on institutional services in hospitals and nursing homes, because these were the major sources of expenditure, and did little to control the capital expenditures of community-based physicians or clinics. The resulting growth in the availability of high-technology facilities outside hospitals is one of the reasons that recent reductions in inpatient utilization have been offset by increased outpatient costs. (Some States are now applying uniform rules across settings.)

Moreover, a community's needs may change unpredictably. New York was more successful than most States in controlling inpatient bed supply; it was one of the few States in which hospital closures occurred on a planned basis. While the number of community hospital beds nationally dropped 1.1 percent between 1977 and 1987, the number in New York dropped 9.9 percent. 24 New demands on these facilities in the 1980s, such as the appearance of AIDS (acquired immune deficiency syndrome) and the rise in drug-related problems, have led to serious overcrowding in some New York hospitals. The reported crisis in New York illustrates one of the potential constraints on the planning process. On the one hand, it may be necessary to maintain enough excess capacity to meet unforeseen needs or random fluctuations in demand. On the other hand, this excess capacity is costly to maintain and may itself generate demand. If the supply of a given kind of service is sufficient that no one ever has to stand in line for it, then the savings from health planning may be limited.

The fullest potential savings from health planning would require a more controversial step: limiting the supply of health resources to the point at which patients may have to wait for some period to obtain needed but non-emergency services. The result is "queueing," the delays in surgery or high-cost diagnostic procedures that are alleged to occur to some extent in Canada and to a greater extent in the United Kingdom. The degree to which queueing actually occurs in either country's health system has often been debated by those who favor or oppose adoption of a similar system here. Some people say that essential care may be unavailable, while others argue that resource limits merely oblige providers to set priorities and avoid unnecessary services.

Whatever the extent to which resources have been limited elsewhere, rationing of supply in the United States might raise concerns that are not as significant in countries where the entire population participates in a single insurance program. In those countries, everyone is in the same queue, and one's place in line is chiefly determined by the urgency or duration of

24 American Hospital Association, Hospital Statistics, 1978 and 1988 editions.

one's need. (There are exceptions: one can step out of line in the United Kingdom by finding a private provider, and there are anecdotal accounts that some Canadians with sufficient resources may seek care in the United States.) When queueing has occurred in the United States, however, places in line may have been determined by financial resources.

The facilities in New York reporting the greatest overcrowding have been those serving the poor and the uninsured. Similar effects may have resulted from health planning's major success, the control of nursing home bed supply. Because Medicaid payment is generally less than that available from private patients, nursing homes in areas with limited bed supply and high occupancy rates have an incentive to accept a private-pay patient when a vacancy occurs, while Medicaid beneficiaries may be unable to find a place. In 28 States, Medicaid administrators report that beneficiaries awaiting hospital discharge had difficulty finding a nursing home bed.25 While supply constraints are not the only factors limiting access to care for low-income Americans, they may exacerbate existing problems. The acceptability of health planning as a cost control strategy may, then, depend in part on the extent to which supply limitations are accompanied by efforts to make distribution of limited resources more equitatie.

One other issue should be raised in the context of a discussion of health resources: the debate over the possible oversupply of physicians and the potential consequences of physician supply on health care costs. In 1980, the Graduate Medical Education National Advisory Committee (GMENAC) reported that the United States would have a surplus of 150,000 physicians by the year 2000.26 The extent of the potential surplus has since been the subject of continuing debate. There are questions about the extent to which technology and the aging of the population could increase demand, or the adoption of utilization controls or managed care could decrease it. The number of medical school admissions could decline, or physicians might spend more of their time on administrative activities and less on patient care.2

27

25 For a fuller discussion of this problem, see U.S. Library of Congress, Congressional Research Service, Medicaid Source Book: Background Data and Analysis. Report prepared for the House Committee on Energy and Com merce (Committee print 100-AA) (Washington, D.C.: November 1988), 467483. (Hereafter cited as Congressional Research Service, Medicaid Source Book.)

26 Graduate Medical Education National Advisory Committee, Report to the Secretary, U.S. Department of Health and Human Services (Washington, D.C.: 1980).

27 For contrasting views on these issues, see William B. Schwartz, Frank A. Sloan, and Daniel N. Mendelson, "Why There Will Be Little or No Phy. sician Surplus between Now and the Year 2000," New England Journal of Medicine 318 (14) (April 7, 1988): 892-897; Ernest P. Schloss, "Beyond GMENAC-Another Physician Shortage from 2010 to 2030?" New England Journal of Medicine 318 (14) (April 7, 1988): 920-922.

