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Health Care Reform:
The Potentially Steep Price for Doing It Wrong

In late summer 2009, health care reform seems almost within reach. President Barack Obama is urging the Congress to pass bills, and both the House and Senate are trying to deliver. There is relatively widespread agreement on the necessity of reform, but the devil is in the details.

In 2007, the United States spent $2.1 trillion on health services and supplies — roughly $6,900 for every man, woman and child. Employer-sponsored health plans paid $614 billion, employers and workers paid $199 billion in payroll taxes to Medicare Hospital Insurance (HI), privately financed health insurance paid $161 billion, and consumers paid $269 billion out of pocket.¹ The rest was paid by other Medicare financing, Medicaid, and veterans and military insurance programs — all largely financed by income taxes paid by workers. The most expensive health care system in the world already levies a heavy toll on America’s workers.

The shape of reform
Figuring out exactly what final health care reform will look like in the midst of evolving discussions is a bit like nailing Jell-O to the wall. One goal of reform is to expand coverage to the lower-income segment of the 46 million currently uninsured Americans. The ongoing discussions have proposed employer coverage mandates, limitations on health benefit tax preferences, taxation of health insurers and “play-or-pay” provisions, all of which would distribute the costs of expanded coverage among employers and, through them, to their workers in the form of slower wage growth.

While supporters of the proposals are hoping that modernization and reorganization of the payment system will reduce the cost of reform, those savings are mostly speculative. In the event they don’t materialize, much of the 10-year $1 trillion to $1.5 trillion price tag could ultimately be financed through new charges against employer-sponsored health plans over the coming decade. What are the implications for workers of potentially higher health benefit costs for employers, and how do those implications vary over the earnings spectrum? These questions are too important to leave unexplored as the health care reform discussion evolves.

Higher health costs widen the gap between compensation and take-home pay
An important — but often overlooked — point in the debate is that health costs paid by employers are part of the compensation paid to workers. Compensation includes wages, employer contributions to Social Security and Medicare, the cost of any health insurance coverage for workers and their dependents, and contributions to any pension plans, 401(k) plans and other capital accumulation programs. While many of the proposals for health reform are looking to employers for funding, there has been little focus on the links among wages, compensation and the cost of employer-sponsored health and retirement benefits. No one has talked much about how higher health benefit costs to employers would affect the paychecks workers bring home.

Health benefit cost inflation has been outpacing inflation and wage growth for some time now. There was a brief respite during the 1990s, when health benefit cost inflation was only 1.5 percentage points more per year than average wage growth for middle- and lower-income workers, but health cost inflation has been much higher over most of the last quarter century. And from 2000 through 2007, wage growth fell to roughly half what it was during the 1990s. Yet there was no comparable drop in overall compensation over the period. What happened?

Figure 1 shows the effects of health and retirement costs on take-home pay for wage-earners at different earnings deciles.

Figure 1
Compound annual growth rates of inflation-adjusted hourly compensation for full-time, full-year workers by earnings decile and for selected periods

Source: Watson Wyatt Worldwide tabulations of the Current Population Survey, various years.

During the 2000s, the health and pension cost share of compensation rose, which drove down cash wages. In 1980, a median-wage, full-time worker’s health benefit costs were roughly 4.6 percent of compensation. By 2007, health benefits constituted more than 10 percent of the worker’s compensation. Benefit costs, already painfully high, could soar even higher under reforms that expand coverage and stimulate utilization but fail to rein in health cost inflation. A 1-percentage-point increase in health costs today erodes pay roughly 2.25 times faster than it did 25 to 30 years ago.

Which future will it be?
To illustrate the importance of controlling costs, we project various health care reform scenarios and the effects on workers (see Figure 2). In the baseline scenario, reforms manage to cut health benefit cost inflation rates roughly in half and do not expand health insurance coverage. In that scenario, wage growth rates are projected to be roughly equivalent to those of the 1990s for the next couple of decades.

If reforms manage to control health cost inflation but expand coverage by means of an employer play-or-pay mandate, it would have a negative effect on wage growth at the bottom of the earnings distribution and slow wage growth in the middle of the earnings distribution for a while. But after 2015, wage growth rates would return to the healthier levels of the 1990s. Bringing health costs under control allows more resources for expanded coverage.

