups of consumers and providers, and its impacts on measures of health status. Given the complexity of the problem, it is likely that the optimal structure will vary for different systems. However, if utilization and health habits are at all sensitive to financial incentives, there is a case for this type of insurance in a varety of institutional settings.'<sup>8</sup> Although we cannot say much about precisely how to structure such a plan in a given country without a good deal more country-specific information, several aspects of this plan are noteworthy. First, the stay-well plan is a _more general and more flexible_ form of insurance, subsuming most ccnventional plans as special cases. For example, if Eg is set to zero and c c 1, we have conventional partial coverage. Similarly, if Eg = Ed, r = 1, c < 1, and the insured is required to pay a lump-sum "tax' equal to rEg, regardless of the full expense for that individual, the stay-well structure in Figure 2 is shifted up so that it becomes equivalent to the conventional deductible plan shown in Figure 1.

Second, the rewards for low utilization might take a variety of forms. As in the Mendocino plan, th . rewards might constitute a credit to a retirement account, but they could just as easily be annual cash rebates, or credits against out-of-pocket expenses that might be incurred if the 18. Thbe plan may be particularly relevant to the Eastern European setting, where utilization is high, behaviorally induced diseases are common, and declining real incomes **might** cause individuals to respond favorably to new financial incentives to reduce utilization and modify uihealthy behavios
11

# individual or family exceeds the expenditure goal (Eg) in a future period.

Third, administration of the stay-well plan does not appear to be unduly complex. In Mendocino, where initial expenditures (E < Eg) are paid by the employer from a self-insurance fund and subsequent outlays (E > Eg) are covered by the insurer, processing and coordination of claims is done through a local medical foundation. If anything, incorporation of a stay-well incentive in a single-payer or national health care system would be somewhat simpler. Insurance records of participants would need to contain information about the depletion (if any) of their potential reward, based on expenditures to date. At the end of the accounting period, these records would be used to issue reward checks or to credit the individual in some other fashion.

Fourth, success of the stay-well plan in reducing overall costs to the system hinges on the capacity of the incentive to shift the frequency distribution of health care spending. The purpose of the stay-well incentive is to reduce unnecessary utilization in the short-run and, in the long-run, to further reduce the need for care by stimulating better health habits. If utilization and personal habits are sufficiently responsive to such incentives, the plan may reduce overall system costs.<sup>19</sup> Fifth, financial solvency of the plan requires that revenues from various sources (premiums paid by individuals and/or employers, government subsidies, and income from any initial endowments) be sufficient to cover not only the insured portion of charges for high utilizers (E > Eg), but also the insured charges and _rewards_ for low utilizers (E < Eg), as well as any administrative costs and allowed profits. Again, the plan has a better chance of remaining independently solvent (i.e., not dependent on external subsidies) if parficipants' demand for health care and their willingness to adopt better health habits are sufficiently responsive to financial incentives. It should be emphasized that, despite the additional payments to low utilizers, the stay19. One might argue that hospital expenditures, which typically account for a significant proportion of total health care expenditures, will be less affected by the stay-well incentive. First, the demand for hospital care will be less responsive to financial incentives than other, less expensive types of services (e.g., routine office visits or examrs). Second, the power of the stay-well incentive hinges on the size of the reward; the lower the reward, the lower the power to affect excessive utilization and , particularly, to reduce the use of costly hospital services. We would argue, however, that this is essentially an empirical question that crucially depends on the expenditure distribution, demographic factors, and lifestyle characteristics of the population. Relationships between these features of the population and their responses (both utilization and health habits) to financial incentives would need to be studied befoe a large-scale stay-well plan is introduced (see the Section VI for some thoughts on this matter). If, however, poor lifestyle is .n important contributor to illnesses or diseases that ultimately require hospitalization, or if a portion of inappropriate' hospitalization is initiated by routine physician visits, even relatively modest incentives provided by the stay-well plan might be effective in reducing hospital costs, particularly in the long run.
12 well plan is potentially less expensive than conventional plans with comparable coverage. If the incentive causes consumers to reduce utilization, search for less expensive providers, and adopt better health habits, and if these responses also reduce the frequency of claims and administrative costs, the stay-well plan may lower overall costs. Also, as in ary insurance plan, solvency is enhanced by group size, due to better risk-pooling (less exposure to "large loss" effects), potential economies of scale in administrative costs and claims processing, and greater birgaining power for the insurer in exacting favorable terms from providers of medical care.