Even less clear than the extent of the future surplus is its possible effect on medical costs. Observations that per capita use of physician services increases in geographic areas with a high ratio of physicians to population have led to the hypothesis of "physicianinduced demand." Just as excess hospital bed capacity may generate more hospital stays, this theory holds that a surplus of physicians all attempting to maintain their incomes would lead-in the absence of any controls-to excess delivery of services. Repeated efforts to demonstrate this have been inconclusive. 28 It is not clear that physicians actually modify their medical practice in order to maintain a "target income." Still, if the projected surplus does in fact appear, there might be greater pressures on physicians to increase the number of services they furnish to each patient. Some people believe that it may eventually be necessary to consider reducing the supply of physicians (or curtailing their working hours).

This has actually been attempted in one Canadian province, British Columbia. A physician who wants to participate in the health program that covers all citizens of the province must have a billing account, and since 1985 the number of accounts has been limited (limits vary by specialty and geographic area). A physician who fails to obtain a billing number cannot earn a living as a physician. Critics of the system contend, however, that British Columbia is merely exporting its physician surplus to other provinces or to the United States. 29 Given the political problems health planners in the United States have experienced in trying to close hospitals, it seems unlikely that British Columbia's efforts could be reproduced here, with government regulators telling new medical school graduates to find some other profession. However, there are proposals to achieve the same goal through private means. Some of the more ambitious "managed care" agendas discussed in the final section of this report contemplate enrollment of the entire population in health maintenance organizations (HMOs) or other structured delivery systems that would match their resources to the needs of the enrolled population; this approach would potentially reduce employment opportunities for physicians. 30

28 See Louis F. Rossiter and Gail R. Wilensky, "A Reexamination of the Use of Physician Services: The Role of Physician-Initiated Demand," Inquiry 20 (2) (Summer 1983): 162-172; Kathryn M. Langwell and Lyle M. Nelson, "Physician Payment Systems: A Review of History, Alternatives and Evidence," Medical Care Review 43 (1) (Spring 1986): 5-58.

29 Morris L. Barer, "Regulating Physician Supply: The Evolution of British Columbia's Bill 41," Journal of Health Politics, Policy, and Law 13 (1) (Spring 1988): 1-25.

30 For example, Alain Enthoven has characterized the "buy right" scheme advanced by Walter McClure as requiring that "good-quality, efficient doctors prosper while others are induced to retire." Alain C. Enthoven, "Managed Competition in Health Care and the Unfinished Agenda," Health Care Financing Review, 1986 Annual Supplement, 105–119.

Reimbursement Reform

Proposals for reimbursement reform begin with the premise that traditional payment systems, under which providers receive their full costs or charges for whatever services they choose to furnish, encourage inefficiency and the delivery of unnecessary care.

The simplest type of reform is for payers to set fixed prices for defined units of service, such as a day of inpatient care or a physician office visit. However, this approach may not reduce costs if providers are able to modify the volume or nature of the services they provide to make up for the lost revenue on individual services. For this reason, the focus of reimbursement reform proposals is on developing pricing mechanisms that give providers incentives to control both volume and unit cost.

This is generally accomplished by redefining the commodity the insurer is purchasing. Instead of paying for individual units of service, the insurer makes one payment for an episode of care (as in Medicare's prospective payment system, PPS), for overall treatment of a patient during a given time. period (capitation), or for treatment of an entire population (as in Canada's global budgeting system for hospitals). These approaches may be seen as aligned on an ascending scale depending on the degree of aggregation of the unit being purchased, with per-case payment at the low end and payment for an entire patient population at the other. In all cases, however, the aim is to define in advance the total amount of resources the provider may consume in furnishing treatment to a patient or group of patients.

Per-case payment and capitation give the provider an incentive to perform more efficiently in treating individual patients, either reducing the cost of producing each unit of service or reducing the number of units furnished to each patient. These approaches may therefore be seen as alternatives to external utilization controls. Global budgeting defines the total resources available for treating all patients, and may be seen as an alternative to health planning.31 Reimbursement controls have the same goals as direct regulation of medical practice and supply, but shift the responsibility for decision-making from the third-party payer or the government to the actual providers of care. In order to live within the established rates or budgets, the providers must be self-regulating; they must make

31 In practice, the Canadian system uses both global budgeting and health planning. However, some of the rate regulation systems in the United States have explicitly superseded the health planning system. A facility that has obtained a certificate of need for expansion may proceed only if the rate commission approves the necessary increase in capital costs. For a discussion of the interplay of planning and rate regulation, see Brown, Common Sense Meets Implementation.

the same sorts of treatment and resource allocation decisions that would otherwise have been imposed externally.

