This article develops a new method of decomposing the cost difference between HMO and non-HMO plans into observed risk selection, unobserved risk selection, utilization differences, and differences in provider reimbursement rates. We implement this method using a large national sample of employer-sponsored health insurance enrollees from the Community Tracking Study Household Survey. We find no evidence that HMO plans attract a disproportionate share of low-risk enrollees; the US$188 difference between HMO and non-HMO medical expenditures per enrollee can be explained by the relatively low provider reimbursement rates paid by HMO plans. This indicates there may be little need for employers to risk adjust insurance premiums or otherwise restrict employee choice of plan types.
Employees had little choice in the type of employer sponsored health plan they could select prior to the growth of managed care plans as an alternative to indemnity insurance plans. Today, various plan types exist; some with strict controls on enrollee use of medical services (i.e., Health Maintenance Organizations (HMOs)), and others with fewer restrictions such as indemnity plans and preferred provider organizations (PPOs). (1) The mean premium for a family policy in 2001 was US$6500 for an HMO plan, US$7700 for an indemnity plan, and US$7200 for a PPO plan. (2) Despite the strict controls on medical service use, HMOs have been able to capture a 45 percent share of the large-employer market by charging considerably lower premiums than indemnity plans and PPOs.
To what can we attribute these lower premiums? We will consider utilization, reimbursement, and risk selection as possible explanations for the lower premiums. First, we consider the utilization effect, which would occur if lower premiums reflect the success of HMO plan managers at restricting access to medical care they believe is worth less to enrollees than it costs HMOs. Second, we consider the reimbursement effect, which would occur if the lower premiums are due to the ability of HMOs to pay physicians and hospitals less than non-HMOs by promising to channel more patients to medical care providers who agree to accept discounted payments. Third, we consider the risk selection effect, which would occur if lower premiums reflect the ability of HMOs to enroll a disproportionate share of people who have a relatively low demand for medical care.
Which stakeholders have been influenced the most by managed care penetration depends largely on which of these explanations tend to dominate. If HMO plans are less expensive because they are designed and managed differently, there are efficiency gains due to the more efficient use of health care resources and consumer welfare gains due to greater product selection. If HMOs are less expensive because they pay hospitals and physicians less than non-HMO plans, this transfers money from medical care providers to consumers or health insurers. And finally, if HMO plans are relatively inexpensive because HMOs attract low-risk enrollees who have low expected costs, policy makers, high-risk enrollees, and employers should be concerned because HMOs may be distorting services to create disincentives for high-risk enrollees and because this differentiation could lead to market disequilibrium (Chernew and Frick, 1999). As the potential economic distortions from risk selection can reduce social welfare, this effect has been the primary focus of the existing literature.
There is some evidence that HMOs do in fact attract a disproportionate share of low-risk enrollees rather than use resources more efficiently. Altman, Cutler, and Zeckhauser (2000) examine differences between indemnity and HMO enrollees in the incidence rates of eight medical conditions, the method used to treat patients with these conditions, and the amount paid to providers. They find that almost half of the expenditure difference between indemnity and HMO plans for these eight diseases is due to a lower incidence rate among HMO patients (favorable risk selection), with the remaining difference largely explained by lower provider reimbursement rates paid by HMOs. …