Finally, the stay-well plan has certain intergenerational implications. For example, younger participants, with better immunological and health characteristics, could be the main beneficiaries of the plan's financial incentives if a single expenditure goal (Eg) is established. This problem could be addressed by scaling the expenditure goal to age or other relevant characteristics, thereby giving a broader range of opportunities for individuals to benefit from reduced utilization and improved health habits. Such modifications could increase administrative costs, but increasing the number of parameters of the insurance plan also might reduce medical expenditures by allowing administrators to better "fit" the plan to characteristics and responses of the population. It also should be pointed out that, even if they cannot cannot directly benefit from the financial incentive, 'inherently high utilizers' may enjoy lower out-of-pocket costs if savings induced by the stay-weU incentive can be used to provide more complete insurance coverage (lower coinsurance rates).

# VI. CONCLUDING REMARKS.

The fundamental dilemma facing health care reformers in many different settings is the conflict between expanding or maintaining access to health care and controlling health care costs. Under conventional insurance, attempts to remove financial barriers to care by lowering coinsurance rates or extending existing coverage to the uninsurel tend to increase demand for care, forcing up utilization and prices in a market setting or increasing the need for rationing in a nonmarket system. This increased demand stems frorn the lower (perhaps zero) out-of-pocket cost to consumers, as well as the reduced incentive for consumers to avoid health problems. It follows that one way to increase access without necessarily increasing health care costs is to alter the structure of insurance to provide stronger incentives for well-protected consumers to adopt healthier lifestyles and to avoid unnecessary utilization.

The stay-well plan is a simple, yet more general, form of insurance that rewards lower util,zation of health care services and encourages positive health habits. Mendocino County's thirteen years of experience with this type of plan suggest that it may be a useful way of balancing
13 the objectives of cost containment and comprehensive insurance protection. Why this type of insurance has not spread or come to the forefront in current discussions of health care reform is unclear. Private insurers may simply lack the incentive to develop or accept innovations in the structure of insurance that would lead to lower premiums.<sup>20</sup> To our knowledge the plan has not been implemented in a public health care system, but the structure of the plan is general enough to allow it to be adapted to a wide variety of health care systems.

Further study of the stay-well plan is clearly needed. Much of the information about the response of consumers to this incentive-based plan is anecdotal in nature. Existing plans ought to be studied more closely, but such plans appear to be scarce and the study of any existing plan is subject to questions about the representativeness of the sample. An alternative approach to acquiring more informnation about the feasibility and effectiveness of stay-well insurance might be the establishment of demonstration projects, in which individuals or families are randomly assigned to either stay-well or conventional insurance plans. Establishing sufficiently large samples and using multivariate techniques to control for personal or demographic characteristics that might also influence behavior, the effects of the difference in insurance structure could be estimated. Given the policy importance that has been attached to health care reforn, the cost of operating such projects mnight be small relative to the potential payoff.

There are no easy solutions to the fundamental question posed in Section II, regarding the difficulty of insilling consumers with appropriate incentives without significantly reducing the protection affordad by health insurance. Insured consumers have economic incentives to be less careful about their health habits and to consume even those services that do relatively little to maintain or improve health. The more comprehensive the coverage, the stronger these adverse incentives will be. The stay-well plan provides a countervailing incentive for even fully insured persons to monitor their own health habits and to avoid unnecessary udlization. We believe that some additional incentive of this type is needed to obtain the desired balance between the social objectives of insurance protection and health care cost containmenL There may be other forms of insurance that would achieve this balance as well or even more effectively than the stay-well plan. What seems clear is that conventional insurance has failed in this regard and, if we are to resolve the whealth care crisis," we need to think much more creatively ab(ut the _strture_ of insurance and the signals it conveys to consumers and health care providers.

20. The stay-weU plan was accepted by the insurer, Blue Shield of California, but was designod by Ed Nickaeman, an Assistant Superintendent of Schools in Mendocino County.