As the Medicare program has demonstrated, it is possible for a single payer with sufficient market power to adopt such reimbursement changes on its own.32 The effects of this unilateral approach in a pluralistic system are uncertain. While some providers may be driven to improve their efficiency, others may instead respond to shortfalls in reimbursement from one payer by raising charges to other groups, those without the market power to dictate prices. The possibility of "cost-shifting" may mean that savings for one purchaser are not translated into real reductions in total system expenditures.

In a sufficiently competitive market, the providers' ability to engage in this "cost-shifting" may be limited. A hospital may face, not only payment limits under Medicare and Medicaid, but pressure from private insurers or employer groups to grant price discounts in order to be assured of an adequate market share. Characteristics other than efficiency may determine a provider's success in the face of these competing demands. For example, a suburban non-teaching hospital with few uninsured patients may be at a relative advantage as compared to a center city teaching facility with a heavy uncompensated care load. Individual purchasers who reduce their costs by favoring the suburban hospital may leave the society to find some other means of subsidizing essential facilities that are handicapped in price competition.

A system in which multiple payers negotiate individually with providers may, then, lead either to costshifting or to a situation in which price concerns override other societal goals, such as medical education and charity care. For this reason, some people argue that real efficiency can be achieved only if all payers are paying under the same rules.

Uniform ratesetting is common in other industrialized nations, both those with single-payer health insurance systems (as in Canada) and those where many different entities provide insurance (as in West Germany). The experience in the United States is limited to experiments in a few States beginning in the 1970s. Federal waivers of Medicare and Medicaid rules made it possible for those two payers to participate in the programs on a demonstration basis, while State laws compelled participation by private insurers and individual payers, resulting in an "all-payer" system.

32 As the Medicaid experience has shown, adoption of payment restraints by a payer with too small a market share may reduce access for the payer's enrollees. For example, low reimbursement rates are the major reason physicians decline to participate in the Medicaid program. See Congressional Research Service, Medicaid Source Book, 448-454.

Medicaid law now permits any State to include Medicaid in such a system, and Medicare may be included if the State can show that its system controls costs as effectively as PPS. However, full "all-payer" systems continue only in Maryland and in part of New York State. Several other States operate "partial-payer" systems that include all payers except Medicare. 33 These systems have generally used the price aggregation approaches described above. That is, they either establish a rate for total treatment of a case (as under PPS) or they establish a total budget for a hospital during a year, setting prices for the hospital in such a way as to achieve a target revenue amount.

It has been shown that, in 6 States with ratesetting systems, annual increases in cost per admission were consistently 3 to 4 percentage points below the na tional average from 1976 to 1984. During the same period, however, other States saw a drop in admissions per capita, while admissions in the ratesetting States were stable. As a result, the difference in growth in per capita rates of spending was not so striking: per capita costs rose at an annual rate of 11.5 percent a year in the ratesetting States and 13 percent a year in other States. 34 In addition, the ratesetting States had much higher costs at the outset than most other States. Some observers have questioned whether ratesetting could have achieved comparable savings in areas where costs were lower to begin with. 35

Evidence from other countries with universal ratesetting systems suggests that greater savings may be possible. In Canada, where the provinces establish global budgets for each hospital, hospital expenditures per capita were one-third lower than in the United States in 1985. (Similar systems in other industrial na tions have been less successful.) 36 As admission rates are not markedly lower, there is considerable uncertainty about the sources of the difference. Some of the saving may be in administrative costs, simply because the hospitals do not need to meet the paperwork requirements of multiple payers. The rest of the difference is often attributed to differences in the intensity of the services furnished to each patient. Whether these differences reflect "underservice" in Canada or

33 Maine's system takes hospitals' Medicare revenues into account when determining what the hospitals may charge other payers, thus achieving overall budgetary control without direct Medicare participation. This ap proach has recently survived a legal challenge by hospitals.

34 Carl J. Schramm, Steven C. Renn, and Brian Biles, "New Perspectives on State Rate-Setting," Health Affairs 5 (3) (Fall 1986): 22-33.

35 Charles L. Eby and Donald R. Cohodes, "What Do We Know About Rate-Setting?" Journal of Health Politics, Policy, and Law 10 (2) (Summer 1985): 299-327.