If reforms expand health insurance coverage but fail to control health cost inflation, the higher overall costs would drive wages down for workers at the bottom of the earnings spectrum and slow wage growth for other workers. These dismal wage outcomes would persist over the next couple of decades, possibly longer.

The final scenario combines expanded health care coverage with accelerated health cost inflation rates. In this case, the higher costs would drive disposable wages downward across most of the earnings spectrum, although the declines would be steepest for lower-earning workers. These depressed conditions would persist over the entire projection period.

Figure 2
Annual wage growth rate projections across earnings deciles under alternative scenarios of expanded coverage and health care cost inflation

Source: Calculated by the authors.

Bringing health care costs under control
Fixing what is broken in our health care system is about more than expanding health insurance coverage or deciding whether taxing employer-sponsored health benefits is good or bad policy. No matter how health care reform is financed — whether by employers, who pass the costs on to workers, or taxpayers — the bill will be unaffordable unless escalating costs are brought under control.

Incentives should encourage health rather than utilization
Medical care in the United States is embedded with incentives that encourage providers to dispense an ever-expanding menu of treatments and medications, even where evidence of their efficacy is scant. Our health care system already costs 40 percent to 100 percent more than its counterparts in other developed countries and is growing twice as fast.

Health care reform should include federal financing of a data and analysis program to identify effective treatment protocols for chronic illnesses, which can be used to stanch the flow of resources into unwarranted service delivery. In its administration of Medicare and Medicaid, the Centers for Medicare and Medicaid Services should move toward reimbursement policies that encourage care coordination and the growth of service delivery groups oriented toward providing good health outcomes while reducing overuse of resources and excess capacity.

More is not necessarily better
John Wennberg, M.D., M.P.H., founder of the Dartmouth Atlas Project, has identified three categories of unwarranted variation in health care services.² The first category is effective care, which is evidence-based care that everyone seeking treatment should receive. The second category is preference-sensitive care that requires patients to make informed choices based on evidence, research and discussions with medical personnel about the treatment choices, risks and range of likely outcomes. The third category is supply-sensitive care, which approaches health care from a resource utilization perspective — i.e., more is better. Medical evidence plays a small role in supply-sensitive care. Dr. Wennberg estimates that under Medicare, 12 percent of spending is on effective care, 25 percent is on preference-sensitive care, and 63 percent is on supply-sensitive care. One reason for our runaway medical inflation is that we pay doctors on the basis of the quantity of services they deliver and generally ignore the quality or even the necessity of those services.

Doing it right
Reliable information about appropriate treatments, associated risks and likely outcomes should be made widely available to the public. Health care reform should consider medical research as a public good that should be publicly financed, and the public institution tasked with this research must be independent of special interests.

At this juncture, we have a choice. We can move forward with reforms, reshuffle the financing and hope to squeeze out enough savings from overall economic productivity and technology gains to offset the costs of broader health insurance coverage, higher utilization and medical cost inflation. History suggests this strategy is not likely to succeed. Alternatively, we can finally eliminate the incentives in our health care payment systems that encourage overutilization of medical goods and services. Bringing these costs under control would enable us to finance the increase in coverage and possibly improve our health in the bargain. Failing to rein in health costs would perpetuate some of the most unproductive and expensive features of our health system, very likely at the long-term expense of American workers.

This article is based on a technical paper developed by Steven A. Nyce and Sylvester J. Schieber, “Productivity Rewards and Pay Illusions Caused by Health and Retirement Benefit Cost Increases,” which is available at www.watsonwyatt.com/research/whitepapers/wprender.asp?id=WT-2009-13478.

¹ Center for Medicare and Medicaid Services, National Health Expenditures by Type of Services and Source of Funds and U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts.

² John E. Wennberg, “Unwarranted variations in healthcare delivery: implications for academic medical centres, BMJ 2002; 325:961-964 (26 October 2002), www.bmj.com/cgi/content/extract/325/7370/961.