36 Organisation for Economic Co-Operation and Development, Financing and Delivering Health Care: A Comparative Analysis of OECD Countries (OECD Social Policy Studies No. 4.) (Paris: 1987), 63.

"overservice" in the United States is the subject of continuing debate. 37

In sense, the statistical evidence may be beside the point. An all-payer system could in theory fix its prices at any level, with the potential consequence of reduced access or quality if the prices are set too low. The available data may thus be taken as indicating, not the savings that could hypothetically be achieved, but the savings that were politically feasible in specific States during a specific period. Continuing pressure by consumers and providers for the adoption of new medical technologies may limit the ability of ratesetting systems to restrain expenditure growth over the long term. Even in Canada, overall medical expenditures outpaced inflation by 2.9 percent a year in the period 1980-87, almost the same as the 3.0 percent annual rate observed in the United States in the same years. 38 The ultimate efficacy of reimbursement controls may depend, in the same way that the success of health planning depends, on the political will to constrain health care consumption.

That political will might in turn depend on perceptions of the impact of reimbursement controls on the quality of care. The effect of Medicare's prospective payment system, for example, has been argued continuously since its implementation in 1983. One of the immediate responses of hospitals to the incentives of the new system was to shorten the average length of stay in the hospital for each Medicare patient (although average length of stay had already been dropping for several years). Opponents of the new system have contended that patients were being discharged "quicker and sicker," transferred to their own homes or to nursing homes at a stage in their recovery when they still required hospital-level care. Because of a lack of satisfactory measures of medical care outcomes for large populations, evidence on this issue remains largely anecdotal. Still, the possibility that there has been a deterioration in quality of care for at least some Medicare patients since the implementation of PPS cannot be ruled out. The hospitals themselves argue that current payment levels are insufficient to maintain adequate quality. At the same time, the Administration and the Prospective Payment Assessment Commission (the independent commission that reviews PPS) have argued that hospitals are still not operating at peak efficiency and that further payment restraint is needed to provide continued incentives for cost reduction. 39

37 For a variety of views on this subject, see the series of articles on Canada's hospital system in Health Affairs 7 (5) (Winter 1988).

38 Schieber and Poullier, International Health Care Expenditure Trends: 1987.

19 U.S. Prospective Payment Assessment Commission, Report and Recommendations to the Secretary, U.S. Department of Health and Human Services (Washington, D.C.: Government Printing Office, March 1989); For a recent review of hospital cost responses to PPS, see Steven H. Sheingold, "The

This debate illustrates one potential dilemma in the strategy of achieving savings by relying on the political process to limit the financial resources available to providers. On the one hand, legislators driven by budgetary concerns may continue to ratchet down spending limits until they have clear evidence that quality has been seriously affected. On the other hand, provider or constituent pressure may lead them to relax those limits before the providers have done everything possible to improve their efficiency. Because no one knows the ideal amount to spend on medical care, some people say that this process can never achieve equilibrium and that cost control efforts should instead depend on the process through which other sectors of the economy achieve "correct" spending levels: the free market. Proposals for encouraging competition in health care represent the last of the strategies to be reviewed in this report.

Competition

The idea of reducing health care costs by promoting competition in the health care marketplace was first advanced in the 1970s. Some analysts, arguing that such initiatives as rate regulation, health planning, and utilization review had been compromised by political interference, contended that the free market was better equipped to control costs than Government was. By the early 1980s, this view had wide currency and had become the official policy of the Reagan Administration. Since then, there has been a continuing debate between advocates of competition and those who favored further regulatory interventions by Government. The debate has been complicated by a lack of agreement over what "competition" consists of. What is the health care market? Who are the purchasers, and what are they buying?

In a simple market, hospitals and physicians would compete directly for the individual consumer's dollar. The consumer would pick the best values just as he or she does when buying any other commodity. As was suggested in the discussion of cost-sharing, it is not clear that consumers are capable of making such evaluations; moreover, many purchasing decisions are made by physicians on their patients' behalf, rather than directly by consumers. Finally, because few people can afford the costs of care for a major illness, most of the consumer's dollar is spent on health insurance, not on medical care itself. As was suggested earlier, this is true even when the insurance plan imposes cost-sharing requirements on enrollees, because most health care costs are incurred by a relatively

First Three Years of PPS: Impact on Medicare Costs," Health Affairs 8 (3) (Fall 1989): 191-204.

small number of high-cost cases. For this reason, most proponents of competition are really talking about price competition among insurers, and only indirectly among providers.

If the insurer is-as traditional health insurance plans were a passive payer for services obtained by policyholders, there is little room for serious price competition. The only element of cost that the insurer can control is its own administrative cost. Competition, if any, may turn on such non-price factors as reputation or the insurer's ability to screen out highrisk applicants.40

Competition among insurers can result in real cost savings only if the insurers have some influence on the costs of health care itself. In this model, insurers compete to offer lower prices by acting as prudent purchasers, proxies for the rational consumer. The insurers are selling a new product, no longer simply insurance, but "insured health care." To some extent, this new insurance market has already arrived. As was suggested earlier, most insurance plans, both public and private, have adopted some utilization control measures. Very few insurers are still passive bill-payers.

Once all insurers have adopted these basic cost control measures, further competition would presumably require more aggressive interventions by insurers in the health care system. Proponents of competition contemplate a marketplace in which insurers develop structured delivery systems, with the highest profits going to those whose networks are most efficient. The prototype for these systems is the HMO. More recently, some insurers have been experimenting with hybrid programs, such as "point-of-service plans," that are less structured and provide somewhat greater flexibility to enrollees.

Health Maintenance Organizations-A health maintenance organization (HMO) is a form of health insurer; like any other insurer, it accepts financial responsibility for a defined set of health care benefits in return for a fixed monthly per capita premium. Unlike other insurers, HMOs directly provide or arrange for health care services, through affiliated physicians, hospitals, and other providers. The enrollees covered by the HMO agree to obtain all services, except emergency and out-of-area care, from or with the authorization of the HMO or its affiliated providers. The

40 Alain Enthoven has summarized the alternatives to price competition: "[S]election of preferred risks, market segmentation, product differentiation that raises the costs of comparing products, discontinuity in coverage, refusal to insure certain individuals or exclusion of coverage for treatment of preexisting medical conditions, biased information regarding coverage and quality, and erection of entry barriers [that is, to new competitors]." Alain C. Enthoven, "Managed Competition of Alternative Delivery Systems," Journal of Health Politics, Policy and Law 13 (2) (Summer 1988): 305-321.

HMO has no liability to pay for unauthorized nonurgent care obtained outside the organization. Ordinarily, the enrollee's point of entry into the system is through a single primary care provider, who func tions as a "gatekeeper," determining when a patient may see a specialist or be admitted to the hospital. The HMO exerts further administrative controls on use of services through authorization mechanisms and/or treatment protocols. HMOs also use a variety of other cost-saving techniques, such as negotiated discounts with providers and payment mechanisms that place individual providers at risk for the costs of the services they furnish or order.

The particular cost-saving techniques adopted by HMOS and other "managed care" plans are not fundamentally different from the regulatory approaches described in the preceding sections. An HMO imposes external utilization review on its participating providers and may develop practice guidelines or protocols. Staff or group practice model HMOs (those that employ physicians on a full-time basis) impose supply constraints, limiting available resources to those needed by their membership. Individual practice associations (IPAs, whose physicians practice in their own offices and see a mix of HMO and non-HMO patients) use payment methods that create financial incentives to control utilization, such as capitation or expendi ture targets.

One additional cost-saving approach that was once unique to HMOs is "gatekeeping." Under a gatekeeping approach, a patient receives all non-emer gency care from, or with the authorization of, a single primary care provider. The provider thus functions as a "gatekeeper," preventing the enrollee from independently accessing specialists or other services and presumably managing the overall care of the patient. The extent to which gatekeeping produces savings over and above those provided by the other costsaving techniques adopted by HMOs is uncertain. The results of one experiment, the SAFECO health plan operated by United HealthCare in the early 1980s, suggest that gatekeeping alone has little effect on overall cost. While primary care providers reduced the number of referrals to specialists, they were unable to control the behavior of the specialists once a referral had occurred. There was no meaningful reduction in hospital admissions, 70 percent of which were controlled by the specialists.41 Greater success

41

Stephen Moore, Diane Martin, and William Richardson, "Does the Pri mary-Care Gatekeeper Control the Costs of Health Care? Lessons from the SAFECO Experience," New England Journal of Medicine 309 (22) (Decem ber 1, 1983): 1400-1404; For the extent to which specialty referrals may determine overall costs, see John K. Glenn, Frank H. Lawler, and Mark S Hoerl, "Physician Referrals in a Competitive Environment: An Estimate of the Economic Impact of a Referral," Journal of the American Medical Association 258 (14) (October 9, 1987): 1920-1923.